Fairfax 1Q17 Earnings Call Notes

Prem Watsa – Chairman and Chief Executive Officer

Administration’s policies have the potential of significantly boosting economic growth

“As I said at our annual meeting, and on our fourth quarter conference call, we believe the new US administration’s proposed policies of reducing corporate taxes to 15% rolling back regulation and business like Obamacare, Dodd-Frank, and a myriad of other regulations and significant infrastructure spending has the potential of boosting economic growth significantly in the United States. Already sentiment among small businesses has improved dramatically and animal spirits in the United States are being revived.”

US economy doing well alleviates some concerns over world wide recession

“When the US economy, which is approximately 20 trillion, does well much of the world does well. To us this means our concerns of China or Europe precipitating a worldwide recession depression have been significantly reduced, but not delaminated. Also the trade policies of the US could precipitate a collapse in world trade, so these risks will be very much monitored by us, but we think the new administration’s policies may make this a stock picker’s market and one in which we have thrived over the past 31 years.”

Have been reducing our short positions

“Paul, we don’t comment on individual securities of course, as you know. But broadly speaking we have been reducing our short positions, but there are certain individual names where we think it is a good match for our long positions and so we continue to maintain them, but we have refrained from mentioning any names of the past.”

Fairfax Financial 3Q16 Earnings Call Notes

Fairfax Financial Holdings’ (FRFHF) CEO Prem Watsa on Q3 2016 Results

35% of the portfolio is in cash

“Given the uncertainties of the U.S. election and the fact that we live in a mark-to-market world in the fourth quarter we have sold approximately 90% of our U.S. long term treasuries in our investment portfolio. And as a result we will have cash and short term investments in excess of $10 billion or 35% of the portfolio. Since we began buying treasuries in 2010 we have realized a cumulative gain. Now this is a cumulative gain of over $1 billion.”

Uncertainties in election were problem

“Yes, as we said, sold 90% plus of our treasury bonds and we made the point that the uncertainties in the U.S. election is the reason. We don’t know who’s going to win the elections, but you could have significant infrastructure spending, you could have that drop in corporate tax rates and while we think that might work in the short term in the long, we still have questions about that. But we do live in a mark-to-market world and we wanted to take that risk and so we’ve done that.”

There is too much debt in the US

“We recognize and we’ve said to you there is too much debt in the United States and in the rest of the world. All of the monetary policy QE 123 all haven’t worked in any significant way. So when you see all of that we like the fact that we have $10 million plus of cash in the investment portfolios with the idea that we can take advantage of opportunity as and when it comes our way.”

Fairfax Financial 1Q16 Earnings Call Notes

Fairfax Financial Holdings’ (FRFHF) CEO Prem Watsa on Q1 2016 Results

Increased our position in long US treasury bonds

“During the quarter, Mark, we added to U.S. treasury bonds, long U.S. treasury bonds and reduced our cash position some. So, what you see is mainly the increase in U.S. treasury bonds.”

We’re concerned that central banks are out of bullets

“the worry we’ve said for some time is with all of this QE1, 2 and 3 in the United States and then followed by Europe and followed by Japan and negative interest rates in Japan and a whole bunch of negative interest rates in Europe, I think more than half the German market is now negative. And so, in spite of all of that the economy is very weak. And if we go into a recession after six-seven years of economic growth, it won’t be unusual, if we go into a recession. Our view has been for some time that we have no bullets; we have no ammunition. ”

You have a lot of debt that’s been raised in the United States and it’s sitting in mutual funds

“you have a lot of debt that’s been raised in the United States. So, the banks we think are relatively safe because they’ve gone through some tough times in ‘07, ‘08, ‘09 but the risk now is in mutual funds. So, there is a lot of high yield debt in mutual funds; there is a lot of corporate bonds and as emerging market bonds all in mutual fund setting where you can have redemptions at any time”

We watch closely for inflationary pressures but we don’t see them

“We watch it carefully of course but as we look and see there is no real pressure on wages yet. Velocity of money, we look at velocity, we talked about that in our annual meeting, velocity of money in the United States, in Europe and in Japan are coming down significantly. And that happens when you’ve got too much debt in the system. There is too much debt in the United States, there’s a lot of debt in Europe even more than the U.S. in terms of percentage of GDP and in Japan of course is the highest. So, you’re not able to, again, inflation going because velocity of money is just plummeting.”

Fairfax Financial (FRFHF) 4th Quarter 2015 Earnings Call Notes

Fairfax Financial (FRFHF) CEO Prem Watsa said the company posted its most profitable insurance underwriting year in its 30 year history

Our underwriting results in 2015 were the best in our 30-year history, with record underwriting profit of $705 and net earnings of $568 million. We had a record low combined ratio of 89.9% with OdysseyRe at 84.7% and all our major insurance companies having combined ratios less than 100%.”

Fairfax Financial (FRFHF) CEO Prem Watsa said the investment portfolio remains conservatively positioned (their equities are hedged and they own primarily US Treasury bonds) in light of what they believe to be a deflationary environment

We are maintaining our defensive equity hedges and deflation protection, as we remain concerned about the financial markets and the economic outlook in this global deflationary environment.  Our common stock portfolios continued to be hedged at approximately 90%. Early in 2016, we increased the hedge to 100%.”  

Fairfax Financial (FRFHF) CEO Prem Watsa said they are seeing evidence of deflation

CPI inflation continues to be at or below 1% in the United States and Europe, levels that we have not seen since the 1950s. In fact, it may surprise many of you to know that in the second-half of 2015, the U.S. had deflation of 0.9% at an annualized rate of 1.8%, and Europe at a 0.5% or an annual rate of 1%, that’s deflation. This is to say prices went down in the second-half of 2015, at an annualized rate of 1.8% in the United States and 1% in Europe.  This is in spite of QE 1, 2, and 3. Long bond – long-term government bond rates in Europe are making record lows, quite often the lowest in 200 years. In Germany, more than half of the German government bond market is yielding negative interest rates. Also, eight countries in Europe already experiencing deflation. 30-year loan German bond rates are currently below 1%. In Japan, 10-year government bond rates are below 0%, that is negative yields.”

