Watford Reports 2019 Fourth Quarter Results and the Authorization of a New $50 Million Share Repurchase Program

PEMBROKE, Bermuda, Feb. 11, 2020 (GLOBE NEWSWIRE) -- WATFORD HOLDINGS LTD. ("Watford" or the "Company") WTRE today reported a net loss of $16.9 million, after $1.2 million of preference dividends, for the three months ended December 31, 2019, compared to a net loss of $95.3 million, after payment of $4.9 million of preference dividends, in the same period in 2018. Book value per diluted common share was $43.49 at December 31, 2019, an increase of 10.9% from December 31, 2018.  The quarterly results included:

  • Net loss available to common shareholders of $16.9 million, or $(0.79) per diluted common share, compared to a net loss of $95.3 million, or $(4.20) per diluted common share, for the 2018 fourth quarter;
  • Combined ratio of 128.3%, comprised of a 100.9% loss ratio, a 22.3% acquisition expense ratio and a 5.1% general and administrative expense ratio, compared to a combined ratio of 115.4% for the prior year fourth quarter, comprised of a 87.9% loss ratio, a 23.4% acquisition expense ratio and a 4.1% general and administrative expense ratio;
  • Net interest income of $29.8 million, a 1.4% yield on average net assets, for the 2019 fourth quarter, compared to net interest income of $30.0 million and a 1.5% yield on average net assets for the 2018 fourth quarter;
  • Net investment income of $32.1 million, a 1.5% return on average net assets, for the 2019 fourth quarter, compared to a net investment loss of $61.1 million and a (3.0)% return on average net assets for the 2018 fourth quarter;
  • The Company repurchased 2,789,405 common shares at an average price of $26.89 per share, fully utilizing the Company's previously announced $75 million share repurchase program.
  • In addition, the Board of Directors has authorized a new share repurchase program under which the Company may repurchase up to $50 million of its outstanding common shares from time to time on the open market or in privately negotiated transactions.

Commenting on the 2019 fourth quarter financial results, John Rathgeber, CEO of Watford, said:

"As reported in our press release of January 28, 2020, our results for the 2019 fourth quarter were negatively impacted by prior year loss reserve strengthening of $24 million and current accident year loss reserve strengthening of approximately $4 million. The reserve increase primarily relates to two large casualty reinsurance contracts, one of which is in run-off, and one of which has been renewed at progressively smaller participations over the past several years.

While painful in the short term, this was the prudent and responsible course of action based on the level of ceding company reported losses compared to actuarial projections. Our response to the data was decisive and we feel confident about the overall level of our net loss reserves, which stand at $1.1 billion.

Our investment income was quite strong, both for the quarter and the year. The net investment income return on net invested assets was 1.5% for the 2019 fourth quarter and 6.0% for the full year. The ratio of net invested assets to equity was 2.5:1 as of December 31, 2019, which points to the return on equity potential of the business going forward.

We fully utilized our $75 million share repurchase program during the 2019 fourth quarter. The Board has authorized a new share repurchase program for up to $50 million.  The exact timing and magnitude of further share repurchases is dependent on a number of factors, but will likely be deployed at a slower pace than our prior program in order to pursue opportunities in an improving insurance market.

Our ultimate objective is to steadily grow book value per share over time. By this measure, we are pleased to report 3.4% quarterly growth in book value per diluted common share, which stands at $43.49 as of December 31, 2019. For the 2019 full year, the increase in book value per diluted common share was 10.9%.

As we enter the new year, we are optimistic about the prospects for further book value growth due to the overall positive insurance rate environment, the composition of our in-force insurance and reinsurance portfolio, the strength of our balance sheet, the earnings power of our fixed-income investment portfolio, and the potential material accretive benefit of our new share repurchase program."

Underwriting

The following table summarizes the Company's underwriting results on a consolidated basis:

 Three Months Ended

December 31,
 Year Ended

December 31,
 2019 2018 % Change 2019 2018 % Change
 ($ in thousands)
Gross premiums written$156,254  $160,937  (2.9)% $754,881  $735,015  2.7%
Net premiums written112,353  132,360  (15.1)% 532,862  604,175  (11.8)%
Net premiums earned133,446  146,973  (9.2)% 556,690  578,862  (3.8)%
Underwriting income (loss) (1)(37,819) (22,660) (66.9)% (54,076) (25,840) (109.3)%
            
     % Point Change     % Point Change
Loss ratio100.9% 87.9% 13.0% 81.4% 76.2% 5.2%
Acquisition expense ratio22.3% 23.4% (1.1)% 22.8% 24.4% (1.6)%
General & administrative expense ratio5.1% 4.1% 1.0% 5.5% 3.9% 1.6%
Combined ratio128.3% 115.4% 12.9% 109.7% 104.5% 5.2%
Adjusted combined ratio (2)126.4% 114.2% 12.2% 107.3% 103.3% 4.0%

(1) Underwriting income (loss) is a non-U.S. GAAP financial measure and is calculated as net premiums earned, less loss and loss adjustment expenses, acquisition expenses and general and administrative expenses. See "Comments on Regulation G" for further discussion, including a reconciliation of underwriting income (loss) to net income (loss) available to common shareholders.

