September 23, 2009
BY EDGAR
Securities and Exchange Commission
Division of Corporation Finance
450 Fifth Street, N.W. Mail Stop 6010
Washington, D.C. 20549
Division of Corporation Finance
450 Fifth Street, N.W. Mail Stop 6010
Washington, D.C. 20549
| Attention: | Mr. Jim B. Rosenberg, Senior Assistant Chief Accountant Mr. Don Abbott, Senior Staff Accountant Mr. Frank Wyman, Staff Accountant |
| Re: | Fairfax Financial Holdings Limited (“Fairfax”) Form 40-F for the Fiscal Year Ended December 31, 2008 Filed March 6, 2009 File No. 1-31556 |
Dear Sirs/Mesdames:
We hereby acknowledge receipt of the comment letter dated September 9, 2009 (the “Comment Letter”)
from the staff of the Division of Corporation Finance (the “Staff”) of the Securities and Exchange
Commission (the “Commission”) concerning the above captioned Form 40-F (the “Form 40-F”). We
submit this letter in response to the Comment Letter. For ease of reference, we have reproduced
the text of the comments in bold-faced type below, followed by Fairfax’s responses. The responses
to each of the comments are set forth in numbered paragraphs that correspond to the numbers of the
Staff comments. Page number references herein refer to the page numbers of the Fairfax 2008 Annual
Report appearing as Exhibits 2 and 3 of the Form 40-F, unless otherwise noted. Terms used but not
defined herein have the meanings set forth in the Form 40-F. Fairfax (sometimes herein called “the
Company”) intends to include the revised disclosure contemplated subsequently in this letter with
respect to financial periods covered by its reports on Form 40-F and Form 6-K, as applicable,
beginning with the Company’s Interim Report filed on Form 6-K for the period ending September 30,
2009 and its Annual Report filed on Form 40-F for the fiscal year ending December 31, 2009.
For purposes of clarity in reading the following responses and commentary, the reader is advised
that the Company has accounted for all of its credit default swap contracts and total return swap
contracts under Canadian and US GAAP as freestanding derivatives carried at fair value on the
consolidated balance sheets, with changes in fair value recorded in net gains (losses) on
investments in the consolidated statements of net
earnings. Accordingly, as the Company has not applied hedge accounting as contemplated in the
Canadian and US GAAP accounting pronouncements to any of its derivative contracts, all references
to hedging activities in the responses which follow refer solely to economic hedging activities.
Form 40-F for fiscal year ended December 31, 2008
18. Financial Risk Management, page 60
| 1. | Please refer to prior comments three, four and six. Please revise your disclosure to explain how you revised the financial objectives of your hedging programs given market conditions and the impact of your sales and close out transactions in 2008 in order to effectively manage the Company’s future credit risk and market risk. | |
| Response 1: Beginning with the consolidated financial statements included in the Company’s Interim Report filed on Form 6-K for the period ending September 30, 2009 and in the Company’s Annual Report filed on Form 40-F for the fiscal year ending December 31, 2009, the Company will include a discussion of the financial objectives of the Company’s hedging programs intended to manage future credit risk and market risk. See Appendices 1 and 2 for pro forma presentations of the Company’s proposed revised note disclosures based upon the results reported for the fiscal year ended December 31, 2008. |
Exhibit 3
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Components of Net Earnings
Net gains on investments, page 111
Net gains on investments, page 111
| 2. | Please refer to prior comments eight and nine. We acknowledge the information provided in your responses, particularly how you employ derivative instruments to mitigate financial risks arising principally from your investment holdings and balances recoverable from reinsurers. The impact of these derivative instruments and related hedged items, as presented in Notes 3 and 4 of your financial statements, appears to have been summarized in Appendix 1 of your response. Please disclose this summarized information in future filings along with an explanation quantifying the effects that the key factors of your hedging programs had on the Company’s financial position, results of operations and cash flows as of and for each period presented. | |
| Response 2: Beginning with the consolidated financial statements included in the Company’s Interim Report filed on Form 6-K for the period ending September 30, 2009 and in the Company’s Annual Report filed on Form 40-F for the fiscal year ending December 31, 2009, the Company will include tables summarizing the impact of derivative instruments and related hedged items along with an explanation |
