Debentures

3 Months Ended

May 31, 2022

DEBENTURES

On September 1, 2020, Hamblin Watsa Investment Counsel Ltd., in its capacity as investment manager of Fairfax Financial Holdings Limited (“Fairfax”), and another institutional investor invested in the Company through a $365 million private placement of new debentures (the “1.75% Debentures”), which replaced $605 million of debentures issued in a private placement on September 7, 2016 (the “3.75% Debentures”).

Due to the conversion option and other embedded derivatives within the 1.75% Debentures, the Company has elected to record the 1.75% Debentures, including the debt itself and all embedded derivatives, at fair value and present the 1.75% Debentures as a single hybrid financial instrument. No portion of the fair value of the 1.75% Debentures has been recorded as equity, nor would be if the embedded derivatives were bifurcated from the host debt contract.

Each period, the fair value of the 1.75% Debentures is recalculated and resulting gains and losses from the change in fair value of the 1.75% Debentures associated with non-credit components are recognized in income, while the change in fair value associated with credit components is recognized in accumulated other comprehensive loss (“AOCL”). The fair value of the 1.75% Debentures has been determined using the significant Level 2 inputs interest rate curves, the market price and volatility of the Company’s listed common shares, and the significant Level 3 inputs related to credit spread and the implied discount of the 1.75% Debentures at issuance.

The Company originally determined its credit spread by calibrating to observable trades of the 3.75% Debentures and trending the calibrated spread to valuation dates utilizing an appropriate credit index. The Company’s credit spread was determined to be 7.90% as of the issuance date of the 1.75% Debentures and 7.31% as of May 31, 2022. An increase in credit spread will result in a decrease in the fair value of 1.75% Debentures and vice versa. The fair value of the 1.75% Debentures on September 1, 2020 was determined to be approximately $456 million and the implied discount approximately $91 million. The Company determined the implied discount on the 1.75% Debentures by calculating the

fair value of the 1.75% Debentures on September 1, 2020 utilizing the above credit spread and other inputs described above.

The following table summarizes the change in fair value of the 1.75% Debentures for the three months ended May 31, 2022, which also represents the total changes through earnings of items classified as Level 3 in the fair value hierarchy:


	As at
	May 31, 2022
Balance as at February 28, 2022	$	507
Change in fair value of the 1.75% Debentures	(48)
Balance as at May 31, 2022	$	459

The difference between the fair value of the 1.75% Debentures and the unpaid principal balance of $365 million is $94 million.

The following table shows the impact of the changes in fair value of the 1.75% Debentures for the three months ended May 31, 2022 and May 31, 2021:


	Three Months Ended
	May 31, 2022		May 31, 2021







Income associated with the change in fair value from non-credit components recorded in the consolidated statements of operations	$	46	$	4
Income associated with the change in fair value from instrument-specific credit components recorded in AOCL	2		1
Total decrease in the fair value of the 1.75% Debentures	$	48	$	5

For the three months ended May 31, 2022, the Company recorded interest expense related to the 1.75% Debentures of $2 million, which has been included in investment loss, net on the Company’s consolidated statements of operations (three months ended May 31, 2021 - $2 million).

Fairfax, a related party under U.S. GAAP due to its beneficial ownership of common shares in the Company after taking into account potential conversion of the 1.75% Debentures, owns $330 million principal amount of the 1.75% Debentures. As such, the payment of interest on the 1.75% Debentures to Fairfax represents a related party transaction. Fairfax receives interest at the same rate as other holders of the 1.75% Debentures.