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HERITAGE INSURANCE HOLDINGS, INC. – 10-Q – Management's Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion in conjunction with our condensed consolidated financial statements and related notes and information included and elsewhere in this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for the year endedDecember 31, 2020 ("2020 Form 10-K"). Unless the context requires otherwise, as used in this Form 10-Q, the terms "we", "us", "our", "the Company", "our Company", and similar references refer toHeritage Insurance Holdings, Inc. , aDelaware corporation, and its subsidiaries.
FINANCIAL HIGHLIGHTS
Overview
Heritage Insurance Holdings, Inc. , is a super-regional property and casualty insurance holding company that primarily provides personal and commercial residential insurance products across its multi-state footprint. We provide personal residential insurance in sixteen states and commercial residential insurance in three of those states, while maintaining licenses in one additional state. As a vertically integrated insurer, we control or manage substantially all aspects of underwriting, customer service, actuarial analysis, distribution and claims processing and adjusting. Our financial strength ratings are important to the Company in establishing our competitive position and can impact our ability to write policies. The discussion of our financial condition and results of operations that follows provides information that will assist the reader in understanding our consolidated financial statements, the changes in certain key items in those financial statements from year to year, and the primary factors that accounted for those changes, as well as how certain accounting principles, policies and estimates affect our consolidated financial statements. This discussion should be read in conjunction with our consolidated financial statements and the related notes that appear elsewhere in this document.
COVID-19 and Other Matters
We continue to monitor the short- and long-term impacts of the COVID-19 virus and its variants. For the year endedDecember 31, 2020 , we saw negligible impact to our business, and that trend has continued through the third quarter of 2021. As a residential property insurer, we view our business as somewhat insulated because property owners and renters generally view our products as a necessity. The majority of our gross and net premiums written are from renewals of expiring policies. New business, which accounts for a smaller portion of our revenue, may be impacted if consumers are not buying as many new homes in our geographies, but this could be partially or fully offset by increased retention in our renewal portfolio. In a prolonged recessionary and social-distancing environment, we could experience disruptions to our independent agency distribution channel, which may have a negative impact on our revenues and financial condition. Increases in the cost of materials and labor for home repairs can influence our losses associated with claims. To the extent state and local requirements allow employees to return to the office, the Company has implemented return-to-office and hybrid programs, with the latter including a combination of in-office and remote work.
Climate Change
Climate change, to the extent it produces extreme changes in temperatures and changes in weather patterns, could affect the frequency or severity of weather-related catastrophes. The incidence and severity of catastrophes are inherently unpredictable and the extent of losses from a catastrophe is a function of both the total amount of insured exposure in the area affected and the severity of the event. Although we attempt to manage our exposure to catastrophes through our underwriting process and the purchase of reinsurance protection, an especially severe catastrophe or series of catastrophes could exceed our reinsurance protection and may have a material adverse impact on our results of operations and financial condition. Further, an increased incidence of catastrophic weather events could impact the cost and availability of our reinsurance program.
Coronavirus Aid, Relief, and Economic Security Act
The CARES Act was enacted onMarch 27, 2020 inthe United States . The CARES Act and related notices include several significant provisions, including delaying certain payroll tax payments, mandatory transition tax payments under the TCJ Act, and estimated income tax payments that we are deferring to future periods. We do not currently expect the CARES Act to have a material impact on our liquidity or our financial results, except for the benefit associated with a 5-year carryback of our 2020 tax net operating loss. We will continue to monitor and assess the impact the CARES Act and similar legislation may have on our business and financial results.
Financial Results Highlights for the Third quarter of 2021
?
Net loss for the quarter was
loss of
27 -------------------------------------------------------------------------------- ? Book value per share of$14.57 , down 4.1% from second quarter 2021 and 8.8% year-over-year. ? Gross premiums written of$274.2 million , down 1.5% year-over-year, stemming from a 12.4% exposure management driven reduction inFlorida , partly offset by 8.0% growth in other states. ? Premiums in force of$1.2 billion , relatively flat from second quarter 2021 and up 13.3% year-over-year. ? Policies-in-force of 581,286, a 2.1% reduction from second quarter 2021 and a 3.0% year-over-year increase. ? Favorable prior year reserve development of$0.8 million . ? Net current accident quarter weather losses of$51.4 million , up from$47.3 million in the prior year quarter. Current accident quarter weather losses include$16.0 million of net current accident quarter catastrophe losses, down from$24.6 million in the prior year quarter, and$35.5 million of other weather losses, up from$22.8 million in the prior year quarter. ? Total capital returned to shareholders of$2.7 million , representing a$0.06 per share regular quarterly dividend and repurchase of 148,109 shares of stock.
