SEC Filing | Watford Holdings

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wtre-20200930

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2020

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number: 001-38788

https://cdn.kscope.io/d666401e37e9eec89939c8ebdea97ddc-wtre-20200930_g1.jpg

Watford Holdings Ltd.


Bermuda						98-1155442
(State or other jurisdiction of incorporation or organization)						(I.R.S. Employer Identification Number)

Waterloo House, 1st Floor

(441)

278-3455

100 Pitts Bay Road,

Pembroke

HM 08,

Bermuda

(Registrant’s telephone number, including area code)

(Address of principal executive offices)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer

☐

Accelerated filer ☐

Non-accelerated filer

☒

Smaller reporting company

☐

Emerging growth company

☒

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☒

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

Securities registered pursuant to Section 12(b) of the Act:

Title of each class

Trading Symbol(s)

Name of each exchange on which registered

Common Shares

WTRE

Nasdaq Global Select Market

8½% Cumulative Redeemable Preference Shares

WTREP

Nasdaq Global Select Market

As of November 10, 2020, there were 19,886,979 common shares, $0.01 par value per share, of the registrant outstanding.


	Watford Holdings Ltd.
	Index to Form 10-Q
		Page
Part I.	Financial information	4
Item 1.	Consolidated financial statements	6
Item 2.	Management’s discussion and analysis of financial condition and results of operations	54
Item 3.	Quantitative and qualitative disclosures about market risk	102
Item 4.	Controls and procedures	106

Part II.	Other information	107
Item 1.	Legal proceedings	107
Item 1A.	Risk factors	107
Item 2.	Unregistered sales of equity securities and use of proceeds	114
Item 3.	Defaults upon senior securities	114
Item 4.	Mine safety disclosures	114
Item 5.	Other information	114
Item 6.	Exhibits	116
	Signatures	117

Explanatory note - Certain defined terms

Unless the context suggests otherwise, any reference in this report to:

•“ACGL” refers to Arch Capital Group Ltd. and its controlled subsidiaries;

•“Arch” refers to any one or more of the following direct or indirect subsidiaries of ACGL, as applicable in the context in which such term appears:

•Arch Investment Management Ltd., or AIM, which manages the majority of our investment grade portfolio;

•Arch Reinsurance Company, or ARC, which is a party to certain quota share agreements with one or more of our operating subsidiaries and a services agreement with Watford Holdings (U.S.) Inc.;

•Arch Reinsurance Ltd., or ARL, which is a party to certain quota share agreements with one or more of our operating subsidiaries and owned approximately 12.6% of our outstanding common shares as of September 30, 2020;

•Arch Underwriters Inc., or AUI, which manages the underwriting business of our U.S. operating subsidiaries;

•Arch Underwriters Ltd., or AUL, which manages the underwriting business of our non-U.S. operating subsidiaries, including Watford Re;

•“HPS” refers to HPS Investment Partners, LLC (formerly known as Highbridge Principal Strategies, LLC), which manages our non-investment grade portfolio, as well as accounts in our investment grade portfolio;

•our “Investment Managers” refers to AIM, HPS or any other investment managers that manage our investment grade portfolio or our non-investment grade portfolio from time to time;

•“Watford,” “we,” “us” and “our” refers to Watford Holdings Ltd. and its subsidiaries;

•“Watford Holdings” refers to our company, Watford Holdings Ltd., a Bermuda exempted company;

•“Watford Re” refers to Watford Re Ltd., a Bermuda domiciled insurance company and a wholly-owned subsidiary of our company;

•“Watford Trust” refers to Watford Asset Trust I, a statutory trust organized under the laws of the State of Delaware;

•“WIC” refers to Watford Insurance Company, a New Jersey domiciled insurance company and a wholly-owned subsidiary of our company;

•“WICE” refers to Watford Insurance Company Europe Limited, a Gibraltar domiciled insurance company and a wholly-owned subsidiary of our company; and

•“WSIC” refers to Watford Specialty Insurance Company, a New Jersey domiciled insurance company and a wholly-owned subsidiary of our company.

