Sunday, March 02, 2008

Fairfax's Next Move?

Although Fairfax has still not published its 2007 Annual Report, we know that Odyssey Re substantial increased its holdings of foreign government bonds during 2007, from $441 million to $1,126 million. These were almost entirely composed of German and French government bonds, and the intent was most likely to capitalize on a strengthening euro.

It is likely that Fairfax made this bet across the entire holding company.So far the bet has been successful, as the dollar has continuously plummeted over the last year.


Anonymous said...

If you believed that you might guess that there would be a currency disclosure on the ORH 10K.

There is not.

My guess - and it is just a guess - is that they are long the bunds and hedged the currency - preferring to play duration in Germany than the USA.

I would agree with that bet too. It is far more likely that the USA will wind up in an inflationary spiral than Germany and so German long bonds hedged to currency will outperform US long bonds.

Incidentally PIMCO believes the same thing - preferring non US duration when possible.

Anon again

Nnejad said...

I doubled checked, and at Dec. 31 the only thing Fairfax had was about 150 million in Canadian dollar swaps. So I maintain my belief that the reason is to play a rising Euro currency.

Anonymous said...

I can find no currency exposure disclosure like there is a bond duration exposure note.

Simplest explanation. They write a lot of business is Europe. They have Euro liabilities. They are called loss and loss adjustment reserves and the like.

They hold Euro assets.

Currency movements do nothing.


Anonymous said...

Further to this - the Euro operation - which generates Euro liabilities - have been growing relatively fast.

There is however a currency benefit when the Euro appreciates because the NET EQUITY that they have in Europe appreciates. This benefit goes through the balance sheet but not the P&L

Nnejad said...

ORH has always had an international book of business, with premiums written around the world. But they have never had a currency exposure disclosure, even though that would technically call for it.

They could have been trying to offset their European liabilities. But I am speculating that they are looking to benefit from a rising Euro because they put over 10% more of their TOTAL investment portfolio into those assets compared to last year.(during a period where their book of business did not change much- EuroAsia premiums increased from 561 to 565 million, and UK premiums increased from 340 to 350)

Anonymous said...

At this point I am sure you are wrong!

The reason is simple enough. Most of the Fairfax subs are run pretty close to regulatory capital limits. (This still shows in their ratings.)

The holding of foreign bonds unpaired by foreign liabilities requires considerable regulatory capital which they do not have.

Almost all the excess capital (at least until very recently) has been used to support credit default swaps.

At the end of the fourth quarter they had not actually cashed may of the credit default swaps so they had not freed up capital.

By results date they had cashed a considerable amount of CDS - so then - and only then - would they have had the capital to hold unpaired foreign bonds.

You will be able to confirm this when you get the stat statements. But Berkshire which has massive excess capital is allowed to hold lots of foreign bonds unpaired by foreign liabilities. Fairfax is not.

Anonymous said...

Further if they owned the Euro bonds at ORH as a speculation on the decline in the USD then they would also have that position elsewhere.

They do not.

Crum and Forster has no European operations.

It owns no European bonds.

I think you will have to correct this post on Fairfax too.


Nnejad said...

Nope. I've spent enough time on this and I really just don't like your attitude so I'll make this brief.

Year,$Foreign bonds,EuroAsia Reserves

2004, 344, 369
2005, 373, 465
2006, 441, 575
2007, 1126, 656

And those are EuroAsia reserves, I said I was just speculating, so how about we just wait until Fairfax files its annual report then?

Anonymous said...


On those numbers I concede.

They are speculating on FOREX.

They will make some money doing it too!


Anonymous said...

Going a little further - they disclose which ones are held for investment (and hence have a currency exposure) and which ones do not. About half have currency exposure. The rest presumably offset foreign liabilities.

So there is about $500 million on which they will have made gains on the currency moves.

One thing perplexes me. At year end the unrealised gains were almost zero.

The currency was pretty weak at year end - so either (a) they just put the position on (which is possible because they just took some CDS off) or (b) they rolled the positions pretty close to year end and realised.

Anyway - you are right. There is this speculation.

Moreover I incorrectly said that there was no such dislcosure at Crum and Forster. I was wrong!

Here is the disclosure:

"At December 31, 2007, the Company’s total exposure to foreign
denominated securities in U.S. dollar terms was approximately $479.0 million, or 10.5%, of the Company’s total investment portfolio,
including cash and cash equivalents and assets pledged for short-sale obligations. The primary foreign currency exposures were in
Canadian dollar denominated and Hong Kong dollar denominated securities, which represented 5.6% and 1.3% of the Company’s
investment portfolio, including cash and cash equivalents and assets pledged for short-sale obligations, respectively. The potential
impact of a hypothetical 10% decline in each of the foreign currency exchange rates on the valuation of investment assets denominated
in those respective foreign currencies would result in a total decline in the fair value of the total investment portfolio of $47.9 million at
December 31, 2007. At December 31, 2006, a hypothetical 10% decline in foreign currency exchange rates would have resulted in a
total decline of $36.8 million in the fair value of the total investment portfolio."

Nnejad said...

On the subject of where the gains are, its a mix of both. Odyssey acquired 204 million of German bonds in March and then sold them in November, realizing a forex gain of about 25 million. Odyssey then added 291 million in German bonds due in 4 to 6 years in November. So this is probably why at year end, not much in unrealized gains was recorded.

Anonymous said...

This is very strange behaviour!

"Odyssey acquired 204 million of German bonds in March and then sold them in November, realizing a forex gain of about 25 million. Odyssey then added 291 million in German bonds due in 4 to 6 years in November. "

In essence ORH sold, realised a tax liability, and then put the same trade back on.


Very peculiar...

Nnejad said...

Longer dated bonds. Previously they were due on 09, now they are due in '12 and '14.

Anonymous said...

I see your point - but you need to go figure just how much better the longer dated bonds need to be in order to justify realising the tax.

See if you can model it out. Anything in my head says that it is better to delay the tax payment.

And ORH - unlike the rest of Fairfax - has no spare tax losses.

Nnejad said...

And the conclusion: Odyssey seems to be the only company that increased its holdings of foreign bonds. So ORH will benefit from its increased exposure, but this was not a company-wide investment decision.