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KINGSWAY FINANCIAL SERVICES INC – 10-Q – Management's Discussion and Analysis of Financial Condition and Results of Operations
FORWARD-LOOKING STATEMENTS
Management's Discussion and Analysis includes "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 that are not historical facts, and involve risks and uncertainties that could cause actual results to differ materially from those expected and projected. Words such as "expects," "believes," "anticipates," "intends," "estimates," "seeks" and variations and similar words and expressions are intended to identify such forward-looking statements. Such forward-looking statements relate to future events or future performance, but reflect Kingsway management's current beliefs, based on information currently available. A number of factors could cause actual events, performance or results to differ materially from the events, performance and results discussed in the forward-looking statements. For information identifying important factors that could cause actual results to differ materially from those anticipated in the forward-looking statements, see Kingsway's securities filings, including its Annual Report on Form 10-K for the year endedDecember 31, 2021 ("2021 Annual Report"). The Company's securities filings can be accessed on the EDGAR section of theU.S. Securities and Exchange Commission's website at www.sec.gov, on the Canadian Securities Administrators' website at www.sedar.com or through the Company's website at www.kingsway-financial.com. Except as expressly required by applicable securities law, the Company disclaims any intention or obligation to update or revise any forward-looking statements because of new information, future events or otherwise. OVERVIEW Kingsway is aDelaware holding company with operating subsidiaries located inthe United States . The Company owns or controls subsidiaries primarily in the extended warranty, business services, asset management and real estate industries. Kingsway conducts its business through three reportable segments: Extended Warranty,Leased Real Estate and Kingsway Search Xcelerator. Extended Warranty includes the following subsidiaries of the Company:IWS Acquisition Corporation ("IWS"),Geminus Holding Company, Inc. ("Geminus"),PWI Holdings, Inc. ("PWI"),Professional Warranty Service Corporation ("PWSC") andTrinity Warranty Solutions LLC ("Trinity"). Throughout Management's Discussion and Analysis, the term "Extended Warranty" is used to refer to this segment. IWS is a licensed motor vehicle service agreement company and is a provider of after-market vehicle protection services distributed by credit unions in25 states and theDistrict of Columbia to their members, with customers in all fifty states. Geminus primarily sells vehicle service agreements to used car buyers acrossthe United States , through its subsidiaries,The Penn Warranty Corporation ("Penn") andPrime Auto Care, Inc. ("Prime"). Penn and Prime distribute these products in 32 and 40 states, respectively, via independent used car dealerships and franchised car dealerships. PWI markets, sells and administers vehicle service agreements to used car buyers in all fifty states via independent used car and franchise network of approved automobile and motorcycle dealer partners. PWI's business model is supported by an internal sales and operations team and partners with AmericanAuto Shield in three states with a white label agreement. PWI also has a white label agreement with Classic to sell a guaranteed asset protection product ("GAP") in states that Classic is approved in.
PWSC sells home warranty products and provides administration services to
homebuilders and homeowners across
products and services through an in-house sales team and through insurance
brokers and insurance carriers throughout all states except
Trinity sells heating, ventilation, air conditioning ("HVAC"), standby
generator, commercial LED lighting and commercial refrigeration warranty
products and provides equipment breakdown and maintenance support services to
companies across the United States . As a seller of warranty products, Trinity
markets and administers product warranty contracts for certain new and used
products in the HVAC, standby generator, commercial LED lighting and commercial
refrigeration industries throughout the United States . Trinity acts as an agent
on behalf of the third-party insurance companies that underwrite and guaranty
these warranty contracts. Trinity does not guaranty the performance underlying
the warranty contracts it sells. As a provider of equipment breakdown and
maintenance support services, Trinity acts as a single point of contact to its
clients for both certain equipment breakdowns and scheduled maintenance of
equipment. Trinity will provide such repair and breakdown services by
contracting with certain HVAC providers.
Leased Real Estate includes the Company's subsidiaries, CMC Industries, Inc.
("CMC") and VA Lafayette, LLC , formerly Roeco Lafayette, LLC ("VA Lafayette ").
Throughout Management's Discussion and Analysis, the term "Leased Real Estate "
is used to refer to this segment.
CMC owns, through an indirect wholly owned subsidiary (the "Property Owner"), a
parcel of real property consisting of approximately 192 acres located in the
State of Texas (the "Real Property"), which is subject to a long-term triple net
lease agreement. The Real Property is also subject to a mortgage, which is
recorded as note payable in the consolidated balance sheets (the "Mortgage").
VA Lafayette owns real property consisting of approximately 6.5 acres and a
29,224 square foot single-tenant medical office building located in the State of
Lousiana (the "LA Real Property"). The LA Real Property serves as a medical and
dental clinic for the Department of Veteran Affairs and is subject to a
long-term lease. The LA Real Property is also subject to a mortgage, which is
recorded as note payable in the consolidated balance sheets (the
"VA Mortgage").
Kingsway Search Xcelerator includes the Company's subsidiary, Ravix Financial,
Inc. ("Ravix"). Ravix provides outsourced financial services and human
resources consulting for short or long duration engagements for customers in 20
states and 6 countries. All services are delivered by employees who are located
in the United States . Throughout Management's Discussion and Analysis, the term
"Kingsway Search Xcelerator" is used to refer to this segment.
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KINGSWAY FINANCIAL SERVICES INC.
Impact of COVID-19
The COVID-19 pandemic has had a notable impact on general economic conditions,
including but not limited to the temporary closures of many businesses; "shelter
in place" and other governmental regulations; and many businesses continue to
operate in a work-from-home mode.
The near-term impacts of COVID-19 are primarily with respect to our Extended
Warranty segment. Consumer spending was initially impacted, including a decline
in the purchase of new and used vehicles, and many businesses through which we
distribute our products remained closed or were open but with capacity
constraints. More recently, consumer spending has improved but supply-chain
issues have caused a shortage of new automobiles which, in turn, has caused
demand for used automobiles to increase. This dynamic has had both positive and
negative impacts on the Company's revenues. With respect to homeowner
warranties, we saw an initial reduction in new enrollments in our home warranty
programs associated with the impact of COVID-19 on new home sales in the United
States .
