Fairfax 2020

[petec]

Which subs do you believe received the capital?

How would  the average investor determine for themselves in an annual or quarterly report which subs are cutting it close to requiring capital? Any walk thorough or guidance would be greatly appreciated.

Well, the quick way to eye-ball it is to look at page 95 of the AR which depicts dividend capacity, because that gives you a sense of "excess capital."  Then you can go to page 195 and look at the premiums:surplus ratio.

We know that last year, FFH drew a divvy from C&F and then for whatever reason, reinjected some capital.  When you look at C&F's dividend capacity on page 95, it was $140m, and then when you look at C&F's premiums:surplus ratio on page 195 it's 1.7:1.  Usually you don't see that ratio go above 2:1.  So, with a surplus of $1.4B, perhaps C&F could bump up its net written premiums by $500m to $2.8B (see page 16).  The problem is that C&F increased its net written by 18% during 2019, and 33% in Q4 2019 compared to Q4 2018 (page 5).  So you have a sub that looks to be a little lean on capital, received an injection in 2019 and is probably growing its premium at a pace of 20%+.  It cannot sustain that kind of premium growth throughout 2020 without a capital injection. 

Northbridge is in a similar situation so they probably would benefit from a bit of capital too, but it's a less pronounced "problem." 

Allied has lots of capital, while Zenith and Brit did not grow their book during 2019.  Odyssey has lots of capital, but it has also shot out the lights in the past when pricing got stupid, so it would not at all surprise me if their book could outgrow their capital.


SJ

SJ I don’t have the stats to hand. How much excess capital does Allied appear to have?

Allied's dividend capacity was $800m as at Dec 31.  Premiums to surplus was 0.6:1.  So, they could increase their premiums by maybe 150% and it would still only be 1.5:1?


SJ

Yes. Which would be a nice surprise.

Arguably more likely, Allied could buy a decent chunk of the OMERS minority stake (which I recall being $1.5bn) themselves and still grow premiums.

Brit could also afford to its the OMERS minority.

That somewhat improves the picture on holdco liquidity.

 

[StubbleJumper]

Which subs do you believe received the capital?

How would  the average investor determine for themselves in an annual or quarterly report which subs are cutting it close to requiring capital? Any walk thorough or guidance would be greatly appreciated.

Well, the quick way to eye-ball it is to look at page 95 of the AR which depicts dividend capacity, because that gives you a sense of "excess capital."  Then you can go to page 195 and look at the premiums:surplus ratio.

We know that last year, FFH drew a divvy from C&F and then for whatever reason, reinjected some capital.  When you look at C&F's dividend capacity on page 95, it was $140m, and then when you look at C&F's premiums:surplus ratio on page 195 it's 1.7:1.  Usually you don't see that ratio go above 2:1.  So, with a surplus of $1.4B, perhaps C&F could bump up its net written premiums by $500m to $2.8B (see page 16).  The problem is that C&F increased its net written by 18% during 2019, and 33% in Q4 2019 compared to Q4 2018 (page 5).  So you have a sub that looks to be a little lean on capital, received an injection in 2019 and is probably growing its premium at a pace of 20%+.  It cannot sustain that kind of premium growth throughout 2020 without a capital injection. 

Northbridge is in a similar situation so they probably would benefit from a bit of capital too, but it's a less pronounced "problem." 

Allied has lots of capital, while Zenith and Brit did not grow their book during 2019.  Odyssey has lots of capital, but it has also shot out the lights in the past when pricing got stupid, so it would not at all surprise me if their book could outgrow their capital.


SJ

SJ I don’t have the stats to hand. How much excess capital does Allied appear to have?

Allied's dividend capacity was $800m as at Dec 31.  Premiums to surplus was 0.6:1.  So, they could increase their premiums by maybe 150% and it would still only be 1.5:1?


SJ

Yes. Which would be a nice surprise.

Arguably more likely, Allied could buy a decent chunk of the OMERS minority stake (which I recall being $1.5bn) themselves and still grow premiums.

Brit could also afford to buy the OMERS minority.

That somewhat changes the picture on holdco liquidity.

Yes, the Allied buy-up is $1.5B, but FFH doesn't have to make that decision for another 3 or 4 years.  FFH could definitely buy the Allied stake and then take a $500m divvy from Allied to offset the cost.  But mostly, I am not preoccupied with the Allied buy-up because there is still plenty of time for capital markets to normalise before FFH needs to do anything.

SJ

[bearprowler6]

I was pleased to see Fairfax release its Q1 update. Hopefully this starts a new trend where they communicate more frequently (quarterly calls and the annual meeting are not sufficient).