(2) Adjusted combined ratio is a non-U.S. GAAP financial measure and is calculated by dividing the sum of loss and loss adjustment expenses, acquisition expenses and general and administrative expenses, less certain corporate expenses, by the sum of net premiums earned and other underwriting income (loss). See "Comments on Regulation G" for further discussion, including a reconciliation of our adjusted combined ratio to our combined ratio.

The following table provides summary information regarding premiums written and earned by line of business:

 Three Months Ended

December 31,
 Year Ended

December 31,
 2019 2018 2019 2018
 ($ in thousands)
Gross premiums written:       
Casualty reinsurance$26,680  $52,025  $279,967  $274,661 
Other specialty reinsurance34,931  45,087  119,518  196,170 
Property catastrophe reinsurance844  1,684  16,226  10,424 
Insurance programs and coinsurance93,799  62,141  339,170  253,760 
Total$156,254  $160,937  $754,881  $735,015 
        
Net premiums written:       
Casualty reinsurance$26,532  $51,379  $225,758  $273,048 
Other specialty reinsurance33,078  42,837  114,876  181,096 
Property catastrophe reinsurance874  1,678  15,517  10,193 
Insurance programs and coinsurance51,869  36,466  176,711  139,838 
Total$112,353  $132,360  $532,862  $604,175 
        
Net premiums earned:       
Casualty reinsurance$55,352  $72,124  $238,437  $278,656 
Other specialty reinsurance30,929  37,420  149,688  162,691 
Property catastrophe reinsurance3,692  3,555  13,399  10,998 
Insurance programs and coinsurance43,473  33,874  155,166  126,517 
Total$133,446  $146,973  $556,690  $578,862 

The following table shows the components of our loss and loss adjustment expenses for the three months and years ended December 31, 2019 and 2018:

 Three Months Ended

December 31,
 Year Ended

December 31,
 2019 2018 2019 2018
 Loss and Loss Adjustment Expenses % of Earned Premiums Loss and Loss Adjustment Expenses % of Earned Premiums Loss and Loss Adjustment Expenses % of Earned Premiums Loss and Loss Adjustment Expenses % of Earned Premiums
 ($ in thousands)
Current year$110,510  82.8% $129,101  87.8% $429,322  77.1% $443,482  76.6%
Prior year development (favorable)/adverse24,145  18.1% 67  0.1% 23,813  4.3% (2,227) (0.4)%
Loss and loss adjustment expenses$134,655  100.9% $129,168  87.9% $453,135  81.4% $441,255  76.2%

Results for the three months ended December 31, 2019 versus 2018:

Gross and net premiums written in the 2019 fourth quarter were 2.9% and 15.1% lower, respectively, than the 2018 fourth quarter.  The decrease in premiums reflected a reduction in reinsurance premiums, offset in part by an increase of new and renewal business bound in insurance programs and coinsurance in the 2019 fourth quarter.

Net premiums earned in the 2019 fourth quarter were 9.2% lower than the 2018 fourth quarter. The decrease in premiums reflected prior period reduced participations in casualty reinsurance and other specialty reinsurance, offset in part by increased writings in insurance programs and coinsurance.

The loss ratio was 100.9% in the 2019 fourth quarter compared to 87.9% in the 2018 fourth quarter. In the 2019 fourth quarter, we experienced $5.0 million in catastrophe losses, primarily due to Typhoon Hagibis in Japan. The increase in the loss ratio reflects 18.1 points of prior year and 2.9 points of current year loss reserve strengthening, primarily in the casualty reinsurance line of business. Casualty reinsurance prior year loss reserves were strengthened by $24.0 million, primarily due to a higher than anticipated level of reported losses on one professional lines quota share treaty program and one non-renewed multi-line quota share treaty. The loss reserve development in the prior year fourth quarter had essentially been flat.

The acquisition expense ratio was 22.3% in the 2019 fourth quarter, compared to 23.4% in the 2018 fourth quarter, reflecting changes in the mix and type of business.

The general and administrative expense ratio was 5.1% in the 2019 fourth quarter, compared to 4.1% in the 2018 fourth quarter. The 1.0 point increase versus the prior year fourth quarter was attributable to ongoing public company expenses. Removing certain corporate expenses, our adjusted general and administrative expense ratio was 3.7% in the 2019 fourth quarter compared to 3.4% in the 2018 fourth quarter.

Investments

The following table summarizes the Company's key investment returns on a consolidated basis:

 Three Months Ended

December 31,
 Year Ended

December 31,
 2019 2018 2019 2018
 ($ in thousands)
Interest income$40,775  $43,086  $163,888  $152,916 
Investment management fees - related parties(4,807) (4,390) (18,392) (17,006)
Borrowing and miscellaneous other investment expenses(6,142) (8,741) (29,285) (28,377)
Net interest income29,826  29,955  116,211  107,533 
Realized gains (losses) on investments(10,664) 4,599  (7,948) (4,788)
Unrealized gains (losses) on investments16,769  (102,196) 32,191  (109,046)
Investment performance fees - related parties(3,849) 6,558  (12,191) (48)
Net investment income (loss)$32,082  $(61,084) $128,263  $(6,349)
        
Unrealized gains on investments (balance sheet)$47,203  $17,109  $47,203  $17,109 
Unrealized losses on investments (balance sheet)(110,448) (134,494) (110,448) (134,494)
Net unrealized gains (losses) on investments (balance sheet)$(63,245) $(117,385) $(63,245) $(117,385)
        
