Fitch Takes Fairfax Off Credit Watch; Affirms Ratings

September 26, 2005

Fitch Ratings announced that it has affirmed the ratings of Canada’s Fairfax Financial Holdings, Ltd. with a stable out look, and has removed the ratings from its negative credit watch.

“The rating action reflects perceived improvements in Fairfax’s overall financial profile, and Fitch’s belief that the company has likely ‘turned the corner’ in its recovery following a sharp decline in credit fundamentals beginning in the late 1990s,” said the announcement.

Fitch also “affirmed and/or upgraded the ratings of Fairfax’s wholly and partially owned subsidiaries. Upgraded ratings include the Insurer Financial Strength (IFS) ratings of members of the Northbridge Group, and the debt ratings of Crum & Forster Holdings and TIG Holdings Inc. (TIG). Fitch also assigned debt ratings to Odyssey Re Holdings Corp. The Rating Outlook for all affiliated ratings is Stable. A full list of all ratings can be found below. Approximately $2.6 billion of debt is affected by these actions.”

Fitch cited improving operational cash flows, increased financial flexibility, earnings improvements and an increased stability in the Group’s operations as positive factors supporting the ratings action.

Signs of recent improvements noted by Fitch included “Fairfax’s ability to unlock over $600 million of funds previously held in trust at the request of the California Insurance Department at runoff company TIG, the ability to upstream dividends from Crum & Forster beginning in 2004, a restructuring of debt to reduce maturities over the next five years, and the need to no longer fund premiums on existing finite reinsurance contracts.” Fitch also said it “believes the risk of further major reserving shortfalls is lower than in the recent past.”

Increased financial flexibility comprises “successful capital market activities, including equity raising at the Fairfax level and debt issuance at the subsidiary level, the successful partial IPOs of subsidiaries Odyssey Re and Northbridge, the sale of shares in strategic investments such as Zenith Insurance, and tapping subsidiaries for cash via ‘arm’s length’ transactions.”

Fitch said: “Fairfax’s earnings are bi-polar in nature, and thus hard to predict, though Fitch believes consolidated earnings trends will likely continue to improve. However, despite improvements, operating earnings remain very weak, and Fitch believes it will take Fairfax several more years to show reasonable consolidated operating margins. On one hand, Fairfax produces strong earnings from its ongoing operations, primarily Odyssey Re, Crum & Forster, and Northbridge, with combined ratios below 100 percent the last couple years. However, strong ongoing earnings have been overwhelmed by runoff losses, together with the reversal of earnings from minority interests in Odyssey Re and Northbridge. In addition, positive net earnings are heavily reliant on realized investment gains, as investment yields have been quite modest and have trended downward. Fully consolidated operating earnings, before realized capital gains, were at a large loss in each year in 2000-2003, with small operating profits produced in 2004 and first-half 2005. Including realized gains, average earnings are stronger, but have shown period-to-period volatility.”

Commenting on Fairfax financial leverage, Fitch noted: “While the risk embedded in Fairfax’s capital structure improved greatly in 2004 due to a debt restructuring that greatly pushed out maturities, financial leverage remains very high. Debt-to-earnings before interest and taxes (Debt/EBIT), even including realized gains, has averaged over 5 times (x) since 2002, and remained very high at 4.8x in first-half 2005. Such high leverage ratios are consistent with the current ‘B minus’ level senior debt rating assigned to Fairfax. While debt-to-capital ratios, which stand at approximately 40 percent, fall on the cusp between low investment grade and high non-investment-grade standards, Fitch believes earnings-based leverage ratios provide a much truer picture of the risks related to Fairfax’s capital structure and debt servicing abilities, and are thus weighed heavily in our analysis. Fitch believes management’s focus on debt/capital ratios instead of ratios such as debt/EBIT may be a key reason the company has not de-leveraged its balance sheet despite its recent challenges. Fitch believes Fairfax’s financial profile would benefit greatly from a material de-leveraging until earnings and cash flows are stronger.”

Fitch concluded that there’s a good chance Fairfax has “turned the corner” as far as primary ratings factors are concerned. “On balance, Fitch’s comfort has increased that Fairfax will continue to show signs of improvement,” the bulletin continued. “In addition to favorable developments previously noted, positive signs include management’s stated commitment to maintain underwriting discipline as markets soften, Crum & Forster reporting a combined ratio below 100 percent for the first time in the recent past during first-half 2005, Fairfax’s ability to free up cash in the second quarter of 2005 from the commutation of a finite reinsurance contract with Chubb, reductions in still high levels of reinsurance recoverables, and reduced levels of adverse reserve development. Lingering concerns include the risk of reserve development or reinsurer bad debts, uncertainty as to ultimate loss levels from Hurricane Katrina, and the uncertain nature of runoff cash flow requirements.”

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