Results of Operations
Comparison of the Three Months Ended
Revenue
For the Three Months Ended September 30,
(Unaudited) 2021 2020 $ Change % Change
(in thousands)
REVENUE:
Gross premiums written $ 274,178 $ 278,242 $ (4,064 ) (1.5 )%
Change in gross unearned
premiums 20,231 (23,260 ) 43,491 (187.0 )%
Gross premiums earned 294,409 254,982 39,427 15.5 %
Ceded premiums (131,964 ) (116,752 ) (15,212 ) 13.0 %
Net premiums earned 162,445 138,230 24,215 17.5 %
Net investment income 1,548 2,817 (1,269 ) (45.0 )%
Net realized and unrealized
(losses) gains (6 ) 20,355 (20,361 ) NM
Other revenue 3,421 3,717 (296 ) (8.0 )%
Total revenue $ 167,408 $ 165,119 $ 2,290 1.4 %
NM= Not Meaningful
Gross premiums written
Gross premiums written were $274.2 million in the third quarter of 2021, down
1.5% from $278.2 million in the prior year quarter. The decrease reflects 12.4%
reduction in Florida gross written premium, partially offset by 8.0% growth in
other states. The reduction in Florida gross written premium reflects our plan
to manage our Florida total insurance value ("TIV") and attritional loss ratios
by controlling renewals and new business written. Rate increases materially
benefited 2021 gross premiums written, particularly in Florida .
Premiums-in-force were $1.2 billion as of third quarter 2021, relatively flat
from second quarter 2021 and up 13.3% year-over-year. Policies-in-force were
581,286, a 2.1% reduction from 593,786 policies at second quarter 2021 and a
3.0% increase year-over-year. The reduction in policies in force from the second
quarter of 2021 reflects our exposure initiatives.
Gross premiums earned
Gross premiums earned were$294.4 million in the third quarter of 2021, up 15.5% from$255.0 million in the prior year quarter. The increase reflects the earning of higher gross premiums written over the twelve months endedSeptember 30, 2021 compared to premiums written over the twelve months endedSeptember 30, 2020 .
Ceded premiums
Ceded premiums were$132.0 million in third quarter 2021, up 13.0% from$116.8 million in the prior year quarter. The increase is attributable to an increase in the cost of our catastrophe excess of loss reinsurance program driven by an increase in TIV. Net premiums earned
Net premiums earned were
higher gross premiums earned, partly offset by higher ceded premiums, as
described above.
Net investment income
28
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Net investment income, inclusive of realized investment gains and unrealized
gains on equity securities, was $1.5 in the third quarter 2021, compared to
$23.2 million in the prior year quarter. The decrease is primarily due to
opportunistic sales of fixed income securities which resulted in significant
realized gains in third quarter 2020 and to a lesser extent, lower yields
associated with the continued low interest rate environment.
Other revenue
Other revenue was
when compared to the prior year quarter.
Total revenue
Total revenue was$167.4 million in third quarter 2021, up 1.4% from$165.1 million in the prior year quarter. The increase primarily stems from higher net premiums earned, partially offset by a reduction in net realized investment gains, as described above. For the Three Months Ended September 30, (Unaudited) 2021 2020 $ Change % Change OPERATING EXPENSES: (in thousands)
Losses and loss adjustment expenses 129,632 119,718
9,914 8.3 % Policy acquisition costs 35,984 31,960 4,024 12.6 % General and administrative expenses 17,169 17,923 (754 ) (4.2 )% Total operating expenses 182,785 169,601 13,183 7.8 %
Losses and loss adjustment expenses
Losses and loss adjustment expenses ("LAE") were $129.6 million in third quarter
2021, up 8.3% from $119.7 million in the prior year quarter. The increase stems
from higher net weather losses, lower favorable reserve development and from a
larger book of business.
Policy acquisition costs
Policy acquisition costs were $36.0 million in third quarter 2021, up 12.6% from
$32.0 million in the prior year quarter. The increase is primarily attributable
to gross premiums written growth and is partially offset by higher ceding
commission income.
General and administrative expenses
General and administrative expenses were
down 4.2% from
primarily attributable to higher ceding commission associated with gross
premiums written growth and lower executive compensation.
