Fairfax Financial Holdings Limited
Q1 2021 Earnings Call Transcript

Published: 30 Apr 2021

[Operator:]

Good morning, and welcome to Fairfax First Quarter Results Conference Call. Your lines have been placed on a listen-only mode. After the presentation, we will conduct a question-and-answer session. Today's conference is being recorded. If you have any objections, you may disconnect at this time. Your host for today's call is Prem Watsa, with opening remarks from Mr. Derek Bulas. Mr. Bulas, please begin.

[Derek Bulas:]

Good morning, and welcome to our call to discuss Fairfax's 2021 first quarter results. This call may include forward-looking statements. Actual results may differ, perhaps materially from those contained in such forward-looking statements as a result of a variety of uncertainties and risk factors. The most foreseeable of which are set out under risk factors in our Base Shelf Prospectus, which has been filed with Canadian Securities Regulators and is available on SEDAR, and which now include the risk of adverse consequences to Fairfax's business, investments, and personnel, resulting from or related to the COVID-19 pandemic. Fairfax disclaims any intention or obligation to update or revise any forward-looking statements, except as required by applicable securities law.

[Prem Watsa:]

Thank you, Derek. Good morning, ladies and gentlemen. Welcome to Fairfax's 2021 first quarter conference call. I plan to give you some of the highlights and then pass the call to Peter Clarke, our Chief Operating Officer to comment on our insurance and reinsurance operations and some additional financial details. Peter will be on all future calls. Unfortunately, Jen Allen, could not be with us today, because her mother in law passed away in the last few days. But she will be back for the second quarter conference call. She is very much in our thoughts and prayers. Fairfax's net earnings were $806 million in the first quarter of 2021, which equates to net earnings per diluted share of $28.91. Fairfax's book value per share in the first quarter increased by 6.1%, adjusted for the $10 per share common dividend paid in the first quarter to $497 per share, a net earnings of $806 million reflected both strong underwriting results and net gains on investments. Our net loss in the first quarter of 2020 of $1.3 billion primarily from the effects of the pandemic reversed with net earnings of $2.3 billion in the last 12 months, and book value of 18%. Our net loss on investment of approximately $1.5 billion at the end of the first quarter of 2020 completely reversed in 2020 with net gains for the year, remember of $313 million. And then it increased further in the first quarter of 2021 by $842 million. In 35 years we have never experienced swings in stock prices like we did in 2020. But stock prices have rebounded extremely well. Most importantly, our total float increased by 12% to $25 billion and float per share increased by 15% to $949 per share in the last 12 months. This is in the last 12 months. We think we are now in a virtuous cycle. Growth in gross premiums written, underwriting profits and value investing were coming to the fore working well. It is still early days. Our insurance and reinsurance companies produced a consolidated combined ratio of 96% in the first quarter, which included above average catastrophe losses of $211 million or 5.7% combined ratio points. Excluding cap losses, the consolidated combined ratio was 19.3% with 17% growth in gross premium written in the back of a strong pricing environment. All of our major insurance companies generated combined ratios of less than 100%, despite the higher level of cap losses in the first quarter. More on this from Peter Clarke. In the first quarter, operating income was strong at $298 million. Net unrealized gains and investments were $842 billion with gains on net equity exposure of $1 billion, partially offset by net unrealized losses and bonds from rising interest rates. The net gains on equities included gains on BlackBerry, Bank of America, Stelco, BDT.

