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Watford Reports 2019 Second Quarter Results

PEMBROKE, Bermuda, July 29, 2019 (GLOBE NEWSWIRE) -- WATFORD HOLDINGS LTD. (“Watford” or the “Company”) (WTRE) today reported net income of $13.8 million, after payment of $4.9 million of preferred dividends, for the three months ended June 30, 2019, compared to net income of $9.1 million, after payment of $4.9 million of preferred dividends, in the same period in 2018. The results included:

  • Net income available to common shareholders of $13.8 million, or $0.61 per diluted common share, a 5.8% annualized return on average equity, compared to net income of $9.1 million, or $0.41 per diluted common share, a 3.8% annualized return on average equity for the 2018 second quarter1;

  • Book value per diluted common share of $42.07 at June 30, 2019, a 1.3% increase from March 31, 2019 and a 7.3% increase from December 31, 2018;

  • Combined ratio of 103.5%, comprised of a 73.6% loss ratio, a 23.4% acquisition expense ratio and a 6.5% general and administrative expense ratio, compared to a combined ratio of 100.6% for the prior year second quarter, comprised of a 73.4% loss ratio, a 23.8% acquisition expense ratio and a 3.4% general and administrative expense ratio;

  • Net interest income of $26.4 million, a 1.2% yield on average net assets for the 2019 second quarter, compared to net interest income of $26.0 million and a 1.3% yield on average net assets for the 2018 second quarter; and

  • Net investment income of $23.8 million, a 1.1% return on average net assets for the 2019 second quarter, compared to net investment income of $13.8 million and a 0.7% return on average net assets for the 2018 second quarter.

  • In addition, on July 2, 2019, the Company completed an offering of $175.0 million of 6.5% senior notes, with a maturity date of July 2, 2029. The net proceeds from the offering will be used in part to redeem a substantial portion of the Company’s 8.5% cumulative redeemable preference shares on August 1, 2019.

1 Annualized return on average equity represents net income (loss) expressed as a percentage of average common shareholders’ equity during the period. Annualized return on average equity for the three months ended June 30, 2019 and 2018 is calculated by extrapolating the quarterly return on average equity over a twelve-month period. For the three-month period, the average common shareholders’ equity is calculated as the average of the beginning and ending common shareholders’ equity of each quarterly period.

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

“We are pleased with our results for the 2019 second quarter. The combined ratio of 103.5% when adjusted for other underwriting income and certain corporate and non-recurring expenses, was 99.9%. Our loss reserves for prior accident years continued to hold up well, with slight net favorable development in the quarter.

Net interest income, at $26.4 million, was strong, while realized and unrealized investment gains were essentially flat.

Through six months, our total shareholders’ equity has increased 8.1% from year-end 2018 and we continue to be optimistic about continued strong book value growth. Insurance and reinsurance market conditions are improving in most lines of business. There is a growing industry consensus that we have entered a new phase of the market cycle, with a noticeably more favorable pricing environment.

During the quarter, the Company’s financial strength ratings of A- (Excellent) and A were reaffirmed by both A.M. Best and Kroll Bond Rating Agency, respectively. The Company also completed a $175.0 million 10-year senior note offering with a coupon of 6.5%. The net proceeds will be used to redeem approximately 75% of our 8.5% cumulative redeemable preference shares, which will result in substantial savings in interest and preferred dividend expense going forward.”

Underwriting

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

  Three Months Ended June 30,   Six Months Ended June 30,
  2019   2018   % Change   2019   2018   % Change
   
  ($ in thousands)
Gross premiums written $ 161,978     $ 175,175     (7.5 )%   $ 348,667     $ 389,045     (10.4 )%
Net premiums written 119,370     140,586     (15.1 )%   264,757     320,138     (17.3 )%
Net premiums earned 151,318     159,518     (5.1 )%   297,412     296,265     0.4 %
Underwriting income (loss) (1) (5,266 )   (1,006 )   (423.5 )%   (11,236 )   (2,268 )   (395.4 )%
                       