For the Three Months Ended September 30,
(Unaudited) 2021 2020 $ Change % Change
(in thousands, except per share and share amounts)
Operating loss (15,377 ) (4,482 ) (10,895 ) 243.1 %
Interest expense, net 2,150 2,251 (101 ) (4.5 )%
Loss before income taxes (17,527 ) (6,733 ) (10,793 ) 160.3 %
Benefit for income taxes (1,117 ) (1,500 ) 383 (25.5 )%
Net loss $ (16,410 ) $ (5,233 ) $ (11,177 ) 213.6 %
Basic net loss per share $ (0.59 ) $ (0.19 ) $ (0.40 ) 209.1 %
Diluted net loss per share $ (0.59 ) $ (0.19 ) $ (0.40 ) 209.1 %
Interest expense, net
Net interest expense was
flat quarter-over-quarter.
Benefit for income taxes Benefit for income taxes was$1.1 million in third quarter 2021 compared to$1.5 million in the prior year quarter. The effective tax rate was 6.4% in third quarter 2021, 15.9 points below the prior year quarter's 22.3% rate. The lower effective tax rate relates to the impact of permanent tax differences on projected results of operations for the calendar year. A change in the estimate from the prior quarter impacted the effect of permanent tax differences. The effective tax rate can fluctuate throughout the year as estimates used in the quarterly tax provision are updated with additional information. 29 --------------------------------------------------------------------------------
Net loss
Third quarter 2021 net loss was$16.4 million ($0.59 per diluted share), up from net loss of$5.2 million ($0.19 per diluted share) in the prior year quarter. The year-over-year change primarily stems from lower realized capital gains, partly offset by a smaller underwriting loss. Higher losses and LAE contributed significantly to the net loss for the quarter, as described above. Ratios For the Three Months Ended September 30, (Unaudited) 2021 2020 Ceded premium ratio 44.8 % 45.8 % Net loss and LAE ratio 79.8 % 86.6 % Net expense ratio 32.7 % 36.1 % Net combined ratio 112.5 % 122.7 % Ceded premium ratio The ceded premium ratio was 44.8% in third quarter 2021, down 1.0 point from 45.8% in the prior year quarter. The decrease is primarily attributable to higher gross earned premium which exceeded the higher cost associated with our reinsurance program. Net loss ratio The net loss ratio was 79.8% in third quarter 2021, down 6.8 points from 86.6% in the prior year quarter. Although the dollar amount of losses is significantly higher than the prior year quarter, the loss ratio is lower than the prior year quarter due to higher net earned premium fueled by growth and rate changes as described above. Net expense ratio The net expense ratio was 32.7% in third quarter 2021, down 3.4 points from 36.1% in the prior year quarter. The decrease primarily stems from lower G&A and policy acquisition cost ("PAC") expense ratio associated with higher net earned premium over the prior year despite an increase in PAC and G&A expenses.
Net combined ratio
The net combined ratio was 112.5% in third quarter 2021, down 10.2 points from 122.7% in the prior year quarter. The decrease primarily stems from lower net loss and operating expense ratios. The net loss increased despite the lower net combined ratio due to the reduction in investment gains from the prior year quarter as described above.
Comparison of the Nine Months Ended
For the Nine Months Ended September 30,
2021 2020 $ Change % Change
(Unaudited) (in thousands)
REVENUE:
Gross premiums written $ 886,059 $ 797,776 $ 88,283 11.1 %
Change in gross unearned
premiums (35,593 ) (66,287 ) 30,694 (46.3 )%
Gross premiums earned 850,466 731,489 118,977 16.3 %
Ceded premiums (399,323 ) (338,197 ) (61,126 ) 18.1 %
Net premiums earned 451,143 393,292 57,851 14.7 %
Net investment income 3,797 9,783 (5,986 ) (61.2 )%
Net realized and unrealized
(losses) gains (926 ) 20,377 (21,303 ) NM
Other revenue 10,835 10,385 450 4.3 %
Total revenue $ 464,849 $ 433,837 $ 31,013 7.1 %
Gross premiums written
Gross premiums written were $886.1 million for the nine months ended September
30, 2021 , up 11.1% from $797.8 million in the prior year period. The increase
reflects 16.2% growth outside Florida and 3.6% growth in Florida . Rate increases
materially benefited 2021 gross premiums written growth, particularly in
Florida . Growth in all states was organic, including growth via independent
agents and strategic partnerships with national carriers.
Gross premiums earned
30 -------------------------------------------------------------------------------- Gross premiums earned were$850.5 million for the nine months endedSeptember 30, 2021 , up 16.3% from$731.5 million in the prior year period. The increase reflects the earning of higher gross premiums written over the twelve months endedSeptember 30, 2021 compared to premiums written over the twelve months endedSeptember 30, 2020 . Ceded premiums earned Ceded premiums earned were$399.3 million for the nine months endedSeptember 30, 2021 , up 18.1% from$338.2 million in the prior year period. The increase is attributable to an increase in the cost of our catastrophe excess of loss reinsurance program and an increase in TIV associated with premium growth as well as higher premium for our severe convective storm reinsurance coverage.