Net interest income yield on average net assets (1)1.4% 1.5% 5.4% 5.4%
Non-investment grade portfolio (1)1.7% 1.9% 6.8% 7.0%
Investment grade portfolio (1)0.6% 0.5% 2.5% 1.9%
Net investment income return on average net assets (1)1.5% (3.0)% 6.0% (0.3)%
Non-investment grade portfolio (1)1.7% (4.3)% 6.8% (0.2)%
Investment grade portfolio (1)0.9% 0.8% 3.9% 0.9%
        
Net investment income return on average total investments (2)1.2% (2.2)% 4.6% (0.2)%
Non-investment grade portfolio (2)1.4% (3.4)% 5.7% (0.1)%
Investment grade portfolio (2)0.9% 0.8% 3.9% 0.9%

(1) Net interest income yield on average net assets and net investment income return on average net assets are calculated by dividing net interest income, and net investment income (loss), respectively, by average net assets. Net assets is calculated as the sum of total investments, accrued investment income and receivables for securities sold, less revolving credit agreement borrowings, payable for securities purchased and payable for securities sold short. For the three- and twelve-month period, average net assets is calculated using the averages of each quarterly period. However, for the investment grade portfolio component of these returns, revolving credit agreement borrowings are not subtracted from the net assets calculation. The separate components of these returns (non-investment grade portfolio and investment grade portfolio) are non-U.S. GAAP financial measures. See "Comments on Regulation G" for further discussion, including a reconciliation of these components of our net interest income yield on average net assets and net investment income return on average net assets.

(2) Net investment income return on average total investments is calculated by dividing net investment income by average total investments. For the three- and twelve-month period, average total investments is calculated using the averages of each quarterly period. The separate components of these returns (non-investment grade portfolio and investment grade portfolio) are non-U.S. GAAP financial measures. See "Comments on Regulation G" for further discussion, including a reconciliation of these components of our net investment income return on average total investments.

The following chart shows the composition of our non-investment grade and investment grade portfolios as of December 31, 2019:

 As of December 31, 2019
 Non-Investment Grade
 ($ in millions)
Total non-investment grade investments$1,862.3 
  
Portfolio allocation by asset class: 
Term loans57.1%
Corporate bonds11.5%
Short-term investments12.5%
Asset-backed securities10.2%
Equities6.7%
Other investments1.6%
Mortgage-backed securities0.4%
Total100.0%



 As of December 31, 2019
 Investment Grade
 ($ in millions)
Total investment grade investments$846.9 
  
Portfolio allocation by asset class: 
U.S. government and government agency bonds33.7%
Corporate bonds18.7%
Asset-backed securities17.2%
Non-U.S. government and government agency bonds15.8%
Short-term investments11.4%
Mortgage-backed securities2.9%
Municipal government and government agency bonds0.3%
Total100.0%

Corporate Function

The Company has a corporate function that includes general and administrative expenses related to corporate activities, interest expense, net foreign exchange gains (losses), income tax expense and items related to the Company's contingently redeemable preference shares.

The Company incurred an interest expense of $3.0 million for the three months ended December 31, 2019, in relation to the 6.5% senior notes issued on July 2, 2019. Interest is paid semi-annually in arrears on January 2 and July 2.

Net foreign exchange gains (losses), which relate to underwriting, fair value option investments, fair value through net income investments, cash and cash equivalents, revolving credit agreement borrowings and realized amounts for available-for-sale investments, are included in the consolidated statements of income (loss).

Unrealized net foreign exchange gains (losses), which relate to available-for-sale investments, are included in the statement of comprehensive income (loss) within "unrealized holding gains (losses) arising during the period".

The consolidated statements of income (loss) include net foreign exchange losses of $7.5 million for the 2019 fourth quarter, while the statement of comprehensive income (loss) includes unrealized net foreign exchange gains of $7.5 million for the 2019 fourth quarter.

Preference dividends were $1.2 million and $4.9 million for the three months ended December 31, 2019 and 2018, respectively.

The Board of Directors has authorized a new share repurchase program under which the Company may repurchase up to $50 million of its outstanding common shares.  Repurchases under the new $50 million authorization may be effected from time to time in open market or privately negotiated transactions. The timing and amount of the repurchase transactions under this program will depend on a variety of factors, including market conditions, the level of future earnings, and rating agency and regulatory considerations.

Conference Call

The Company will hold a conference call on Wednesday, February 12, 2020 at 1:00 p.m. Eastern time to discuss its 2019 fourth quarter results. A live webcast of this call will be available via the Investors section of the Company's website at http://investors.watfordre.com. A replay of the conference call will also be available via the Investors section of the Company's website beginning on February 13, 2020.

About Watford Holdings Ltd.

Watford Holdings Ltd. is a global property and casualty insurance and reinsurance company with approximately $1.1 billion in capital as of December 31, 2019, comprised of: $172.4 million of senior notes, $52.3 million of contingently redeemable preference shares and $872.4 million of common shareholders' equity, with operations in Bermuda, the United States and Europe. Its operating subsidiaries have been assigned financial strength ratings of "A-" (Excellent) from A.M. Best and "A" from Kroll Bond Rating Agency.