The Company could experience other potential impacts as a result of COVID-19,
including, but not limited to, potential impairment charges to the carrying
amounts of goodwill, indefinite-lived intangibles and long-lived assets, the
loss in value of investments, as well as the potential for adverse impacts on
the Company's debt covenant financial ratios. The Company is not aware of any
specific event or circumstance that would require an update to its estimates or
judgments or a revision of the carrying value of its assets or liabilities as
of the date of issuance of this Quarterly Report on Form 10-Q. Actual results
may differ materially from the Company's current estimates as the scope of
COVID-19 evolves or if the duration of business disruptions is longer than
initially anticipated. We continue to monitor the impact of the COVID-19
pandemic closely. However, the extent to which the COVID-19 pandemic will impact
our operations or financial results is uncertain. There remain many unknowns
and the Company continues to monitor the expected trends and related demand for
its services and will continue to adjust its operations accordingly.
NON-
Throughout this quarterly report, we present our operations in the way we believe will be most meaningful, useful and transparent to anyone using this financial information to evaluate our performance. Our unaudited consolidated interim financial statements have been prepared in accordance with accounting principles generally accepted inthe United States of America ("U.S. GAAP") for interim financial information. In addition to theU.S. GAAP presentation of net (loss) income, we present segment operating income as a non-U.S. GAAP financial measure, which we believe is valuable in managing our business and drawing comparisons to our peers. Below is a definition of our non-U.S. GAAP measure and its relationship toU.S. GAAP. Segment Operating Income Segment operating income represents one measure of the pretax profitability of our segments and is derived by subtracting direct segment expenses from direct segment revenues. Revenues and expenses are presented in the unaudited consolidated statements of operations, but are not subtotaled by segment; however, this information is available in total and by segment in Note 17, "Segmented Information," to the unaudited consolidated interim financial statements, regarding reportable segment information. The nearest comparableU.S. GAAP measure to total segment operating income is (loss) income before income tax benefit that, in addition to segment operating income, includes net investment income, net realized gains, loss on change in fair value of equity investments, gain (loss) on change in fair value of limited liability investments, at fair value, interest expense not allocated to segments, other revenue and expenses not allocated to segments, net, amortization of intangible assets, loss on change in fair value of debt and gain on extinguishment of debt not allocated to segments. A reconciliation of total segment operating income to (loss) income before income tax benefit for the three months endedMarch 31, 2022 andMarch 31, 2021 is presented below in Table 1 of the "Results of Continuing Operations" section of Management's Discussion and Analysis.
SIGNIFICANT ACCOUNTING POLICIES AND CRITICAL ESTIMATES
The preparation of unaudited consolidated interim financial statements in conformity withU.S. GAAP requires management to make estimates and assumptions that affect the reported amounts and classifications of assets and liabilities, revenues and expenses, and the related disclosures of contingent assets and liabilities in the consolidated financial statements and accompanying notes. Actual results could differ from these estimates. Estimates and their underlying assumptions are reviewed on an ongoing basis. Changes in estimates are recorded in the accounting period in which they are determined. The Company's most critical accounting policies are those that are most important to the portrayal of its financial condition and results of operations, and that require the Company to make its most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. The critical accounting policies and judgments in the accompanying unaudited consolidated interim financial statements include the valuation of fixed maturities and equity investments; impairment assessment of investments; valuation of limited liability investments, at fair value; valuation of real estate investments; valuation of deferred income taxes; accounting for business combinations and asset acquisitions; valuation and impairment assessment of intangible assets; goodwill recoverability; deferred contract costs; fair value assumptions for subordinated debt obligations; fair value assumptions for subsidiary stock-based compensation awards; contingent consideration; and revenue recognition. Although management believes that its estimates and assumptions are reasonable, they are based upon information available when they are made, and therefore, actual results may differ from these estimates under different assumptions or conditions. The Company's significant accounting policies and critical estimates are described in Management's Discussion and Analysis of Financial Condition and Results of Operations included in the 2021 Annual Report. There has been no material change subsequent toDecember 31, 2021 to the information previously disclosed in the 2021 Annual Report with respect to these significant accounting policies and critical estimates. 35
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KINGSWAY FINANCIAL SERVICES INC.
RESULTS OF CONTINUING OPERATIONS
A reconciliation of total segment operating income to net (loss) income for the three months endedMarch 31, 2022 andMarch 31, 2021 is presented in Table 1 below:
Table 1 Segment Operating Income
(in thousands of dollars)
For the three months ended March 31,
2022 2021 Change
Segment operating income:
Extended Warranty $ 1,723 $ 5,310 $ (3,587 )
Leased Real Estate 1,559 1,293 266
Kingsway Search Xcelerator 806 - 806
Total segment operating income 4,088 6,603 (2,515 )
Net investment income 619 421 198
Net realized gains 54 51 3
Loss on change in fair value of equity
investments (10 ) (151 ) 141
Gain (loss) on change in fair value of
limited liability investments, at fair value 127 (202 ) 329
Interest expense not allocated to segments (1,364 ) (1,552 ) 188
Other revenue and expenses not allocated to
segments, net (3,065 ) (3,491 ) 426
Amortization of intangible assets (1,494 ) (497 ) (997 )
Loss on change in fair value of debt (1,868 ) (1,019 ) (849 )
Gain on extinguishment of debt not allocated
to segments - 311 (311 )
(Loss) income before income tax benefit (2,913 ) 474 (3,387 )
Income tax benefit (409 ) (425 ) 16
Net (loss) income $ (2,504 ) $ 899 $ (3,403 )
Segment Operating Income and Net (Loss) Income
In the first quarter of 2022, we reported segment operating income of
million
is primarily due to the following items:
• 2021 operating income in Extended Warranty segment includes a gain on
extinguishment of debt of
Program ("PPP") loan forgiveness;
• A reduction to IWS operating income of
estimate of IWS' deferred revenue and deferred contract costs associated
with vehicle service contract fees; both of which were partially offset by
• Increased operating income in
Kingsway Search Xcelerator (resulting from the Ravix acquisition in
October 2021 ).