Net premiums earned
Net premiums earned were$451.1 million for the nine months endedSeptember 30, 2021 , up 14.7% from$393.3 million in the prior year period. The increase primarily stems from higher gross premiums earned, partly offset by higher ceded premiums, as described above. Net investment income Net investment income, inclusive of realized investment gains and unrealized gains on equity securities for the nine months endedSeptember 30, 2021 , was$2.9 million , down 90.3% from$30.2 million in the prior year period. The decrease is primarily due to opportunistic sales of fixed income securities which held significant unrealized gains in third quarter 2020 and to a lesser extent, lower yields associated with the continued low interest rate environment.
Other revenue
Other revenue was
relatively flat from
Total revenue
Total revenue was$464.8 million for the nine months endedSeptember 30, 2021 , up 7.1% from$433.8 million in the prior year period. The increase primarily stems from higher net premiums earned, partially offset by a reduction in net investment income, as described above. For the Nine Months Ended September 30, (Unaudited) 2021 2020 $ Change % Change OPERATING EXPENSES: (in thousands)
Losses and loss adjustment expenses 328,376 266,769 61,607
23.1 % Policy acquisition costs 109,183 92,243 16,940 18.4 % General and administrative expenses 52,490 59,583 (7,093 ) (11.9 )% Total operating expenses 490,049 418,595 71,454 17.1 %
Losses and loss adjustment expenses
Losses and loss adjustment expenses ("LAE") were $328.4 million for the nine
months ended September 30, 2021 , up 23.1% from $266.8 million in the prior year
period. The increase primarily stems from higher net weather losses and from a
larger book of business.
Policy acquisition costs
Policy acquisition costs were $109.2 million for the nine months ended September
30, 2021 , up 18.4% from $92.2 million in the prior year period. The increase is
primarily attributable to higher acquisition costs associated with growth in
gross premiums written.
General and administrative expenses
General and administrative expenses were$52.5 million for the nine months endedSeptember 30, 2021 , down 11.9% from$59.6 million in the prior year period. The decrease is primarily attributable to a state tax credit recorded in second quarter 2021 and lower executive compensation expense. 31 --------------------------------------------------------------------------------
For the Nine Months Ended September 30,
(Unaudited) 2021 2020 $ Change % Change
(in thousands, except per share and share amounts)
Operating (loss) income (25,200 ) 15,242 (40,442 ) (265.3 )%
Interest expense, net 5,953 5,939 14 0.2 %
(Loss) income before income taxes (31,153 ) 9,303 (40,456 ) (434.9 )%
(Benefit) provision for income taxes (5,644 ) 2,784 (8,428 ) (302.7 )%
Net (loss) income $ (25,509 ) $ 6,519 $ (32,028 ) (491.3 )%
Basic net (loss) income per share $ (0.91 ) $ 0.23 $ (1.14 ) (497.5 )%
Diluted net (loss) income per share $ (0.91 ) $ 0.23
Interest expense, net
Interest expense was
relatively flat from
(Benefit) Provision for income taxes
(Benefit) provision for income taxes was$(5.6) million and$2.8 million for the nine months endedSeptember 30, 2021 and 2020, respectively. The effective tax rate for the current year period was 18.1%, 11.8 points lower than the prior year's 29.9%. The lower effective tax rate relates to the impact of permanent tax differences on projected results of operations for the calendar year. A change in the estimate from the prior quarter impacted the effect of permanent tax differences. The effective tax rate can fluctuate throughout the year as estimates used in the quarterly tax provision are updated with additional information.
Net (loss) income
Net loss for the nine months endedSeptember 30, 2021 was$25.5 million ($(0.91) per diluted share) compared to net income of$6.5 million ($0.23 per diluted share) in the prior year period. The decrease primarily reflects a higher net loss ratio, largely driven by elevated weather losses, and lower investment income, partly offset by higher total revenue and a lower net expense ratio. For the Nine Months Ended September 30, (Unaudited) 2021 2020 Ceded premium ratio 47.0 % 46.2 % Net loss and LAE ratio 72.8 % 67.8 % Net expense ratio 35.8 % 38.6 % Net combined ratio 108.6 % 106.4 % Ceded premium ratio The ceded premium ratio was 47.0% for the nine months endedSeptember 30, 2021 , up 0.8 points from 46.2% in the prior year period. The increase resulted from a larger increase in gross earned premium than the increase in ceded premium.
