Saturday, June 30, 2007

Where the Hell was the Fed Two Years Ago?

The august Federal Reserve finally releases its statement on subprime lending and guess what? They are concerned about the following issues:

1) Low initial payments based on a fixed introductory rate that expires after a short period and then adjusts to a variable index rate plus a margin for the remaining term of the loan

2) Very high or no limits on how much the payment amount or the interest rate may increase on reset dates.

3) Limited or no documentation of borrowers’ income.

4) Product features likely to result in frequent refinancing to maintain an affordable monthly payment.

5) Substantial prepayment penalties and/or prepayment penalties that extend beyond the initial fixed interest rate period.

Now remember that the Federal Reserve released this last Friday. This is a little like worrying about your daughter's virtue after she gets knocked up isn't it?

Here is a folksy saying to describe the situation:

"You are closing the barn door after the horse has left."

It is too late to be concerned about subprime lending now. Everyone in the world is concerned about the subprime lending mess. You are our economic leaders and we needed you back then, not last Friday.

Friday, June 29, 2007

Symetra Financial IPO

Symetra Financial announced today that they have filed with the Securities and Exchange Commission (SEC) to do an initial public offering of its stock. The shares will trade under the symbol SYA. Symetra is owned by White Mountains Insurance (WTM), Berkshire Hathaway, Inc. (BKRA) and a host of other private investors and hedge funds. The investor group purchased the company in August 2004, when it was known as Safeco Life and Investments, for $1.35 billion.

It's hard to tell what type of return WTM made on its investment in the three years it held it. The issue has not been priced yet, and although we know what the total purchase price was back in 2004, WTM and others had to put capital in at the closing of the deal. They also may have withdrawn capital over the preceding three years.

If you assume that the offer is priced at a 1.5 times multiple of Symetras book value of $124.6 per fully diluted shares and shares owned by WTM of 3,090,560 then that will value its stake at $577.8 million.

I don't remember WTM saying much about Symetra at the recent analyst meeting - a quick look at my notes shows the following:

"Private equity buyout of Safeco Life and Investments in 2004. 14% after tax rate of return – paid $100 mm dividend to shareholders."

There was a question at the end about the tendency of WTM to exercise excellent cycle management when it comes to exiting and entering different businesses so maybe this is an example of that. I looked up an old story from 2004 and it appears that WTM paid less than book value for the Safeco assets at the time.

Monday, June 25, 2007

"Whatsoever a Man Soweth, That Shall He Also Reap"

I am not a religious person, but I couldn't think of a better title for the story below:

Mortgage Broker Loses House

Wednesday, June 20, 2007

The Most Terrifying Thing I Have Ever Read in My Life

I get an e-mail every morning with a recap of what is going in the market. Most of the time the articles are something I have read somewhere else or I am not interested in them. Today was different. The headline was enticing. It read:

How do you pay off your home mortgage in a few years or less? Learn to use hedged

The last word was left off but it was not rocket science to guess that the missing word was "futures." Oh this was going to be fun. When I clicked on the link it was even better than I thought. It read:

How do you pay off your home mortgage in a few years or less? Learn to use hedged futures with options and arbitrageur strategy

Well sure why not? There's nothing wrong with 80 million homeowners entering the futures market. This might even solve the sub prime lending mess. People who can't even read a mortgage note trading futures and options.

It gets even better though once you read the article. A homeowner in California borrowed $11,600 against her 401K and paid off her $320,000 mortgage in just under 5 years. It must have been a small house because $320,000 can't buy much in California.

Here is the link so you can really appreciate this one

Wednesday, June 13, 2007

White Mountains Insurance (WTM)

Here are my notes from the WTM analyst day. Please forgive the misspellings and abbreviations.

White Mountains Investor Day June 8, 2007

Ray Barrette - Introduction

2006 was a good year for WTM. A complex year with reserve developments at WTM Re and Olympus Re but grew BV by 21% in 2006. One Beacon IPO in June 2006 helped but would be 16% growth without One Beacon. Track record is 17-18% range.