In the first quarter of 2022, we reported net loss of $2.5 million compared to
net income of $0.9 million in the first quarter of 2021. The net loss for the
three months ended March 31, 2022 is primarily due to interest expense not
allocated to segments, other revenue and expenses not allocated to segments,
net, amortization of intangible assets and loss on change in fair value of debt,
partially offset by segment operating income. The net loss also includes a
reduction to IWS operating income of $0.9 million , due to a change in estimate
of IWS' deferred revenue and deferred contract costs as described above.
The net income for the three months ended March 31, 2021 is primarily due
to operating income in Extended Warranty (which includes gain on extinguishment
of debt of $2.2 million , related to PPP loan forgiveness) and Leased Real
Estate , partially offset by interest expense not allocated to segments, other
income and expenses not allocated to segments, net and loss on change in fair
value of debt. See Note 10 "Debt," to the unaudited consolidated interim
financial statements, for further discussion on PPP.
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KINGSWAY FINANCIAL SERVICES INC.
Extended Warranty
The Extended Warranty service fee and commission revenue decreased 1.6% (or
$0.3 million ) to $18.3 million for the three months ended March 31, 2022
compared with $18.6 million for the three months ended March 31, 2021 . Service
fee and commission revenue was impacted by the following for the three months
ended March 31, 2022 :
• A
its equipment breakdown and maintenance support services, as Trinity
continues to recover from the original impacts of the COVID-19 pandemic;
and a
result of marketing efforts leading to new customers; • A$0.1 million increase at PWSC;
• A
was a change in estimate of IWS' deferred revenue associated with vehicle
service contract fees, which resulted in a reduction to IWS revenue of
$1.2 million . This reduction was partially offset by an increase in
revenue due primarily to a 19% increase in the number of VSAs written in
2022, as sales volume continues to trend up towards pre-COVID levels.
While IWS' market is impacted by macro-economic conditions brought on by
the continued COVID-19 pandemic, IWS sells a substantial amount of VSAs
for new automobiles but, more importantly, its products are distributed
through credit unions at the point of vehicle financing, which has been
less impacted by the recent macro-economic conditions;
• A
supply-chain issues in the automotive industry, resulting in significant
increases in the prices of used automobiles (PWI's primary market), making
it difficult for smaller automobile dealers to obtain inventory and,
therefore, putting downward pressure on PWI's revenue; and
• A
macro-economic conditions brought on by the continued COVID-19 pandemic as
explained above for PWI. The Extended Warranty operating income was$1.7 million for the three months endedMarch 31, 2022 compared with$5.3 million for the three months endedMarch 31, 2021 . The decrease in operating income is primarily due to the following:
• Inclusion of Paycheck Protection Program ("PPP") loan forgiveness related to
Extended Warranty companies of
31, 2021;
• A
increases noted above; however, the increase in gross margin was partially
offset by the fact that 2021 included a benefit to bad debt expense due to a
recovery, as well as slightly higher marketing expenses in 2022;
• A
in estimate of IWS' deferred revenue and deferred contract costs associated
with vehicle service contract fees, which resulted in a reduction to IWS
operating income of
agreements increased slightly, as a decrease in the number of claims was
slightly more than offset by an increase in the average cost of a claim;
• A
in claims authorized on vehicle service agreements compared with the three
months ended
higher average cost per claim);
• A
slight decrease in claims authorized on vehicle service agreements and
slightly lower general and administrative expenses compared with the three
months endedMarch 31, 2021 ; and
• A
March 31, 2022 . 37
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KINGSWAY FINANCIAL SERVICES INC.
Leased Real Estate
Leased Real Estate rental revenue was $3.7 million and $3.3 million for the
three months ended March 31, 2022 and March 31, 2021 , respectively. The rental
income is derived from Leased Real Estate's long-term leases. The increase in
rental income is due to the inclusion of VA Lafayette in the first quarter of
2022 following its acquisiton on December 30, 2021 .
Leased Real Estate operating income was $1.6 million for the three months ended
March 31, 2022 compared with $1.3 million for the three months ended March 31,
2021 . Leased Real Estate operating income includes interest expense of $1.7
million and $1.5 million for the three months ended March 31, 2022 and March 31,
2021 , respectively.
The increase in operating income for the three months ended March 31, 2022 is
primarily due to the increase in rental revenue due to the inclusion of VA
Lafayette in the first quarter of 2022 following its acquisiton on December 30,
2021 .
Kingsway Search Xcelerator
The Kingsway Search Xcelerator revenue was
ended
that was acquired on
income was$0.8 million for the three months ended
Net Investment Income
Net investment income was$0.6 million in the first quarter of 2022 compared to$0.4 million in the first quarter of 2021. The increase in net investment income for the three months endedMarch 31, 2022 relates primarily to higher investment income from the Company's limited liability investments. Income from limited liability investments is recognized based on the Company's share of the earnings of the limited liability entities.
Loss on Change in Fair Value of Equity Investments
Loss on change in fair value of equity investments was less than
the first quarter of 2022 compared to
2021. Significant drivers include:
• Unrealized losses of less than
investments held during the three months ended
2021, respectively; and
• Net realized gains of zero and less than
sold during the three months endedMarch 31, 2022 andMarch 31, 2021 , respectively.
Gain (Loss) on Change in Fair Value of Limited Liability Investments, at Fair
Value
Gain on change in fair value of limited liability investments, at fair value was$0.1 million in the first quarter of 2022 compared to a loss of$0.2 million in the first quarter of 2021. The gain for the three months endedMarch 31, 2022 represents an increase in fair value of$0.4 million related toNet Lease Investment Grade Portfolio LLC ("Net Lease"), partially offset by a decrease in fair value of$0.3 million related toArgo Holdings Fund I, LLC ("Argo Holdings "). The loss for the three months endedMarch 31, 2021 represents a decrease in fair value of$0.3 million related to Net Lease, partially offset by an increase in fair value of$0.1 million related toArgo Holdings . 38
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KINGSWAY FINANCIAL SERVICES INC.