          % Point
Change
          % Point
Change
Loss ratio 73.6 %   73.4 %   0.2 %   74.7 %   72.6 %   2.1 %
Acquisition expense ratio 23.4 %   23.8 %   (0.4 )%   23.3 %   24.6 %   (1.3 )%
General & administrative expense ratio 6.5 %   3.4 %   3.1 %   5.8 %   3.5 %   2.3 %
Combined ratio 103.5 %   100.6 %   2.9 %   103.8 %   100.7 %   3.1 %
Adjusted combined ratio (2) 99.9 %   99.6 %   0.3 %   101.1 %   99.6 %   1.5 %

(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 shows the components of our loss and loss adjustment expenses for the three and six months ended June 30, 2019 and 2018:


  Three Months Ended June 30,   Six Months Ended June 30,
  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 $ 111,494     73.7 %   $ 117,780     73.8 %   $ 222,395     74.8 %   $ 215,166     72.6 %
Prior year development (favorable)/adverse (78 )   (0.1 )%   (639 )   (0.4 )%   (129 )   (0.1 )%   (36 )   %
Loss and loss adjustment expenses $ 111,416     73.6 %   $ 117,141     73.4 %   $ 222,266     74.7 %   $ 215,130     72.6 %


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

  Three Months Ended June 30,   Six Months Ended June 30,
  2019   2018   2019   2018
   
  ($ in thousands)
Gross premiums written:              
Casualty reinsurance $ 32,557     $ 56,399     $ 108,158     $ 142,362  
Other specialty reinsurance 37,836     49,150     62,134     113,649  
Property catastrophe reinsurance 5,929     3,542     11,921     7,387  
Insurance programs and coinsurance 85,656     66,084     166,454     125,647  
Total $ 161,978     $ 175,175     $ 348,667     $ 389,045  
               
Net premiums written:              
Casualty reinsurance $ 32,077     $ 55,825     $ 107,142     $ 141,520  
Other specialty reinsurance 36,523     45,255     59,705     102,793  
Property catastrophe reinsurance 5,621     3,339     11,603     7,173  
Insurance programs and coinsurance 45,149     36,167     86,307     68,652  
Total $ 119,370     $ 140,586     $ 264,757     $ 320,138  
               
Net premiums earned:              
Casualty reinsurance $ 67,506     $ 75,499     $ 130,819     $ 143,240  
Other specialty reinsurance 42,635     50,506     87,196     88,284  
Property catastrophe reinsurance 3,119     2,326     6,090     4,962  
Insurance programs and coinsurance 38,058     31,187     73,307     59,779  
Total $ 151,318     $ 159,518     $ 297,412     $ 296,265  

Results for the three months ended June 30, 2019 versus 2018:

Gross and net premiums written and net premiums earned in the 2019 second quarter were 7.5%, 15.1% and 5.1% lower, respectively, than the 2018 second quarter. The decrease in premiums reflected a reduction in casualty reinsurance and other specialty reinsurance premiums written, offset in part by an increase in insurance programs and coinsurance in the 2019 second quarter.

The loss ratio was 73.6% in the 2019 second quarter, in-line with 73.4% in the 2018 second quarter. Across all lines, net loss reserve development was slightly favorable and had a negligible impact on the 2019 second quarter loss ratio. This compares to 0.4 points of net favorable loss reserve development in the 2018 second quarter.

The acquisition expense ratio was 23.4% in the 2019 second quarter, compared to 23.8% in the 2018 second quarter, reflecting changes in the mix and type of business.

The general and administrative expense ratio was 6.5% in the 2019 second quarter, compared to 4.9% in the 2019 first quarter and 3.4% in the second quarter of 2018. The 1.6 point increase this quarter versus the first quarter of 2019 reflected the timing of certain long-term incentive compensation expenses, including a one-time accelerated expense equating to approximately 1.0% of earned premium. The 3.1 point increase versus the prior year second quarter was attributable to ongoing public company expenses, as well as the timing of long-term incentive compensation expenses mentioned above. Removing certain corporate non-operating and non-recurring expenses, our adjusted general and administrative expense ratio was 3.3% in the 2019 second quarter compared to 3.5% in the first quarter of 2019.