In addition, unless the context suggests otherwise, any reference in this report to:

•“HoldCo” refers to Greysbridge Holdings Ltd., a newly formed entity of which ACGL will own approximately 40%, and funds managed by Warburg Pincus LLC and Kelso & Company will each own approximately 30%;

•“Merger” refers to the merger of Merger Sub with and into Watford pursuant to the Merger Agreement, with Watford surviving as a wholly-owned subsidiary of HoldCo;

•“Merger Agreement” refers to the Agreement and Plan of Merger, dated as of October 9, 2020, among Watford, ACGL and Merger Sub, as amended by Amendment No. 1 to Agreement and Plan of Merger, dated as of November 2, 2020, among Watford, ACGL and Merger Sub; and

•“Merger Sub” refers to Greysbridge Ltd., a wholly-owned subsidiary of HoldCo.

Explanatory note - Proposed merger

On October 9, 2020, we announced that we had entered into a definitive agreement to be acquired by ACGL. Further, on November 2, 2020, ACGL assigned its interests and obligations in connection with this acquisition to Greysbridge Holdings Ltd., a newly formed entity of which ACGL will own approximately 40%, and funds managed by Warburg Pincus LLC and Kelso & Company will each own approximately 30%. Unless stated otherwise, all forward-looking information contained in this report on Form 10-Q does not take into account or give any effect to the impact of the Merger (as defined herein). For additional details regarding the Merger, see Part II Item 1A “Risk factors” and Part I Item 2 “Management’s discussion and analysis of financial condition and results of operations” of this Quarterly Report on Form 10-Q, and Note 19 to our consolidated financial statements contained in Part I Item 1 of this Quarterly Report on Form 10-Q.

Part I. Financial information

Cautionary note regarding forward-looking statements

The Private Securities Litigation Reform Act of 1995 (or the PSLRA) provides a “safe harbor” for forward-looking statements. This report contains forward-looking statements that are intended to enhance the reader’s ability to assess our future financial and business performance. These statements are based on the beliefs and assumptions of our management, and are subject to risks and uncertainties. Generally, statements that are not about historical facts, including statements concerning our possible or assumed future actions or results of operations are forward-looking statements. Forward-looking statements include, but are not limited to, statements that represent our beliefs, expectations or estimates concerning future operations, strategies, financial results or performance, financings, investments, acquisitions, expenditures or other developments and anticipated trends and competition in the markets in which we operate. Forward-looking statements, for purposes of the PSLRA or otherwise, can also be identified by the use of forward-looking terminology such as “may,” “believes,” “intends,” “anticipates,” “plans,” “estimates,” “expects,” “should” or similar expressions.

Forward-looking statements involve our current assessment of risks and uncertainties. Actual events and results may differ materially from those expressed or implied in these statements. Important factors that could cause actual events or results to differ materially from those indicated in such statements are discussed below and elsewhere in this report and in our other reports and other documents filed with the Securities and Exchange Commission, or the SEC, and include:

◦our limited operating history;

◦fluctuations in the results of our operations;

◦our ability to compete successfully with more established competitors;

◦our losses exceeding our reserves;

◦downgrades, potential downgrades or other negative actions by rating agencies, including the recent announcements by A.M. Best Company, or A.M. Best, that it has placed under review with negative implications our financial strength and credit ratings and Kroll Bond Rating Agency, or KBRA, that it has revised the outlook of our financial strength and credit ratings to negative and placed such ratings on “watch developing” status;

◦our dependence on key executives and inability to attract qualified personnel, or the potential loss of suitably qualified personnel as a result of Bermuda employment and immigration restrictions;

◦our dependence on letter of credit facilities and borrowing facilities that may not be available on commercially acceptable terms;

◦our potential inability to pay dividends or distributions;

◦our potential need for additional capital in the future and the potential unavailability of such capital to us on favorable terms or at all;

◦our dependence on clients’ evaluations of risks associated with such clients’ insurance underwriting;

◦the suspension or revocation of our subsidiaries’ insurance licenses;

◦Watford Holdings potentially being deemed an investment company under U.S. federal securities law;

◦the potential characterization of us and/or any of our subsidiaries as a passive foreign investment company, or PFIC;

