DBRS Confirms Fairfax Financial at BBB after Announced Purchase of Brit PLC, Trend Remains Stable

DBRS Limited (DBRS) has today confirmed the Issuer Rating and Senior Unsecured Debt of Fairfax Financial Holdings Limited (Fairfax) at BBB and the Company’s Preferred Shares at Pfd-3. The trends on all ratings remain Stable. The Senior Unsecured Notes of Fairfax (US) Inc. are guaranteed by Fairfax Financial Holdings Limited. This rating action follows the announcement that Fairfax has agreed to purchase Brit PLC (Brit) for $1.88 billion, a premium of 11.2% per share. Fairfax has obtained a sales agreement with approximately 73% of the voting shares of Brit. The transaction is expected to close in Q2 2015, subject to customary conditions, including regulatory approvals. As a Lloyd’s of London (Lloyd’s) insurer, Brit focuses on global specialty insurance and reinsurance and is the eighth-largest Lloyd’s insurer with a written premium capacity of GBP 1.0 billion as of July 2014.

The rating action reflects DBRS’s view that the purchase is consistent with Fairfax’s strategy of extending its franchise globally through opportunistic investments whereby it acquires businesses with demonstrated underwriting discipline that add to its existing franchise. Fairfax engages in property and casualty insurance, reinsurance and investment management. Brit focuses on property casualty (62% of premium) combined with complex specialty insurance lines such as marine, energy and terrorism risks. DBRS anticipates that the acquisition will help both Fairfax and Brit to expand globally. Fairfax is expected to benefit from the significant expansion in the specialty insurance markets, an enhanced distribution network and Brit’s underwriting skills in specialty insurance. Brit is expected to benefit from the greater scale of the combined companies in the Lloyd’s market, Fairfax’s franchise network presence and Fairfax’s resources, including Fairfax’s strong investment record. Pro forma, the purchase would result in Fairfax strengthening its position in the Lloyd’s market as it is expected to become the fifth-largest insurer with a premium capacity exceeding GBP 1.3 billion as of 2015, which is likely to enhance Fairfax’s ability to manage pricing and to facilitate greater lead opportunities in arranging deal terms.

The friendly nature of the purchase is an important feature from DBRS’s perspective, as the strong support of Brit’s management is likely to ease any transitional challenges and ensure the retention of management. Brit’s management is reported to value Fairfax’s decentralized operating approach. Fairfax places a high reliance on local management to manage their businesses prudently, but manages the investment portfolios of its subsidiaries centrally. This decentralized structure has allowed Fairfax to grow by acquisition globally and to take advantage of profitable niches held by existing businesses. In addition, Brit is likely to benefit from Fairfax’s strong investment record. Over the long term, Fairfax has generally achieved strong results on the investment portfolios it manages for its insurance subsidiaries.

While Brit adds diversification to Fairfax’s insurance risk profile, it also adds significantly to Fairfax’s exposure to insurance lines with less predictable risks. Tempering this additional risk is Brit’s strong underwriting track record as indicated by Brit’s success in maintaining a solid combined ratio. This ratio was 88% as at June 30, 2014, and has been below 100% for nine of the last ten years. DBRS therefore deems it important that Fairfax successfully retain Brit’s underwriting expertise during the transition.

DBRS anticipates that Fairfax’s proposed financing mix will maintain or increase the leverage ratio only slightly and it will remain at an acceptable level given the rating. Fairfax has announced its intention to finance the transaction with excess capital, debt, equity and preferred shares. On February 20, 2015, Fairfax launched bought deals for CAD 650 million in equity financing, CAD 200 million in preferred shares and CAD 300 million in senior debt, all of which may be increased with over-allotment options. Fairfax also expects to continue with its policy of keeping a minimum of $1.0 billion in cash at the parent holding company. If the actual mix of financing results in a material increase in leverage, DBRS will consider any impact on the rating; however, Fairfax has announced and is in the process of implementing its financing plans. DBRS has confidence in Fairfax’s capital strength, liquidity at the holding company to fund any immediate capital needs of a subsidiary as well as Fairfax’s and Brit’s disciplined underwriting records, positive reserve developments and strong earnings in the face of a slow premium growth environment.

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

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

The applicable methodologies are Rating Companies in the Canadian Property and Casualty Insurance Industry (January 2015), Preferred Share and Hybrid Criteria for Corporate Issuers (January 2015), Rating Holding Companies and Their Subsidiaries (January 2015) and DBRS Criteria: Guarantees and Other Forms of Explicit Support (February 2015), which can be found on our website under Methodologies.