Fairfax 2020

[StubbleJumper]

On an unrelated note, anyone have the transcript from Q1 earnings call? Seeking Alpha doesn't seem to have it and I'm uncertain that it will be posted at this point.

If there is no transcript, does anyone mind summarizing what was said about the Equity Total Return swaps previously mentioned in the thread. It sounded like Fairfax went long total return swaps in March?

If that is so, these are likely a source of additional liquidity since these things tend to be standardized and settled on a quarterly basis in cash payments. Depending on the size of the TRS purchase, Fairfax could have tens of millions of cash coming to it in June simply based on what the indices have done since March.

Transcript is here: https://finance.yahoo.com/news/edited-transcript-ffh-earnings-conference-024448274.html


SJ

[TwoCitiesCapital]

On an unrelated note, anyone have the transcript from Q1 earnings call? Seeking Alpha doesn't seem to have it and I'm uncertain that it will be posted at this point.

If there is no transcript, does anyone mind summarizing what was said about the Equity Total Return swaps previously mentioned in the thread. It sounded like Fairfax went long total return swaps in March?

If that is so, these are likely a source of additional liquidity since these things tend to be standardized and settled on a quarterly basis in cash payments. Depending on the size of the TRS purchase, Fairfax could have tens of millions of cash coming to it in June simply based on what the indices have done since March.

Transcript is here: https://finance.yahoo.com/news/edited-transcript-ffh-earnings-conference-024448274.html


SJ

Thanks. Wasn't aware YAHOO also provided the service and Google didn't pull it up in a search. Have always relied on SeekingAlpha!

Doesn't seem like a whole lot of information is given on the swaps, notional amounts, or underlying indices. The quarterly report does say the notional for the swaps is $952 million though.

When I worked for a hedge fund, these were typically standardized on total return indices and would settle on the 3rd Thursday of the month ending the quarter or something like that. Things might've changed since then given the move to Central Clearing and whatnot, but I'm just trying to ballpark figures of incoming liquidity to Fairfax as a result of these derivative positions.

Using the S&P 500 total return index and a last settlement date of 3/19 - Fairfax would be in the money by 18.7% on the current run and would be owed a cash payout of $178 million if values don't change between now and June. $178 million of incoming cash in a quarter is nothing to sneeze at for those who are concerned about liquidity issues.

[StubbleJumper]

On an unrelated note, anyone have the transcript from Q1 earnings call? Seeking Alpha doesn't seem to have it and I'm uncertain that it will be posted at this point.

If there is no transcript, does anyone mind summarizing what was said about the Equity Total Return swaps previously mentioned in the thread. It sounded like Fairfax went long total return swaps in March?

If that is so, these are likely a source of additional liquidity since these things tend to be standardized and settled on a quarterly basis in cash payments. Depending on the size of the TRS purchase, Fairfax could have tens of millions of cash coming to it in June simply based on what the indices have done since March.

Transcript is here: https://finance.yahoo.com/news/edited-transcript-ffh-earnings-conference-024448274.html


SJ

Thanks. Wasn't aware YAHOO also provided the service and Google didn't pull it up in a search. Have always relied on SeekingAlpha!

Doesn't seem like a whole lot of information is given on the swaps, notional amounts, or underlying indices. The quarterly report does say the notional for the swaps is $952 million though.

When I worked for a hedge fund, these were typically standardized on total return indices and would settle on the 3rd Thursday of the month ending the quarter or something like that. Things might've changed since then given the move to Central Clearing and whatnot, but I'm just trying to ballpark figures of incoming liquidity to Fairfax as a result of these derivative positions.

Using the S&P 500 total return index and a last settlement date of 3/19 - Fairfax would be in the money by 18.7% on the current run and would be owed a cash payout of $178 million if values don't change between now and June. $178 million of incoming cash in a quarter is nothing to sneeze at for those who are concerned about liquidity issues.

Yes, $178m is $6/share pre-tax, so that's great.  I am, however, curious where those swaps are held.  Are they held in holdco or in one or more of the subs?  Money is money, but as you suggested, it would be a happy situation if a cash influx happened to be at the holdco.


SJ

[petec]

Excuse my ignorance, but if you’re long a TRS what happens if the market drops? Do you just lose your principal, or is the liability greater?

[TwoCitiesCapital]

Excuse my ignorance, but if you’re long a TRS what happens if the market drops? Do you just lose your principal, or is the liability greater?

Typically, index TRS are quarterly cash settled. So if you have $1B of notional that goes up 10% over the quarter, you'd be owed $100 million, less financing costs, at the end of the quarter and the contract would continue forward for the next quarter until maturity.

So in this case, if the $950 million in notional that Fairfax owns goes down more than the $180 million that we estimated they were in the money by, they'd owe cash at the June settlement

[Xerxes]

What a the advantage of using a swap instead of just buying the index if the bet was rebound in the market ?

[TwoCitiesCapital]

What a the advantage of using a swap instead of just buying the index if the bet was rebound in the market ?

Cash. With the TRS you only need initial margin and maintenance margin to maintain. Fairfax's $950 million position probably only costed something like $90-100 million in cash to put on

[petec]

So in this case, if the $950 million in notional that Fairfax owns goes down more than the $180 million that we estimated they were in the money by, they'd owe cash at the June settlement

This all makes my head hurt but I find it very hard to find a positive. A few thoughts:

1) If I understand correctly, Fairfax are exposed in both directions. I am struggling to see how this is much different from the short swaps that so hurt us in the bull market. Fairfax took a levered bet on stock movements without capping their downside or the potential cash collateral calls if they are wrong. In return for a possible $178m profit which doesn't really move the needle, they risked moving the liquidity/capital situation from "mildly concerning" to "oh fuck". If this interpretation is correct, I would argue that they have kept to the letter of their promise not to short equities again, but perhaps not the spirit of it.