I was relieved and somewhat surprised that the RiverstoneUK deal closed without adjustment on March 31/20. Fairfax needed that $600 million big time.

Having said that I am not sure that the hard market is guaranteed. Sure the Q1 premium growth was nice to see but this is somewhat a rear-view mirror story. Given the economic back drop that we are now experiencing I think that premium growth is more than likely to slow considerably given the financial strain that so many companies are under. In addition, the current environment is likely to result in higher claims experience than expected in certain lines (e.g., workers comp).

As for the draw down in the revolver----yes it was the right thing to do however it shows how cash tight they really were/are.

But my biggest wish is they stay away from any significant new equity investments. I have absolutely no confidence in their ability to "select stocks" that will outperform. The equity team should focus on getting out of the equities they are in currently and leave any new investing to Brian B who will once again work his magic in the corporate bond market.

Overall...it was a good update but the long term became quite a bit longer if you ask me.

[Parsad]

They can’t buy any more equities. Simplistically, they can invest their equity in equities but their float must be invested in fixed income.

So the opportunities are in switching from treasuries to corporates at expanded spreads and buying back stock. They’re doing a little of both but neither will change their prospects much.

They entered this sell off fully invested in cyclical value stocks. As a result, there’s not much they can do.

Hi Petec,

How did you conclude this?  They've said numerous times, Sam Mitchell, Prem, Brian, Francis...there is no limitation to how much they can allocate to equities, be it float or equity, but they have to make sure the portfolio is in a position where they aren't risking a huge reduction in statutory surplus or liquidity.

I asked and they told me. As I understand it regulation does not explicitly forbid it but as you say, they can't risk the surplus or their liquidity, so to all practical intents and purposes they are limited, and it shows in their behaviour, because IIRC they have never invested substantially more than book value in equities. I must check.

They only had about 30% of shareholder equity in equities at the end of 2019...$5.3B versus $17.3B in shareholder equity.  Assume book value fell 15% to date...to $14B, but their equity portfolio is off 40% to $3B...now equity investments to shareholder equity is 21%.  They invested up to 60-70% of shareholder equity into equities at different times during their history...that means they could double or triple their current equity exposure if they wanted and still stay under historical ratios. 

I certainly don't think they are going to do that presently, but if stock market prices fell even more dramatically, there is no restriction on how much they could put in equities, and they could certainly go far higher than what they presently have.  Cheers!

[Cigarbutt]

They can’t buy any more equities. Simplistically, they can invest their equity in equities but their float must be invested in fixed income.
So the opportunities are in switching from treasuries to corporates at expanded spreads and buying back stock. They’re doing a little of both but neither will change their prospects much.
They entered this sell off fully invested in cyclical value stocks. As a result, there’s not much they can do.

Hi Petec,
How did you conclude this?  They've said numerous times, Sam Mitchell, Prem, Brian, Francis...there is no limitation to how much they can allocate to equities, be it float or equity, but they have to make sure the portfolio is in a position where they aren't risking a huge reduction in statutory surplus or liquidity.

I asked and they told me. As I understand it regulation does not explicitly forbid it but as you say, they can't risk the surplus or their liquidity, so to all practical intents and purposes they are limited, and it shows in their behaviour, because IIRC they have never invested substantially more than book value in equities. I must check.

They only had about 30% of shareholder equity in equities at the end of 2019...$5.3B versus $17.3B in shareholder equity.  Assume book value fell 15% to date...to $14B, but their equity portfolio is off 40% to $3B...now equity investments to shareholder equity is 21%.  They invested up to 60-70% of shareholder equity into equities at different times during their history...that means they could double or triple their current equity exposure if they wanted and still stay under historical ratios. 
I certainly don't think they are going to do that presently, but if stock market prices fell even more dramatically, there is no restriction on how much they could put in equities, and they could certainly go far higher than what they presently have.  Cheers!

Added for historical perspective and using the following for data:
-table found towards the end of annual reports and labeled "investments" a few years back and "overview of investment performance" more recently
-using total equity (including NCI)
-keeping FI and FA in the consolidated numbers and including investments in associates as equity or equity-like
-using total equity and equity-like over total shareholders equity, TE/TS
-using total equity and equity-like over total investments, TE/TI

-Period leading to the dot-com
TE/TS 25-35%, TE/TI around 8 to 10%   with significant hedges in place (index puts and short position on basket of tech stocks)
Personal note: I remember fairly well (i'm quite sure it was) Roger Lace answering a question about the relevance of maintaining S&P puts around that time. i don't recall the exact words but the gist of it was that it would have been inappropriate NOT to have them, at that specific time.