Investments

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

  Three Months Ended June 30,   Six Months Ended June 30,
  2019   2018   2019   2018
   
  ($ in thousands)
Interest income $ 38,596     $ 36,481     $ 81,737     $ 71,126  
Investment management fees - related parties (4,570 )   (4,156 )   (8,979 )   (8,302 )
Borrowing and miscellaneous other investment expenses (7,611 )   (6,283 )   (15,909 )   (12,643 )
Net interest income 26,415     26,042     56,849     50,181  
Realized gains (losses) on investments 789     (1,750 )   2,071     (13,391 )
Unrealized gains (losses) on investments (1,725 )   (8,864 )   30,713     771  
Investment performance fees - related parties (1,692 )   (1,602 )   (7,492 )   (4,199 )
Net investment income (loss) $ 23,787     $ 13,826     $ 82,141     $ 33,362  
               
Unrealized gains on investments (balance sheet). $ 35,228     $ 43,535     $ 35,228     $ 43,535  
Unrealized losses on investments (balance sheet) (113,937 )   (48,447 )   (113,937 )   (48,447 )
Net unrealized gains (losses) on investments (balance sheet). $ (78,709 )   $ (4,912 )   $ (78,709 )   $ (4,912 )
               
Net interest income yield on average net assets (1) 1.2 %   1.3 %   2.7 %   2.6 %
Non-investment grade portfolio (1) 1.6 %   1.7 %   3.5 %   3.3 %
Investment grade portfolio (1) 0.6 %   0.5 %   1.2 %   0.9 %
Net investment income return on average net assets (1) 1.1 %   0.7 %   3.9 %   1.7 %
Non-investment grade portfolio (1) 1.2 %   1.0 %   4.6 %   2.8 %
Investment grade portfolio (1) 1.0 %   0.2 %   2.1 %   (0.4 )%
               
Net investment income return on average total investments (2) 0.8 %   0.5 %   2.9 %   1.3 %
Non-investment grade portfolio (2) 1.0 %   0.8 %   3.7 %   2.3 %
Investment grade portfolio (2) 1.0 %   0.2 %   2.1 %   (0.4 )%

(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 six-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 six-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 June 30, 2019:

  As of June 30, 2019
  Non-Investment Grade
  ($ in millions)
Total non-investment grade investments $ 1,833.5  
   
Portfolio allocation by asset class:  
Term loans 57.0 %
Corporate bonds 17.4 %
Asset-backed securities 10.6 %
Short-term investments 6.7 %
Equities 6.6 %
Other investments 1.3 %
Mortgage-backed securities 0.4 %
Total 100.0 %


  As of June 30, 2019
  Investment Grade
  ($ in millions)
Total investment grade investments $ 936.6  
   
Portfolio allocation by asset class:  
U.S. government and government agency bonds 39.2 %
Corporate bonds 16.2 %
Asset-backed securities 15.7 %
Non-U.S. government and government agency bonds 14.7 %
Short-term investments 11.6 %
Mortgage-backed securities 1.8 %
Municipal government and government agency bonds 0.8 %
Total 100.0 %

Corporate Function

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

There was a net foreign exchange loss for the 2019 second quarter of $0.4 million, compared to net foreign exchange gains for the 2018 second quarter of $0.5 million. There was a net foreign exchange loss for the six months ended June 30, 2019 of $0.9 million, compared to a net foreign exchange loss for the six months ended June 30, 2018 of $0.7 million.

Preferred dividends for the 2019 second quarter were $4.9 million, compared to $4.9 million for the 2018 second quarter. Preferred dividends for the six months ended June 30, 2019 were $9.8 million, in-line with $9.8 million for the six months ended June 30, 2018.

Conference Call

The Company will hold a conference call on Tuesday, July 30, 2019 at 1:00 p.m. Eastern time to discuss its 2019 second 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 August 1st.

About Watford Holdings Ltd.