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| quantifying the effects that the key factors of the Company’s hedging program had on the Company’s financial position, results of operations and cash flows as of and for each period presented. See Appendices 1 and 2 for a pro forma presentation of the Company’s proposed revised note disclosures based upon the results reported for the fiscal year ended December 31, 2008. The Company has determined that the disclosures described in the Staff’s comment closely resemble the disclosure requirements of Statement of Financial Accounting Standards No. 161, Disclosures about Derivative Instruments and Hedging Activities — an Amendment of FASB Statement No. 133 (“SFAS 161”) which the company adopted on January 1, 2009. Therefore, in accordance with SFAS 161, the Company intends to make these disclosure revisions in its consolidated financial statements rather than in its Management’s Discussion and Analysis of Financial Condition and Results of Operations. |
| 3. | You assert in your responses to comments 3, 4 and 7 that it is not possible to “definitively quantify” how your derivative instruments and related hedged items are expected to affect your future financial position, results of operations and cash flows. Please revise your MD&A to describe and quantify the “reasonably likely” future impact of your hedging programs. Otherwise, disclose the risks, data limitations, market uncertainties or other factors that prohibit you from providing this information. | |
| Response 3: Beginning with the Management’s Discussion and Analysis of Financial Condition and Results of Operations included in the Company’s Interim Report filed on Form 6-K for the period ending September 30, 2009 and in the Company’s Annual Report filed on Form 40-F for the fiscal year ending December 31, 2009, the Company will include an explanation as to why it is not possible to quantify the “reasonably likely” future impact of the company’s hedging programs as it pertains to managing credit risk. As a result of the Company having discontinued its equity hedges in 2008, it will not be possible to describe and quantify the future impact of equity market price risk hedging programs. See Appendix 3 for a pro forma presentation of the Company’s proposed revised disclosure related to credit risk management based upon the results reported for the fiscal year ended December 31, 2008. | ||
| As a result of the Company having discontinued its equity hedging program in the fourth quarter of 2008, the Company is unable to disclose the “reasonably likely” future impact of the Company’s hedging programs as it pertains to managing equity market price risk, however the Company will describe the risk management strategies it intends to follow in the future. Should the Company undertake any new hedging activities related to its equity risk exposure, the Company will determine the extent to which it is possible to quantify the future impact of such a hedging strategy and will undertake to satisfy the requirement to disclose this quantification. Beginning with the consolidated financial statements included in the Company’s Interim Report filed on Form 6-K for the period ending September 30, 2009 and in the Company’s Annual Report filed on Form 40-F for the fiscal year ending December 31, 2009, the Company will include disclosure highlighting the discontinuation of the Company’s equity hedging program in the fourth quarter of 2008 and the risk management |
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| strategies it intends to follow in the future. See Appendix 2 for a pro forma presentation of the Company’s proposed revised disclosure related to equity risk management based upon the results reported for the fiscal year ended December 31, 2008. | ||
| 4. | Please refer to prior comment 11. We acknowledge the information provided in your response. Please confirm to us that you will incorporate this information in future filings. | |
| Response 4: Beginning with the Management’s Discussion and Analysis of Financial Condition and Results of Operations included in the Company’s Interim Report filed on Form 6-K for the period ending September 30, 2009 and in the Company’s Annual Report filed on Form 40-F for the fiscal year ending December 31, 2009, the Company will include disclosure of the material terms of its credit default swap contracts, including the identity of counterparties to these transactions, the specific covered financial risks, the defined credit events and collateral posting requirements, as well as the nature of events and conditions that trigger them. See Appendix 3 for a pro forma presentation of the Company’s proposed revised disclosure based upon the results reported for the fiscal year ended December 31, 2008. |
* * * * * * * * * * * * * * * *
The Company acknowledges that: (i) the Company is responsible for the adequacy and accuracy of the
disclosure in the Form 40-F; (ii) Staff comments or changes to disclosure in response to Staff
comments do not foreclose the Commission from taking any action with respect to the Form 40-F; and
(iii) the Company may not assert Staff comments as a defense in any proceeding initiated by the
Commission or any person under the federal securities laws of the United States.
We appreciate your assistance in reviewing this response letter. Please direct all questions or
comments regarding this filing to the undersigned at (416) 367-4941 or g_taylor@fairfax.ca.