Interest Expense not Allocated to Segments
Interest expense not allocated to segments for the first quarter of 2022 was$1.4 million compared to$1.6 million in the first quarter of 2021. This includes interest on all debt except for interest on the Mortgage, Additional Mortgage, and LA Mortgage (which is included in the Real Estate Segment). The decrease for the three months endedMarch 31, 2022 is primarily attributable to an increase in fair value of the interest rate swap related to the Company's 2020 KWH bank loan, which resulted in lower interest expense of$0.2 million during the first quarter of 2022 compared to the same period in 2021.
Other Revenue and Expenses not Allocated to Segments, Net
Other revenue and expenses not allocated to segments, net was a net expense of$3.1 million in the first quarter of 2022 compared to$3.5 million in the first quarter of 2021. Included are revenue and expenses associated with our various other investments that are accounted for on a consolidated basis, our insurance company that has been in run-off since 2012, and and expenses associated with our corporate holding company. The decrease in net expense for the three months endedMarch 31, 2022 is primarily attributable to lower expense related to restricted stock awards of officers of the Company, partially offset by an increase in fair value of previously-granted awards to subsidiary employees that are accounted for on a fair value basis, as well as an increase in the fair value of the Ravix contingent consideration liability during the three months endedMarch 31, 2022 .
Amortization of Intangible Assets
Amortization of intangible assets was$1.5 million in the first quarter of 2022 compared to$0.5 million in the first quarter of 2021. The higher amortization expense for the three months endedMarch 31, 2022 is related to amortization of intangible assets recorded in conjunction with the Company's acquisitions of PWI effectiveDecember 1, 2020 , Ravix effectiveOctober 1, 2021 and VALafayette effectiveDecember 30, 2021 . During the third quarter of 2021, the Company finalized its fair value analysis of the assets acquired and liabilities assumed in its acquisition of PWI and recorded a measurement period adjustment related to PWI's customer relationship intangible asset. As a result,$0.6 million of the amortization expense recorded in the third quarter of 2021 related to the three months endedMarch 31, 2021 . During the first quarter of 2022, the Company recorded$1.1 million of amortization expense related to the intangible assets identified as part of the acquisitions of PWI, Ravix and VALafayette . See Note 4, "Acquisitions" to the consolidated financial statements in the 2021 Annual Report for further details on the Company's acquisitions of PWI, Ravix and VALafayette .
Loss on Change in Fair Value of Debt
Loss on change in fair value of debt was$1.9 million in the first quarter of 2022 compared to$1.0 million in the first quarter of 2021. The loss for the three months endedMarch 31, 2022 andMarch 31, 2021 reflect increases in the fair value of the subordinated debt resulting primarily from changes in interest rates used (not related to instrument-specific credit risk). The following summarizes the impacts: Impact of Rate Change on Fair Value 2022 Result 2021
Result
Libor:
increase causes fair value to increase; Increase to Decrease to decrease causes fair value to decrease fair value fair
value
Risk free rate: increase causes fair value to decrease; Decrease to Increase to decrease causes fair value to increase fair value fair value
See "Debt" section below for further information.
Gain on Extinguishment of Debt not Allocated to Segments
For the three months endedMarch 31, 2021 , gain on extinguishment of debt not allocated to segments consists of a$0.3 million gain on forgiveness of the balance of the holding company's loan obtained through the PPP. See Note 10 "Debt," to the unaudited consolidated interim financial statements, for further discussion. Income Tax Benefit Income tax benefit for the first quarter of 2022 was$0.4 million compared to$0.4 million in the first quarter of 2021. For the three months endedMarch 31, 2022 andMarch 31, 2021 , the Company released into income$0.5 million and$0.6 million , respectively, of its valuation allowance associated with business interest expense carryforwards with an indefinite life. See Note 13, "Income Taxes," to the unaudited consolidated interim financial statements, for additional detail of the income tax benefit recorded for the three months endedMarch 31, 2022 andMarch 31, 2021 . 39
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KINGSWAY FINANCIAL SERVICES INC.
INVESTMENTS
Portfolio Composition
The following is an overview of how we account for our various investments:
• Investments in fixed maturities are classified as available-for-sale and are
reported at fair value. • Equity investments are reported at fair value.
• Limited liability investments are accounted for under the equity method of
accounting. The most recently available financial statements of the limited
liability investments are used in applying the equity method. The difference
between the end of the reporting period of the limited liability investments
and that of the Company is no more than three months.
• Limited liability investments, at fair value represent the underlying
investments of the Company's consolidated entities Net Lease and Argo
Holdings . The difference between the end of the reporting period of the
limited liability investments, at fair value and that of the Company is no
more than three months.
• Investments in private companies consist of: convertible preferred stocks and
notes in privately owned companies; and investments in limited liability
companies in which the Company's interests are deemed minor. These investments
do not have readily determinable fair values and, therefore, are reported at
cost, adjusted for observable price changes and impairments. • Real estate investments are reported at fair value.
• Other investments include collateral loans and are reported at their unpaid
principal balance.
• Short-term investments, which consist of investments with original maturities
between three months and one year, are reported at cost, which approximates
fair value.
At
investments with a carrying value of
Investments held by our insurance subsidiary,Kingsway Amigo Insurance Company ("Amigo"), must comply with domiciliary state regulations that prescribe the type, quality and concentration of investments. OurU.S. operations typically invest inU.S. dollar-denominated instruments to mitigate their exposure to currency rate fluctuations.
Table 2 below summarizes the carrying value of investments, including cash and
cash equivalents and restricted cash, at the dates indicated.