Net loss and LAE ratio
The net loss and LAE ratio was 72.8% for the nine months endedSeptember 30, 2021 , up 5.0 points from 67.8% in the prior year period. The increase primarily stems from higher current accident year weather and lower favorable reserve development, partly offset by the increase in net earned premium.
Net expense ratio
The net expense ratio was 35.8% for the nine months endedSeptember 30, 2021 , down 2.8 points from 38.6% in the prior year period. The decrease primarily stems from a lower net G&A expense ratio, driven by lower G&A expenses coupled with higher net premiums earned, partly offset by a slightly higher net PAC expense ratio, driven by higher gross premiums written.
Net combined ratio
The net combined ratio was 108.6% for nine months endedSeptember 30, 2021 , up 2.2 points from 106.4% in the prior year period. The increase primarily stems from a higher net loss ratio, partly offset by a lower net expense ratio, as described above. 32
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Liquidity and Capital Resources
Our principal sources of liquidity include cash flows generated from operations, existing cash and cash equivalents, our marketable securities balances and borrowings available under our credit facilities. As ofSeptember 30, 2021 , we had$393.4 million of cash and cash equivalents and$686.1 million in investments, compared to$441.0 million and$589.0 million , respectively, as ofDecember 31, 2020 . The decrease in cash and cash equivalents was primarily due to the allocation of cash used for investing activities. We generally hold substantial cash balances to meet seasonal liquidity needs including amounts to pay quarterly reinsurance installments as well as meet the collateral requirements of Osprey, our captive reinsurance company, which is required to maintain a collateral trust account equal to the risk that it assumes from our insurance company affiliates.
We believe that our sources of cash are adequate to meet our cash requirements
for at least the next twelve months.
We may continue to pursue the acquisition of complementary businesses and make
strategic investments. We may increase capital expenditures consistent with our
investment plans and anticipated growth strategy. Cash and cash equivalents may
not be sufficient to fund such expenditures. As such, in addition to the use of
our existing Credit Facilities, we may need to utilize additional debt to secure
funds for such purposes.
Cash Flows
For the Nine Months Ended September 30,
2021 2020 Change
(in thousands)
Net cash provided by (used in):
Operating activities $ 70,150 $ 118,561 $ (48,411 )
Investing activities (110,305 ) 136,642 (246,947 )
Financing activities (7,402 ) (23,178 ) 15,776
Net (decrease) increase in cash and
cash equivalents $ (47,557 ) $ 232,025 $ (279,582 )
Operating Activities
Net cash provided by operating activities was $70.1 million for the nine months
ended September 30, 2021 compared to net cash provided by operating activities
of $118.6 million for the comparable period in 2020. The decrease in cash from
operating activities relates primarily to timing of cash flows associated with
claim and reinsurance payments as well as reinsurance reimbursements during the
first nine months of 2021 compared to the first nine months of 2020.
Investing Activities
Net cash used in investing activities for the nine months endedSeptember 30, 2021 was$110.3 million as compared to net cash provided by of$136.6 million for the comparable period in 2020. The change in cash used for investing activities relates primarily to allocations of funds for investment in the current period compared to our strategic sales of investments to yield realized gains in the comparable period in 2020.