Yours very truly,
Greg Taylor
Vice President and Chief Financial Officer
Vice President and Chief Financial Officer
| cc: | V. Prem Watsa, Chairman and Chief Executive Officer, Fairfax Financial Holdings Limited Bruce Winter, Partner PricewaterhouseCoopers LLP |
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Appendix 1
Fairfax Financial Holdings Limited
Response to SEC Comment Letter of September 9, 2009
Response to SEC Comment Letter of September 9, 2009
Pro forma Disclosure Revision — Revised financial objectives of hedging programs
The following is a pro forma presentation of information disclosed in notes to the
consolidated financial statements of Fairfax Financial Holdings Limited (the “Company”) relating to
its credit risk hedging activities as reported in the Company’s Annual Report filed on Form 40-F
for the fiscal year ended December 31, 2008. This disclosure will be included in notes to
financial statements included in its Interim Report filed on Form 6-K for periods ending on or
after September 30, 2009 and in its Annual Report filed on Form 40-F for fiscal years ending on or
after December 31, 2009:
18. Financial Risk Management — Credit Risk, page 61
Credit risk is the risk that one party to a financial instrument fails to discharge an obligation
and thereby causes financial loss to another party. The company’s exposure to credit risk is
concentrated in two specific areas: investment assets and underwriting and operating balances,
including on balances recoverable and receivable from reinsurers on ceded losses (including ceded
incurred losses, ceded paid losses and ceded unearned premiums) and accounts receivable.
The aggregate gross credit risk exposure at December 31, 2008 (without taking into account amounts
pledged to and held by the company as collateral of $1,307.1 (2007 — $2,358.5)) was $21,366.0
(2007 — $23,699.6) and was comprised as follows:
| December 31, | ||||||||
| 2008 | 2007 | |||||||
Gross recoverable from reinsurers |
4,234.2 | 5,038.5 | ||||||
Bonds |
||||||||
U.S., Canadian and other government |
2,441.8 | 8,374.1 | ||||||
Corporate and other and U.S. states and municipalities |
6,212.8 | 2,138.2 | ||||||
Derivatives (primarily credit default swaps) |
455.5 | 1,213.4 | ||||||
Accounts receivable |
1,688.7 | 1,906.9 | ||||||
Cash and short term investments |
6,333.0 | 5,028.5 | ||||||
Total gross exposure |
21,366.0 | 23,699.6 | ||||||
Since 2003, the company has used credit default swap contracts referenced to various issuers in the
banking, mortgage and insurance sectors of the financial services industry as an economic hedge of
risks affecting specific financial assets (recoverables from reinsurers), exposures potentially
affecting the fair value of the company’s fixed income portfolio (principally investments in fixed
income securities classified as corporate and other and U.S. states and municipalities in the
company’s consolidated financial statements) and of broader systemic risk. The company’s holdings
of credit default swap contracts have declined significantly in 2009 relative to prior years,
largely as a result of significant sales in 2008. In the latter part of 2008, the company revised
the financial objectives of its hedging program by determining not to replace its credit default
swap hedge position as
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sales or expiries occurred based on the significant increase in the cost of purchasing credit
protection (reducing the attractiveness of the credit default swap contract as a hedging
instrument), the fact that the company’s capital and liquidity had benefited significantly from
more than $2.4 billion in cash proceeds of sales of credit default swaps realized since 2007, and
the company’s judgment that its exposure to elevated levels of credit risk had moderated and that
as a result the company had made the determination that its historical approaches to managing
credit risk (as described below) were once again satisfactory as a means of mitigating the
company’s exposure to credit risk arising from its exposure to financial assets. As a result, the
effects that credit default swaps as hedging instruments may be expected to have on the company’s
future financial position, liquidity and operating results may be expected to diminish
significantly relative to the effects in recent years. The company may initiate new credit default
swap contracts as an effective hedging mechanism in the future, but there can be no assurance that
it will do so.