Watford Holdings Ltd. is a global property and casualty insurance and reinsurance company with approximately $1.2 billion in capital, as of June 30, 2019, comprised of $221.2 million of contingently redeemable preference shares and $961.3 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)    
  June 30,   December 31,
  2019   2018
   
Assets ($ in thousands)
Investments:      
Term loans, fair value option (Amortized cost: $1,099,970 and $1,055,664)  $ 1,042,879     $ 1,000,652  
Fixed maturities, fair value option (Amortized cost: $634,920 and $972,653)  616,863     922,819  
Short-term investments, fair value option (Cost: $232,488 and $281,959)  232,177     282,132  
Equity securities, fair value option  56,524     56,638  
Other investments, fair value option  24,505     49,762  
Investments, fair value option  1,972,948     2,312,003  
Fixed maturities, available for sale (Amortized cost: $728,757 and $397,509)  732,454     393,351  
Equity securities, fair value through net income  64,703     33,013  
Total investments  2,770,105     2,738,367  
Cash and cash equivalents  68,977     63,529  
Accrued investment income  16,916     19,461  
Premiums receivable  228,588     227,301  
Reinsurance recoverable on unpaid and paid losses and loss adjustment expenses  123,961     86,445  
Prepaid reinsurance premiums  79,513     61,587  
Deferred acquisition costs, net  71,557     80,858  
Receivable for securities sold  29,425     24,507  
Intangible assets  7,650     7,650  
Funds held by reinsurers  55,536     44,830  
Other assets 16,300     18,321  
Total assets $ 3,468,528     $ 3,372,856  
Liabilities      
Reserve for losses and loss adjustment expenses $ 1,126,080     $ 1,032,760  
Unearned premiums  375,323     390,114  
Losses payable  71,270     24,750  
Reinsurance balances payable  23,312     21,034  
Payable for securities purchased  51,216     60,142  
Payable for securities sold short  48,823     8,928  
Revolving credit agreement borrowings  558,297     693,917  
Amounts due to affiliates  5,741     5,888  
Investment management and performance fees payable  12,490     3,807  
Other liabilities  13,505     20,916  
Total liabilities  $ 2,286,057     $ 2,262,256  
Commitments and contingencies      
Contingently redeemable preferred shares  221,175     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 capital  897,716     895,386  
Retained earnings (deficit)  60,182     (1,275 )
Accumulated other comprehensive income (loss) 3,171     (4,730 )
Total shareholders’ equity  961,296     889,608  
Total liabilities, contingently redeemable preferred shares and shareholders’ equity  $ 3,468,528     $ 3,372,856  


CONSOLIDATED STATEMENT OF INCOME (LOSS) (UNAUDITED)

  (Unaudited)   (Unaudited)
  Three Months Ended June 30,   Six Months Ended June 30,
  2019   2018   Change
QTR %
  2019   2018   Change
YTD %
   
Revenues ($ in thousands except share and per share data)
Gross premiums written  $ 161,978     $ 175,175     (8 )%   $ 348,667     $ 389,045     (10 )%
Gross premiums ceded  (42,608 )   (34,589 )   23 %   (83,910 )   (68,907 )   22 %
Net premiums written  119,370     140,586     (15 )%   264,757     320,138     (17 )%
Change in unearned premiums 31,948     18,932     69 %   32,655     (23,873 )   (237 )%
Net premiums earned  151,318     159,518     (5 )%   297,412     296,265     %
Other underwriting income (loss)  673     688     (2 )%   1,265     1,389     (9 )%
Interest income  38,596     36,481     6 %   81,737     71,126     15 %
Investment management fees - related parties  (4,570 )   (4,156 )   10 %   (8,979 )   (8,302 )   8 %
Borrowing and miscellaneous other investment expenses  (7,611 )   (6,283 )   21 %   (15,909 )   (12,643 )   26 %
Net interest income  26,415     26,042     1 %   56,849     50,181     13 %
Realized and unrealized gains (losses) on investments  (936 )   (10,614 )   (91 )%   32,784     (12,620 )   (360 )%
Investment performance fees - related parties  (1,692 )   (1,602 )   6 %   (7,492 )   (4,199 )   78 %
Net investment income (loss)  23,787     13,826     72 %   82,141     33,362     146 %
Total revenues  175,778     174,032     1 %   380,818     331,016     15 %
Expenses                      
Loss and loss adjustment expenses  (111,416 )   (117,141 )   (5 )%   (222,266 )   (215,130 )   3 %
Acquisition expenses  (35,417 )   (37,967 )   (7 )%   (69,391 )   (72,930 )   (5 )%
General and administrative expenses  (9,751 )   (5,416 )   80 %   (16,991 )   (10,473 )   62 %
Net foreign exchange gains (losses)  (441 )   548     (180 )%   (878 )   (735 )   19 %
Total expenses  (157,025 )   (159,976 )   (2 )%   (309,526 )   (299,268 )   3 %
Income (loss) before income taxes  18,753     14,056     33 %   71,292     31,748     125 %
Income tax expense (20 )   (24 )   (17 )%   (20 )   (27 )   (26 )%
Net income (loss) before preferred dividends  18,733     14,032     34 %   71,272     31,721     125 %
Preferred dividends (4,908 )   (4,908 )   %   (9,815 )   (9,815 )   %
Net income (loss) available to common shareholders  $ 13,825     $ 9,124     52 %   $ 61,457     $ 21,906     181 %
Earnings (loss) per share:                      
Basic  $ 0.61     $ 0.41     49 %   $ 2.71     $ 0.97     179 %
Diluted  $ 0.61     $ 0.41     49 %   $ 2.71     $ 0.97     179 %
Weighted average number of ordinary shares used in the determination of earnings (loss) per share:                      
Basic  22,740,762     22,682,875     %   22,711,833     22,682,875     %
Diluted  22,747,033     22,682,875     %   22,714,969     22,682,875     %


