DBRS Confirms Fairfax at BBB (low), Changes Trend to Positive

DBRS is today confirming the BBB (low) rating on the Senior Unsecured Debt of Fairfax Financial Holdings Limited (Fairfax or the Company) and changing the trend to Positive from Stable. DBRS is also assigning a Preferred Shares rating of Pfd-3 (low) with a Positive trend. The Positive trend reflects the Company’s enhanced financial flexibility following its strong earnings performance in 2008 and 2007 largely related to strong investment performance and reasonable underwriting results, the retention of close to $900 million in holding company cash and marketable securities at June 30, 2009, and, through the recent purchases of the outstanding minority interests in its major operating subsidiaries, access to an estimated annual operating cash flow of close to $1 billion. This enhanced financial flexibility was recently demonstrated with the Company’s ability to raise CAD 400 million in term debt financing and $1 billion in common share financing in an otherwise cautious market.

The Company’s capitalization has become increasingly conservative, following an earlier period when elevated financial leverage ratios captured both the impact of debt financing of acquisitions and subsequent financial and operating difficulties with certain of these acquired operations. Consolidated and unconsolidated debt ratios are just above 25% and 17%, respectively, having been as high as 45% and 41% in 2005. This improvement has been achieved by a $500 million reduction in holding company debt and an almost $2.3 billion increase in equity capital, primarily in the form of retained earnings over the same period. Double leverage, which had approached 150% in 2005, has been reduced to 105%, which is acceptable.

The Company has recently increased its holding company cash and marketable securities to a level close to $1 billion, which would be available to fund any unforeseen capital requirements at the operating companies, strategic acquisitions and opportunistic share buybacks. Net of holding company cash and marketable securities, the Company’s consolidated debt ratio is just 15%, a reduction from close to 40% in 2005; the unconsolidated debt ratio is just 5.4%, reduced from 32%. The recently completed CAD 400 million debt issue and $1 billion equity issue will have only a small adverse net impact on the Company’s capitalization ratios, mitigated substantially by the enhanced financial flexibility resulting from having no minority interest claims on the earnings and cash flows from its major operating subsidiaries.

The Company’s Run-off book, which had been an earlier source of concern to DBRS as net adverse reserve development continued to be experienced in prior years, is shrinking in line with expectations. While underwriting results in the Run-off segment are expected to continue to be negative given the absence of earned premium, reduced expenses and strong investment earnings are expected to support Run-off results going forward. While reduced investment income is likely to erode some of this positive performance in the future, the existing Run-off block is unlikely to have a significant negative impact on the Company in the future.

Current underwriting results are not strong, reflecting the current softness in commercial insurance markets and the effects of higher catastrophe losses on underwriting results in 2008. When adjusting for non-recurring catastrophe losses and a commutation of a reinsurance agreement at Crum & Forster (Crum), the 2008 consolidated underwriting result was positive and largely in line with industry results. However, Fairfax continues to be more exposed than some of its Canadian peer group to large catastrophe losses due to its reinsurance exposure through Odyssey Re.

While DBRS acknowledges that large investment gains over the past two years resulted from a unique set of factors and portfolio responses, such results are nevertheless consistent with the Company’s long-term investment horizon and deep-value strategy, which has resulted in consistent outperformance. The repositioned investment portfolio should allow Fairfax to benefit from having bought portfolio assets such as corporate and municipal bonds and returned to long equity positions at close to the recent market lows. The Company remains focused on prudent and profitable underwriting as demonstrated in the relatively strong underwriting results of its major operating subsidiaries, although such results are always subject to the inherent risks and cyclicality associated with operating in the global general insurance and reinsurance industry, which will inevitably limit any upside on the current ratings. In addition, DBRS is confident that the Company has successfully emerged from the financial stresses imposed by earlier acquisitions and adverse reserve development in the Runoff book.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The applicable methodology is Rating Canadian Property and Casualty Insurance Companies.

This is a Corporate (Financial Institutions) rating.