The table that follows summarizes the pre-tax impact on the company’s consolidated statement of
comprehensive income of the company’s risk management program to mitigate credit risk:
| December 31, | ||||||||
| 2008 | 2007 | |||||||
| ($ millions) | ||||||||
Net gains on credit default swap contracts |
1,290.5 | 1,145.0 | ||||||
Net gains on bonds — corporate and other and U.S.
states and municipalities |
(359.4 | ) | 10.2 | |||||
Change in unrealized gains on bonds — available
for sale corporate and other and U.S. states and
municipalities |
(32.2 | ) | (57.0 | ) | ||||
Other than temporary impairments recorded on bonds |
(29.1 | ) | (15.0 | ) | ||||
Credit losses recorded on reinsurance recoverable |
(15.0 | ) | (46.2 | ) | ||||
Investments in Debt Instruments
The company’s risk management strategy is to invest primarily in debt instruments of high credit
quality issuers and to limit the amount of credit exposure with respect to any one issuer. While
the company reviews third party ratings, it carries out its own analysis and does not delegate the
credit decision to rating agencies. The company endeavours to limit credit exposure by imposing
fixed income portfolio limits on individual corporate issuers and limits based on credit quality
and may, from time to time, invest in credit default swaps to further mitigate credit risk
exposure.
The following table presents the composition of the company’s fixed income portfolio classified
according to the higher of each security’s respective S&P and Moody’s issuer credit ratings.
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| December 31, 2008 | December 31, 2007 | |||||||||||||||
| Carrying | Carrying | |||||||||||||||
| Issuer Credit Rating | value | % | value | % | ||||||||||||
AAA |
6,512.5 | 75.2 | 8,814.3 | 83.8 | ||||||||||||
AA |
1,377.8 | 15.9 | 1,401.0 | 13.3 | ||||||||||||
A |
194.9 | 2.3 | 1.4 | 0.0 | ||||||||||||
BBB |
2.1 | 0.0 | 146.1 | 1.4 | ||||||||||||
BB |
10.0 | 0.1 | 18.3 | 0.2 | ||||||||||||
B |
232.0 | 2.7 | 39.1 | 0.4 | ||||||||||||
Lower than B and unrated |
325.3 | 3.8 | 92.1 | 0.9 | ||||||||||||
Total |
8,654.6 | 100.0 | 10,512.3 | 100.0 | ||||||||||||
At December 31, 2008, 93.4% (2007 — 98.5%) of the fixed income portfolio at carrying value was
rated investment grade, with 91.1% (2007 — 97.1%) (primarily consisting of government obligations)
being rated AA or better. As of December 31, 2008, holdings of fixed income securities in the ten
issuers (excluding federal governments) to which the company had the greatest exposure was
$2,619.4, which was approximately 13.1% of the total investment portfolio. The exposure to the
largest single issuer of corporate bonds held as of December 31, 2008 was $321.1, which was
approximately 1.6% of the total investment portfolio.
The consolidated investment portfolio included $4.1 billion in U.S. state, municipal and other
tax-exempt bonds, almost all of which were purchased during 2008. Of the $4.0 billion held in the
subsidiary investment portfolios at December 31, 2008, approximately $3.5 billion were fully
insured by Berkshire Hathaway Assurance Corp. for the payment of interest and principal in the
event of issuer default; the company believes that that insurance significantly mitigates the
credit risk associated with these bonds.
Subsidiary portfolio investments and holding company investments included $415.0 (2007 — $1,119.1)
at fair value of credit default swaps (with a remaining average life of approximately 3.3 years
(2007 — 4.0 years)) referenced to various issuers in the banking, mortgage and insurance sectors of
the financial services industry, which served as an economic hedge against declines in the fair
value of the company’s financial assets as described previously. The company endeavours to limit
counterparty risk through the terms of agreements negotiated with the counterparties to its total
return swap and credit default swap contracts, pursuant to which the counterparties to these
transactions are contractually required to deposit cash or government securities in collateral
accounts for the benefit of the company in amounts related to the then current fair value of the
total return and credit default swaps. The fair value of this collateral at December 31, 2008, all
of which consists of government securities, is $285.1 (2007 — $886.0), $107.6 of which (2007 — nil)
the company has the right to sell or repledge, and $177.5 (2007 — $886.0) of which the company does
not have the right to sell or repledge.
