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, 2020 ("2020 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, asset management and real estate industries. Kingsway conducts its business through two reportable segments: Extended Warranty andLeased Real Estate . 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 in 26
states and the
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.
PWSC sells new home warranty products and provides administration services to
homebuilders and homeowners across
Trinity sells heating, ventilation, air conditioning ("HVAC"), standby generator, commercial LED lighting and refrigeration warranty products and provides equipment breakdown and maintenance support services to companies acrossthe 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 refrigeration industries throughoutthe 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 subsidiary,CMC Industries, Inc. ("CMC"). CMC owns, through an indirect wholly owned subsidiary (the "Property Owner"), a parcel of real property consisting of approximately 192 acres located in theState 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. Throughout Management's Discussion and Analysis, the term "Leased Real Estate " is used to refer to this segment. Impact of COVID-19 InMarch 2020 , the outbreak of COVID-19 caused by a novel strain of the coronavirus was recognized as a pandemic by theWorld Health Organization , and the outbreak has become increasingly widespread inthe United States , including in the markets in which we operate. The COVID-19 outbreak 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 reduced consumer spending due to both job losses and other effects attributable to COVID-19. There remain many unknowns and the Company continues to monitor the expected trends and related demand for its services and has and will continue to adjust its operations accordingly. The near-term impacts of COVID-19 are primarily with respect to our Extended Warranty segment. As consumer spending has been impacted, including a decline in the purchase of new and used vehicles, and many businesses through which we distribute our products either remain closed or are open but with capacity constraints, we have seen cash flows being affected by a reduction in new warranty sales for vehicle service agreements. 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 inthe United States . 32
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Table of ContentsKINGSWAY FINANCIAL SERVICES INC. 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 outbreak closely. However, the extent to which the COVID-19 outbreak will impact our operations or financial results is uncertain.
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 (loss) 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 (Loss)
Segment operating income (loss) 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 18, "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 from continuing operations before income tax benefit that, in addition to segment operating income (loss), includes net investment income, net realized gains, (loss) gain on change in fair value of equity investments, gain (loss) on change in fair value of limited liability investments, at fair value, net change in unrealized loss on private company investments, other-than-temporary impairment loss, interest expense not allocated to segments, other revenue and expenses not allocated to segments, net, amortization of intangible assets, (loss) gain 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 from continuing operations before income tax benefit for the three and six months endedJune 30, 2021 andJune 30, 2020 is presented 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; valuation of mandatorily redeemable preferred stock; accounting for business combinations; valuation and impairment assessment of intangible assets; goodwill recoverability; deferred acquisition costs; fair value assumptions for subordinated debt obligations; fair value assumptions for stock-based compensation liabilities; 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 2020 Annual Report. There has been no material change subsequent toDecember 31, 2020 to the information previously disclosed in the 2020 Annual Report with respect to these significant accounting policies and critical estimates. The Company has added the following critical accounting policy:
Accounting for Business Combinations:
The acquisition method of accounting is used to account for acquisitions of subsidiaries or other businesses by assigning the purchase price to tangible and intangible assets acquired and liabilities assumed. Assets acquired and liabilities assumed are recorded at their fair values and the excess of the purchase price over the amounts assigned is recorded as goodwill. We determine the fair value of such assets and liabilities, often in consultation with third-party valuation advisors. Acquired intangible assets with finite lives are amortized over their estimated useful lives. Adjustments to fair value assessments are recorded to goodwill over the purchase price allocation period. 33
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Table of ContentsKINGSWAY FINANCIAL SERVICES INC.
RESULTS OF CONTINUING OPERATIONS
A reconciliation of total segment operating income to net (loss) income for the three and six months endedJune 30, 2021 andJune 30, 2020 is presented in Table 1 below:
Table 1 Segment Operating Income
(in thousands of dollars) For the three months ended June 30, For the six months ended June 30, 2021 2020 Change 2021 2020 Change Segment operating income: Extended Warranty$ 2,600 $ 1,285 $ 1,315 $ 7,910 $ 2,135 $ 5,775 Leased Real Estate (2,302 ) 838 (3,140 ) (1,009 ) 1,435 (2,444 ) Total segment operating income 298 2,123 (1,825 ) 6,901 3,570 3,331 Net investment income 403 681 (278 ) 824 1,400 (576 ) Net realized gains 187 8 179 238 216 22 (Loss) gain on change in fair value of equity investments (45 ) 489 (534 ) (196 ) (108 ) (88 ) Gain (loss) on change in fair value of limited liability investments, at fair value 731 (123 ) 854 529 1,776 (1,247 ) Net change in unrealized loss on private company investments - - - - (670 ) 670
Other-than-temporary
impairment loss - - - - (117 ) 117 Interest expense not allocated to segments (1,593 ) (1,997 ) 404 (3,145 ) (4,150 ) 1,005 Other revenue and expenses not allocated to segments, net (2,261 ) (2,133 ) (128 ) (5,752 ) (5,163 ) (589 ) Amortization of intangible assets (496 ) (573 ) 77 (993 ) (1,147 ) 154 (Loss) gain on change in fair value of debt (738 ) (202 ) (536 ) (1,757 ) 2,443 (4,200 ) Gain on extinguishment of debt not allocated to segments - - - 311 - 311 Loss from continuing operations before income tax benefit (3,514 ) (1,727 ) (1,787 ) (3,040 ) (1,950 ) (1,090 ) Income tax benefit (3,258 ) (300 ) (2,958 ) (3,683 ) (130 ) (3,553 ) (Loss) income from continuing operations (256 ) (1,427 ) 1,171 643 (1,820 ) 2,463 Gain on disposal of discontinued operations, net of taxes - 6 (6 ) - 6 (6 ) Net (loss) income$ (256 ) $ (1,421 ) $ 1,165 $ 643 $ (1,814 ) $ 2,457