[Peter Clarke:]

Thank you, Prem. Our insurance and reinsurance companies have had a great start to 2021. We grew by 17% over the first quarter of 2020, generating gross premiums written of $5.4 billion. We also produced a combined ratio of 96% and $149 million of underwriting profit despite above average catastrophe losses for a first quarter. By comparison, underwriting profit in the first quarter of 2020 was $103 million. On the underwriting front, Northbridge and Zenith reported the lowest combined ratios being 87% and 88%, respectively. All of our major companies produced combined ratios below 100%. And in fact, with the exception of Brit in South Africa, all our standalone companies had combined ratios under 100%. As mentioned previously, our gross premium for the quarter was up 17% or $800 million from the year before. This growth has been made possible by favorable market conditions that prevail in many of our markets, but particularly in North America. Allied World grew its premiums by 28% with growth especially strong in Directors and Officers and excess casualty segment. Odyssey Group's gross premiums were up 24% with expansion in both its insurance and reinsurance segments. And in Canada, Northbridge's top line expanded 19% in U.S dollar terms, as it continues to register double-digit rate increases. While these three posted the most impressive growth among our major companies, Brit, Crum & Forster and Zenith were all able to expand their businesses this quarter as well. Of note, Brit launched its innovative follow on syndicate key in the first quarter, which contributed to its growth rate of 10%.

[Prem Watsa:]

Okay. Thank you, Peter, and look forward to answering your questions. Please give us your name and your company name and try to limit your question to only one, so that it’s all -- it's all fair to everyone on the call. Amanda, we are ready for your questions.

[Operator:]

Our first question comes from Junior Rob with Private Investor. Your line is open.

[Jr. Rob:]

Good morning. Congratulations on a wonderful quarter. Question for you guys, did you guys increase your total return swaps in 2021 for Fairfax? It seems like it grew by 500,000?

[Prem Watsa:]

Yes, we've had the ability to do that Jr. and we continue to look at it. We think it's a great investment for Fairfax and we will continue to look at it as we go forward.

[Jr. Rob:]

Okay. So that's maybe about like 7% to 8% of the outstanding shares there, right? I think.

[Prem Watsa:]

Yes, yes. So it's about 2 billion shares and .

[Jr. Rob:]

Yes, that's what it is. Yes.

[Prem Watsa:]

Yes. Yes. That's what it is.

[Jr. Rob:]

Okay. Thanks a lot.

[Prem Watsa:]

Thank you, Jr. Next question, Amanda.

[Operator:]

Thank you. Our next question comes from Tom MacKinnon with BMO Capital. Your line is open.

[Tom MacKinnon:]

Yes. Thanks very much. Just following up on the …

[Prem Watsa:]

Hey, good morning, Tom.

[Tom MacKinnon:]

Yes, morning, Prem. Just following up on the long total return swaps. Is the total notional that you have in this and these investments over $2 billion, is that correct? And does that mean I think that you've -- now that you've increased it and Fairfax would be nearly a third of that is associated with the Fairfax stock? Is there any color you can give us to what other instruments are in or other stocks or indices or whatever are in the remaining $1.5 billion or so in terms of what you have in terms of total return swaps, long notional?

[Prem Watsa:]

Yes. So, Tom, in terms of Fairfax shares as you see in the press release, right, we have about 730 million, 2 million shares at approximately US$372. This is all of U.S dollars, 730 million is the total return swaps in Fairfax. And, of course, it's already doing well. on an opportunistic basis, we've looked at buying some common shares, Tom, but they're not long-term and they're the ones that we bought quite a bit, we've already sold. And so we continue to look at opportunities, but it's short-term stuff, meaning for a long -- longer period of time.

[Tom MacKinnon:]

Okay, that's great. And if I could just squeeze another 40% cash, where do you think you would want to deploy that? As I understand what you have in terms of your equity holdings, this includes like your investments in non-insurance companies and investments and associates, I think you're kind of at your internal max there. So would we think that if you were to deploy that cash, it would more than likely go into fixed income as opposed to equities.