Financing Activities
Net cash used in financing activities for the nine months endedSeptember 30, 2021 was$7.4 million , as compared to cash used in financing activities of$23.2 million for the comparable period in 2020. The reduction in cash used in financing activities is due primarily to the decrease in the amount of stock repurchased under the stock repurchase program and use of proceeds from our term loan facility which offset principal payments made. 33 --------------------------------------------------------------------------------
Credit Facilities
OnDecember 14, 2018 , the Company entered into a credit agreement (as amended from time to time, the "Credit Agreement") by and among the Company, as borrower, certain subsidiaries of the Company from time to time party thereto as guarantors, the lenders from time to time party thereto (the "Lenders"),Regions Bank , as Administrative Agent and Collateral Agent,BMO Harris Bank N.A ., as Syndication Agent,Hancock Whitney Bank and Canadian Imperial Bank of Commerce, as Co-Documentation Agents, andRegions Capital Markets andBMO Capital Markets Corp. , as Joint Lead Arrangers and Joint Bookrunners. OnJuly 28, 2021 , the Company entered into the Fifth Amendment to the Credit Agreement (the "Fifth Amendment") with the guarantors and Lenders. The Fifth Amendment amended the Credit Agreement to, among other things, (i) increase the revolving credit facility from$50 million to$75 million and make related changes to the Credit Agreement, (ii) provide for a$13.75 million advance under the existing$75 million term loan facility for an aggregate of$70 million principal amount outstanding as of the date of the Fifth Amendment, extend the maturity of the term loan facility from December of 2023 toJuly 2026 and reduce the amortization of the term loan facility, (iii) reduce the applicable margin for loans under the Credit Agreement to 2.5% to 3.0% per annum for LIBOR loans (reduced from the prior range of 3.25% to 3.75%) and 1.5% to 2.0% per annum for base rate loans (reduced from the prior range of 2.25% to 2.75%), in each case based on a consolidated leverage ratio ranging from less than or equal to 1.25-to-1 to greater than 2.25-to-1 (previously less than or equal to 2.0-to-1 to greater than 3.0-to-1), (iv) reduce the restriction on negative covenants thereby allowing the Company greater flexibility and (iv) provide mechanics relating to a transition away from LIBOR as a benchmark interest rate and replace LIBOR with an alternative benchmark rate. Pursuant to the Credit Agreement, as amended, the participating Lenders agreed to provide (1) a five-year senior secured term loan facility in an aggregate principal amount of$75 million (the "Term Loan Facility") and (2) a five-year senior secured revolving credit facility in an aggregate principal amount of$75 million (inclusive of a$5 million sublimit for the issuance of letters of credit and a$10 million sublimit for swingline loans) (the "Revolving Credit Facility" and together with the Term Loan Facility, the "Credit Facilities"). As ofSeptember 30, 2021 , the Company had in aggregate$70 million principal outstanding under the Term Loan Facility, which was increased to$70 million on the date of the Fifth Amendment, and no borrowings outstanding under the Revolving Credit Facility. At our option, borrowings under the Credit Facilities bear interest at rates equal to either (1) a rate determined by reference to LIBOR (based on one, two, three or six-month interest periods), adjusted for statutory reserve requirements, plus an applicable margin or (2) a base rate determined by reference to the greatest of (a) the "prime rate" ofRegions Bank , (b) the federal funds rate plus 0.50%, and (c) the LIBOR index rate applicable for an interest period of one month plus 1.00%, plus an applicable margin. The applicable margin for loans under the Credit Facilities, as amended, varies from 2.5% to 3.0% per annum (for LIBOR loans) and 1.5% to 2.0% per annum (for base rate loans) based on our consolidated leverage ratio. Interest payments with respect to the Credit Facilities are required either on a quarterly basis (for base rate loans) or at the end of each interest period (for LIBOR loans) or, if the duration of the applicable interest period exceeds three months, then every three months. As ofJune 30, 2021 , the borrowing under our Credit Facilities were accruing interest at a rate of 3.38% per annum. In addition to paying interest on outstanding borrowings under the Revolving Credit Facility, we are required to pay a quarterly commitment fee based on the unused portion of the Revolving Credit Facility, which is determined by our consolidated leverage ratio. Each of the Revolving Credit Facility and the Term Loan Facility mature onDecember 31, 2026 . The principal amount of the Term Loan Facility amortizes in quarterly installments, which began with the close of the fiscal quarter endedMarch 31, 2019 , in an amount equal to$1,875,000 per quarter, payable quarterly, decreasing to$875,000 per quarter commencing with the quarter endingDecember 31, 2021 and increasing to$1,375,000 per quarter commencing with the quarter endingDecember 31, 2024 , with the balance payable at maturity. The Company may prepay the loans under the Credit Facilities, in whole or in part, at any time without premium or penalty, subject to certain conditions including minimum amounts and reimbursement of certain costs in the case of prepayments of LIBOR loans. In addition, the Company is required to prepay the loan under the Term Loan Facility with the proceeds from certain financing transactions, involuntary dispositions or asset sales (subject, in the case of asset sales, to reinvestment rights). All obligations under the Credit Facilities are or will be guaranteed by each existing and future direct and indirect wholly owned domestic subsidiary of the Company, other than all of the Company's current and future regulated insurance subsidiaries (collectively, the "Guarantors"). The Company and the Guarantors entered into a Pledge and Security Agreement, onDecember 14, 2018 (the "Security Agreement"), in favor ofRegions Bank , as collateral agent. Pursuant to the Security Agreement, amounts borrowed under the Credit Facilities are secured on a first priority basis by a perfected security interest in substantially all of the present and future assets of the Company and each Guarantor (subject to certain exceptions), including all of the capital stock of the Company's domestic subsidiaries, other than its regulated insurance subsidiaries. 34