(Loss) Income from Continuing Operations and Net (Loss) Income
In the second quarter of 2021, we reported loss from continuing operations of$0.3 million compared to$1.4 in the second quarter of 2020. The loss from continuing operations for the three months endedJune 30, 2021 is primarily due to operating loss inLeased Real Estate , interest expense not allocated to segments and other revenue and expenses not allocated to segments, net, partially offset by operating income in Extended Warranty and income tax benefit. The loss from continuing operations for the three months endedJune 30, 2020 is primarily due to interest expense not allocated to segments and other income and expenses not allocated to segments, net, partially offset by operating income in Extended Warranty andLeased Real Estate and net investment income. For the six months endedJune 30, 2021 , we reported income from continuing operations of$0.6 million compared to loss from continuing operations of$1.8 million for the six months endedJune 30, 2020 . The income from continuing operations for the six months endedJune 30, 2021 is primarily due to operating income in Extended Warranty and net investment income, partially offset by operating loss inLeased Real Estate , interest expense not allocated to segments, other revenue and expenses not allocated to segments, net, loss on change in fair value of debt and income tax benefit. For the six months endedJune 30, 2021 , Extended Warranty segment operating income includes gain on extinguishment of debt of$2.2 million , related to PPP loan forgiveness. See Note 11, "Debt," to the unaudited consolidated interim financial statements, for further discussion. The loss from continuing operations for the six months endedJune 30, 2020 is primarily due to interest expense not allocated to segments and other income and expenses not allocated to segments, net, partially offset by operating income in Extended Warranty andLeased Real Estate , gain on change in fair value of debt and gain on change in fair value of limited liability investments, at fair value. Extended Warranty The Extended Warranty service fee and commission revenue increased 80.8% (or$8.4 million ) to$18.8 million for the three months endedJune 30, 2021 compared with$10.4 million for the three months endedJune 30, 2020 ($37.3 million year to date compared to$21.6 million prior year to date). The increase in service fee and commission revenue is primarily due to the inclusion of PWI for the three and six months endedJune 30, 2021 following its acquisition effectiveDecember 1, 2020 . PWI service fee and commission revenue was$7.4 million and$14.8 million for the three and six months endedJune 30, 2021 , respectively. The Extended Warranty operating income was$2.6 million for the three months endedJune 30, 2021 compared with$1.3 million for the three months endedJune 30, 2020 ($7.9 million year to date compared to$2.1 million prior year to date). The increase in operating income is primarily due to the following:
• Inclusion of Paycheck Protection Program ("PPP") loan forgiveness related to
Extended Warranty companies of
2021; 34
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Table of ContentsKINGSWAY FINANCIAL SERVICES INC.
•
effectiveDecember 1, 2020 ($2.0 million year to date);
• A
30, 2021 (an increase of
decrease in claims authorized on vehicle service agreements and lower general
and administrative expenses that was partially offset by a slight decrease in
revenue;
• A
driven by increased revenues in its equipment breakdown and maintenance
support services, as well as increased revenue and gross profit on the
extended warranty services product, partially offset by a related increase in
cost of services sold compared to the same period in 2020;
• A
to an increase in revenue and lower general and administrative expenses; and
• A
general and administrative expenses compared with the three months ended June
30, 2020 (an increase of
decrease in claims authorized on vehicle service agreements and lower general
and administrative expenses that was partially offset by a decrease in revenue compared with the six months endedJune 30, 2020 ).Leased Real Estate Leased Real Estate rental revenue was$3.3 million for each of the three months endedJune 30, 2021 andJune 30, 2020 ($6.7 million for each of the six months endedJune 30, 2021 andJune 30, 2020 ). The rental income is derived from CMC's long-term triple net lease.Leased Real Estate operating loss was$2.3 million for the three months endedJune 30, 2021 compared with operating income of$0.8 million for the three months endedJune 30, 2020 (operating loss of$1.0 million year to date compared to operating income of$1.4 million prior year to date). The operating loss for the three and six months endedJune 30, 2021 is primarily the result of a$2.9 million expense recorded during the second quarter of 2021 to write-off an indemnification receivable (which is exactly offset by a tax benefit of$2.9 million in net (loss) income), as well as management expense of$0.2 million for the three months endedJune 30, 2021 as a result of the March settlement agreement. The operating loss for the six months endedJune 30, 2021 also includes a$0.6 million benefit recorded in 2021 related to the finalization of management fees and legal expenses associated with the settlement of CMC litigation (see Note 21, "Commitments and Contingencies," to the unaudited consolidated interim financial statements, for further information on the settlement).Leased Real Estate operating income includes interest expense of$1.5 million for each of the three months endedJune 30, 2021 andJune 30, 2020 ($3.0 million for each of the six months endedJune 30, 2021 andJune 30, 2020 ). Net Investment Income Net investment income was$0.4 million in the second quarter of 2021 compared to$0.7 million in the second quarter of 2020 ($0.8 million year to date compared to$1.4 million prior year to date). The decrease in net investment income for the three and six months endedJune 30, 2021 relates primarily to lower investment income from the Company's limited liability investments, at fair value and fixed maturities as a result of general changes in market conditions. Net Realized Gains Net realized gains were$0.2 million in the second quarter of 2021 compared to less than$0.1 million in the second quarter of 2020 ($0.2 million year to date compared to$0.2 million prior year to date). The net realized gains for the three and six months endedJune 30, 2021 primarily relate to realized gains recognized byArgo Holdings Fund I, LLC ("Argo Holdings "). The net realized gains for the three months endedJune 30, 2020 relate to sales of fixed maturities. The net realized gains for the six months endedJune 30, 2020 relate primarily to sales of fixed maturities and distributions received from one of the Company's investments in which its carrying value previously had been written down to zero as a result of prior distributions.