TABLE 2 Carrying value of investments, including cash and cash equivalents and
restricted cash
(in thousands of dollars, except for percentages)
December
Type of investment March 31, 2022 % of Total 31, 2021 % of Total
Fixed maturities:
U.S. government, government agencies and
authorities 14,878 15.3 % 16,223 16.5 %
States, municipalities and political
subdivisions 1,701 1.7 % 1,878 1.9 %
Mortgage-backed 7,613 7.8 % 7,629 7.8 %
Asset-backed 1,046 1.1 % 445 0.5 %
Corporate 9,912 10.2 % 9,491 9.7 %
Total fixed maturities 35,150 36.1 % 35,666 36.4 %
Equity investments:
Common stock 169 0.2 % 171 0.2 %
Warrants - - % 8 0.0 %
Total equity investments 169 0.2 % 179 0.2 %
Limited liability investments 1,488 1.5 % 1,901 1.9 %
Limited liability investments, at fair
value 18,940 19.5 % 18,826 19.1 %
Investments in private companies 790 0.8 % 790 0.8 %
Real estate investments 10,662 11.0 % 10,662 10.8 %
Other investments 239 0.2 % 256 0.3 %
Short-term investments 157 0.2 % 157 0.1 %
Total investments 67,595 69.5 % 68,437 69.6 %
Cash and cash equivalents 13,053 13.4 % 12,642 12.9 %
Restricted cash 16,682 17.1 % 17,257 17.5 %
Total 97,330 100.0 % 98,336 100.0 %
Other-Than-Temporary Impairment
The Company performs a quarterly analysis of its investments to determine if
declines in market value are other-than-temporary. Further information regarding
our detailed analysis and factors considered in establishing an
other-than-temporary impairment on an investment is discussed within the
"Significant Accounting Policies and Critical Estimates" section of Management's
Discussion and Analysis of Financial Condition included in the 2021 Annual
Report.
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KINGSWAY FINANCIAL SERVICES INC.
As a result of the analysis performed, the Company recorded write downs for
other-than-temporary impairment related to limited liability investments, at
fair value of zero and less than $0.1 million for the three months ended March
31, 2022 and March 31, 2021 , respectively, which are included in gain (loss) on
change in fair value of limited liability investments, at fair value in the
consolidated statements of operations.
There were no write-downs recorded for other-than-temporary impairments related
to available-for sale investments, limited liability investments, investments in
private companies and other investments for the three months ended March 31,
2022 and March 31, 2021 .
The length of time a fixed maturity investment may be held in an unrealized loss
position may vary based on the opinion of the investment manager and their
respective analyses related to valuation and to the various credit risks that
may prevent us from recapturing the principal investment. In the case of a fixed
maturity investment where the investment manager determines that there is little
or no risk of default prior to the maturity of a holding, we would elect to hold
the investment in an unrealized loss position until the price recovers or the
investment matures. In situations where facts emerge that might increase the
risk associated with recapture of principal, the Company may elect to sell a
fixed maturity investment at a loss.
At March 31, 2022 and December 31, 2021 , the gross unrealized losses for fixed
maturities amounted to $1.4 million and $0.3 million , respectively, and there
were no unrealized losses attributable to non-investment grade fixed maturities.
At each of March 31, 2022 and December 31, 2021 , all unrealized losses on
individual investments were considered temporary.
Impact of COVID-19 on Investments
The Company continues to assess the impact that the COVID-19 pandemic may have on the value of its various investments, which could result in future material decreases in the underlying investment values. Such decreases may be considered temporary or could be deemed to be other-than-temporary, and management may be required to record write-downs of the related investments in future reporting periods. DEBT
See Note 10, "Debt," to the unaudited consolidated interim financial statements
for further details to those provided below.
Bank Loans In 2019, the Company formedKingsway Warranty Holdings LLC ("KWH"), whose subsidiaries at the time included IWS, Geminus and Trinity. As part of the acquisition of PWI onDecember 1, 2020 , PWI became a wholly owned subsidiary of KWH, which borrowed a principal amount of$25.7 million from a bank to partially finance its acquisition of PWI and to fully repay the prior outstanding loan at KWH (the "2020 KWH Loan"). The 2020 KWH Loan has an annual interest rate equal to LIBOR, having a floor of 0.75%, plus 2.75% (current rate of 3.5%) and is carried in the consolidated balance sheets at its amortized cost, which reflects the quarterly pay-down of principal as well as the amortization of the debt discount and issuance costs using the effective interest rate method. The 2020 KWH Loan matures onDecember 1, 2025 . The 2020 KWH Loan contains a number of covenants, including, but not limited to, a leverage ratio, a fixed charge ratio and limits on annual capital expenditures, all of which are as defined in and calculated pursuant to the 2020 KWH Loan that, among other things, restrict KWH's ability to incur additional indebtedness, create liens, make dividends and distributions, engage in mergers, acquisitions and consolidations, make certain payments and investments and dispose of certain assets. As part of the acquisition of Ravix onOctober 1, 2021 , Ravix became a wholly owned subsidiary ofRavix Acquisition LLC ("Ravix LLC "), and together they borrowed from a bank a principal amount of$6.0 million in the form of a term loan, and established a$1.0 million revolver to finance the acquisition of Ravix (together, the "Ravix Loan"). The Ravix Loan has an annual interest rate equal to the greater of the Prime Rate plus 0.5%, or 3.75% (current rate of 4.00%) and is carried in the consolidated balance sheets at its amortized cost, which reflects the monthly pay-down of principal as well as the amortization of the debt discount and issuance costs using the effective interest rate method. The revolver matures onOctober 1, 2023 and the term loan matures onOctober 1, 2027 . The Ravix Loan contains a number of covenants, including, but not limited to, a leverage ratio and a fixed charge ratio, all of which are as defined in and calculated pursuant to the Ravix Loan that, among other things, restrict Ravix's ability to incur additional indebtedness, create liens, make dividends and distributions, engage in mergers, acquisitions and consolidations, make certain payments and investments and dispose of certain assets. Notes Payable As part of its acquisition of CMC inJuly 2016 , the Company assumed the Mortgage and recorded the Mortgage at its estimated fair value of$191.7 million , which included the unpaid principal amount of$180.0 million as of the date of acquisition plus a premium of$11.7 million . The Mortgage matures onMay 15, 2034 and has a fixed interest rate of 4.07%. The Mortgage is carried in the consolidated balance sheets at its amortized cost, which reflects the monthly pay-down of principal as well as the amortization of the premium using the effective interest rate method. OnJune 2, 2021 , TRT Leaseco ("TRT"), a subsidiary of CMC, entered into an amendment to the Mortgage to borrow an additional$15.0 million , which is recorded as note payable in the consolidated balance sheets ("the Additional Mortgage"). The net proceeds from the Additional Mortgage were used to advance increased rental payments to the parties that had entered into a legal settlement agreement reached during the first quarter of 2021, including the Company which received$2.7 million . The Additional Mortgage matures onMay 15, 2034 and has a fixed interest rate of 3.20%. The Additional