-------------------------------------------------------------------------------- The Credit Agreement contains, among other things, covenants, representations and warranties and events of default customary for facilities of this type. The Company is required to maintain, as of each fiscal quarter (1) a maximum consolidated leverage ratio of 2.75 to 1.00 for each fiscal quarter in 2021, stepping down to 2.50 to 1.00 in 2022 and thereafter; (2) a minimum consolidated fixed charge coverage ratio of 1.20 to 1.00 and (3) a minimum consolidated net worth for the Company and its subsidiaries. Events of default include, among other events, (i) nonpayment of principal, interest, fees or other amounts; (ii) failure to perform or observe certain covenants set forth in the Credit Agreement; (iii) breach of any representation or warranty; (iv) cross-default to other indebtedness; (v) bankruptcy and insolvency defaults; (vi) monetary judgment defaults and material nonmonetary judgment defaults; (vii) customary ERISA defaults; (viii) a change of control of the Company; and (ix) failure to maintain specified catastrophe retentions in each of the Company's regulated insurance subsidiaries. Convertible Notes OnAugust 10, 2017 , the Company andHeritage MGA, LLC (the "Notes Guarantor") entered into a purchase agreement (the "Purchase Agreement") withCitigroup Global Markets Inc. , as the initial purchaser (the "Initial Purchaser"), pursuant to which the Company agreed to issue and sell, and the Initial Purchaser agreed to purchase,$125.0 million aggregate principal amount of the Company's 5.875% Convertible Senior Notes due 2037 (the "Convertible Notes") in a private placement transaction pursuant to Rule 144A under the Securities Act, as amended (the "Securities Act"). The Purchase Agreement contained customary representations, warranties and agreements of the Company and the Notes Guarantor and customary conditions to closing, indemnification rights and obligations of the parties and termination provisions. The net proceeds from the offering of the Convertible Notes, after deducting discounts and commissions and estimated offering expenses payable by the Company, were approximately$120.5 million . The offering of the Convertible Notes was completed onAugust 16, 2017 . The Company issued the Convertible Notes under an Indenture (the "Convertible Note Indenture"), datedAugust 16, 2017 , by and among the Company, as issuer, the Notes Guarantor, as guarantor, andWilmington Trust, National Association , as trustee (the "Trustee"). The Convertible Notes bear interest at a rate of 5.875% per year. Interest is payable semi-annually in arrears, onFebruary 1 andAugust 1 of each year. The Convertible Notes are senior unsecured obligations of the Company that rank senior in right of payment to the Company's future indebtedness that is expressly subordinated in right of payment to the Convertible Notes; equal in right of payment to the Company's unsecured indebtedness that is not so subordinated; effectively junior to any of the Company's secured indebtedness to the extent of the value of the assets securing such indebtedness; and structurally junior to all indebtedness or other liabilities incurred by the Company's subsidiaries other than the Notes Guarantor, which fully and unconditionally guarantee the Convertible Notes on a senior unsecured basis.
The Convertible Notes mature on
redeemed or converted.
Holders may convert their Convertible Notes at any time prior to the close of business on the business day immediately precedingFebruary 1, 2037 , other than during the period from, and including,February 1, 2022 to the close of business on the second business day immediately precedingAugust 5, 2022 , only under the following circumstances: (1) during any calendar quarter commencing after the calendar quarter ending onSeptember 30, 2017 , if the closing sale price of the Company's common stock, for at least 20 trading days (whether or not consecutive) in the period of 30 consecutive trading days ending on the last trading day of the calendar quarter immediately preceding the calendar quarter in which the conversion occurs, is more than 130% of the conversion price of the Convertible Notes in effect on each applicable trading day; (2) during the ten consecutive business-day period following any five consecutive trading-day period in which the trading price for the Convertible Notes for each such trading day was less than 98% of the closing sale price of the Company's common stock on such date multiplied by the then-current conversion rate; (3) if the Company calls any or all of the Convertible Notes for redemption, at any time prior to the close of business on the second business day immediately preceding the redemption date; or (4) upon the occurrence of specified corporate events. During the period from and includingFebruary 1, 2022 to the close of business on the second business day immediately precedingAugust 5, 2022 , and on or afterFebruary 1, 2037 until the close of business on the second business day immediately precedingAugust 1, 2037 , holders may surrender their Convertible Notes for conversion at any time, regardless of the foregoing circumstances. The conversion rate for the Convertible Notes was initially 67.0264 shares of common stock per$1,000 principal amount of Convertible Notes (equivalent to an initial conversion price of approximately$14.92 per share of common stock). The conversion rate is subject to adjustment in certain circumstances and is subject to increase for holders that elect to convert their Convertible Notes in connection with certain corporate transactions (but not, at the Company's election, a public acquirer change of control (as defined in the Convertible Note Indenture)) that occur prior toAugust 5, 2022 .
