3rd quarter results

[Daphne]

TORONTO, Oct. 31, 2019 (GLOBE NEWSWIRE) -- Fairfax Financial Holdings Limited (TSX:FFH and FFH.U) announces net earnings of $68.6 million ($2.04 net earnings per diluted share after payment of preferred share dividends) in the third quarter of 2019 compared to net earnings of $106.2 million ($3.34 net earnings per diluted share after payment of preferred share dividends) in the third quarter of 2018, primarily reflecting net losses on investments, partially offset by higher operating income.  Book value per basic share at September 30, 2019 was $462.98 compared to $432.46 at December 31, 2018 (an increase of 9.5% adjusted for the $10 per common share dividend paid in the first quarter of 2019).

"Despite the catastrophe activity in the quarter, our insurance companies continued to have strong underwriting performance with a third quarter consolidated combined ratio of 97.5%, with Zenith National at 87.1% and all but one of our other major companies between 96.2% and 97.9%, and our operating income remained excellent, improving to $280 million. We continue to be soundly financed, with over $1 billion cash and marketable securities at the holding company and no significant holding company debt maturities until 2022," said Prem Watsa, Chairman and Chief Executive Officer.

The table below shows the sources of the company's net earnings, set out in a format which the company has consistently used as it believes it assists in understanding Fairfax:

    Third quarter       First nine months
    2019       2018       2019       2018
    ($ millions)
Gross premiums written   4,211.6           3,763.6           13,273.6           11,763.0   
Net premiums written   3,318.3           2,960.8           10,614.1           9,376.7   
                            
Underwriting profit   81.3           74.2           270.7           299.1   
Interest and dividends - insurance and reinsurance   163.1           139.2           501.5           400.8   
Share of profit of associates - insurance and reinsurance   35.7           36.5           84.6           24.9   
Operating income   280.1           249.9           856.8           724.8   
Run-off (excluding net gains (losses) on investments)   (14.2   )       (49.2   )       (45.0   )       (102.3   )
Non-insurance operations   8.2           65.7           163.9           244.8   
Interest expense*   (121.5   )       (84.8   )       (355.0   )       (259.9   )
Corporate overhead and other income / expense   14.0           (2.6   )       97.1           (113.8   )
Net gains (losses) on investments   (96.7   )       41.2           1,075.8           917.2   
Pre-tax income   69.9           220.2           1,793.6           1,410.8   
Income taxes and non-controlling interests   (1.3   )       (114.0   )       (461.5   )       (557.2   )
Net earnings attributable to shareholders of Fairfax   68.6           106.2           1,332.1           853.6   
                                            
* Including $19.2 million and $50.8 million in the third quarter and first nine months of 2019, respectively, related to the revised accounting for leases effective January 1, 2019

Highlights for the third quarter of 2019 (with comparisons to the third quarter of 2018 except as otherwise noted) include the following:

The consolidated combined ratio of the insurance and reinsurance operations was 97.5%, producing an underwriting profit of $81.3 million, compared to a combined ratio of 97.6% and an underwriting profit of $74.2 million in 2018.
Net premiums written by the insurance and reinsurance operations increased by 12.1% to $3,318.1 million (13.7% excluding the net premiums written by operations not present in the third quarters of both 2019 and 2018).
The operating income of the insurance and reinsurance operations increased to $280.1 million from $249.9 million, reflecting primarily higher interest and dividends.
Interest and dividends of $214.9 million increased from $193.7 million, primarily reflecting higher interest income earned on increased holdings of high quality U.S. corporate bonds, partially offset by lower interest income earned on decreased holdings of U.S. municipal bonds.
Share of profit of associates of $149.6 million increased from $63.9 million, principally reflecting increased share of profit of Eurolife and IIFL Finance.
Interest expense of $121.5 million is comprised of $65.7 million incurred on borrowings by the holding company and the insurance and reinsurance companies, $36.6 million incurred on borrowings by the non-insurance companies (which are non-recourse to the holding company) and $19.2 million of accretion on lease liabilities subsequent to the adoption of IFRS 16 on January 1, 2019.
Short-dated U.S. treasury bonds and high quality corporate bonds represented 25.7% of the company's portfolio investments at September 30, 2019 compared to 34.7% at December 31, 2018.
Net investment losses of $96.7 million in 2019 consisted of the following:
    Third quarter of 2019
    ($ millions)
    Realized gains (losses)       Unrealized gains
(losses)
    Net gains
(losses)
Net gains (losses) on:                   
Long equity exposures   170.7           (159.3   )       11.4   
Short equity exposures   —           (17.9   )       (17.9   )
Net equity exposures   170.7           (177.2   )       (6.5   )
Bonds   14.3           48.0           62.3   
Other   (136.7   )       (15.8   )       (152.5   )
    48.3           (145.0   )       (96.7   )