CONSOLIDATED BALANCE SHEETS (UNAUDITED)

 (Unaudited)  
 December 31, December 31,
 2019 2018
Assets($ in thousands)
Investments:   
Term loans, fair value option (Amortized cost: $1,113,212 and $1,055,664)$1,061,934  $1,000,652 
Fixed maturities, fair value option (Amortized cost: $432,576 and $972,653)416,594  922,819 
Short-term investments, fair value option (Cost: $325,542 and $281,959)329,303  282,132 
Equity securities, fair value option59,799  56,638 
Other investments, fair value option30,461  49,762 
Investments, fair value option1,898,091  2,312,003 
Fixed maturities, available for sale (Amortized cost: $739,456 and $397,509)745,708  393,351 
Equity securities, fair value through net income65,338  33,013 
Total investments2,709,137  2,738,367 
Cash and cash equivalents102,437  63,529 
Accrued investment income14,025  19,461 
Premiums receivable273,657  227,301 
Reinsurance recoverable on unpaid and paid losses and loss adjustment expenses170,974  86,445 
Prepaid reinsurance premiums132,577  61,587 
Deferred acquisition costs, net64,044  80,858 
Receivable for securities sold16,288  24,507 
Intangible assets7,650  7,650 
Funds held by reinsurers42,505  44,830 
Other assets17,562  18,321 
Total assets$3,550,856  $3,372,856 
Liabilities   
Reserve for losses and loss adjustment expenses$1,263,628  $1,032,760 
Unearned premiums438,907  390,114 
Losses payable61,314  24,750 
Reinsurance balances payable77,066  21,034 
Payable for securities purchased18,180  60,142 
Payable for securities sold short66,257  8,928 
Revolving credit agreement borrowings484,287  693,917 
Senior notes172,418   
Amounts due to affiliates4,467  5,888 
Investment management and performance fees payable17,762  3,807 
Other liabilities21,912  20,916 
Total liabilities$2,626,198  $2,262,256 
Commitments and contingencies   
Contingently redeemable preference shares52,305  220,992 
Shareholders' equity   
Common shares ($0.01 par; shares authorized: 120 million; shares issued: 22,692,300 and 22,682,875)227  227 
Additional paid-in capital898,083  895,386 
Retained earnings (deficit)43,470  (1,275)
Accumulated other comprehensive income (loss)5,629  (4,730)
Common shares held in treasury, at cost (shares: 2,789,405 and Nil)(75,056)  
Total shareholders' equity872,353  889,608 
Total liabilities, contingently redeemable preference shares and shareholders' equity$3,550,856  $3,372,856 

CONSOLIDATED STATEMENTS OF INCOME (LOSS) AND COMPREHENSIVE INCOME (LOSS) (UNAUDITED)

 (Unaudited)(Unaudited)
 Three Months Ended

December 31,
Year Ended

December 31,
 2019 2018 2019 2018
Revenues($ in thousands except share and per share data)
Gross premiums written$156,254  $160,937  $754,881  $735,015 
Gross premiums ceded(43,901) (28,577) (222,019) (130,840)
Net premiums written112,353  132,360  532,862  604,175 
Change in unearned premiums21,093  14,613  23,828  (25,313)
Net premiums earned133,446  146,973  556,690  578,862 
Other underwriting income (loss)568  630  2,412  2,722 
Interest income40,775  43,086  163,888  152,916 
Investment management fees - related parties(4,807) (4,390) (18,392) (17,006)
Borrowing and miscellaneous other investment expenses(6,142) (8,741) (29,285) (28,377)
Net interest income29,826  29,955  116,211  107,533 
Realized and unrealized gains (losses) on investments6,105  (97,597) 24,243  (113,834)
Investment performance fees - related parties(3,849) 6,558  (12,191) (48)
Net investment income (loss)32,082  (61,084) 128,263  (6,349)
Total revenues166,096  86,519  687,365  575,235 
Expenses       
Loss and loss adjustment expenses(134,655) (129,168) (453,135) (441,255)
Acquisition expenses(29,785) (34,428) (126,788) (141,136)
General and administrative expenses(6,825) (6,037) (30,843) (22,311)
Interest expense(2,950)   (5,791)  
Net foreign exchange gains (losses)(7,536) 1,764  (8,247) 3,611 
Non-recurring direct listing expenses  (9,000)   (9,000)
Total expenses(181,751) (176,869) (624,804) (610,091)
Income (loss) before income taxes(15,655) (90,350) 62,561  (34,856)
Income tax expense    (20) (27)
Net income (loss) before preference dividends(15,655) (90,350) 62,541  (34,883)
Preference dividends(1,209) (4,909) (13,632) (19,633)
Accelerated amortization of costs related to the redemption of preference shares    (4,164)  
Net income (loss) available to common shareholders$(16,864) $(95,259) $44,745  $(54,516)
Other comprehensive income (loss) net of income tax:       
Available-for-sale investments:       
Unrealized holding gains (losses) arising during the period (1)$5,847  $(1,010) $16,021  $(5,204)
Reclassification of net realized (gains) losses, net of income taxes, included in net income(2,146) 362  (5,611) 1,046 
Foreign currency translation adjustments(384) 160  (51) 400 
Other comprehensive income (loss) net of income tax3,317  (488) 10,359  (3,758)
Comprehensive income (loss)$(13,547) $(95,747) $55,104  $(58,274)
Earnings (loss) per share:       
Basic$(0.79) $(4.20) $2.00  $(2.40)
Diluted$(0.79) $(4.20) $2.00  $(2.40)
Weighted average number of ordinary shares used in the determination of earnings (loss) per share:       
Basic21,277,287  22,682,875  22,366,682  22,682,875 
Diluted21,277,287  22,682,875  22,373,968  22,682,875 

(1) Includes $7.5 million and $(1.4) million unrealized net foreign exchange gains (losses) for the three months ended December 31, 2019 and 2018. Includes $3.4 million and $(2.7) million unrealized net foreign exchange gains (losses) for the years ended December 31, 2019 and 2018.