-Period leading to the GFC
TE/TS 50-90%, TE/TI from about 12% rising to about 22% in 2008   with (from 2004 on) significant equity hedges in place (about 50%)

-2009
TE/TS 74%, TE/TI 27%   a time when FFH was wildly profitable and when markets were...lower than now (absolute and relative basis)

-2010-2016
TE/TS 50-60%, TE/TI 18-22%   with (from 2010 on) significant equity hedges in place (went from 30 to 100% hedge in 2010)

-2017-9
TE/TS 49% rising to 59%, TE/TI 23% rising to 27%   with no equity hedge

IMHO, ratings agency (and regulators) have always kept an eye on the unusual degree of equity exposure for a typical P+C (re)insurer. The issue was dealt with lumpy but overall good results, keeping at least 1B at the holding level and...hedging.
At this point, FFH maintains the same level of equity acrobatics but they're performing at a higher level with no net. It can still be an impressive show but i find it unusual for an insurer and wonder if they're not one step away from a share issue.

[petec]

@SJ - of course, using YE19 dividend capacity is misleading when we know that capital has since been destroyed at the subs. But assuming the stocks come back, and I think most of them will, Allied can probably largely fund the buyout of its own minority over the next 4 years. It just can't do that and grow.

@bearprowler - I sincerely hope Fairfax do not to communicate more frequently. They were right to this time, because it's a weird quarter and they know they will get questions at the AGM. But normally, 90 days is the blink of an eye in business terms.

@Sanjeev - I'll be quite happy if you're right but that's not my understanding. Thinking back, they may not have drawn the link between book value and equities quite as clearly as I did upthread - apologies for the confusion. But they have said publicly that equities will generally be 25-30% of the portfolio (which very roughly = common equity), and that there is a practical limit to how high they can go. For example, Rivett said on the 4q18 call that they will generally have 25-30% of the portfolio in equities and that "we're roughly at the upper end of our limit...given the rules and regulations...in the reinsurance and insurance companies". He didn't mention ratings agencies but I believe they represent a restriction, too. BTW for the purposes of this discussion I believe equities refers to all equity exposure, whether private or public and no matter how accounted.

Either way I agree they won't pile in at these levels, at least not to markets generally, although they might find a few of the levered smallcaps in troubled industries that they seem to specialise in!

All that said, they might be able to get good equity upside from converts or pref/warrant deals, without actually investing more in equities.

[petec]

I enjoyed Prem's clarity on the topic of how much they could invest in equities at the AGM:

Q: How high could you take that percentage of the portfolio for equity exposure?

A: We have selected about that, you know, what we have today and you can always trade something that we may not - we like a lot, but we like something even better higher quality. So we've done that and selectively but situation at the, will that be like but yes so that's where we are right now on our equity portfolio.

 

[Xerxes]

This is hilarious. Different softer style.

Charlie Munger would have said: "that is how we like it; nothing to add"

BTW if you have a link to the AGM transcript (FFH, FIH) please do share.
I listened to them, but had a hard time hearing sometimes.

[StubbleJumper]

This is hilarious. Different softer style.

Charlie Munger would have said: "that is how we like it; nothing to add"

BTW if you have a link to the AGM transcript (FFH, FIH) please do share.
I listened to them, but had a hard time hearing sometimes.

+1 on the transcript request.  I rarely bother listening to the conference calls because I quickly tire of the "rah-rah, the past was great and the future will be great" part of the calls.  I can normally read a quarterly conference call transcript from Seeking Alpha in about 10 minutes, which is a lot better than listening for 60.  But, I saw no transcript of the annual meeting, so I had to listen to a two hour call.  Suffice it to say that the call gave me a year's worth of BS about how great the past was, how valuable the culture is and how the best is yet to come.  If somebody can point the way to a transcript of that meeting, it will guarantee that I will not have to endure a replay!


SJ

[TwoCitiesCapital]

I enjoyed Prem's clarity on the topic of how much they could invest in equities at the AGM:

Q: How high could you take that percentage of the portfolio for equity exposure?

A: We have selected about that, you know, what we have today and you can always trade something that we may not - we like a lot, but we like something even better higher quality. So we've done that and selectively but situation at the, will that be like but yes so that's where we are right now on our equity portfolio.

 

If I had to take a stab at interpreting that, it likely means they will NOT be increasing equity allocation and will be doing relative value trades with the existing portfolio.

There' still going to be meat on the bone for them in fixed income which is GREAT! But definitely not the outcome we would've envisioned from the "financial ark" that Fairfax was setting itself up to be when it was hedged.