    First nine months of 2019
    ($ millions)
    Realized gains (losses)       Unrealized gains
(losses)
    Net gains
(losses)
Net gains (losses) on:                   
Long equity exposures   599.6           362.2           961.8   
Short equity exposures   (7.9   )       117.0           109.1   
Net equity exposures   591.7           479.2           1,070.9   
Bonds   (260.2   )       471.6           211.4   
Other   (134.6   )       (71.9   )       (206.5   )
    196.9           878.9           1,075.8   
                                
Net losses on Other in the third quarter of 2019 in the table above was primarily due to foreign exchange impacts on investments denominated in the euro, which weakened against the U.S. dollar.
In two approximately equal transactions in late September and early October 2019 the company sold its remaining 9.9% equity interest in ICICI Lombard for gross proceeds of $729.0 million.
On July 15, 2019, the company redeemed its remaining Cdn$395.6 million principal amount of 6.40% unsecured senior notes due May 25, 2021 for cash consideration of $329.1 million (Cdn$429.0 million) including accrued interest, and recognized a loss on repurchase of long term debt of $23.7 million (Cdn$30.7 million).
The company held $1,701.8 million of cash, short term investments and marketable securities at the holding company level ($1,699.0 million net of short sale and derivative obligations) at September 30, 2019, compared to $1,557.2 million ($1,550.6 million net of short sale and derivative obligations) at December 31, 2018.
The company's total debt to total capital ratio, excluding non-insurance operations, increased to 27.1% at September 30, 2019 from 25.0% at December 31, 2018, primarily reflecting increased borrowings at the holding company, partially offset by increased common shareholders' equity.
During the third quarter of 2019 the company purchased 65,815 subordinate voting shares for treasury at an aggregate cost of $29.8 million. From the fourth quarter of 2017 up to September 30, 2019, the company has purchased 621,204 subordinate voting shares for cancellation and 662,789 subordinate voting shares for treasury at an aggregate cost of $635.9 million.
At September 30, 2019, common shareholders' equity was $12,417.2 million, or $462.98 per basic share, compared to $11,779.3 million, or $432.46 per basic share, at December 31, 2018. The increase in common shareholders' equity per basic share was primarily due to net earnings.
There were 26.9 million and 27.4 million weighted average common shares effectively outstanding during the third quarters of 2019 and 2018 respectively.  At September 30, 2019 there were 26,820,057 common shares effectively outstanding.

Unaudited consolidated balance sheet, earnings and comprehensive income information, together with segmented premium and combined ratio information, follow and form part of this news release.

In presenting the company’s results in this news release, management has included operating income (loss), combined ratio and book value per basic share measures.  Operating income (loss) is used in the company's segment reporting.  The combined ratio is calculated by the company as the sum of claims losses, loss adjustment expenses, commissions, premium acquisition costs and other underwriting expenses, expressed as a percentage of net premiums earned.  Book value per basic share is calculated by the company as common shareholders' equity divided by the number of common shares effectively outstanding.

As previously announced, Fairfax will hold a conference call to discuss its third quarter 2019 results at 8:30 a.m. Eastern time on Friday, November 1, 2019.  The call, consisting of a presentation by the company followed by a question period, may be accessed at 1 (800) 369-2013 (Canada or U.S.) or 1 (517) 308-9087 (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, November 15, 2019.  The replay may be accessed at 1 (866) 356-4351 (Canada or U.S.) or 1 (203) 369-0104 (International).

Fairfax Financial Holdings Limited is a holding company which, through its subsidiaries, is engaged in property and casualty insurance and reinsurance and the associated investment management.