Mortgage is carried in the consolidated balance sheets at its amortized cost, which reflects the monthly pay-down of principal as well as the amortization of the debt discount and issuance costs using the effective interest rate method. See Note 20(a), "Commitments and Contingencies - Legal proceedings," to the unaudited consolidated interim financial statements for further discussion of the CMC litigation settlement agreement. As part of its acquisition of VALafayette onDecember 30, 2021 , the Company assumed the LA Mortgage, which is comprised of a senior amortizing note, a senior interest only note and a junior note. The Company recorded the LA Mortgage at its aggregate unpaid principal amount of$13.5 million as of the date of acquisition plus a premium of$3.5 million . The senior amortizing note matures onSeptember 14, 2036 and has a fixed interest rate of 3.75%. The senior interest only note matures onOctober 14, 2036 and has a fixed interest rate of 5.682%. The junior note matures onSeptember 16, 2036 and has a fixed interest rate of 7.0%, of which a fixed amount is payable semi-annually and the remainder is added to the principal balance of the junior note. The LA Mortgage is carried in the consolidated balance sheets at its aggregate unpaid principal balance. 41
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OnJanuary 5, 2015 , Flower Portfolio 001, LLC assumed a$9.2 million mortgage in conjunction with the purchase of investment real estate properties ("theFlower Note "). The Flower Note matures onDecember 10, 2031 and has a fixed interest rate of 4.81%. The Flower Note is carried in the consolidated balance sheets at its unpaid principal balance. InApril 2020 , certain subsidiaries of the Company received loan proceeds under the PPP, totaling$2.9 million with a stated annual interest rate of 1.00%. The PPP, established as part of the CARES Act and administered by theU.S. Small Business Administration (the "SBA"), provides for loans to qualifying businesses for amounts up to 2.5 times of the average monthly payroll costs (as defined for purposes of the PPP) of the qualifying business. The loans and accrued interest are forgivable as long as the borrower uses the loan proceeds for eligible purposes, including payroll, costs, rent and utilities, during the twenty-four week period following the borrower's receipt of the loan and maintains its payroll levels and employee headcount. The amount of loan forgiveness will be reduced if the borrower reduces its employee headcount below its average employee headcount during a benchmark period or significantly reduces salaries for certain employees during the covered period. The Company used the entire loan amount for qualifying expenses.The U.S. Department of the Treasury has announced that it will conduct audits for PPP loans that exceed$2.0 million . If we were to be audited and receive an adverse outcome in such an audit, we could be required to return the full amount of the PPP Loan and may potentially be subject to civil and criminal fines and penalties. OnDecember 21, 2020 the SBA approved the forgiveness of the full amount of one of the five PPP loans, which included principal and interest of$0.4 million . InJanuary 2021 andMarch 2021 , the SBA provided the Company with notices of forgiveness of the full amount of the remaining four loans. The forgiveness in the first quarter of 2021 included total principal and interest of$2.5 million . Subordinated Debt BetweenDecember 4, 2002 andDecember 16, 2003 , six subsidiary trusts of the Company issued$90.5 million of 30-year capital securities to third parties in separate private transactions. In each instance, a corresponding floating rate junior subordinated deferrable interest debenture was then issued byKingsway America Inc. to the trust in exchange for the proceeds from the private sale. The floating rate debentures bear interest at the rate of LIBOR, plus spreads ranging from 3.85% to 4.20%. The Company has the right to call each of these securities at par value any time after five years from their issuance until their maturity. During the third quarter of 2018, the Company gave notice to its Trust Preferred trustees of its intention to exercise its voluntary right to defer interest payments for up to 20 quarters, pursuant to the contractual terms of its outstanding Trust Preferred indentures, which permit interest deferral. This action does not constitute a default under the Company's Trust Preferred indentures or any of its other debt indentures. AtMarch 31, 2022 andDecember 31, 2021 , deferred interest payable of$19.9 million and$18.7 million , respectively, is included in accrued expenses and other liabilities in the consolidated balance sheets. The agreements governing our subordinated debt contain a number of covenants that, among other things, restrict the Company's ability to incur additional indebtedness, make dividends and distributions, and make certain payments in respect of the Company's outstanding securities. The Company's subordinated debt is measured and reported at fair value. AtMarch 31, 2022 , the carrying value of the subordinated debt is$61.9 million . The fair value of the subordinated debt is calculated using a model based on significant market observable inputs and inputs developed by a third party. For a description of the market observable inputs and inputs developed by a third party used in determining fair value of debt, see Note 18, "Fair Value of Financial Instruments," to the unaudited consolidated interim financial statements. During the three months endedMarch 31, 2022 , the market observable swap rates changed, and the Company experienced an increase in the credit spread assumption developed by the third-party. Changes in the market observable swap rates affect the fair value model in different ways. An increase in the LIBOR swap rates has the effect of increasing the fair value of the Company's subordinated debt while an increase in the risk-free swap rates has the effect of decreasing the fair value. The increase in the credit spread assumption has the effect of decreasing the fair value of the Company's subordinated debt while a decrease in the credit spread assumption has the effect of increasing the fair value. The other primary variable affecting the fair value of debt calculation is the passage of time, which will always have the effect of increasing the fair value of debt. The changes to the credit spread and swap rate variables during the three months endedMarch 31, 2022 , along with the passage of time, contributed to the$0.9 million increase in fair value of the Company's subordinated debt betweenDecember 31, 2021 andMarch 31, 2022 . Of the$0.9 million increase in fair value of the Company's subordinated debt betweenDecember 31, 2021 andMarch 31, 2022 ,$1.0 million is reported as decrease in fair value of debt attributable to instrument-specific credit risk in the Company's unaudited consolidated statements of comprehensive loss and$1.9 million is reported as loss on change in fair value of debt in the Company's unaudited consolidated statements of operations. Though changes in the market observable swap rates will continue to introduce some volatility each quarter to the Company's reported gain or loss on change in fair value of debt, changes in the credit spread assumption developed by the third party does not introduce volatility to the Company's consolidated statements of operations. The fair value of the Company's subordinated debt will eventually equal the principal value totaling$90.5 million of the subordinated debt by the time of the stated redemption date of each trust, beginning with the trust maturing onDecember 4, 2032 and continuing throughJanuary 8, 2034 , the redemption date of the last of the Company's outstanding trusts.