[Prem Watsa:]

Yes, so, Tom, a big risk today, I'd say this many times. In the 1980s, Tom, interest rates are very high, inflation was very high, and nobody expected to come down. This is in the 1981, '82, long treasuries were like 14%, long Canada's was 16% and nobody expected to come down and phasing was high. Today, it's the opposite. 10-year treasuries in the United States are lower today than they were in the great depression and the only exception was last year. Last year, they went down to like a 0.5%, that back to the 1.65%. But the 1.65% is lower than in the great depression and nobody sees inflation picking up. You heard the Federal Reserve, the Fed says it's transitory and you look at commodities, copper price is at the highest price it's been, a record high. Lumber prices are record high, steel prices are very close to record high, corn prices. Procter and Gamble is increasing prices. So there's all sorts of price increases taking place. And then you've got the economy coming back, if pent up demand with all the supply problem that takes place till things normalize. And so the big risk in our mind is inflation increasing, and we can say our prices increases and interest rates increase. You saw in the last year, 2-year rates in the United States or less, I mean 2 years, 1 year, 6 months have been flat. But 10-year rates have gone from 0.5%, and 10-year rates to, as I said, 1.65%. And -- but that's -- if you go a further little back pre-COVID, that’s being some 2% . And so that's a big risk we see. So, we'd rather not take capital loss. We take the bond markets, so they have no margin of safety. So, you’ve to be very, very careful. And so, for low interest in dividend income, interest income purposely we can easily buy longer bonds and get higher interest rate, but we think that this tactic will capitalize. So that’s what they , Tom.

[Tom MacKinnon:]

Okay. Okay, thanks for the color.

[Prem Watsa:]

Superb. Thank you very much, Tom. Amanda, next question.

[Operator:]

Thank you. Our next question comes from Jaeme Gloyn with National Bank Financial. Your line is open.

[Jaeme Gloyn:]

Yes, thanks. Good morning.

[Prem Watsa:]

Hey, good morning, Jaeme.

[Jaeme Gloyn:]

First question, it's great to see the leverage commentary. And that's starting to trend from downward. On the flip side, I'm seeing the premiums to surplus ratio pick up nicely as you take advantage of the harder markets. Just wondering if you could talk about your capital position in terms of being able to continue to drive those premium growth rates in line with other markets?

[Prem Watsa:]

Yes, I will take a , but the markets are hard. The markets grow, Jaeme, a price increase that’s taking place across the board pretty well across the world. And our companies are exposed to property and casualty insurance across the world, and they're taking advantage of it. And who knows how long it'll last, but for this -- a little -- should last for a few years. We have the ability to expand. We have the capital to expand. Our companies are very well capitalized. And as Peter said, we've got the $1.3 billion in the holding company. But, Peter, your response or anything you'd like to add to that?

[Peter Clarke:]

Sure, thanks. Hi, Jaeme. I think, last year, we put some capital into our insurance and reinsurance operations. So they started the year well capitalized and their premiums are growing, but they're growing profitably. So they're generating some significant earnings, add to that the investments bouncing back, I think the earnings within the operations will fund -- fund the growth going forward. So I think, generally right across the group, we're quite satisfied where we are on the capital plan.

[Prem Watsa:]

So, to add to what Peter said, Jaeme, I mentioned this in our comments on the call, this is a virtuous cycle. This means and the last time was really that there isn't any significant risk in 2001, after September 11. Premiums are growing. Prices are -- real increases are taking place. You're growing your premium. Underwriting profit and reserves are big redundancies, they've built up only see over time. And so the cycle it's virtuous right now. And and we’ve saw some of them in our AGM, they're all experienced veterans in the marketplace. They know how to take advantage of the business and get paid. Basically, you're getting paid for the risk that you're taking. And insurance is a risky business. So you need to get paid. And if you don't get paid, that you weren't, like I’ve seen it, then you keep premiums flat, or you come down as they have been, because there have been rate decreases in workers' compensation and tremendous job. But this is a virtual cycle. And on top of that, sort of not different from 2001 because you remember, the peak for the .com boom was in 2000. And 2000 -- if you look at our annual reports, 2000 to 2002, 2003, stock markets all over the world led by the .com, led by NASDAQ dropped by 50%. And NASDAQ dropped by something like 75%. Our portfolios, our stock portfolio went up 100%. That's 100% because value investing came back into the fall and it lasted for many, many years after that. We see a lot of similarities today when we look at the companies that we own. And so we think not only as the insurance business in a virtuous cycle, but it's backed as Peter was saying, by the fact that value investing and making a comeback, Jaeme.

