Prem Watsa: Very Concerned About US, Europe, China

Prem Watsa’s Fairfax Financial Holdings Ltd (TSE:FFH) reported results yesterday. We noted that “The Warren Buffett Of Canada” has been bearish for a while and that was affirmed once again through the firm’s quarterly filing. Below are the remarks from Watsa on the conference call this morning as well as those from the Q&A section.

Good morning, ladies and gentlemen.

Prem Watsa: Very Concerned About US, Europe, China

Welcome to Fairfax Financial Holdings Ltd (TSE:FFH)’s third quarter conference call.

Our insurance companies are doing very well with a combined ratio.

In the first nine months of 2013. And we continue to be soundly financed with quarter end cash and marketable securities at the holding Company of $1.1 billion.

However, we were affected in the quarter with mark-to-market losses on bonds because of rising interest rates in the quarter and a mismatch in our equity portfolios between our common stocks and our hedges.

The Russell 2000 index used for much of our hedging was up about 10%, while the S&P 500 index was up about 5%. Our common stock portfolios were up in the 6% range, not dissimilar to the S&P 500, but significantly less than the Russell 2000. Our long-term performance as you know has been in excess of most indices.

As you know, on a quarterly basis we get fluctuations in our hedging but over time it has been very effective and we expect the mark-to-market losses in this quarter to reverse over time.

In the meantime, we continue to be protected from a significant decrease in the equity markets.
Our insurance and reinsurance businesses continue to expand profitably.

Net premiums written by the Company’s insurance and reinsurance operations in the third quarter of 2013 increased by 3.9%.

As I said, the combined ratio for our insurance and reinsurance operations in 2013 was 93.4% for the third quarter and 93.9% for the first nine

At the subsidiary level, the percentage increase in net premiums written in the third quarter compared to the third quarter 2012 and the combined ratios were as follows.

OdysseyRe, a 7% increase in net premium with a combined ratio of 87.6%, Crum & Forster, 1.8% increase in net premiums, 99.3% combined ratio,

Northbridge, 1% increase in the net premium, 101.5% combined ratio, Zenith, 12.4% increase in premium with a combined ratio of 96.8, and Fairfax Asia, 1.3% increase in net premiums and a combined ratio of 80.9%.

During 2013 many underwriting initiatives have been implemented but I wanted to highlight the progress of a couple of companies.

Zenith, which has demonstrated many times over the years its ability to manage the underwriting cycle has done it again.

Cut premiums during the soft market years, 2008-2010, combined ratios for them because of the lesser premium has increased, driven by higher expense ratios, other participants, competitors have entered the market to grow their business significantly, as the industry’s underwriting loss
increases, prices begin to increase.

Reserves develop and peer companies exit the industry which is what is happening today.

Rates continue to increase and Zenith continues to grow its exposure base.

Zenith cut its premium base from $1.1 billion to about $450 million, when we bought it in 2010. It now writes approximately $700 million, and it’s rising.

Over time, I have no question it will write more than $1.1 billion.

Although Crum & Forster’s gross premiums written remain flat for the first nine months of the year, its more profitable specialty business was up 11%, while its standard lines business was down 33%.

This has led to a 2.5% improvement in that combined ratio year-over-year.

Fairfax Brazil, a start-up in 2010 with zero premium has built a first class operation over the last three years with approximately 60 people.

For the nine months of this year, the Company has written $115 million gross, $48 million net at a combined ratio approaching 100%.

We expect Brazil to be a contributor to our overall under writing profitability well into the future under leadership.

Odyssey and Fairfax Asia

Odyssey and Fairfax Financial Holdings Ltd (TSE:FFH) Asia of course continue to hit the ball out of the park with excellent combined ratios.

So we continue to grow, depending on the Company.

As we have said before, very low interest rates and the reduced reserve redundancies mean there’s no flies hide for the industry.

Well below 100% for the industry to make a single digit return on equity with these low interest rates.
While the short-term is always tough to predict, fundamentals we think will eventually play out.

Now, in terms of the investment area net investment losses of $828.6 million in the third quarter of 2013 consisted of the following.

Please note table on page two of our press release.

Net losses on equity and equity related investments of $478 million was after an $816 million net loss on our equity hedge.

Because of the mismatch between the Russell index and our portfolios, we expect trends to reverse over time.

This happened before in the fourth quarter of 2011. The realized loss of $577 million on our equity hedges was due to the sale of common stocks and consequently a permanent reduction in our hedges and also the reduction of our hedge ratio to our target 100%.

On a year-to-date basis, our net equity losses after our equity hedge was approximately $300 million.

As we have mentioned in our annual meetings, annual reports and quarterly calls, with IFRS accounting where stocks and bonds are at market and subject to mark-to-market gains or losses, quarterly and annual income will fluctuate significantly and will only make sense over the long term.

Because of rising interest rates in the quarter, we had $215 million in unrealized mark-to-market bond losses, a majority of which are in munis insured by Berkshire Hathaway.

We considered these unrealized bond losses as fluctuations and expect them to reverse over time.

Our muni bond portfolio as you know was mainly acquired in the last quarter of 2008 after an aftertax yield of 5.7% — 79%.

The core inflation continues to be at or below 1% in the United States and Europe.

Levels not seen since the 1950s.

This is in spite of QE1, QE2 and QE3. Our CPI linked derivatives, however, are down 76% from our cost.

And are carried on our balance sheet at $130.5 million.

Even though they have almost eight years to run.

Our CDS experience comes to mind.

When you review our statements, please remember that we own more than 20% — when we own more than 20% of a Company, we equity account and above 50% we consolidate so that mark-to-market gains in these companies are not reflected in our results.

Let me mention some of these gains.

As you can