◦our dependence on Arch for services critical to our underwriting operations;

◦changes to our strategic relationship with Arch or the termination by Arch of any of our services agreements or quota share agreements;

◦our dependence on HPS and AIM to implement our investment strategy;

◦the termination by HPS or AIM of any of our investment management agreements;

◦risks associated with our investment strategy being greater than those faced by competitors;

◦changes in the regulatory environment;

◦our potentially becoming subject to U.S. federal income taxation;

◦our potentially becoming subject to U.S. withholding and information reporting requirements under the U.S. Foreign Account Tax Compliance Act, or FATCA, provisions;

◦our ability to complete acquisitions and integrate businesses successfully;

◦adverse general, societal, economic and market conditions, including those caused by pandemics, including the current global pandemic related to the novel coronavirus, or COVID-19, and government actions in response thereto;

◦one or more closing conditions to the Merger, including certain regulatory approvals, may not be satisfied or waived, on a timely basis or otherwise, including that a governmental entity may prohibit, delay or refuse to grant approval for the consummation of the Merger, or that the required approval of the Merger Agreement by our shareholders may not be obtained;

◦our business may suffer as a result of uncertainty surrounding the Merger and there may be challenges with employee retention as a result of the Merger;

◦the Merger may involve unexpected costs, liabilities or delays;

◦legal proceedings may be initiated related to the Merger;

◦an event, change or other circumstance may occur that could give rise to the termination of the Merger Agreement (including circumstances requiring us to pay HoldCo a termination fee pursuant to the Merger Agreement); and

◦the other matters set forth under Item 1A “Risk factors,” Item 7 “Management’s discussion and analysis of financial condition and results of operations,” and other sections of the Company’s Annual Report on Form 10-K for the year ended December 31, 2019, Part II Item 1A “Risk factors” and Part I Item 2 “Management’s discussion and analysis of financial condition and results of operations” of this Quarterly Report on Form 10-Q as well as the other factors set forth in the Company’s other documents on file with the SEC, and management’s response to any of the aforementioned factors.

Consequently, such forward-looking statements should be regarded solely as our current plans, estimates or belief as of the date of this report. All subsequent forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements. The foregoing review of important factors should not be construed as exhaustive and should be read in conjunction with other cautionary statements that are included herein or elsewhere. We do not intend, and do not undertake, any obligation to update any forward-looking statements to reflect future events or circumstances after the date of this report.

Item 1. Consolidated financial statements


			Page
Consolidated Balance Sheets
September 30, 2020 (unaudited) and December 31, 2019			7

Consolidated Statements of Income (Loss)
For the three and nine months ended September 30, 2020 and 2019 (unaudited)			8

Consolidated Statements of Comprehensive Income (Loss)
For the three and nine months ended September 30, 2020 and 2019 (unaudited)			9

Consolidated Statements of Changes in Shareholders’ Equity
For the three and nine months ended September 30, 2020 and 2019 (unaudited)			10

Consolidated Statements of Cash Flows
For the nine months ended September 30, 2020 and 2019 (unaudited)			11

Notes to the Consolidated Financial Statements (unaudited)
Note 1 - Organization			12
Note 2 - Basis of Presentation and Significant Accounting Policies			13
Note 3 - Segment Information			16
Note 4 - Reinsurance			17
Note 5 - Reserves for Losses and Loss Adjustment Expenses			18
Note 6 - Allowance for Expected Credit Losses			19
Note 7 - Investment Information			19
Note 8 - Fair Value			30
Note 9 - Derivative Instruments			39
Note 10 - Earnings Per Common Share			41
Note 11 - Income Taxes			41
Note 12 - Transactions With Related Parties			42
Note 13 - Commitments and Contingencies			47
Note 14 - Leases			50
Note 15 - Senior Notes			50
Note 16 - Contingently Redeemable Preference Shares			51
Note 17 - Share Transactions			52
Note 18 - Legal Proceedings			53
Note 19 - Subsequent Events			53

WATFORD HOLDINGS LTD.