 

 Three Months Ended

December 31,
 Year Ended

December 31,
 2019 2018 2019 2018
Numerator:($ in thousands except share and per share data)
Net income (loss) before preference dividends$(15,655) $(90,350) $62,541  $(34,883)
Preference dividends(1,209) (4,909) (13,632) (19,633)
Accelerated amortization of costs related to the redemption of preference shares    (4,164)  
Net income (loss) available to common shareholders$(16,864) $(95,259) $44,745  $(54,516)
Denominator:       
Weighted average common shares outstanding - basic21,277,287  22,682,875  22,366,682  22,682,875 
Effect of dilutive common share equivalents:       
Weighted average non-vested restricted share units (1)(2)    7,286   
Weighted average common shares outstanding - diluted21,277,287  22,682,875  22,373,968  22,682,875 
Earnings (loss) per common share:       
Basic$(0.79) $(4.20) $2.00  $(2.40)
Diluted$(0.79) $(4.20) $2.00  $(2.40)

(1) During the second quarter of 2019, the Company granted 165,287 restricted share units and common shares to certain employees and directors, 82,360 of which are non-vested as of December 31, 2019.

(2) The weighted average non-vested restricted share units are excluded from the calculation of diluted weighted average common shares outstanding for the three months ended December 31, 2019, due to a net loss reported.

 December 31, 2019 September 30, 2019 June 30, 2019 March 31, 2019 December, 31, 2018
Numerator:($ in thousands except share and per share data)
Total shareholders' equity$872,353  $960,773  $961,296  $941,891  $889,608 
Denominator:         
Common shares outstanding - basic 19,976,397   22,765,802   22,765,802   22,682,875   22,682,875 
Effect of dilutive common share equivalents:         
Non-vested restricted share units (1) 82,360   82,360   82,360       
Common shares outstanding - diluted 20,058,757   22,848,162   22,848,162   22,682,875   22,682,875 
          
Book value per common share$43.67  $42.20  $42.23  $41.52  $39.22 
Book value per diluted common share$43.49  $42.05  $42.07  $41.52  $39.22 

(1) During the second quarter of 2019, the Company granted 165,287 restricted share units and common shares to certain employees and directors, 82,360 of which are non-vested as of December 31, 2019.

Comments on Regulation G

Throughout this release, the Company presents its operations in the way it believes will be the most meaningful and useful to investors, analysts, rating agencies and others who use the Company's financial information in evaluating the performance of the Company and that investors and such other persons benefit from having a consistent basis for comparison between quarters and for comparison with other companies within the industry. These measures may not, however, be comparable to similarly titled measures used by companies outside of the insurance industry. Investors are cautioned not to place undue reliance on these non-GAAP financial measures in assessing the Company's overall financial performance.

This presentation includes the use of "underwriting income (loss)" (which is defined as net premiums earned less loss and loss adjustment expenses, acquisition expenses and general and administrative expenses), "adjusted underwriting income (loss)" (which is defined as underwriting income (loss) plus other underwriting income (loss) less certain corporate expenses), and "adjusted combined ratio" (which is calculated by dividing the sum of loss and loss adjustment expenses, acquisition expenses and general and administrative expenses, less certain corporate expenses, by the sum of net premiums earned and other underwriting income (loss)).  Certain corporate expenses are generally comprised of non-recurring costs of the holding company, such as costs associated with the initial setup of subsidiaries, as well as costs associated with the ongoing operations of the holding company such as compensation of certain executives.

The presentation of underwriting income (loss), adjusted underwriting income (loss) and the adjusted combined ratio are non-GAAP financial measures as defined in Regulation G. The reconciliation of such measures to net income (loss) available to common shareholders (the most directly comparable GAAP financial measure) in accordance with Regulation G is included on the following pages of this release.

Underwriting income (loss) is useful in evaluating our underwriting performance, without regard to other underwriting income (losses), net investment income (losses), net foreign exchange gains (losses), interest expense, income tax expenses and preference dividends, and adjusted underwriting income (loss) is useful in evaluating our underwriting performance, without regard to net investment income (losses), net foreign exchange gains (losses), interest expense, income tax expenses, preference dividends and certain corporate expenses, and the adjusted combined ratio is a key indicator of our profitability, without regard to certain corporate expenses.  The Company believes that preference dividends, income tax expense, foreign exchange gains (losses), interest expense, net investment income (loss), other underwriting income (loss) and certain corporate expenses in any particular period are not indicative of the performance of, or trends in, the Company's underwriting performance. Although preference dividends, income tax expense, foreign exchange gains (losses), interest expense, net investment income (loss) and other underwriting income (loss) are an integral part of the Company's operations, the decision to realize investment gains or losses, the recognition of the change in the carrying value of investments accounted for using the fair value option in net realized gains or losses, and the recognition of foreign exchange gains or losses are independent of the underwriting process and result, in large part, from general economic and financial market conditions. Furthermore, certain users of the Company's financial information believe that, for many companies, the timing of the realization of investment gains or losses is largely opportunistic. The Company believes that certain corporate expenses, due to their non-recurring nature, are not indicative of the performance of, or trends in, the Company's business performance. Due to these reasons, the Company excludes preference dividends, income tax expense, foreign exchange gains (losses), interest expense, net investment income (loss), other underwriting income (loss) from the calculation of underwriting income (loss), and excludes preference dividends, income tax expense, foreign exchange gains (losses), interest expense, net investment income (loss) and certain corporate expenses from the calculation of adjusted underwriting income (loss) and the adjusted combined ratio.

