Prem Watsa: China Has Biggest Housing Bubble in History

Prem Watsa’s Fairfax Financial Holdings Ltd (TSE:FFH) is out with their 2012 shareholder letter. Prem Watsa covers a variety of topics in the lengthy letter to investors.  One topic mentioned is the vastly different trading environment.  Watsa discusses how the trading environment has changed over the past few years and is now dominated by computers and speculators.

Prem Watsa also has some interesting comments about China. First the verbatim quote:

 In our 2010 and 2011 Annual Reports, we discussed the Chinese bubble in real estate. This past Sunday (March 3,2013), the CBS show “60 Minutes” did a segment on the Chinese residential real estate bubble. They showed vast empty cities with “new towers with no residents, desolate condos and vacant subdivisions uninhabited for miles and miles, and miles and miles of empty apartments.” They called it the biggest housing bubble in history. We agree! The ultimate collapse of this bubble will have major consequences for the world economy.

In the 2011 shareholder letter Prem Watsa states:

As for China, late in 2011 the Chinese bubble in real estate burst. Developers have reduced prices by 25%+ to sell apartments in Shanghai – causing riots by angry buyers who paid full price. Expect apartment prices in China to come down significantly in the next few years. This may result in a hard landing in China, again with major consequences for the world economy.

In the 2010 letter referenced by Prem Watsa he states:

Meanwhile we have concerns over potential bubbles in emerging markets. Consider, for instance, what we learned on a recent trip to China: many house (apartment) prices in Beijing and Shanghai had gone up almost four times – in the past four to five years!; many individuals own multiple apartments as investments with the certain belief that real estate prices can only go up; and maids are taking holidays so that they can buy apartments also.

Watsa has clearly not thrown in the towel on his bearish views regarding China. Jim Chanos has Watsa as an ally in terms of his belief regarding China. Pre Watsa agrees that China has the ultimate housing bubble “in history”. Prem Watsa specifically refers to a recent episode of 60 Minutes regarding Chinese ghost towns which we posted last week. Because of this fear and other reasons Watsa states that Fairfax Financial continues to be fully hedged.

Furthermore, according to a transcript from the company’s earnings call on February 15th 2013, Watsa states:

We continue to be very concerned about the prospects for the financial markets, and the economies of North America and Western Europe, accentuated by potential weakness in China. There appears to be a big disconnect between the financial markets and the underlying economic fundamentals.

For the fiscal year ended 31 December 2012, Fairfax Financial Holdings Ltd (TSE:FFH) revenues increased 7% to $8.02B. Net income applicable to common stockholders totaled $471.9M vs. loss of $6.4M. Revenues reflect Shareof profit (loss) of associates increase from $1.8M to $15M. Net Income reflects Reinsurance – OdysseyRe segment income totaling $394.1M vs. loss of $76.9M, Reinsurance & Insurance other segment income totaling $15.8M vs. loss of $159.3M.

The company’s position in derivatives and similar positions declined during the quarter from a total fair value of the assets standpoint, dropping to $181 million from $238.5 million. On a cost basis, the position was essentially unchanged at $524 million up from $520 million. Equity hedges represented approximately 100.6% of the company’s equity and equity related holdings at the end of the year.

The composition of the equity hedges were mostly unchanged although Fairfax added an $800 million notional equity index total return swap long position during the quarter. During the quarter the credit default swaps position was reduced with notional falling to $1.9 billion from $2.2 billion (a $10 million reduction in cost basis). The CPI-linked positions were increased by about $21 million at cost and an additional $2 billion notional (now at $48 billion).

Although the hedges has cost the company, if Prem Watsa is correct he will save shareholders a great deal of money.

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