CONSOLIDATED BALANCE SHEETS

(U.S. dollars in thousands, except share data)


	(Unaudited)
	September 30,		December 31,
	2020		2019
Assets
Investments:
Term loans, fair value option (Amortized cost: $969,929 and $1,113,212)	$	893,030	$	1,061,934
Fixed maturities, fair value option (Amortized cost: $677,977 and $432,576)	632,664		416,594
Short-term investments, fair value option (Cost: $348,479 and $325,542)	350,391		329,303
Equity securities, fair value option	60,951		59,799
Other investments, fair value option (1)	—		30,461
Investments, fair value option	1,937,036		1,898,091
Fixed maturities, available for sale (Amortized cost: $645,663 and $739,456)	649,781		745,708
Equity securities, fair value through net income	52,829		65,338
Total investments (1)	2,639,646		2,709,137
Cash and cash equivalents	195,333		102,437
Accrued investment income	16,234		14,025
Premiums receivable (1)	263,748		273,657
Reinsurance recoverable on unpaid and paid losses and loss adjustment expenses (1)	263,293		170,974
Prepaid reinsurance premiums (1)	131,885		132,577
Deferred acquisition costs, net (1)	58,583		64,044
Receivable for securities sold	1,730		16,288
Intangible assets	7,650		7,650
Funds held by reinsurers (1)	46,787		42,505
Other assets	28,331		17,562
Total assets	$	3,653,220	$	3,550,856
Liabilities
Reserve for losses and loss adjustment expenses (1)	$	1,429,656	$	1,263,628
Unearned premiums (1)	459,476		438,907
Losses payable (1)	78,537		61,314
Reinsurance balances payable (1)	68,339		77,066
Payable for securities purchased	67,602		18,180
Payable for securities sold short	24,909		66,257
Revolving credit agreement borrowings	390,195		484,287
Senior notes (1)	172,621		172,418
Amounts due to affiliates (1)	5,060		4,467
Investment management and performance fees payable (1)	7,539		17,762
Other liabilities (1)	30,012		21,912
Total liabilities	$	2,733,946	$	2,626,198
Commitments and contingencies
Contingently redeemable preference shares (1)	52,375		52,305
Shareholders’ equity
Common shares ($0.01 par; shares authorized: 120 million; shares issued: 22,804,128 and 22,692,300)	228		227
Additional paid-in capital	899,213		898,083
Retained earnings (deficit)	42,184		43,470
Accumulated other comprehensive income (loss)	3,197		5,629
Common shares held in treasury, at cost (shares: 2,917,149 and 2,789,405)	(77,923)		(75,056)
Total shareholders’ equity	866,899		872,353
Total liabilities, contingently redeemable preference shares and shareholders’ equity	$	3,653,220	$	3,550,856

(1) See Note 12, “Transactions with related parties” for disclosure of related party amounts.

See Notes to Consolidated Financial Statements

WATFORD HOLDINGS LTD.

CONSOLIDATED STATEMENTS OF INCOME (LOSS)

(U.S. dollars in thousands, except share and per share data)


	(Unaudited)				(Unaudited)
	Three Months Ended September 30,				Nine Months Ended September 30,
	2020		2019		2020		2019
Revenues
Gross premiums written (1)	$	197,480	$	249,960	$	590,309	$	598,627
Gross premiums ceded (1)	(50,164)		(94,208)		(150,437)		(178,118)
Net premiums written	147,316		155,752		439,872		420,509
Change in unearned premiums (1)	(1,285)		(29,920)		(22,267)		2,735
Net premiums earned (1)	146,031		125,832		417,605		423,244
Other underwriting income (loss)	546		579		1,547		1,844
Interest income	34,553		41,376		108,830		123,113
Investment management fees - related parties (1)	(4,380)		(4,606)		(12,994)		(13,585)
Borrowing and miscellaneous other investment expenses	(3,657)		(7,234)		(14,089)		(23,143)
Net interest income	26,516		29,536		81,747		86,385
Realized and unrealized gains (losses) on investments	67,995		(14,646)		(50,444)		18,138
Investment performance fees - related parties (1)	(1,758)		(850)		(1,758)		(8,342)
Net investment income (loss)	92,753		14,040		29,545		96,181
Total revenues	239,330		140,451		448,697		521,269