  Three Months Ended June 30,   Six Months Ended June 30,
    2019     2018     2019     2018
   
Numerator: ($ in thousands except share and per share data)
Net income (loss) before preferred dividends  $ 18,733     $ 14,032     $ 71,272     $ 31,721  
Preferred dividends   (4,908 )     (4,908 )     (9,815 )     (9,815 )
Net income (loss) available to common shareholders  $ 13,825     $ 9,124     $ 61,457     $ 21,906  
Denominator:              
Weighted average common shares outstanding - basic    22,740,762       22,682,875       22,711,833       22,682,875  
Effect of dilutive common share equivalents:               
Weighted average non-vested restricted share units (1)    6,271             3,136        
Weighted average common shares outstanding - diluted    22,747,033       22,682,875       22,714,969       22,682,875  
Earnings (loss) per common share:              
Basic  $ 0.61   $ 0.41   $ 2.71   $ 0.97
Diluted  $ 0.61   $ 0.41   $ 2.71   $ 0.97

(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 June 30, 2019.


  June 30,   March 31,   December 31,
  2019   2019   2018
   
Numerator: ($ in thousands except share and per share data)
Total shareholders’ equity  $ 961,296     $ 941,891     $ 889,608  
Denominator:          
Common shares outstanding - basic    22,765,802       22,682,875       22,682,875  
Effect of dilutive common share equivalents:          
Non-vested restricted share units (1)    82,360              
Common shares outstanding - diluted    22,848,162       22,682,875       22,682,875  
           
Book value per basic common share  $ 42.23   $ 41.52   $ 39.22
Book value per diluted common share  $ 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 June 30, 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), income tax expenses and preferred 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), income tax expenses, preferred 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 preferred dividends, income tax expense, foreign exchange gains (losses), 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 preferred dividends, income tax expense, foreign exchange gains (losses), 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 preferred dividends, income tax expense, foreign exchange gains (losses), net investment income (loss), other underwriting income (loss) from the calculation of underwriting income (loss), and excludes preferred dividends, income tax expense, foreign exchange gains (losses), 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-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 presents 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):

The adjusted combined ratio reconciles to the combined ratio for the three and six months ended June 30, 2019 and 2018 as follows:

  Three Months Ended June 30,   Six Months Ended June 30,
  2019   2018   2019   2018
   
  ($ in thousands)
Net income (loss) available to common shareholders  $ 13,825     $ 9,124     $ 61,457     $ 21,906  
Preferred dividends 4,908     4,908     9,815     9,815  
Net income (loss) before dividends  18,733     14,032     71,272     31,721  
Income tax expense 20     24     20     27  
Net foreign exchange (gains) losses  441     (548 )   878     735  
Net investment (income) loss  (23,787 )   (13,826 )   (82,141 )   (33,362 )
Other underwriting (income) loss  (673 )   (688 )   (1,265 )   (1,389 )
Underwriting income (loss)  (5,266 )   (1,006 )   (11,236 )   (2,268 )
Certain corporate expenses  4,795     1,010     6,758     2,153  
Other underwriting income (loss)  673     688     1,265     1,389  
Adjusted underwriting income (loss)  $ 202     $ 692     $ (3,213 )   $ 1,274  