[Jaeme Gloyn:]

Yes, that's great. Thank you. And my next question is around the expense ratio and the commentary around that coming down. Can you please give me a little bit of color as to like the sustainability of that expense ratio? Or is that probably -- is that driven by any initiatives or changes in the operations or is it more just factor of the markets and the higher premiums earned?

[Prem Watsa:]

Yes, so, Jaeme, this is the advantage, as Peter mentioned in his comments what last thing to add after I just say this. But when premiums go up and up, one of the things we did in last year with our we said, yes, you cannot use COVID-19 as a reason to stuff to fire people. These are our loyal employees who have been with us for a long time. And so we've said to each of our Presidents, you cannot use COVID-19 to reduce staff. So we had no reduction in staff at all. And our employees appreciated that. And for now we're increasing our premiums, but we're not adding staff, right? Jaeme, so it's not any restructuring or any of that type of thing. Because these are all our loyal staff, but we are not adding to them, and they're working hard, more premium, but Peter?

[Peter Clarke:]

Yes, I think the only thing I just sort of add to what you've already said, Prem, is that it's really when the premium, a lot of the expense ratio benefits coming from the premium side, and especially when it's through pricing, right, your premiums going up because of increased rates, you don't need additional expenses to support that. So that's where the biggest benefit comes -- is coming from. I should point out that all our companies are very cost conscious and focus on the expense ratio as well. And we have benefited in the past 12 months to -- from some lower expenses generally related to travel and entertainment because as everybody has been working from home and really travel has been nonexistent.

[Prem Watsa:]

Oh, that’s well said. Jaeme, what Peter was saying it's because of the rate increases, like 17% growth in that first quarter is maybe rate increases as opposed to volume. And so the expense ratio, Allied being a great example locked almost points. Any other questions, Jaeme?

[Jaeme Gloyn:]

That's great. Thank you very much.

[Prem Watsa:]

Thank you, Jaeme. Amanda, next question, please.

[Operator:]

Thank you. Our next question comes from Ken Macneal with Richardson Wealth. Your line is open.

[Ken Macneal:]

Thank you. My question is around Blackberry. Are you restricted from selling Blackberry? If you aren't, when it hit 36, did you sell any? And if you didn't, why wouldn't you?

[Prem Watsa:]

Yes, thank you for the question. I think at the annual meeting, we discussed this, and I made the point that we were restricted. We were restricted from September last year to March 1. And the restriction was because our conversion price went from $10 to $6 and what the SEC rules, the short swing rule, if you transact in Blackberry Securities, or any securities that we had issued to you, and they considered the convertible to be a new issue, you'd have to give all the profits back to the company. So we were restricted. There was no way we checked it 10 times, we checked the warrants, and so we had no option but to wait. And after we waited, as you know, the stock price came down significantly. So that's where we are today.

[Ken Macneal:]

Thank you.

[Operator:]

Thank you. And our last question …

[Prem Watsa:]

Thank you for your question. Amanda, next question.

[Operator:]

Thank you. Our last question comes from Mark Dwelle with RBC Capital Markets. Your line is open.

[Mark Dwelle:]

Yes, good morning. A couple of questions.

[Prem Watsa:]

Good morning, Mark.

[Mark Dwelle:]

Good morning, Prem. I wanted to get an update on a couple of the transactions that are outstanding. The RiverStone Barbados and the partial sale of shares in Brit to OMERS. Particularly on the Barbados transaction, it seems like it's been delayed quite a bit from where it -- when it was originally expected to close. So I was just curious what seems to be the holdup, or what the timing is looks like at this point?