Expenses
Loss and loss adjustment expenses (1)	(115,813)		(96,214)		(331,275)		(318,480)
Acquisition expenses (1)	(31,110)		(27,612)		(88,963)		(97,003)
General and administrative expenses (1)	(7,346)		(7,027)		(22,326)		(24,018)
Interest expense (1)	(2,912)		(2,841)		(8,735)		(2,841)
Net foreign exchange gains (losses)	(2,926)		167		4,752		(711)
Total expenses	(160,107)		(133,527)		(446,547)		(443,053)
Income (loss) before income taxes	79,223		6,924		2,150		78,216
Income tax benefit (expense)	(69)		—		333		(20)
Net income (loss) before preference dividends and redemption costs	79,154		6,924		2,483		78,196
Preference dividends (1)	(1,061)		(2,608)		(3,341)		(12,423)
Accelerated amortization of costs related to the redemption of preference shares (1)	—		(4,164)		—		(4,164)
Net income (loss) available to common shareholders	$	78,093	$	152	$	(858)	$	61,609

Earnings (loss) per common share:
Basic	$	3.93	$	0.01	$	(0.04)	$	2.71
Diluted	$	3.92	$	0.01	$	(0.04)	$	2.71
Weighted average number of common shares used in the determination of earnings (loss) per share:
Basic	19,890,784		22,765,802		19,901,921		22,729,848
Diluted	19,904,051		22,776,204		19,901,921		22,734,464

(1) See Note 12, “Transactions with related parties” for disclosure of related party amounts.

See Notes to Consolidated Financial Statements

WATFORD HOLDINGS LTD.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(U.S. dollars in thousands)


	(Unaudited)				(Unaudited)
	Three Months Ended September 30,				Nine Months Ended September 30,
	2020		2019		2020		2019
Comprehensive income (loss)
Net income (loss) available to common shareholders	$	78,093	$	152	$	(858)	$	61,609
Other comprehensive income (loss) net of income tax:
Available for sale investments:
Unrealized holding gains (losses) arising during the period	6,631		3,785		9,440		14,398
Unrealized foreign currency gains (losses) arising during the period	5,729		(3,676)		(1,691)		(4,224)
Credit loss recognized in net income (loss)	59		—		410		—
Reclassification of net realized (gains) losses, included in net income (loss)	368		(1,254)		(10,368)		(3,465)
Unrealized holding gains (losses) of available for sale investments	12,787		(1,145)		(2,209)		6,709
Foreign currency translation adjustments	(411)		286		(223)		333
Other comprehensive income (loss) net of income tax	12,376		(859)		(2,432)		7,042
Comprehensive income (loss)	$	90,469	$	(707)	$	(3,290)	$	68,651

See Notes to Consolidated Financial Statements

WATFORD HOLDINGS LTD.

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(U.S. dollars in thousands)


	(Unaudited)				(Unaudited)
	Three Months Ended September 30,				Nine Months Ended September 30,
	2020		2019		2020		2019
Common shares
Balance at beginning of period	$	228	$	227	$	227	$	227
Common shares issued	—		—		1		—
Balance at end of period	228		227		228		227

Additional paid-in capital
Balance at beginning of period	898,935		897,716		898,083		895,386
Common shares issued under share plans	—		—		490		250
Share-based compensation	278		184		640		2,264
Balance at end of period	899,213		897,900		899,213		897,900

Accumulated other comprehensive income (loss)
Balance at beginning of period	(9,179)		3,171		5,629		(4,730)
Unrealized holding gains (losses) of available for sale investments:
Balance at beginning of period	(8,744)		3,696		6,252		(4,158)
Unrealized holding gains (losses) of available for sale investments, net of reclassification adjustments	12,787		(1,145)		(2,209)		6,709
Balance at end of period	4,043		2,551		4,043		2,551
Currency translation adjustment:
Balance at beginning of period	(435)		(525)		(623)		(572)
Currency translation adjustment	(411)		286		(223)		333
Balance at end of period	(846)		(239)		(846)		(239)
Balance at end of period	<