The Company believes that showing underwriting income (loss), adjusted underwriting income (loss) and the adjusted combined ratio exclusive of the items referred to above reflects the underlying fundamentals of the Company's business since the Company evaluates the performance of its business using underwriting income (loss), adjusted underwriting income (loss) and the adjusted combined ratio. The Company believes that this presentation enables investors and other users of the Company's financial information to analyze the Company's performance in a manner similar to how the Company's management analyzes performance. The Company also believes that this measure follows industry practice and, therefore, allows the users of the Company's financial information to compare the Company's performance with its industry peer group. The Company believes that the equity analysts and certain rating agencies, which follow the Company and the insurance industry as a whole generally exclude these items from their analysis for the same reasons.

This presentation also includes the non-investment grade portfolio and investment grade portfolio components of our investment returns: "net interest income yield on average net assets" (calculated as net interest income divided by average net assets), "net investment income return on average total investments" (calculated as net investment income divided by average total investments), and "net investment income return on average net assets" (calculated as net investment income divided by average net assets). Net assets is calculated as the sum of total investments, accrued investment income and receivables for securities sold, less revolving credit agreement borrowings, payable for securities purchased and payables for securities sold short. For the three and twelve-month periods, average net assets is calculated using the averages of each quarterly period. However, for the investment grade portfolio component of these returns, the impact of the revolving credit agreement borrowings is not subtracted from net interest income, net investment income (loss) or the net assets calculation.

The presentation of the separate components of our investment returns (non-investment grade portfolio and investment grade portfolio) are non-GAAP financial measures as defined in Regulation G. The reconciliation of such measures to net interest income and net investment income (loss), the most directly comparable GAAP financial measures, in accordance with Regulation G is included on the following pages of this release.

The non-investment grade portfolio and investment grade portfolio components of our investment returns (net interest income yield on average net assets, net investment income return on average net assets and on average total investments, respectively) are useful in evaluating our investment performance. The non-investment grade portfolio components of these investment returns reflect the performance of our investment strategy under HPS Investment Partners, LLC ("HPS"), which includes the use of leverage. The investment grade portfolio component of these returns reflect the performance of the investment portfolios that predominantly support our underwriting collateral.

The following tables present a reconciliation of underwriting income (loss) to net income (loss) available to common shareholders, and a reconciliation of adjusted underwriting income (loss) to underwriting income (loss):

 Three Months Ended

December 31,
 Year Ended

December 31,
 2019 2018 2019 2018
 ($ in thousands)
Net income (loss) available to common shareholders$(16,864) $(95,259) $44,745  $(54,516)
Preference dividends1,209  4,909  13,632  19,633 
Accelerated amortization of costs related to the redemption of preference shares    4,164   
Net income (loss) before preference dividends(15,655) (90,350) 62,541  (34,883)
Income tax expense    20  27 
Interest expense2,950    5,791   
Net foreign exchange (gains) losses7,536  (1,764) 8,247  (3,611)
Non-recurring direct listing expenses  9,000    9,000 
Net investment (income) loss(32,082) 61,084  (128,263) 6,349 
Other underwriting (income) loss(568) (630) (2,412) (2,722)
Underwriting income (loss)(37,819) (22,660) (54,076) (25,840)
Certain corporate expenses1,882  1,009  10,812  4,109 
Other underwriting income (loss)568  630  2,412  2,722 
Adjusted underwriting income (loss)$(35,369) $(21,021) $(40,852) $(19,009)

The adjusted combined ratio reconciles to the combined ratio for the three months and years ended December 31, 2019 and 2018 as follows:

 Three Months Ended

December 31,
 2019 2018
 Amount Adjustment As Adjusted Amount Adjustment As Adjusted
 ($ in thousands)
Losses and loss adjustment expenses$134,655  $  $134,655  $129,168  $  $129,168 
Acquisition expenses29,785    29,785  34,428    34,428 
General & administrative expenses (1)6,825  (1,882) 4,943  6,037  (1,009) 5,028 
Net premiums earned (1)133,446  568  134,014  146,973  630  147,603 
            
Loss ratio100.9%     87.9%    
Acquisition expense ratio22.3%     23.4%    
General & administrative expense ratio5.1%     4.1%    
Combined ratio128.3%     115.4%    
Adjusted loss ratio    100.5%     87.5%
Adjusted acquisition expense ratio    22.2%     23.3%
Adjusted general & administrative expense ratio    3.7%     3.4%
Adjusted combined ratio    126.4%     114.2%

(1) Adjustments include certain corporate expenses, which are deducted from general and administrative expenses, and other underwriting income (loss), which is added to net premiums earned.