The adjusted combined ratio reconciles to the combined ratio for the three and six months ended June 30, 2019 and 2018 as follows:

  Three Months Ended June 30,
  2019   2018
  Amount   Adjustment   As
Adjusted
  Amount   Adjustment   As
Adjusted
   
  ($ in thousands)
Losses and loss adjustment expenses  $ 111,416     $     $ 111,416     $ 117,141     $     $ 117,141  
Acquisition expenses  35,417         35,417     37,967         37,967  
General & administrative expenses (1)  9,751     (4,795 )   4,956     5,416     (1,010 )   4,406  
Net premiums earned (1)  151,318     673     151,991     159,518     688     160,206  
                       
Loss ratio 73.6 %           73.4 %        
Acquisition expense ratio  23.4 %           23.8 %        
General & administrative expense ratio (1)  6.5 %           3.4 %        
Combined ratio  103.5 %           100.6 %        
Adjusted loss ratio          73.3 %           73.1 %
Adjusted acquisition expense ratio          23.3 %           23.7 %
Adjusted general & administrative expense ratio          3.3 %           2.8 %
Adjusted combined ratio          99.9 %           99.6 %

(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.


  Six Months Ended June 30,
  2019   2018
  Amount   Adjustment   As
Adjusted
  Amount   Adjustment   As
Adjusted
   
  ($ in thousands)
Losses and loss adjustment expenses  $ 222,266     $     $ 222,266     $ 215,130     $     $ 215,130  
Acquisition expenses  69,391         69,391     72,930         72,930  
General & administrative expenses (1)  16,991     (6,758 )   10,233     10,473     (2,153 )   8,320  
Net premiums earned (1)  297,412     1,265     298,677     296,265     1,389     297,654  
                       
Loss ratio 74.7 %           72.6 %        
Acquisition expense ratio  23.3 %           24.6 %        
General & administrative expense ratio (1)  5.8 %           3.5 %        
Combined ratio  103.8 %           100.7 %        
Adjusted loss ratio          74.4 %           72.3 %
Adjusted acquisition expense ratio          23.2 %           24.5 %
Adjusted general & administrative expense ratio          3.5 %           2.8 %
Adjusted combined ratio          101.1 %           99.6 %

(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 and six months ended June 30, 2019 and 2018:

  Three Months Ended June 30, 2019   Three Months Ended June 30, 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  $ 32,492     $ 6,104     $     $ 38,596     $ 32,378     $ 4,103     $     $ 36,481  
Investment management fees - related parties  (4,171 )   (399 )       (4,570 )   (3,868 )   (288 )       (4,156 )
Borrowing and miscellaneous other investment expenses  (3,809 )   (238 )   (3,564 )   (7,611 )   (3,579 )   (59 )   (2,645 )   (6,283 )
Net interest income  24,512     5,467     (3,564 )   26,415     24,931     3,756     (2,645 )   26,042  
Net realized gains (losses) on investments  (177 )   966         789     (79 )   (1,671 )       (1,750 )
Net unrealized gains (losses) on investments (1)  (4,511 )   2,786         (1,725 )   (8,594 )   (270 )       (8,864 )
Investment performance fees - related parties  (1,692 )           (1,692 )   (1,602 )           (1,602 )
Net investment income (loss)  $ 18,132     $ 9,219     $ (3,564 )   $ 23,787     $ 14,656     $ 1,815     $ (2,645 )   $ 13,826  
                               
Average total investments (2)  $ 1,871,286     $ 928,850     $     $ 2,800,136     $ 1,830,469     $ 800,567     $     $ 2,631,036  
Average net assets (3)  $ 1,548,237     $ 924,948     $ (327,619 )   $ 2,145,566     $ 1,460,949     $ 804,513     $ (284,561 )   $ 1,980,901  
                               
Net interest income yield on average net assets (3)  1.6 %   0.6 %       1.2 %   1.7 %   0.5 %       1.3 %
Net investment income return on average total investments (2)  1.0 %   1.0 %       0.8 %   0.8 %   0.2 %       0.5 %
Net investment income return on average net assets (3)  1.2 %   1.0 %   (1.1 )%   1.1 %   1.0 %   0.2 %   (0.9 )%   0.7 %

(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.