2) Although at the end of the quarter their long TRS position was 10x the size of their short position, note 7 suggests they either really f***ed up the timing on their shorts or they were short stocks that have gone up a lot, including in q1. If it is the latter, one might reasonably infer that they shorted the tech stocks they wrote about in the 2019 newsletter - and did so without telling us. Here is the wording: During the first quarter of 2020 the company closed out $404.4 notional amount of its short equity total return swaps and recorded net losses on investments of $107.4 (realized losses of $248.1, of which $140.7 was recorded as unrealized losses in prior quarters). I am no expert but I would assume a $248m loss on $404m of notional means they were very wrong.

@SJ, the wording re: the collateral suggests to me the TRS's are at least partly held at the holding company. Note 7 says: At March 31, 2020 the aggregate fair value of the collateral deposited for the benefit of derivative counterparties included in holding company cash and investments and in assets pledged for short sale and derivative obligations was $413.4 (December 31, 2019 - $152.4)…" Presumably if the collateral is at the holdco, the TRS is too.

@TCC, two questions if I may:
a) note 7 shows zero cost for the long and the short equity TRS's. How does that work? Is the only cost the collateral that needs to be posted? Or is there an up front "premium"?
b) what is the advantage of these TRSs vs a call with capped downside and no need for collateral?

Finally, also in note 7 of the 1q report, can anyone explain the assets & liability columns under "fair value"? Does the asset represent swaps that are in the money and the liability represent swaps that are out of the money?

[TwoCitiesCapital]

So in this case, if the $950 million in notional that Fairfax owns goes down more than the $180 million that we estimated they were in the money by, they'd owe cash at the June settlement

This all makes my head hurt but I find it very hard to find a positive. A few thoughts:

1) If I understand correctly, Fairfax are exposed in both directions. I am struggling to see how this is much different from the short swaps that so hurt us in the bull market. Fairfax took a levered bet on stock movements without capping their downside or the potential cash collateral calls if they are wrong. In return for a possible $178m profit which doesn't really move the needle, they risked moving the liquidity/capital situation from "mildly concerning" to "oh fuck". If this interpretation is correct, I would argue that they have kept to the letter of their promise not to short equities again, but perhaps not the spirit of it.

Yes. Exposed in both directions just like owning the stock would, just with a lesser cash outlay upfront. This position provides liquidity at zero gain and positive gains and costs liquidity at negative gains but still likely better than owning the actual security (from a liquidity perspective).

Say they buy $1000 stock. That's $1000 out the door. They buy a TRS for $1000 notional on the same stock and they put up $100-$150. Even if the stock moves against them 50% and they now owe $500, they've still only had a total outlay of $600-650 versus the $1000 from owning the stock directly. Roughly same P&L (less financing costs), but way less cash used.

2) Although at the end of the quarter their long TRS position was 10x the size of their short position, note 7 suggests they either really f***ed up the timing on their shorts or they were short stocks that have gone up a lot, including in q1. If it is the latter, one might reasonably infer that they shorted the tech stocks they wrote about in the 2019 newsletter - and did so without telling us. Here is the wording: During the first quarter of 2020 the company closed out $404.4 notional amount of its short equity total return swaps and recorded net losses on investments of $107.4 (realized losses of $248.1, of which $140.7 was recorded as unrealized losses in prior quarters). I am no expert but I would assume a $248m loss on $404m of notional means they were very wrong.

I think you're right about what they were short, though sounds to me it's not as bad as you think. They had $404 million of exposure during the first quarter carried @ a $140 million unrealized loss. During the quarter, that $140/million loss became a $240 million realized loss. So yes, they're down 50% on the position as a whole, but only 25% or so came from the 1st quarter. Sounds to me like they were short Amazon?

@TCC, two questions if I may:
a) note 7 shows zero cost for the long and the short equity TRS's. How does that work? Is the only cost the collateral that needs to be posted? Or is there an up front "premium"?
b) what is the advantage of these TRSs vs a call with capped downside and no need for collateral?

Finally, also in note 7 of the 1q report, can anyone explain the assets & liability columns under "fair value"? Does the asset represent swaps that are in the money and the liability represent swaps that are out of the money?

Typically there is zero cost upfront because the only cash required from you is posting initial margin which is still owned by you. As far as a premium, you pay LIBOR+spread that accrues while the contract is ongoing - financing costs are netted from P&L monthly or quarterly when the contract settles.

For calls your paying a premium for the right to own a contract. For TRS you only pay ongoing LIBOR+spread that is  typically quite a bit less than call premiums AND you're only paying while the contract is active/accruing where calls you pay for the entire time premium upfront.

[Xerxes]

Folks
Would it be fair to say that the $2.9 billion that FFH invested in March when credit spread blew out, now that Fed stepped in and closed opportunity for distress fixed income investor, those spread have narrowed, so ... does it mean that a significant portion of that capital gain would be marked-to-market as unrealized gain by close of June (Q2). I think that capital gain is front-loaded where you see most of the snap back happen in Q2 ... and the rest panned over several quarters.

This is 7% of the $39 billion portfolio. The position is significantly larger than Blackberry, Resolute and Seaspan combined. This fixed income unrealized gain on its own might in turn snap back the discount between market and BV.

What am I missing here ?