[Viking]

Overall, looks like a solid quarter to me.
1.) CR = 97.5; lots of commentary about companies being under-reserved; good result
2.) growth of Net Premiums Written at Odyssey, Crum and Allied +20%. Hello hard market.
3.) a number of Fairfax’s equity investments were down massive amounts this quarter (Blackberry, Stelco etc). I was wondering if this was going to drag them into reporting an earnings loss for the quarter. This did not happen. Looks like the ICICI gain on sale helped (with a second large gain to come in Q4).

[Viking]

Below is a summary of a number of Fairfax stock holdings that dropped in value a bunch in Q3. The good news is these low prices are now baked into the current book price of Fairfax of $463. The stocks are looking more and more fair valued (some perhaps even under valued) :-)

                     Sept 30.     June 30
Blackberry.      $5.25.       $7.46 us$
Resolute.         $4.70.       $7.20 us$
Stelco.             $9.26.     $15.20 can$
Fairfax Africa.    $6.30.     $7.78 can$

[Viking]

Thomas Cook India stock was down a bunch this quarter; this decline is not reflected in Book Value Per Share calculation

Book Value Per Share (page 68 of Q report): "Common shareholders’ equity at September 30, 2019 was $12,417.2 or $462.98 per basic share (excluding the unrecorded $561.8 pre-tax deficiency of fair value over the carrying value of investments in associates and certain consolidated subsidiaries) compared to $11,779.3 or $432.46 per basic share (excluding the unrecorded $48.3 pre-tax excess of fair value over the carrying value of investments in associates and certain consolidated subsidiaries) at December 31, 2018"

Thomas Cook India        Fair Value $473      Carrying Value $928      Deficiency $455
(Fair Value June 30 was $826)
                     

[Cigarbutt]

^Today revealed a resolutely lower mark-to-market adjustment for Resolute (3.62 USD).
At some point, this is bound to meet the value tag.
I've been reading about patience this week.

Because of the following disclosure, I will add more harassing comments.
Disclosure: presently defining a sufficient margin to re-enter FFH, if the discount to intrinsic value widens more. Perceived near-death assault on the asset side of the balance sheet associated with a systemic credit crunch contributing to further insurance hardening would be ideal but you don't always get what you want.

It feels like this is real hardening. Update on a post from last August.

It does look like price increases are permeating across many lines. Is it for real?
The last part of this cycle has been unusually soft and I wonder if unusual access to cheap capital has distorted the underwriting price signals, maybe like the lack of capital discipline displayed in the shale gas industry.
Watching for underwriting cycles to turn is like watching an apple to fall. 2017 and 2018 were relatively poor years for (re)insurers due, in part, to higher catastrophe activity. The ILS segment, thought to be more sophisticated with more advanced models, turned out to be a persistenly disappointing factor recently due to loss creep. For example, Markel was 'surprised' by this development (which was compounded by 'issues' with top management) and had to put an entire segment into runoff. The component of dwindling reserve redundancies also seems to be a relevant contemporary catalyst. If interested, see the following, which offers a satisfactory industry perspective:
https://deconstructingrisk.com/2019/07/30/creepy-things/

For Fairfax, reserve redundancies, in combined ratio points:
2016            7.8%
2017            8.5%
2018            6.8%
Q1Q2 2018   3.5%
Q1Q2 2019   1.5% 

For Fairfax, net favourable development has been very strong vs the industry and the real action is often concentrated in the latter part of the year. IMO, FFH has established a strong underwriting culture and is likely to continue to show a better reserve development profile than the industry but, if history is any guide, across the industry, in a typical cycle, the extent of reserve deficiency eventually reported is directly proportional to the softness and extent of reserve releases of the previous component of the cycle.

Q1-Q3 2018   4.2%
Q1-Q3 2019   2.0%

So, relatively speaking, reserves are holding up well but there seems to be a trend.

Looking across the industry, there have been many false starts but this time appears different.
An interesting aspect (when it is disclosed and we'll know more by year-end with more detailed annual disclosures) is that reserve development is developing into a pattern where, for specific companies, years-ago reserves keep releasing redundancies while more recent years are starting to show deficiencies with, still very often, a net redundancy across all years but that may be about to change. Many, including FFH I believe, are likely writing new business and "building" reserves to be released eventually but the race is on. It will be interesting to see.