  Six Months Ended June 30, 2019   Six Months Ended June 30, 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  $ 69,831     $ 11,906     $     $ 81,737     $ 63,256     $ 7,870     $     $ 71,126  
Investment management fees - related parties    (8,242 )     (737 )           (8,979 )     (7,720 )     (582 )           (8,302 )
Borrowing and miscellaneous other investment expenses    (8,667 )     (442 )     (6,800 )     (15,909 )     (7,525 )     (194 )     (4,924 )     (12,643 )
Net interest income    52,922       10,727       (6,800 )     56,849       48,011       7,094       (4,924 )     50,181  
Net realized gains (losses) on investments    1,142       929             2,071       (9,325 )     (4,066 )           (13,391 )
Net unrealized gains (losses) on investments (1)    23,114       7,599             30,713       6,569       (5,798 )           771  
Investment performance fees - related parties    (7,492 )                 (7,492 )     (4,199 )                 (4,199 )
Net investment income (loss)  $ 69,686     $ 19,255     $ (6,800 )   $ 82,141     $ 41,056     $ (2,770 )   $ (4,924 )   $ 33,362  
                               
Average total investments (2)  $ 1,883,565     $ 908,637     $     $ 2,792,202     $ 1,788,239     $ 784,975     $     $ 2,573,214  
Average net assets (3)  $ 1,527,241     $ 905,937     $ (322,303 )   $ 2,110,875     $ 1,447,414     $ 788,692     $ (275,463 )   $ 1,960,643  
                               
Net interest income yield on average net assets (3)   3.5 %     1.2 %         2.7 %     3.3 %     0.9 %         2.6 %
Net investment income return on average total investments (2)   3.7 %     2.1 %         2.9 %     2.3 %     (0.4 )%         1.3 %
Net investment income return on average net assets (3)    4.6 %     2.1 %     (2.1 )%     3.9 %     2.8 %     (0.4 )%     (1.8 )%     1.7 %

(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 six-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 June 30, 2019   As of June 30, 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  $ 1,871,286     $ 928,850     $     $ 2,800,136     $ 1,830,469     $ 800,567     $     $ 2,631,036  
Average total investments - YTD  1,883,565     908,637         2,792,202     1,788,239     784,975         2,573,214  
                               
Average net assets - QTD  1,548,237     924,948     (327,619 )   2,145,566     1,460,949     804,513     (284,561 )   1,980,901  
Average net assets - YTD  1,527,241     905,937     (322,303 )   2,110,875     1,447,414     788,692     (275,463 )   1,960,643  
                               
Total investments  $ 1,833,476     $ 936,629     $     $ 2,770,105     $ 1,920,978     $ 806,525     $     $ 2,727,503  
Accrued Investment Income  11,834     5,082         16,916     13,980     4,128         18,108  
Receivable for Securities Sold  29,367     58         29,425     31,352     35         31,387  
Less: Payable for Securities Purchased  46,412     4,804         51,216     132,164             132,164  
Less: Payable for Securities Sold Short  48,823             48,823     24,529             24,529  
Less: Revolving credit agreement borrowings  229,546         328,751     558,297     324,655         289,807     614,462  
Net assets  $ 1,549,896     $ 936,965     $ (328,751 )   $ 2,158,110     $ 1,484,962     $ 810,688     $ (289,807 )   $ 2,005,843  
Non-investment grade borrowing ratio (1)  14.8 %               21.9 %            
                               
Unrealized gains on investments  $ 27,068     $ 8,160     $     $ 35,228     $ 43,329     $ 206     $     $ 43,535  
Unrealized losses on investments  (109,200 )   (4,737 )       (113,937 )   (35,373 )   (13,074 )       (48,447 )
Net unrealized gains (losses) on investments  $ (82,132 )   $ 3,423     $     $ (78,709 )   $ 7,956     $ (12,868 )   $     $ (4,912 )

(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.

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