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Appendix 2
Fairfax Financial Holdings Limited
Response to SEC Comment Letter of September 9, 2009
Response to SEC Comment Letter of September 9, 2009
Pro forma Disclosure Revision — Revised financial objectives of hedging programs
The following paragraph is a pro forma presentation of information disclosed in notes to the
consolidated financial statements of Fairfax Financial Holdings Limited (the “Company”) relating to
its market price risk hedging activities as reported in the Company’s Annual Report filed on Form
40-F for the fiscal year ended December 31, 2008. This disclosure will be included in notes to
financial statements included in its Interim Report filed on Form 6-K for periods ending on or
after September 30, 2009 and in its Annual Report filed on Form 40-F for fiscal years ending on or
after December 31, 2009:
18. Financial Risk Management — Market Price Fluctuations, page 65
Market Price Fluctuations
The company’s investment portfolios are managed with a long term, value-oriented investment
philosophy emphasizing downside protection. The company has policies to limit and monitor its
individual issuer exposures and aggregate equity exposure. Aggregate exposure to single issuers
and total equity positions are monitored at the subsidiary level and in aggregate at the company
level.
During much of 2008 and immediately preceding years, the company had been concerned with the
valuation level of worldwide equity markets, uncertainty resulting from credit issues in the United
States and global economic conditions. As protection against a decline in equity markets, the
company had held short positions effected by way of equity index-based exchange-traded securities
including the SPDRs, U.S. listed common stocks, equity total return swaps and equity index total
return swaps, referred to in the aggregate as the company’s equity hedges. The company had
purchased short term S&P 500 index call options to limit the potential loss on U.S. equity index
total return swaps and the SPDRs short positions and to provide general protection against the
short position in common stocks. In November 2008, following significant declines in global equity
markets, the company revised the financial objectives of its hedging program on the basis of its
assessment that elevated risks in the global equity markets had moderated and subsequently closed
substantially all of its equity hedge positions. During the remainder of the fourth quarter of
2008, the company significantly increased its investments in equities as a result of the
opportunities presented by significant declines in valuations. In the absence of the company’s
equity hedges, the company will continue to manage its exposure to market price fluctuations
through policies designed to monitor and limit its individual issuer exposures and aggregate equity
exposure as described previously. The company may initiate new total return swap contracts as an
effective hedging mechanism in the future, but there can be no assurance that it will do so. As at
December 31, 2008, the company had aggregate equity holdings with fair value of $4,816.5 (common
stocks of $4,241.2 plus investments,
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at equity of $575.3). As at December 31, 2007, the company had aggregate equity holdings with fair
value of $3,338.2 (common stocks of $2,852.5 plus investments, at equity of $485.7) and had short
positions in the form of SPDRs, common stocks and total return swaps with an aggregate fair value
and notional amount of $2,856.9 (as described in note 4), representing 85.6% of the company’s
aggregate equity holdings. In addition, the company held S&P 500 index call options with a
notional amount of $2,480.0 to limit the potential loss on short equity positions as at
December 31, 2007.
The table that follows summarizes the pre-tax impact on the company’s consolidated statement of
comprehensive income of the company’s risk management program to mitigate market price risk:
| December 31, | ||||||||
| 2008 | 2007 | |||||||
| ($ millions) | ||||||||
Net gains on common stock and equity index short
positions (including equity index call options) |
2,079.6 | 143.0 | ||||||
Net realized gains on common stocks |
20.6 | 140.5 | ||||||
Change in net unrealized gains on common stocks —
available for sale |
(499.3 | ) | 50.5 | |||||
Other than temporary impairments recorded on common stocks |
(966.4 | ) | (87.3 | ) | ||||
The table that follows summarizes the potential impact of a 10% change in the company’s equity and
equity-related holdings (including equity hedges where appropriate) on the company’s pre-tax other
comprehensive income and pre-tax net income for the years ended December 31. Certain shortcomings
are inherent in the method of analysis presented, as the analysis is based on the assumptions that
the equity and equity-related holdings had increased/decreased by 10% with all other variables held
constant and that all the company’s equity and equity-related instruments move according to a
one-to-one correlation with global equity markets.
| 2008 | 2007 | |||||||||||||||
| Effect on other | Effect on | Effect on other | Effect on | |||||||||||||
| comprehensive income | net income | comprehensive income | net income | |||||||||||||
| Change in global equity markets | (pre-tax) | (pre-tax) | (pre-tax) | (pre-tax) | ||||||||||||
10% increase |
398.3 | 8.1 | 285.3 | (285.7 | ) | |||||||||||
10% decrease |
(398.3 | ) | (8.1 | ) | (285.3 | ) | 285.7 | |||||||||
Generally, a 10% decline in global equity markets would decrease the value of the company’s equity
investment holdings resulting in decreases, in the company’s pre-tax other comprehensive income as
the majority of the company’s equity investment holdings are classified as available for sale.