One Beacon had a good year with a 96% combined ratio – 1Q is typically a bad quarter for a New England based insurer with lots of claims. Still had a 98% ratio anyhow

White Mountains Re – 102% combined ratio very much impacted by reserve developments - pricing going down – had $45 mm Catastrophe hit in 1Q-07 in WTM Re - Some competitors did better with lower ratios – sometimes you get big claims in reinsurance.

Esurance at annualized premium rate of $701 mm through May. Will be $900 million by end of year in premiums here.

Underwriting comes first in all businesses excepting Esurance – where premiums come first. This is the exception because it is a good business and can grow profitably.

To understand Esurance you have to look through the GAAP combined ratio since the marketing expenses are up front. These are very large but are expensed in first 6 months despite life of policy being much higher.

2% return in Q1-07 on investments. Investment people have done a great job – they just have to keep doing it.

Track record is 17% annualized growth in TBV since 1985 - 20% since 1999 – it will get tougher to grow this book value as business getting tougher and less profitable going forward.

Bermuda and hard market has helped over last few years on TBV growth. Overall we have ramped up business well.

He has come back after two years of turmoil in reinsurance business to assess what has been going on. We found an IRR of 15% in WTM Re from 1996-2006. This is a decent result – wish it was 20% but this is acceptable. We sold Montpelier Re giving us an 18% IRR – all these returns are after tax. One Beacon has had a 20% IRR –

We can deliver value because of our structure and because of our management teams – we have a good board and can focus on what matters. We are merchant bankers – we make money buying well – fixing broken businesses and exiting well. We do our own due diligence rather than outsource - won’t buy business unless we feel that we can run it.

One Beacon - $2.0 billion capital
White Mountains Re – $2.6 billion capital
Esurance - $0.4 billion capital

One Beacon

Bought for $2.1 billion in 2001 – took combined ratio from 120% to 96%.

Restructured it from top to bottom and now a specialty company – IPO’d it at 1.5 times book value.

Took $1.8 billion in capital distributions out over last five years. IPO very successful since WTM was able to maintain Bermuda structure for Beacon – effective tax rate is 23%.

20% IRR will be a challenge to maintain as markets become more competitive – but some people feel that insurance companies are worth 2 times book.

One beacon has many opportunities to grow – now in specialty Lines, commercial lines and personal lines – about 1/3 each premium volume. 20% growth in specialty lines.

Commercial lines are niche lines not general. (General commercial is 1/3) – will continue to add niche lines.

Personal lines – NY marketplace is declining so net written premiums are shrinking. Forty percent decline year over year in market.

Had underwriting profitably last 4 years and growth in book value per share – 4-½% in the first quarter.

Focus is on growing specialty business. Just entered four new specialty segments, and lowering expense ratio overall is goal.

Premiums have gone down last 5 years but combined ratio going down.

One Beacon has always expensed stock options fully so expense ratio higher relative to others. Not an apples to apples comparison to peers.

White Mountains RE

Bought Folksamerica in 1996 – and have done 12 transactions since then. One bad one – Risk Capital Re.

Market has been going sideways or down and will be a real challenge to maintain margins going forward.

FolksAmerica – have established many long-term stable relationships (A & H and agricultural)

Sirius Intl – run by same guy for 17 years – rock solid relationships across Europe. Long term track record of truly conservative reserving – just had a $22 million release in Q1. A short tail writer mostly property but great A & H business and aviation. They also have a tax advantage – net earnings added to statutory reserve so no Swedish tax added.

Just issued a hybrid capital for this business so $2.6 billion capital to go up.

FolksAmerica ReSolutions – specialize in buying from motivated sellers who want out of reinsurance business – they get great deals – will buy net assets of business below economic value.

Overall in WTM Re net written premiums grew strongly and then peaked and declined in 2006, and Q1-07 due to moderating soft market and UW discipline. KRW havoc in 2005 leaked into 2006 and took 84% combined ratio to 102%,

Combined ratio not the entire story – company earns fee income also.

Numbers are much better than ratings indicate.

Reinsurance business becoming more competitive and will be a challenge to keep it a better business.


