Monday, February 11, 2008

Is it possible Fairfax Financial might have raised their CDS bet?

With AIG's recent report of larger than expected CDS "mark to mark" losses and default spreads on AIG hitting over 200 bps as of today, Odyssey re & Fairfax Financial would have received another boost to the value of their enormous CDS portfolio (AIG is one of their CDS positions held most likely for hedging rather than investment purposes).

I believe it is more probable than not that Fairfax would have taken profits on positions in CDS positions in Countrywide, MBIA & Ambac amongst others over the last few months. That is my expectation given the excellent pricing Fairfax would have received, MBIA & Ambac were recently priced for a 70% chance of bankruptcy. However, this is pure speculation and journalistic opinion on my part. We won't know until they report their results for this quarter.

Economic conditions have degenerated rapidly throughout the world particularly in North America but also Europe, Japan and other regions. Risk continues to be re-priced into corporate bonds and expectations are that default rates will increase considerably from current levels.

Further, in two interviews given since November ,Prem Watsa, CEO of Fairfax, has maintained that we that we are only at the beginning stages of a credit crunch and the US could be facing a Japan like economic situation of deflation.

Finally, the largest equity positions recently added by Fairfax are in healthcare/pharmaceutical stocks which definitely have defensive characteristics in a recession like environment.

The question therefore I want to pose is this , if Prem Watsa feels we are only in the beginning stages of a credit crunch and Fairfax continues to set up its equity and bond portfolio for recession, is it possible that during the 4th Quarter 2007 Fairfax Financial may have raised its CDS bet on some names perhaps already held or others not held at the end of the 3rd Quarter 2007?

Disclosure: I own shares of FFH & AIG

Disclaimer: The opinions expressed by the author in this article are not intended as investment advice and should not be relied upon as investment advice.


oldye said...

I wouldn't bet on it.

FFH CDS position at the begining of 07, had about 13 billion in notional value and the market price was about 70 million dollars(Their cost was somewhere around 300 million). They the went on to add another 5 billion in notional value sometime early in 2007, My bet is that it cost them somewhere around 35 million. As of Q3 the market value was around 1 billion dollars! If they added, it would have to of been sometime after that, with prices probably being 6-12x higher than what they initially paid. They also trimmed some of their CDS position as of Q3. I don't think its likely but we'll find out on Feb 22. I know I have the date marked!

Tarn P Crowe said...

thanks for your observations oldye, I'm looking forward to the report also

oldye said...

looks like you were right after all!
From the report: including 2008 purchases of $2.2 billion notional amount of credit default swaps for $62.1 million.

Damn, it feels good to be a gangster , I mean shareholder ;0

Tarn P Crowe said...

hi oldye

it would be interesting to find out what they added to but what a
great result for!

it certainly made up for HCC which was a bit disappointing, but all my investments are long term in nature. Even if wall st has a short term mindset. Fairfax is a much bigger investment for me at this time than HCC in any case.