Conversely, a 10% increase in global equity markets would generally increase the value of the
company’s equity investment holdings resulting in increases in the company’s pre-tax other
comprehensive income. For the year ended December 31, 2007, the effect of changes in global equity
markets on pre-tax other comprehensive income was substantially offset by the effect on pre-tax net
income indicative of the company’s equity hedges effected primarily through positions in
derivatives and securities sold but not yet purchased where changes in realized and unrealized
gains and losses are recognized in the consolidated statement of earnings.
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As of December 31, 2008, the company’s equity related holdings in the ten issuers to which the
company had the greatest exposure was $2,465.9 which was approximately 12.4% of the total
investment portfolio. The exposure to the largest single issuer of equity related holdings held as
of December 31, 2008 was $453.4 which was approximately 2.3% of the total investment portfolio.
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Appendix 3
Fairfax Financial Holdings Limited
Response to SEC Comment Letter of September 9, 2009
Response to SEC Comment Letter of September 9, 2009
Pro forma Disclosure Revision — Revised financial objectives of hedging programs
The following paragraph is a pro forma presentation of information disclosed in Management’s
Discussion and Analysis of Financial Condition and Results of Operations of Fairfax Financial
Holdings Limited (the “Company”) relating to disclosure of the material terms of the Company’s
credit default swap contracts, including the identity of counterparties to these transactions, the
specific covered financial risks, the defined credit events and collateral posting requirements, as
well as the nature of events and conditions that trigger them as reported in the Company’s Annual
Report filed on Form 40-F for the fiscal year ended December 31, 2008. This disclosure will be
included in Management’s Discussion and Analysis of Financial Condition and Results of Operations
included in its Interim Report filed on Form 6-K for periods ending on or after September 30, 2009
and in its Annual Report filed on Form 40-F for fiscal years ending on or after December 31, 2009:
Exhibit 3
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Components of Net Earnings
Net gains on investments, page 111
Net gains on investments, page 111
The purchased credit protection positions held by the company at December 31, 2008 comprised a
diversified portfolio of industry-standard credit default swap contracts referenced to
approximately two dozen entities in the global financial services industry. At the inception of a
purchase of credit protection in the form of a credit default swap (or in very limited instances,
at regular intervals during the term of the credit default swap contract), the company paid a cash
premium to the counterparty for the right to recover any decrease in value of the underlying debt
security that resulted from a credit event related to the referenced issuer for a period ranging
from five to seven years from the contract’s inception. The credit events, as defined by the
respective credit default swap contracts establishing the rights to recover amounts from the
counterparties, are comprised of ISDA standard credit events which are: bankruptcy, obligation
acceleration, obligation default, failure to pay, repudiation/moratorium and restructuring. All
credit default swap contracts held at December 31, 2008 have been entered into with Citibank,
Deutsche Bank AG, Barclays Bank PLC or the Bank of Montreal as the counterparty, with contracts
referenced to certain issuers held with more than one of these counterparties. As the company’s
only exposure to loss on these contracts stems from the initial premium paid in cash to enter into
the contract at inception, there are no requirements for the company to post collateral with
respect to these
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contracts. With the exception of the Bank of Montreal (with which the company has placed only one
small contract), the bank counterparties are required to post government debt securities as
collateral in support of their total obligation owed to the company for all credit default swap
contracts outstanding once such total obligation, aggregated for all contracts with that
counterparty, exceeds a threshold amount (except for Citibank where there was no threshold), as
defined in the individual master agreements with each counterparty.
The credit default swaps are extremely volatile, with the result that their market value and their
liquidity may vary dramatically either up or down in short periods, and their ultimate value will
therefore only be known upon their disposition. The timing and amount of changes in fair value of
fixed income securities and recoverable from reinsurers are by their nature uncertain. As a result
of these data limitations and market uncertainties, it is not possible to estimate the reasonably
likely future impact of the company’s economic hedging programs related to credit risk.
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