Variable Interest Entities and Noncontrolling Interests

3 Months Ended

Mar. 31, 2020

Variable Interest Entity and Noncontrolling Interests

Variable Interest Entities and Noncontrolling Interests

Watford

In March 2014, the Company invested $100.0 million and acquired 2,500,000 common shares, approximately 11% of Watford’s outstanding common equity. Watford’s common shares are listed on the Nasdaq Select Global Market under the ticker symbol “WTRE”. As of March 31, 2020, the Company owns approximately 13% of Watford’s outstanding common equity.

In July 2019, Watford completed an offering of $175.0 million in aggregate principal amount of its 6.5% senior notes, due July 2, 2029 (“Watford Senior Notes”). Interest on the Watford Senior Notes is payable semi-annually in arrears on each January 2 and July 2 commencing on January 2, 2020. The $172.4 million net proceeds from the offering were used to redeem a portion of Watford’s outstanding preference shares (“Watford Preference Shares”). The Company purchased $35.0 million in aggregate principal amount of the Watford Senior Notes.

Watford is considered a VIE and the Company concluded that it is the primary beneficiary of Watford. As such, the results of Watford are included in the Company’s consolidated financial statements.

The Company does not guarantee or provide credit support for Watford, and the Company’s financial exposure to Watford is limited to its investment in Watford’s senior notes, common and preferred shares and counterparty credit risk (mitigated by collateral) arising from reinsurance transactions.

The following table provides the carrying amount and balance sheet caption in which the assets and liabilities of Watford are reported:



	March 31,		December 31,
	2020		2019
Assets
Investments accounted for using the fair value option	$	1,732,086	$	1,898,091
Fixed maturities available for sale, at fair value	717,552		745,708
Equity securities, at fair value	63,169		65,338
Cash	96,580		102,437
Accrued investment income	16,344		14,025
Premiums receivable	281,541		273,657
Reinsurance recoverable on unpaid and paid losses and LAE	197,458		170,973
Ceded unearned premiums	128,570		132,577
Deferred acquisition costs	71,402		64,044
Receivable for securities sold	26,789		16,287
Goodwill and intangible assets	7,650		7,650
Other assets	67,493		60,070
Total assets of consolidated VIE	$	3,406,634	$	3,550,857

Liabilities
Reserve for losses and loss adjustment expenses	$	1,300,249	$	1,263,628
Unearned premiums	478,663		438,907
Reinsurance balances payable	71,204		77,066
Revolving credit agreement borrowings	500,587		484,287
Senior notes	172,486		172,418
Payable for securities purchased	63,829		18,180
Other liabilities (1)	203,234		171,714
Total liabilities of consolidated VIE	$	2,790,252	$	2,626,200

Redeemable noncontrolling interests	$	52,328	$	52,305


(1)	Includes certain borrowings related to investing activities.

For the three months ended March 31, 2020, Watford generated $24.6 million of cash provided by operating activities, $35.7 million of cash used for investing activities and $12.3 million of cash provided by financing activities, compared to $70.3 million of cash provided by operating activities, $105.9 million of cash used for investing activities and $28.1 million of cash provided by financing activities for the three months ended March 31, 2019.

Non-redeemable noncontrolling interests

The Company accounts for the portion of Watford’s common equity attributable to third party investors in the shareholders’ equity section of its consolidated balance sheets. The noncontrolling ownership in Watford’s common shares was approximately 87% at March 31, 2020. The portion of Watford’s income or loss attributable to third party investors is recorded in the consolidated statements of income in ‘net (income) loss attributable to noncontrolling interests.’

The following table sets forth activity in the non-redeemable noncontrolling interests:



	March 31,
	2020			2019
Three Months Ended
Balance, beginning of year	$	762,777		$	791,560
Additional paid in capital attributable to noncontrolling interests	(123		)	—
Repurchases attributable to non-redeemable noncontrolling interests ⁽¹⁾	(2,867		)	—
Amounts attributable to noncontrolling interests	(233,944		)	42,382
Other comprehensive income (loss) attributable to noncontrolling interests	(33,058		)	4,139
Balance, end of period	$	492,785		$	838,081

(1) During 2020, Watford’s board of directors authorized the investment in Watford’s common shares through a share repurchase program.