Fairfax Financial (FRFHF) CEO Prem Watsa is worried about the unintended consequences of Central Bank policy

We continued to be concerned about the prospects of the financial markets and the economies of North America and Western Europe. Accentuated as we have said many times before by the potential weakness in China. Early in 2016, these concerns are being reflected in the marketplace with the Russell 2000 being down more than 10%. We see the potential for major dislocations in the marketplace with many significant unintended consequences, and we want to protect our company from them.”

Fairfax Financial (FRFHF) CEO Prem Watsa said he has the company positioned to survive worst case scenarios

What we’re trying to do is protect our company from worst-case events. And deflation is the very difficult environment to make a return in. You’re seeing interest rates in Japan, rates are negative. German rates are below 0.3% like below 0.3 like 30 basis points, for 10 years.  So in that environment it’s very difficult to make a return and we’re trying to protect, and there’s all sorts of unintended consequences and so we’re protecting our company from that.”

They are avoiding take any credit risk in the bond portfolio in favor of taking duration risk. 

“One of the things we don’t want to do in this environment is take credit risk. So when we acquired Brit one of the first things we did was to eliminate credit risk and invest in government bonds and in this case U.S. government bonds.  But we do take duration risk we, we buy a long U.S. government bonds.”

Fairfax Financial (FRFHF) CEO Prem Watsa is massively worried about macro events in China & Japan

China we’ve been worried about for many years and their foreign exchange reserves have come down by one whole billion or trillion dollars as you know.  And that the foreign exchange market, the stock market, the bond market, the residential housing market, so all of those markets that they’re trying to support. You got Japan with negative interest rates. And the effect on banks is very significant, so bank stocks have dropped 30% plus in Japan.”

Fairfax Financial 4Q15 Earnings Call Notes

Prem Watsa

Our common stock portfolios are hedged 100%

“We have yet to significantly benefit from our hedges and our approximate $110 billion notional amount of deflation swaps, and of course, our cash position gives us great optionality. At our last annual meeting, we made the point that while we were protecting our capital on the downside, our investment portfolio could also do very well. Our common stock portfolios continued to be hedged at approximately 90%. Early in 2016, we increased the hedge to 100%.”

Deflation is a very difficult environment to make a return in

“Yes. So on the deflation swaps, deflation contracts that we put in, Dave, as I said it’s almost seven years yet to go. What we’re trying to do is protect our company from worst-case events. And deflation is the very difficult environment to make a return in. You’re seeing interest rates in Japan, tenure rates are negative. German rates are below – tenure German rates are below 0.3% like below 0.3 like 30 basis points, 10 years. So in that environment it’s very difficult to make a return and we’re trying to protect, and there’s all sorts of unintended consequences and so we’re protecting our company from that”

Pricing of derivative contracts is very volatile, really not meaningful until we sell them

“I’d say up and down and we saw the same in credit default swaps. But as looking back in our 2008 Annual Report and you can see what I said there, but in eight months from June 2007 to February 2008, the valuation of our credit default swaps went from $200 million to $2 billion, in eight months it went up 10 times. And for three or four years prior to that it did nothing. So these valuations from what we see, from where we said is, and it’s in our books, we have taken a big hit in terms of our cost. And the next important number is when we sell it. And till that time there – as you point out valuations.”

The US P&C insurance environment is soft, so our business is shrinking

“the U.S. property and casualty environment as you know it’s a soft environment. So our business broadly speaking is shrinking, Odyssey came down. We did not renew a major property account. The pricing wasn’t right. So, as we’re very focused on underwriting and are reserving very important to keep the reserving at a very good level.”

Many of our competitors have reached for yield and taken credit risk

“I’ve said for some time that we have on the left-hand side of the balance sheet there has been many of our competitors have reached the yield and have taken credit risk to get more income is one of the questions earlier, it is very difficult to get income. So they’ve gone up the credit risk. We think that’s probably not an appropriate thing to do and the spreads are very narrow.”

We buy these instruments to protect the company in a mark to market world

“Yes, so it’s a combination. We bought these hedges to protect our company, right? So it’s like the deflation swaps that we bought and Chris. And the – we’re in a mark-to-market world. So if we wanted to expand our insurance business, because prices are going up, but if the prices are going up in an environment where the stock price are coming down, spreads are widening, while our capital will be reduced significantly, and so we may not be able to take advantage of the opportunity to increase our insurance business.”

We think of it like storms

“So we protect our capital. In 2008, 2009, the last time we did that. The markets came down about 50% and we took our hedges off. We just think we’re facing an insurance business you think of it as a 150 within 100 years on like not often, but you get these storms, you get an earthquake in California sometimes or you get big wind storm in Florida. We’ve had many and we have to protect ourselves from that. So it’s just similar situation that we’re looking at. We want to protect ourselves. And we think right now with interest rates at zero for sometime and in many case, it’s going negative and a ton of debt in the system, we think that the possibilities on the downside are significant. So we want to protect our company and we have no intention of taking those hedges off soon.”

We’re well prepared for recession but if we continue to muddle through then returns will be mediocre

” if we go into recession in the next year or two, my suggestion is even I have all sorts of unintended consequences and that’s the worry we have, Tom. So our company is well structured for that. But if we muddle through like we have in the last few years, our returns are not going to be exceptional. They’re going to be mediocre. We accept that with the idea that these are very difficult times and we have to be careful.”