Bought it for $9 mm in 2000 and put in $53 million to get it breakeven.

Business is profitable but there are GAAP losses due to required expensing of policy costs over 6 months vs. 30-month term of policy.

Low cost operating model – expense ratio of 8.6% - as this business gains scale it will have an even lower expense ratio. Will have 30% of claims reported without human intervention.

Writes personal auto in 27 states – spending a lot of money for advt to increase business – avg cost for policy acquisition was down 22% however.

Fastest growing auto insurer

GAAP combined ratio reflects requirement to amortize policy acquisition costs over 6 months. – economic combined ratio expenses it over 30 months.

Goals – Loss + LAE – to be at 75%.

Company pays a lot of attention to reserving – more confident about reserving in this sector.

Barrette comments:

Combined ratio if WTM stops writing new business – 82% combined ratio. It is incredible that you can write new business at a combined ratio at that level. 2/3rds of Esurance is new business. It’s so good we are going to grow.

Spend well under $500 to acquire each policy at Esurance.

Value of auto policy in marketplace – look at what PGR and other public companies trade at - look at premium over book for companies buying that type of business and convert that to a pct of premium volume. AIG buy of 21st century stub – buying 81% of premium volume. If you apply that to Esurance then you have a value of well over $1000 per policy. That is the economics of what we are doing. WTM is paying well below $500 per policy for something worth in the marketplace well over $1000 per policy. Grow as fast as you can without breaking the machine.

Co is also in merchant banking – looking for all kinds of opportunities. Looked at 60 or 70 last year but didn’t find any interesting. We did create two new businesses from scratch and one more built up

Galileo Weather Risk Mgt - start up – help utilities and others mgt risk. Chemical companies in Europe ship materials on Rhine River – but if not enough rain then Rhine isn’t deep enough for barge traffic – companies bought river depth cover. Business broke even in first year.

WTM life re – second new business – reinsures life (variable annuities) in Japan. Focused on Japan not US because it is easier to hedge because the way Japanese invest.
Very specialized.

Pentalia – invest in remote insurance risks - WTM is a seed investor and part minority owner of Mgt Company. Good potential returns for WTM’s.

Capital Position

WTM in excellent shape – total tangible capital at $6.5 billion – leverage ratios at 18% of total tangible capital.

Capital raising – IP of One Beacon at 1.5 times book value.


Private equity buyout of Safeco Life and Investments in 2004. 14% after tax rate of return – paid $100 mm dividend to shareholders.


2.0% total return in 1Q-07 – 6.8% cumulative over time.

Internal benchmark is 10-year treasury plus 150 bp’s points. WTM has done better than that. WTM has done well in all asset classes.

Value oriented approach in Equity portfolio beat S & P 500 by 500 bps in Q1-07.

Two primary rules of investing – rule #1 is don’t lose money and don’t forget rule number 1.

WTM uses bottom up view of what securities to own – MBS as pct of fixed has increased to 40% from 6%. Totally avoided sub prime and other sub classes that imploded because thought that risk reward wasn’t good enough.


Total portfolio above $2.5 billion – top ten is 2/3rds of portfolio – much more use of converts to protect portfolio – much more diversified use of large cap names. WTM has been harvesting gains in Energy and Utilities.

What to expect from WTM

Growth in BV per share – how we do it is unknown or how lumpy or smooth we don’t know.

UW comes first – disciplined balance sheet.

Market is more competitive and assets very expensive so will deploy capital prudently. Have a loaded gun but will be prudent in deploying capital.

Q and A

Stock repurchase plan announced? What is status?

Has to make sense for remaining shareholders – follow Buffett rule - compute intrinsic business value and then pay 80% of that value – so far have not felt that we are right place do not use it for share support but as an investment – we compare it to other investments – 17% rate of return on investments is goal. We have excess capital but do not see using that now to buyback shares.

What is book value for Esurance on your books?

$360 million or $30 per share but much of book value on books of WTM Re.

If sold it sale would be tax-free since it is in Bermuda.