RECENTLY ISSUED ACCOUNTING STANDARDS
SeeNote 4, "Recently Issued Accounting Standards," to the unaudited consolidated
interim financial statements, for discussion of certain accounting standards
that may be applicable to the Company's current and future consolidated
financial statements.
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KINGSWAY FINANCIAL SERVICES INC.
LIQUIDITY AND CAPITAL RESOURCES
The purpose of liquidity management is to ensure there is sufficient cash to meet all financial commitments and obligations as they fall due. The liquidity requirements of the Company and its subsidiaries have been met primarily by funds generated from operations, capital raising, disposal of discontinued operations, investment maturities and investment income, and other returns received on investments and from the sale of investments. A significant portion of the cash provided by our Extended Warranty companies is required to be placed into restricted trust accounts, as determined by the insurers who back-up our service contracts, in order to fund future expected claims. On a periodic basis (quarterly or annually), we may be required to contribute more into the restricted accounts or we may be permitted to draw additional funds from the restricted accounts, dependent upon actuarial analyses performed by the insurers regarding sufficiency of funds to cover future expected claims. A substantial portion of the restricted trust accounts are invested in fixed maturities and other instruments that have durations similar to the expected future claim projections.
Cash provided from these sources is used primarily for warranty expenses,
business service expenses, debt servicing, acquisitions and operating expenses
of the holding company.
The Company's Extended Warranty and Kingsway Search Xcelerator subsidiaries fund their obligations primarily through service fee and commission revenue. The Company'sLeased Real Estate subsidiaries fund their obligations through rental revenue. Cash Flows During the three months endedMarch 31, 2022 , the Company reported$3.8 million of net cash provided by operating activities, primarily due to operating income from the segments, partially offset by the increase in service fee receivable. During the three months endedMarch 31, 2022 , the net cash used in investing activities was$0.2 million . This use of cash was primarily attributed to purchases of fixed maturities and property and equipment in excess of proceeds from limited liability investments and from sales and maturities of fixed maturities. During the three months endedMarch 31, 2022 , the net cash used in financing activities was$3.8 million . This use of cash was attributed to principal repayment on bank loans of$1.8 million , principal repayments on the notes payable of$1.5 million and distributions to noncontrolling interest holders of$0.5 million . Holding Company Liquidity
The liquidity of the holding company is managed separately from its
subsidiaries. The obligations of the holding company primarily consist of
holding company operating expenses; transaction-related expenses; investments;
and any other extraordinary demands on the holding company.
Actions available to the holding company to increase liquidity in order to meet its obligations include the sale of passive investments; sale of subsidiaries; issuance of debt or equity securities; exercise of warrants; distributions from the Company's Extended Warranty and Kingsway Search Xcelerator subsidiaries, as further described below; and giving notice to its Trust Preferred trustees of its intention to exercise its voluntary right to defer interest payments for up to 20 quarters on the six subsidiary trusts of the Company's subordinated debt, which right the Company exercised during the third quarter of 2018. Receipt of dividends from the Company's insurance subsidiaries has not generally been considered a source of liquidity for the holding company. The insurance subsidiaries have required regulatory approval for the return of capital and, in certain circumstances, prior to the payment of dividends. AtMarch 31, 2022 , Amigo was restricted from making any dividend payments to the holding company without regulatory approval pursuant to domiciliary insurance regulations. OnDecember 1, 2020 , the Company closed on the acquisition of PWI, a full-service provider of vehicle service agreements. Related to the PWI acquisition, the Company secured the 2020 KWH Loan with IWS, Trinity, Geminus and PWI (the "KWH Subs") as borrowers under the 2020 KWH Loan. Pursuant to satisfying the covenants under the 2020 KWH Loan, the KWH Subs were permitted to make distributions to the holding company in an aggregate amount not to exceed$1.5 million in any 12-month period. Beginning in 2022, the holding company is permitted to receive a portion of the excess cash flow (as defined in the 2020 KWH Loan document) generated by the KWH Subs in the previous year. Based on current covenants, the holding company would be entitled to 50% of the excess cash flow with the other 50% used to pay down the 2020 KWH Loan. The holding company is expected to receive$1.7 million and has inMarch 2022 paid down the KWH 2020 Loan by$1.7 million .
The amount of excess cash flow the Company is entitled to retain is dependent
upon the leverage ratio (as defined in the 2020 KWH Loan document):
Percent of excess cash flow
If leverage ratio is retained by the Company
Greater than 1.75:1.00 50%
Less than 1.75:1.00 but greater than 0.75:1.00 75%
Less than 0.75:1.0 100%
On October 1, 2021 , the Company closed on the acquisition of Ravix. Related to
the Ravix acquisition, the Company secured the Ravix Loan with Ravix and Ravix
LLC as borrowers under the Ravix Loan. Pursuant to the covenants under the Ravix
Loan, Ravix is permitted to make distributions to the holding company so long as
doing such would not cause non-compliance with the various covenants outlined
within the Ravix Loan.
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KINGSWAY FINANCIAL SERVICES INC.
Historically, dividends from the Leased Real Estate segment were not generally
considered a source of liquidity for the holding company. However, as more fully
described in Note 20(a), "Commitments and Contingencies," to the unaudited
consolidated interim financial statements, the holding company is now permitted
to receive 20% of the proceeds from the increased rental payments resulting from
an earlier amendment to the CMC lease (or any borrowings against such increased
rental payments). Refer to Note 10, "Debt," to the unaudited consolidated
interim financial statements, for further information about this borrowing. In
conjunction with the Additional Mortgage, TRT paid a guarantee fee of $1.1
million to a third-party during the second quarter of 2021, who is serving as a
guarantor or indemnitor with respect to certain obligations between TRT and the
holder of the Additional Mortgage. Refer to Note 20(b), "Commitments and
Contingencies," to the unaudited consolidated interim financial statements for
further discussion of this off-balance sheet guarantee.