Upon the occurrence of a fundamental change (as defined in the Convertible Note
Indenture) (but not, at the Company's election, a public acquirer change of
control (as defined in the Convertible Note Indenture), holders of the
Convertible Notes may require the Company to repurchase for cash all or a
portion of their Convertible Notes at a fundamental change repurchase price
equal
35 -------------------------------------------------------------------------------- to 100% of the principal amount of the Convertible Notes to be repurchased, plus accrued and unpaid interest to, but excluding, the fundamental change repurchase date. Except as described below, the Company may not redeem the Convertible Notes prior toAugust 5, 2022 . On or afterAugust 5, 2022 but prior toFebruary 1, 2037 , the Company may redeem for cash all or any portion of the Convertible Notes, at the Company's option, at a redemption price equal to 100% of the principal amount of the Convertible Notes to be redeemed, plus accrued and unpaid interest to, but excluding, the redemption date. No sinking fund is provided for the Convertible Notes, which means that the Company is not required to redeem or retire the Convertible Notes periodically. Holders of the Convertible Notes are able to cause the Company to repurchase their Convertible Notes for cash on any ofAugust 1, 2022 ,August 1, 2027 andAugust 1, 2032 , in each case at 100% of their principal amount, plus accrued and unpaid interest to, but excluding, the relevant repurchase date. The Convertible Note Indenture contains customary terms and covenants and events of default. If an Event of Default (as defined in the Convertible Note Indenture) occurs and is continuing, the Trustee by notice to the Company, or the holders of at least 25% in aggregate principal amount of the Convertible Notes then outstanding by notice to the Company and the Trustee, may declare 100% of the principal of, and accrued and unpaid interest, if any, on, all the Convertible Notes to be immediately due and payable. In the case of certain events of bankruptcy, insolvency or reorganization (as set forth in the Convertible Note Indenture) with respect to the Company, 100% of the principal of, and accrued and unpaid interest, if any, on, the Notes automatically become immediately due and payable.
As of
principal amount of
FHLB Loan Agreements
InDecember 2018 , a subsidiary of the Company pledgedU.S. government and agency fixed maturity securities with an estimated fair value of$31.0 million as collateral and received$19.2 million in a cash loan under an advance agreement with the FHLB Atlanta. The loan originated onDecember 12, 2018 and bears a fixed interest rate of 3.094% with interest payments due quarterly commencing inMarch 2019 . The principal balance on the loan has a maturity date ofDecember 13, 2023 . In connection with the agreement, the subsidiary became a member of FHLB. Membership in the FHLB required an investment in FHLB's common stock which was purchased onDecember 31, 2018 and valued at$1.4 million . The subsidiary is permitted to withdraw any portion of the pledged collateral over the minimum collateral requirement at any time, other than in the event of a default by the subsidiary. The proceeds from the loan was used to prepay the Company's Senior Secured Notes due 2023 in 2018.
Critical Accounting Policies and Estimates
When we prepare our condensed consolidated financial statements and accompanying notes in conformity withU.S. generally accepted accounting principles (GAAP), we must make estimates and assumptions about future events that affect the amounts we report. Certain of these estimates result from judgments that can be subjective and complex. As a result of that subjectivity and complexity, and because we continuously evaluate these estimates and assumptions based on a variety of factors, actual results could materially differ from our estimates and assumptions if changes in one or more factors require us to make accounting adjustments. During the nine months endedSeptember 30, 2021 , we reassessed our critical accounting policies and estimates as disclosed within our 2020 Annual Report on Form 10-K. Seasonality of our Business Our insurance business is seasonal; hurricanes typically occur during the period fromJune 1 through November 30 and winter storms generally impact the first and fourth quarters each year. With our catastrophe reinsurance program effective onJune 1 each year, any variation in the cost of our reinsurance, whether due to changes to reinsurance rates or changes in the total insured value of our policy base will occur and be reflected in our financial results beginningJune 1 of each year, subject to certain adjustments.
Recent Accounting Pronouncements
The information set forth under Note 1 to the condensed consolidated financial statements under the caption "Basis of Presentation and Significant Accounting Policies" is incorporated herein by reference. We do not expect any recently issued accounting pronouncements to have a material effect on our condensed consolidated financial statements.
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