[Prem Watsa:]

So, Mark, this is regulatory bodies, and you're right, we expect it to -- we expect it to be completed in the first quarter. But CBC very much, the buyer of U.K., very much wants to buy it. And that's discussions that CBC is having with the regulatory body, which is the PRA in London. And we expect that it will happen sometime in the second quarter. But you're right, that's being delayed so.

[Mark Dwelle:]

And then on the OMERS and Brit transaction, is that still on track to close in the second quarter as well? I think that was what the original timeline was?

[Prem Watsa:]

Yes. Yes. simultaneous, Mark. So they will close at the same time because, of course …

[Mark Dwelle:]

I see.

[Prem Watsa:]

… when they close CBC transaction U.K they almost gets paid, I think $600 million plus for their investment. And is that right, Peter, $600 million?

[Peter Clarke:]

Yes, that’s correct. Yes.

[Mark Dwelle:]

That makes perfect sense. I don't think I saw the .

[Prem Watsa:]

So they both together. We can -- yes, we have every reason to expect that they close together.

[Mark Dwelle:]

Okay, very good. The second question I wanted to ask about was the long equity total return swaps related to the Fairfax shares. You increased the total amount of notional in the quarter. I guess I had understood when those were originally taken out late last year, the notion was an opportunistic play on this Fairfax shares, you were a little bit cash constrained with some debt and trying to get these transactions closed. I guess this quarter we also bought back stock just in the ordinary course. I was curious why to continue increasing the size of the notional on the swap rather than just direct that same cash flow to ordinary repurchases.

[Prem Watsa:]

So, Tom -- so, Mark, when you look at us, right, where we're buying back stock, first thing financially sound. Second thing is to make sure we did full advantage, full advantage of the insurance marketplace, which we did in the first quarter, we expect to continue in the next few years. So those are very, very important. Then we look at our stock price, and we think it's very attractive. We think we're in the midst of a virtuous cycle. We talked about in terms of insurance, reinsurance business, which you’re very familiar with. What perhaps people are less familiar with is value investing coming back in States. So you're seeing that then, I gave the example of Fairfax India and Atlas. But Eurobank -- Eurobank's book value next year will be about 50. And I've said this before, and I'll say it again, the Greek government is perhaps the best government in Europe. And they're doing all the right things, and look at it again, tremendous towards season, tremendous investment, or tremendous attraction for capital investment, they understand that, and they €500 million, I think it was Euros and 2% for 5 years, 6 years. And so Eurobank is selling at little less than $0.80. And it's got tremendous prospects. I go on to Bank of America, Stelco, and on and on and on. At Page 59, 60, we talked about that. These are big positions that we've had, that in 2019 at the end of the year, you could see it coming back. And then COVID-19 in early 2020. No one can forecast these things. It happened. And in our minds all the delay was going to take place, which is interesting as the economy expands, inflation interest rates pick up I mean, for Biden's but also to programs on top of the economy recovering significantly. And so inflation picks up, interest rates pick up, the economy produces a huge amount of profits for all the companies that I just mentioned. And interest rates go up, and we've got a ton of cash that will benefit from higher income and we won't get capital losses, which people will reach for yield, we will do. So we think our company is really well-positioned with that tremendous management and so we're very excited. So our stock -- we think I've said this many times about stock myself, but we think our stock is very good for long-term investors, which a lot of the people on this call are long-term investors. And so that's probably the best way we continue to add to it, Mark, because we think it's going to be a very good investment and already it is, but we think it's early days.

[Mark Dwelle:]

Okay. I appreciate the insights. Thanks very much.

[Prem Watsa:]

Thank you very much, Mark. Amanda, any more questions?

[Operator:]

And at this time, we have no further questions on the audio line.

[Prem Watsa:]

Thank you very much, Amanda. If there are no further questions, we thank you for joining us on this call, and we look forward to talking to you after the second quarter. Thank you, Amanda.

[Operator:]

Thank you. That concludes today's conference. Thank you for participating. You may disconnect at this time.