Redeemable noncontrolling interests

The Company accounts for redeemable noncontrolling interests in the mezzanine section of its consolidated balance sheets in accordance with applicable accounting guidance. Such redeemable noncontrolling interests primarily relate to the Watford Preference Shares issued in late March 2014 with a par value of $0.01 per share and a liquidation preference of $25.00 per share. The Watford Preference Shares were issued at a discounted amount of $24.50 per share. Preferred dividends, including the accretion of the discount and issuance costs, are included in ‘net (income) loss attributable to noncontrolling interests’ in the Company’s consolidated statements of income.

In August 2019, Watford redeemed 6,919,998 of its 9,065,200 issued and outstanding Watford Preference Shares. The Watford Preference Shares were redeemed at a total redemption price of $25.19748 per share, inclusive of all declared and unpaid dividends, with accumulation of any undeclared dividends on or after June 30, 2019. In addition, the Company received $11.5 million pursuant to the redemption of Watford Preference Shares.

The following table sets forth activity in the redeemable non-controlling interests:



	March 31,
	2020			2019
Three Months Ended
Balance, beginning of year	$	55,404		$	206,292
Accretion of preference share issuance costs	23			91
Other	(51		)	—
Balance, end of period	$	55,376		$	206,383

The portion of income or loss attributable to third party investors, recorded in the Company’s consolidated statements of income in ‘net (income) loss attributable to noncontrolling interests,’ are summarized in the table below:



	March 31,
	2020			2019
Three Months Ended
Amounts attributable to non-redeemable noncontrolling interests	$	233,944		$	(42,382	)
Amounts attributable to redeemable noncontrolling interests	(1,153		)	(4,588		)
Net (income) loss attributable to noncontrolling interests	$	232,791		$	(46,970	)

Bellemeade Re

The Company has entered into various aggregate excess of loss mortgage reinsurance agreements with various special purpose reinsurance companies domiciled in Bermuda (the “Bellemeade Agreements”). At the time the Bellemeade Agreements were entered into, the applicability of the accounting guidance that addresses VIEs was evaluated. As a result of the evaluation of the Bellemeade Agreements, the Company concluded that these entities are VIEs. However, given that the ceding insurers do not have the unilateral power to direct those activities that are significant to their economic performance, the Company does not consolidate such entities in its consolidated financial statements.

The following table presents the total assets of the Bellemeade entities, as well as the Company’s maximum exposure to loss associated with these VIEs, calculated as the maximum historical observable spread between the one month LIBOR, the basis for the contractual payments to bond holders, and short term invested trust asset yields.



			Maximum Exposure to Loss
Bellemeade Entities (Issue Date)	Total VIE Assets		On-Balance Sheet (Asset) Liability			Off-Balance Sheet		Total
Mar 31, 2020
Bellemeade 2017-1 Ltd. (Oct-17)	$	190,324	$	204		$	1,491	$	1,695
Bellemeade 2018-1 Ltd. (Apr-18)	299,909		(132		)	3,790		3,658
Bellemeade 2018-2 Ltd. (Aug-18)	380,986		83			2,787		2,870
Bellemeade 2018-3 Ltd. (Oct-18)	383,268		(116		)	4,272		4,156
Bellemeade 2019-1 Ltd. (Mar-19)	228,940		396			3,072		3,468
Bellemeade 2019-2 Ltd. (Apr-19)	462,057		814			4,373		5,187
Bellemeade 2019-3 Ltd. (Jul-19)	603,465		1,033			8,449		9,482
Bellemeade 2019-4 Ltd. (Oct-19)	563,160		1,420			10,320		11,740
Total	$	3,112,109	$	3,702		$	38,554	$	42,256
Dec 31, 2019
Bellemeade 2017-1 Ltd. (Oct-17)	$	216,429	$	(442	)	$	2,794	$	2,352
Bellemeade 2018-1 Ltd. (Apr-18)	328,482		(1,574		)	5,757		4,183
Bellemeade 2018-2 Ltd. (Aug-18)	437,009		(877		)	2,524		1,647
Bellemeade 2018-3 Ltd. (Oct-18)	426,806		(1,113		)	3,937		2,824
Bellemeade 2019-1 Ltd. (Mar-19)	257,358		(226		)	3,027		2,801
Bellemeade 2019-2 Ltd. (Apr-19)	525,959		(78		)	2,579		2,501
Bellemeade 2019-3 Ltd. (Jul-19)	656,523		(585		)	9,273		8,688
Bellemeade 2019-4 Ltd. (Oct-19)	577,267		(302		)	12,193		11,891
Total	$	3,425,833	$	(5,197	)	$	42,084	$	36,887