If interested, an example of that 'phenomenon' is found on page 32 of the 2019 semi-annual Beazley report:
https://investor.relations.beazley.com/~/media/Files/B/Beazley-IR/documents/interim-results-release-23-07-2019.pdf
You know, during elections, they keep talking about ridings (I think they're called bellwether ridings in English) that move with the to-be elected government. FWIW, I find Beazley has this flavor for the underwriting cycle.

Looking at the "Liquidity" section of the quarterly report reveals that cash has moved from parent to subs in order to support growth. At year-end, FFH reported significant dividend capacity but growing NPW in a risk-based capital world seems to be a limiting factor for the buybacks and other potential capital allocation decisions.

[Viking]

Cigar, thanks for posting your thoughts on the underwriting side of their business. Very informative. I think WR Berkley has also seen a shrinkage in reserve redundancies over the years and i think they have been very close to zero the past couple of quarters.  Even so, WRB reported CR is still very good (and hence their share price supports a very high P to BV).

It is impressive to see the growth of Net Premiums Written. The underwriting side of the business looks to be growing nicely. And the majority of the investment portfolio (in bonds) is positioned very conservatively (short and quality).

The issue for this company is the toxic mix of equities they own.  They have absolutely been crushed over the past three months (when the overall market was doing ok). One has to think that the bleeding has to stop at some point. The problem is many of the investments they have made are not that easy to understand or track or they are turnaround plays. So it comes down to do you trust management... and the answer here is a clear no. Their track record with equities is so bad the past 7 years a person would have to be a fool to say they have any confidence in Fairfax’s ability to pick good equities.

Fortunately, i have only recently started following Fairfax again. And i do like the stock at US$425.

[Viking]

Just finished listening to the Q3 conference call. Here are a few takeaways:
1.) on ‘monetization’ of some investments; how far along are they in the process?
- far along in the process
- a number of opportunities are close to fruition
- ICICI sale was one example (cash proceeds of this sale are at holding co)

2.) on hard market; what is driving it?
- low interest rate environment, social inflation, capacity coming out (like Lloyds), historically large catastrophe years (2017).
- ‘A whole generation of underwriters need price again.’

3.) on social inflation
- they fell they are ahead of the curve on this issue and feel good about reserving

4.) on use of cash
- priority is to support business growth at subs
- need to take out minority holders at Brit and Eurolife in coming months
- Q3 can be a big cat quarter so little stock was repurchased this quarter

5.) Fairfax India
- Bangalore Airport was recently approved to construct a third terminal; this increase value of investment in quarter. Value of asset may be increased further (something having to do with land lease for airport).

6.) Toys R Us: retail operations mildly underperforming; value of asset is real estate. Feel good about investment and prospects.

7.) Q4 Hagibis catastrophe loss estimates? ‘No indication’

[Viking]

RBC just released its most recent report on FFH. Pretty balanced assessment (and might explain some of the increase in the shares as they started moving up just when the report hit my in box).

“Price target: We’re keeping our price target at $600 (C$790) which still applies approximately a 1.2x multiple to estimated 2020 book value. We recently commented in our weekly newsletter that Fairfax is probably the most overlooked story in the P&C insurance universe, we still strongly believe that. While we appreciate that the company’s investment portfolio is different than most, operating results have been good, reserves have proved strong and growth is clearly accelerating. We don’t think the market is pricing for much of this right now and that represents an opportunity in our view.”

[Spekulatius]

^ A big thanks to the authorities (Viking and Cigarbutt) for going through the earnings release. It saves me quite a bit of time. As I mentioned in the “what did you buy today” thread, I reentered FFH in a small way for a trade. I think $480-500 are possible. The results are a post I’ve surprised to me, I expected a loss in book value and they gnerwtrd a small gain. I am a bit concerned about the increased leverage (at the holding level) which in conjunction with their substantial equity holdings (as a percentage of equity) makes this quite a leveraged bet, compared to for example BRK or an insurer like RE or TRV. (RE is more of a single line insurer with large catastrophe exposure, so they have a different kind of risk).

[petec]

Some of the commentary around the hard market (generational shift etc.) is very different in tone to anything I remember them saying in the last decade.

I am also struck by the commentary around the equity portfolio: they want more diversified and more liquid, and they can add to equities in a recession via converts (an obvious thing I hadn't really thought through properly).