Common investments have even better if you take out Montpelier re investment so why not add money to this asset class it since you can go to 100% of stockholders equity?

This is totally up to investment team. We are putting money in market as fast as we can – we are putting it in at fastest clip we can but are selling also. Also, has been a long time since we have had a market correction so we would add to equity market faster if there was a correction.

Put some numbers behind right sizing CAT exposure? How much willing to lose over season?

At WTM RE have introduced concept of limiting exposure to maximum loss not probable loss – 1 in 10,000 year event – counting operating earnings of year – and accumulation of 1, 2,3,4 or 5 events - limit loss to 15% of total equity. ($2 billon of equity.)

Type of business that you would prefer to have in Bermuda? Long tail that would build up tax-free investment income maybe?

Long-tail profitable business – CAT business belongs in Bermuda, but when events happen there you lose heck of a tax deduction. Real advantage in Bermuda is having capital there. Your book of business turns over but capital is permanent.

What is One Beacon exposure to Cat 98? (Event in Northeast)

Haven’t announced anything but comfortable saying that it will not be over $15 million.

Question regarding claims in Esurance? What are actual benefits in seeing car being repaired? Is that good for customer?

Think that it is good for customer – customer want to know what is going on - want to see process and chose auto body shop. Can go online and see what is going on. Introduced this in January – 13% of insured are following this on line. It is good for customer and good for WTM so they don’t call. This is better service and maybe better retention. Two ways to lose customer - poor claim service or rates too high. It will help retention definitely.

Tax status of Bermuda discussions in Congress?

Legislation being rumored is same that has been introduced every year since 2001. It is not likely to be passed and many would be hurt as Bermuda brings a lot of money in so has some strong opposition. Great value in an efficient reinsurance market. Doesn’t think it will pass and won’t hurt WTM too much.

Question on reinsurance – compared to One Beacon – bought it at great time – great cycle management – are there market conditions where you would consider exiting reinsurance as a cycle management play?

Bought in reinsurance very well – did a fine job at underwriting – difference between one beacon – is that in One Beacon just can’t stop underwriting because whole infrastructure being fed by premium volume. In reinsurance business – no agents so you can reduce underwriting very easily – don’t have to sell WTM re but will just stop underwriting.

Jack Byrne made comment at last meeting about multi decade prospects of returns of reciprocal business – do you share that excitement and why?

We do but wish others would get excited - has to be multiple partners helping us. Farmers is very successful model for reciprocals with $2 billion in fees in 2006 with 50% margins. Travelers makes a lot of money but $20 billion in capital at risk – didn’t make much more than farmers – so which model would you pick.

One Beacon question – talked about reducing expense ratio – since we are entering soft market and top line will shrink- how will you reduce this ratio?

A good question – will have to through overall expense side – opportunities to cut expenses as infrastructure for $4 billion company can reduce since it is a $2 billion company. Looking for 300 bp reduction in expenses – half that coming from expense management initiatives and the other half coming from mid single digit growth. Opportunities on IT side as well.

What is next step on One Beacon in terms of spin out?

Looking at all opportunities but spinout would be taxable so does not add value. But our ownership will depend on market going forward – will WTM have better opportunities elsewhere for capital?

White Mountains Insurance (WTM) - Analyst Day

White Mountains Insurance (WTM) is a publicly traded insurer that does not get a lot of publicity. It is part owned by Berkshire Hathaway and keeps a relatively low profile spending its limited time running its businesses. It has grown tangible book value at a rate of 17% since it IPO'd in 1985. This is an extraordinary achievement as this time period encompassed hard markets, soft markets, high interest rates, low interest rates, inverted yield curves, steep yield curves, flat yield curves, recessions, expansions and management changes.

The company just had its analyst day up in NYC on June 8, which I unfortunately was unable to attend, but due to the wonders of technology I was able to listen to it on a web cast. This may be even better because I could rewind when I had to.

A 17% growth in book value is extraordinary but the real question is - can it continue going forward? There are indications that they can grow book value in the mid teens long term even though the management team admits that the lines they are in are becoming more competitive. Specifically, half its capital is deployed in White Mountains Re where according to management:

"Market has been going sideways or down and will be a real challenge to maintain margins going forward...has been one of our better businesses but the reinsurance business becoming more competitive and will be a challenge to keep it a better business."

