May 2007 – Page 3 – The Aleph Blog

Insurance Earnings So Far 1Q07 ? VI

Posted on 2 May 2007 by David Merkel

Looks like Seeking Alpha missed yesterday’s post.? Oh, well.? Onto the tidal wave of earnings:

Life

Assurant beat handily, on higher revenues.? Only the health division lagged. Prudential Insurance beat as well, with its international division leading the way.? UnumProvident beat, showing that its turnaround has legs.? American Equity missed stating that their interest spread margins had shrunk.? That’s a difficult condition to turn around in the short run, particularly given the long duration of the liabilities.? I would stay away.

Personal lines

Twenty-first Century, Erie Indemnity, Infinity Property Casualty, Horace Mann, and Cincinnati Financial all beat, while Kingsway and ALFA both miss.? Infinity reported before Wednesday’s open, and raised guidance; it was up 11% on the day.? Kingsway had to raise reserves, and ALFA had damage from tornadoes down South.

Primary Casualty

Procentury, FPIC, First Mercury, White Mountains, and EMC Insurance beat.? CRM Holdings met estimates.? OneBeacon missed estimates.? In general, it has been a great quarter for long tail insurance writers.? Investment income up, claims low, what more can you ask for?? Premium trends are mixed.? Only FPIC and EMC Insurance wrote less business.

The Bermudans

Both Endurance Specialty and Aspen Holdings beat, and both wrote less business than this time last year.? Endurance had significant claims from European windstorm Kyrill.? Ren Re beat earnings handily Tuesday evening, but the stock went nowhere on Wednesday, given the shrinkage of written premium.? The same may prove true of Endurance and Aspen.

We’re past the halfway point of the earnings season for insurance.? In general, Bermuda and primary casualty are strong.? Life and personal lines are pretty good.? Only mortgage is having any significant difficulties.

Full disclosure: long AIZ ENH

You Can Buy, But You Can’t Sell, And Vice-Versa

Posted on 2 May 2007 by David Merkel

Be sure and check out this article from the Wall Street Journal.? Derivatives being private contracts between two parties, they can’t easily be traded.? To eliminate a position prior to maturity, one can do three things:

Sell it back to the party you bought it from.
Sell an equivalent contract to a third party.
Sell your interest in the contract to a third party.

In situation 1, the exposure goes away, but the negotiation can be tough because they know they are the only ones that can eliminate the exposure in entire.? In situation 2, the exposure goes away, but one still has counterparty risk, in that they have bought and sold the same item to two different parties.? If one party defaults while owing money, the other obligation does not go away.

In situation 3, the exposure goes away if it can be done.? Sometimes the derivatives prohibit such a trade, because they don’t want the possibility of diminished creditworthiness.

So, as the WSJ points out: derivatives, even crdit and equity derivatives can’t be traded like stocks.

A Modest Proposal to Raise Taxes on Mr. Buffett (and me)

Posted on 2 May 2007 by David Merkel

I doubt that it will go anywhere, but there is a proposal on Capitol Hill to tax private equity funds more.? As usual with Congress, we can criticize this from two angles.? The first is that they are creating a discriminatory rule that will create more clever structuring, but not result in significantly more taxes.? Private equity funds might float stubs of their holdings on the public equity markets in order to avoid taxation.? There are other ways they could deal with it as well.

The other criticism is that the proposal is not broad enough.? We need to tax everyone on the appreciation of their assets every year, whether they have sold them or not. Granted, this modest proposal would require a substantially larger IRS, but as for real estate, the Feds could piggyback off of what is done at the state level, with suitable massaging to create comparability.

This would whack the life insurance industry, certain tax-efficient mutual funds, etc.? It would lead to many abandoning their holdings on which they wanted to avoid taking the tax hit.

With the money raised here, the AMT could be easily eliminated.? What’s more, we could lower the top marginal tax rates, still bring in excess revenue.? We could have a flat tax, and the rich would pay a lot more than today.? No more shelters; everyone pays on the increase of their beneficial income, whether they have received it in cash or not.? This would create greater liquidity and volatility in the markets as stock that was locked away comes out for sale to create liquidity for tax payments.

Do I want this system?? If it is part of radical simplification and flattening of the tax code, yes.? Those who benefit from the system would pay their fair share, rich and poor alike.? I might end up paying more, but it would be more equitable.

PS — private businesses would still be difficult to apply this to, but I would tax them on their EBITDA.

Bridging the Accounting GAAP

Posted on 2 May 2007 by David Merkel

When I started this blog, I did not plan on writing so much? about accounting, but I follow the news flow.? It seems like the EU and the US have come to a meeting of the minds in unifying accounting standards.? It looks like the EU gave up the least in the compromise.

Though there are some ways that IFRS are better than GAAP, (more consistent in the way they treat financial assets and liabilities), I think that the change will make accounting slightly more opaque, and lower comparability, until all US firms are forced to use one standard or the other.