 Year Ended December 31,
 2019 2018
 Amount Adjustment As Adjusted Amount Adjustment As Adjusted
 ($ in thousands)
Losses and loss adjustment expenses$453,135  $  $453,135  $441,255  $  $441,255 
Acquisition expenses126,788    126,788  141,136    141,136 
General & administrative expenses (1)30,843  (10,812) 20,031  22,311  (4,109) 18,202 
Net premiums earned (1)556,690  2,412  559,102  578,862  2,722  581,584 
            
Loss ratio81.4%     76.2%    
Acquisition expense ratio22.8%     24.4%    
General & administrative expense ratio5.5%     3.9%    
Combined ratio109.7%     104.5%    
Adjusted loss ratio    81.0%     75.9%
Adjusted acquisition expense ratio    22.7%     24.3%
Adjusted general & administrative expense ratio    3.6%     3.1%
Adjusted combined ratio    107.3%     103.3%

(1) Adjustments include certain corporate expenses, which are deducted from general and administrative expenses, and other underwriting income (loss), which is added to net premiums earned.



The following tables summarize the components of our total investment return for the three months and years ended December 31, 2019 and 2018:

 Three Months Ended

December 31, 2019
 Three Months Ended

December 31, 2018
 Non-Investment Grade Investment Grade Cost of

U/W Collateral (4)
 Total Non-Investment Grade Investment Grade Cost of

U/W Collateral (4)
 Total
 ($ in thousands)
Interest income$34,435  $6,340  $  $40,775  $38,253  $4,833  $  $43,086 
Investment management fees - related parties(4,431) (376)   (4,807) (4,090) (300)   (4,390)
Borrowing and miscellaneous other investment expenses(2,807) (316) (3,019) (6,142) (5,419) (101) (3,221) (8,741)
Net interest income27,197  5,648  (3,019) 29,826  28,744  4,432  (3,221) 29,955 
Net realized gains (losses) on investments(13,539) 2,875    (10,664) 5,590  (991)   4,599 
Net unrealized gains (losses) on investments (1)17,283  (514)   16,769  (105,208) 3,012    (102,196)
Investment performance fees - related parties(3,849)     (3,849) 6,558      6,558 
Net investment income (loss)$27,092  $8,009  $(3,019) $32,082  $(64,316) $6,453  $(3,221) $(61,084)
                
Average total investments (2)$1,869,300  $870,208  $  $2,739,508  $1,905,464  $851,710  $  $2,757,174 
Average net assets (3)$1,635,302  $872,771  $(328,750) $2,179,323  $1,492,417  $852,176  $(304,487) $2,040,106 
                
Net interest income yield on average net assets (3)1.7% 0.6%   1.4% 1.9% 0.5%   1.5%
Net investment income return on average total investments (2)1.4% 0.9%   1.2% (3.4)% 0.8%   (2.2)%
Net investment income return on average net assets (3)1.7% 0.9% (0.9)% 1.5% (4.3)% 0.8% (1.1)% (3.0)%

(1) Net unrealized gains (losses) on investments excludes unrealized gains and losses from the available for sale portfolios, which are recorded in other comprehensive income.

(2) Net investment income return on average total investments is calculated by dividing net investment income by average total investments. For the three-month period, average total investments is calculated using the average of the beginning and ending balance of each quarterly period. However, for the investment grade portfolio component of these returns, the impact of revolving credit agreement borrowings is not subtracted from net investment income.

(3) Net interest income yield on average net assets and net investment income return on average net assets are calculated by dividing net interest income, and net investment income (loss), respectively, by average net assets. For the non-investment grade component of investment returns and total investment returns, net assets is calculated as the sum of total investments, accrued investment income and receivables for securities sold, less total revolving credit agreement borrowings, payable for securities purchased and payable for securities sold short.  However, for the investment grade portfolio component of these returns, the impact of the revolving credit agreement borrowings is not subtracted from net interest income, net investment income (loss), or the net assets calculation.

(4) The cost of underwriting collateral is calculated as the revolving credit agreement expenses for the investment grade portfolios divided by the average total revolving credit agreement borrowings for the investment grade portfolios during the period.

 Year Ended December 31, 2019 Year Ended December 31, 2018
 Non-Investment Grade Investment Grade Cost of

 U/W Collateral (4)
 Total Non-Investment Grade Investment Grade Cost of

 U/W Collateral (4)
 Total
 ($ in thousands)
Interest income$139,280  $24,608  $  $163,888  $135,847  $17,069  $  $152,916 
Investment management fees - related parties (16,877)  (1,515)     (18,392)  (15,818)  (1,188)     (17,006)
Borrowing and miscellaneous other investment expenses (15,047)  (983)  (13,255)  (29,285)  (16,994)  (375)  (11,008)  (28,377)
Net interest income 107,356   22,110   (13,255)  116,211   103,035   15,506   (11,008)  107,533 
Net realized gains (losses) on investments (13,147)  5,199      (7,948)  392   (5,180)     (4,788)
Net unrealized gains (losses) on investments (1) 24,729   7,462      32,191   (105,768)  (3,278)     (109,046)
Investment performance fees - related parties (12,191)        (12,191)  (48)        (48)
Net investment income (loss)$106,747  $34,771  $(13,255) $128,263  $(2,389) $7,048  $(11,008) $(6,349)
                
Average total investments (2)$1,872,835 $900,641  $  $2,773,476  $1,851,650  $812,186 $  $2,663,836 
Average net assets (3)$1,568,980 $900,069  $(325,527) $2,143,522  $1,472,297  $814,154 $(287,765) $1,998,686 
                
Net interest income yield on average net assets (3) 6.8%  2.5%    5.4%  7.0%  1.9%    5.4%
Net investment income return on average total investments (2) 5.7%  3.9%    4.6%  (0.1)%  0.9%    (0.2)%
Net investment income return on average net assets (3) 6.8%  3.9%  (4.1)%  6.0%  (0.2)%  0.9%  (3.8)%  (0.3)%

(1) Net unrealized gains (losses) on investments excludes unrealized gains and losses from the available for sale portfolios, which are recorded in other comprehensive income.