So how can they grow book value in this environment? Two reasons come to mind

1) WTM has seen soft markets before and can manage its business well through a down cycle. A question was asked later in the call about whether the company would consider exiting this business as a cycle management strategy - the way it bought One Beacon at a time when this business was out of favor. The response was that in reinsurance there is not a lot of infrastructure to support so rather than sell they could just cut back or stop underwriting new business rather than sell. This affirms the credo of WTM, which is - underwriting comes first.

2) The second reason has to do with time horizon and diversification - 2007 may be tougher for White Mountains Re but they have other parts of the business that are doing well to offset and if management takes a long term view of the reinsurance business, then they will manage through this. If things get tough in reinsurance, other companies will make mistakes and exit and WTM will be there to make strategic purchases at the right price.

WTM is trading at a reasonable price to book relative to its history - $415 of book value for $585. It is not rock bottom cheap and there have been times when it has sold at tangible book value.

I am putting my raw notes from the analyst meeting in another post. They are raw so they may have misspellings and abbreviations and may not capture fully the point management was trying to make but there is so little information out there on this company I figured I would post it.

Disclaimer - I own this stock.

Monday, June 11, 2007

Hedge Fund Activism

It is a fairly common event now for Hedge Funds to "motivate" management to do the "right thing." I do not pass judgement on those who do this type of investing as they have been very successful at this technique. Here is a SEC filing that details the activities that are going on between a company called Building Materials Corporation (BLG) and Chapman Capital, LLC, a West Coast based hedge fund:

Skip to the end and the appendix has the actual e-mail correspondence between the two parties.

Saturday, June 9, 2007

Bexil (BXL) Update

Bexil, one of the stocks selling for less than net current asset value, held a call last month at which it was "to discuss the recent results of the Company and other matters." I had to miss the call as I was out of the office that day, but was expecting the replay to be posted to the Bexil website since they have a conference call archive page on the web site. So I waited and nothing was put up there. I sent an e-mail to John Ramirez who is listed as the contact and received no reply as to the status of the replay. Then a few weeks ago this cryptic message appeared on the site:

"Investment Conference calls May 11, 2007 and November 8, 2006 will not be available due to technical issues."

I am still wary on investing in this stock despite the intuitive appeal of a net-net stock.

Kaiser Group Holdings, Inc. (KGHI.PK)

An update on KGHI - on May 29, 2007 they filed an 8-K announcing that they were postponing the annual meeting at which they would have voted on the reverse split and other issues. The reason they gave was that the proxy materials were "not ready."

Tuesday, June 5, 2007

Private Equity Wisdom

I was listening to the AG Edwards High Yield Conference webcast from May and heard some interesting comments on the Private Equity boom from Joseph Massoud, the CEO of an outfit called Compass Diversified Trust Inc. (CODI). CODI is an investment vehicle that invests in middle market companies. We should all pay attention to his thoughts because they came from someone who has been involved with the industry for years. They are not exact quotes but they capture the spirit of what he was trying to say.

“We think the entire private equity model right now is broken. The whole notion that you would raise half a billion dollars or a billion dollars with a promise that I will invest this money in three years is absurd because you have no idea what yields you’re gonna see or whether they will be attractive or not.”

"We liken it to if you said to my 8 year old son – here is a $100 – go buy good things with it and he came back and said dad I could only find $60 worth of stuff the last thing I would do is send him to his room, but that is specifically where the Private Equity market is now which is LP’s (limited partners) don’t reward GP’s (General Partners) for discipline. LP’s say if you can’t invest it I will find someone who can. It’s a broken model.”

“The only thing more broken than that is the notion that once you buy a company you have to turn around and sell it in three to four years so you can post IRR’s so you can raise your next larger fund, this even more problematic.”

CODI is an interesting company as well and one to keep your eye on. The website is here:

Compass Diversified Trust Inc. (CODI)