I do not look forward to having to study IFRS.

The Global Monetary/Currency Conundrum

Posted on 2 May 20072 May 2007 by David Merkel

Here are the facts to be reconciled:

M3 (or its equivalent) is growing smartly in most major nations around the world year-over-year at present.
Most major central banks are tightening or on hold; few if any are loosening.
The US current account deficit persists, and nations that trade with us continue to buy our bonds.
The US dollar continues to sag slowly against most major currencies.

Here’s the way that I reconcile them. Many of the central banks are not very independent, and so they are under pressure not to let their currencies appreciate versus the dollar. So, they take excess dollar liquidity and buy US bonds, forestalling the problem, because bonds will pay them more dollars in the future. This gives some lift to the dollar, but not enough, because not all central banks are willing to do this, so the US dollar sags slowly.

Because of the excess liquidity, M3 rises, and in response, the foreign central bank tightens monetary policy, but then they undo a large part of it by buying US bonds as a part of their monetary base. It will take many interest rate rises to cool off these economies, or an unwillingness to buy US bonds with their US dollar liquidity.

The Business Week article that I linked to talked about how interest rates rose 1.5% in less than two months when foreigners ceased to lend to the US in early 1987. (This followed a fall in the US dollar in late 1986.) This could happen again, but it will take a large central bank that acknowledges that they have embedded losses on their US bond portfolio not reflected in current prices, and then works to limit their losses by eliminating dollar reserve.
My advice: be aware, and don’t keep all of your bonds in US currency-denominated issues.

Taking a Few Lumps in April

Posted on 1 May 200722 June 2017 by David Merkel

My broad market portfolio did well in absolute terms in April but trailed the S&P 500 for the month by a little; I’m still leading the S&P 500 for the years by a decent margin.? Some of it boiled down to selling ABN Amro too soon, and hanging onto Barclays and Royal Bank of Scotland.? I followed my ordinary valuation rules that have protected me well in the past; they will protect me well in the future as well.? You can’t win them all, but you can reduce risk.? That’s why on Monday, I trimmed my postions in Vishay Intertechnology, Valero, and Bronco Drilling.? They have run; time to trim.

Today’s action in two stocks impressed me: Liz Claiborne, and Fresh Del Monte.? One down a lot, and the other up a lot.? I have owned both in the recent past, and sold them due to over valuation and possible accounting difficulties, respectively.? This is why it’s not wise to pat yourself on the back too much when you miss a mistake by selling early, or kick yourself too hard for missing a winner by selling too soon.? These things happen, and “woulda, coulda, shoulda” just confuses matters.? No one gets out at the top and in at the bottom.? Just do your best, and follow your plan.? Nothing will ever be optimal, but things can often be very good.

Full disclosure: long VLO, VSH, BRNC, BCS, RBSPF

Insurance Earnings So Far 1Q07 ? V

Posted on 1 May 2007 by David Merkel

When I started writing this series, I did not think that I was starting to write a series, but it seems that I have done so.? Since this is percolating out to a number of media outlets, let me simply ask that if you find this valuable, email me, or post a comment on my blog.? I will continue this series through the end of first quarter earnings, but with demand, I would do this next quarter, assuming that I am not swamped.? On to the earnings:

Life

At last the big dogs of this sub-industry begin to report.? I mentioned about the disappointments from Genworth and Principal yesterday, well, they got whacked in Tuesday’s trading, as did Sun Life, which met estimates, but they decided to eliminate their Clarica brand, which presumably will reduce some future revenues.? On the other hand, the buy side may simply have gotten ahead of the sell side.

After the close today, both MetLife and Lincoln National beat estimates.? I reviewed them in detail, and I couldn’t find much to quibble with.? MetLife’s International division did especially well.

Primary Commercial

Markel beat handily after the close, with a rising top line as well.? Two of the companies? beating the estimates yesterday soared — Hanover Group and Ohio Casualty.? National Interstate missed estimates after the close due to a higher than expected expense ratio.

Personal Lines

Safeco beat estimates by a tiny bit, but it looks like the buyside was looking for more.? Given the incredible performance of the stock over the past twelve months, it was just a matter of time before a pullback would happen.? I still think Safeco is overvalued versus peers, even after the fall in price.

The Bermudans

Ren Re beats the estimate by a wide margin, but on a lower earned premium year-over-year.? I suspect the stock moves up, but the questioning on the conference call should be interesting as they flesh out the strategy of management.

Here’s my quick summary of the sectors then: in general, primary commercial, and P&C reinsurance (the Bermudans) have done well.? (Amazing what you can do when there are few catastrophes, or negative legal trends.)? Personal lines, title, and life are mixed bags, but generally positive.? Mortgage has had problems, and I expect that the problems will persist for at least a few quarters.

Full disclosure: long MET and LNC