On October 18, 2018 , the Company completed the previously announced sale of its
non-standard automobile insurance companies Mendota Insurance Company , Mendakota
Insurance Company and Mendakota Casualty Company (collectively "Mendota"). As
part of the transaction, the Company will indemnify the buyer for any loss and
loss adjustment expenses with respect to open claims in excess of Mendota's
carried unpaid loss and loss adjustment expenses at June 30, 2018 related to the
open claims. The maximum obligation to the Company with respect to the open
claims is $2.5 million . Per the purchase agreement, a security interest on the
Company's equity interest in its consolidated subsidiary, Net Lease, as well as
any distributions to the Company from Net Lease, was to be collateral for the
Company's payment of obligations with respect to the open claims. During the
third quarter of 2021, the purchasers of Mendota and the Company agreed to
release the Company's equity interest in Net Lease as collateral and allow Net
Lease to make distributions to the Company. In exchange, the Company agreed
to deposit $2.0 million into an escrow account and advance $0.5 million to the
purchaser of Mendota to satisfy the Company's payment obligation with respect to
the open claims. There is no maximum obligation to the Company with respect to
the specified claims. Refer to Note 20, "Commitments and Contingencies," to the
unaudited consolidated interim financial statements for further discussion of
this off-balance sheet guarantee.
The holding company's liquidity, defined as the amount of cash in the bank
accounts of Kingsway Financial Services Inc. and Kingsway America Inc. , was
$3.4 million (approximately seven months of operating cash outflows) and $2.2
million at March 31, 2022 and December 31, 2021 , respectively, which
excludes future actions available to the holding company that could be taken to
generate liquidity. The holding company cash amounts are reflected in the cash
and cash equivalents of $13.1 million and $12.6 million reported at March 31,
2022 and December 31, 2021 , respectively, on the Company's consolidated balance
sheets.
The holding company's liquidity at March 31, 2022 represents only actual cash on
hand and does not include cash that would be made available to the holding
company from the sale of investments owned by the holding company. In addition,
the holding company has access to some of the operating cash generated by the
Extended Warranty and Kingsway Search Xcelerator subsidiaries as described
above. While these sources do not represent cash of the holding company, they do
represent future sources of liquidity.
As of March 31, 2022 , there are 169,733 shares of the Company's Class A
Preferred Stock (the "Preferred Shares"), issued and outstanding. The
outstanding Preferred Shares were required to be redeemed by the Company on
April 1, 2021 ("Redemption Date") if the Company had sufficient legally
available funds to do so. Additionally, the Company has exercised its right to
defer payment of interest on its outstanding subordinated debt ("trust preferred
securities") and, because of the deferral which totaled $19.9 million at March
31, 2022 , the Company is prohibited from redeeming any shares of its capital
stock while payment of interest on the trust preferred securities is being
deferred. If the Company was required to pay either the Preferred Shares
redemption value or both the deferred interest on the trust preferred securities
and redeem all the Preferred Shares currently outstanding, then the Company has
determined that it does not have sufficient legally available funds to do so.
However, the Company is prohibited from doing so under Delaware law and, as
such, (a) the interest on the trust preferred securities remains on deferral as
permitted under the indentures and (b) in accordance with Delaware law the
Preferred Shares were not redeemed on the Redemption Date and instead remain
outstanding with a redemption value of $6.6 million as of March 31, 2022 ,
continue to be convertible at the discretion of the holder, and will accrue
dividends until such time as the Company has sufficient legally available funds
to redeem the Preferred Shares and is not otherwise prohibited from doing so.
The Company continues to operate in the ordinary course.
The Company notes there are several variables to consider in such a situation,
and management is exploring the following opportunities: negotiating with the
holders of the Preferred Shares with respect to the key provisions, raising
additional funds through capital market transactions, as well as the Company's
strategy of working to monetize its non-core investments while attempting to
maximize the tradeoff between liquidity and value received.
Based on the Company's current business plan and revenue prospects, existing
cash, cash equivalents, investment balances and anticipated cash flows from
operations are expected to be sufficient to meet the Company's working capital
and operating expenditure requirements, excluding the cash that may be required
to redeem the Preferred Shares and deferred interest on its trust preferred
securities, for the next twelve months. However, the Company's assessment could
also be affected by various risks and uncertainties, including, but not limited
to, the effects of the COVID-19 pandemic.
Regulatory Capital
In the United States , a risk-based capital ("RBC") formula is used by the
National Association of Insurance Commissioners ("NAIC") to identify property
and casualty insurance companies that may not be adequately capitalized. In
general, insurers reporting surplus as regards policyholders below 200% of the
authorized control level, as defined by the NAIC, at December 31 are subject to
varying levels of regulatory action, including discontinuation of operations. As
of December 31, 2021 , surplus as regards policyholders reported by Amigo
exceeded the 200% threshold.
During the fourth quarter of 2012, the Company began taking steps to place all
of Amigo into voluntary run-off. In April 2013 , Kingsway filed a comprehensive
run-off plan with the Florida Office of Insurance Regulation , which outlines
plans for Amigo's run-off. Amigo remains in compliance with that plan.
Kingsway Reinsurance Corporation ("Kingsway Re"), our reinsurance subsidiary
domiciled in Barbados , is required by the regulator in Barbados to maintain
minimum statutory capital of $125,000 . Kingsway Re is currently operating with
statutory capital near the regulatory minimum, requiring us to periodically
contribute capital to fund operating expenses. Kingsway Re incurs operating
expenses of approximately $0.1 million per year.
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UNIVERSAL HEALTH SERVICES INC – 10-Q – Management's Discussion and Analysis of Financial Condition and Results of Operations
NI Holdings, Inc. Files Results for First Quarter Ended March 31, 2022
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