(2) Net investment income return on average total investments is calculated by dividing net investment income by average total investments. For the twelve-month period, average total investments is calculated using the average of the beginning and ending balance of each quarterly period. However, for the investment grade portfolio component of these returns, the impact of revolving credit agreement borrowings is not subtracted from net investment income.

(3) Net interest income yield on average net assets and net investment income return on average net assets are calculated by dividing net interest income, and net investment income (loss), respectively, by average net assets. For the non-investment grade component of investment returns and total investment returns, net assets is calculated as the sum of total investments, accrued investment income and receivables for securities sold, less total revolving credit agreement borrowings, payable for securities purchased and payable for securities sold short.  However, for the investment grade portfolio component of these returns, the impact of the revolving credit agreement borrowings is not subtracted from net interest income, net investment income (loss), or the net assets calculation.

(4) The cost of underwriting collateral is calculated as the revolving credit agreement expenses for the investment grade portfolios divided by the average total revolving credit agreement borrowings for the investment grade portfolios during the period.

 As of December 31, 2019 As of December 31, 2018
 Non-Investment Grade Investment Grade Borrowings for U/W Collateral Total Non-Investment Grade Investment Grade Borrowings for U/W Collateral Total
 ($ in thousands)
Average total investments - QTD$1,869,300  $870,208  $  $2,739,508  $1,905,464  $851,710  $  $2,757,174 
Average total investments - YTD1,872,835  900,641    2,773,476  1,851,650  812,186    2,663,836 
                
Average net assets - QTD1,635,302  872,771  (328,750) 2,179,323  1,492,417  852,176  (304,487) 2,040,106 
Average net assets - YTD1,568,980  900,069  (325,527) 2,143,522  1,472,297  814,154  (287,765) 1,998,686 
                
Total investments$1,862,253  $846,884  $  $2,709,137  $1,882,591  $855,776  $  $2,738,367 
Accrued investment income9,679  4,346    14,025  15,000  4,461    19,461 
Receivable for securities sold16,275  13    16,288  23,820  687    24,507 
Less: Payable for securities purchased18,180      18,180  60,142      60,142 
Less: Payable for securities sold short66,257      66,257  8,928      8,928 
Less: Revolving credit agreement borrowings155,537    328,750  484,287  386,430    307,487  693,917 
Net assets$1,648,233  $851,243  $(328,750) $2,170,726  $1,465,911  $860,924  $(307,487) $2,019,348 
Non-investment grade borrowing ratio (1)9.4%       26.4%      
                
Unrealized gains on investments$38,057  $9,146  $  $47,203  $15,635  $1,474  $  $17,109 
Unrealized losses on investments(108,444) (2,004)   (110,448) (119,633) (14,861)   (134,494)
Net unrealized gains (losses) on investments$(70,387) $7,142  $  $(63,245) $(103,998) $(13,387) $  $(117,385)

(1) The non-investment grade borrowing ratio is calculated as revolving credit agreement borrowings divided by net assets.

Cautionary Note Regarding Forward-Looking Statements

The Private Securities Litigation Reform Act of 1995 (the "PSLRA") provides a "safe harbor" for forward-looking statements. This release or any other written or oral statements made by or on behalf of the Company may include forward-looking statements, which reflect the Company's current views with respect to future events and financial performance. All statements other than statements of historical fact included in or incorporated by reference in this release are forward-looking statements. Forward-looking statements, for purposes of the PSLRA or otherwise, can generally be identified by the use of forward-looking terminology such as "may," "will," "expect," "intend," "estimate," "anticipate," "believe" or "continue" and similar statements of a future or forward-looking nature or their negative or variations or similar terminology. These forward-looking statements include statements regarding the Company's return on equity potential and prospects for further book value growth.

Forward-looking statements involve the Company's 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 release, in the Company's Registration Statement on Form S-1 (File No. 333-230080) (as amended, the "Form S-1") filed with the Securities and Exchange Commission (the "SEC"), and in the Company's periodic reports filed with 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;
  • our dependence on key executives and inability to attract qualified personnel, or the potential loss of Bermudian personnel as a result of Bermuda employment restrictions;
  • our dependence on letter of credit 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 ("PFIC");
  • our dependence on certain subsidiaries of Arch Capital Group Ltd. ("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 Arch Investment Management Ltd. ("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 ("FATCA") provisions; and
  • the other matters set forth under "Risk Factors," "Management's Discussion and Analysis of Financial Condition and Results of Operations," "Business" and other sections of the Company's Form S-1, 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.

All subsequent written and oral forward-looking statements attributable to the Company or persons acting on its 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. The Company undertakes no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise.

Contacts

Robert L. Hawley: (441) 278-3456

rhawley@watfordre.com 

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