(Loss) Gain on Change in Fair Value of Equity Investments
Loss on change in fair value of equity investments was less than
• Unrealized losses of less than
2021 and
and
• Net realized gains of zero on equity investments sold during the three months
ended
date and prior year to date). 35
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Table of ContentsKINGSWAY FINANCIAL SERVICES INC.
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$0.7 million in the second quarter of 2021 compared to a loss of$0.1 million in the second quarter of 2020 (gain of$0.5 million year to date compared to a gain of$1.8 million prior year to date). The gain for the three months endedJune 30, 2021 represents an increase in fair value of$0.8 million related toNet Lease Investment Grade Portfolio LLC ("Net Lease") due to an increase in fair value of the properties held by the underlying LLC's and a reduction in debt at one of the underlying LLC's, partially offset by a decrease in fair value of$0.1 million related toArgo Holdings . The loss for the three months endedJune 30, 2020 represents a decrease in fair value of$0.1 million related toArgo Holdings .
The gain for the six months ended
Net Change in Unrealized Loss on Private Company Investments
Net change in unrealized loss on private company investments was zero in both the second quarter of 2021 and the second quarter of 2020 (zero year to date compared to$0.7 million prior year to date). For the three and six months endedJune 30, 2021 andJune 30, 2020 , the Company did not record any adjustments to the fair value of its investments in private companies for observable price changes. Also, as part of the Company's quarterly impairment analysis of its investments in private companies, the Company determined it should write down one of its investments for other-than-temporary impairment of$0.7 million for the six months endedJune 30, 2020 as a result of the impact of COVID-19 on the investment's underlying business.
Interest Expense not Allocated to Segments
Interest expense not allocated to segments for the second quarter of 2021 was$1.6 million compared to$2.0 million in the second quarter of 2020 ($3.1 million year to date compared to$4.2 million prior year to date). The decrease for the three and six months endedJune 30, 2021 is primarily attributable to lower interest expense at Net Lease as a result of repaying their existing financing during the first quarter of 2021, as well as lower interest expense related to the Company's subordinated debt, which resulted from generally lowerLondon interbank offered interest rates for three-monthU.S. dollar deposits ("LIBOR") during the three and six months endedJune 30, 2021 compared to the same periods in 2020. The Company's subordinated debt bears interest at the rate of LIBOR, plus spreads ranging from 3.85% to 4.20%. See "Debt" section below for further details.
Other Revenue and Expenses not Allocated to Segments, Net
Other revenue and expenses not allocated to segments, net was a net expense of$2.3 million in the second quarter of 2021 compared to$2.1 million in the second quarter of 2020 ($5.8 million year to date compared to$5.2 million prior year to date).
The increase in net expense for the three months ended
The increase in net expense for the six months endedJune 30, 2021 is primarily attributable higher salary expense related to restricted stock awards, partially offset by a$0.9 million decrease in expense recorded pursuant to outstanding litigation between the Company andAegis Security Insurance Company ("Aegis") recorded during the first quarter of 2020 and a decrease in audit professional services fees incurred during the six months endedJune 30, 2021 compared to the same period in 2020.
See Note 21, "Commitments and Contingencies," to the unaudited consolidated interim financial statements, for further discussion related to Aegis.
(Loss) Gain on Change in Fair Value of Debt
Loss on change in fair value of debt was$0.7 million in the second quarter of 2021 compared to$0.2 million in the second quarter of 2020 (loss of$1.8 million year to date compared to a gain of$2.4 million prior year to date). The loss for the three and six months endedJune 30, 2021 and the three months endedJune 30, 2020 reflect increases in the fair value of the subordinated debt resulting from changes in inputs, other than the instrument-specific credit risk, to the Company's fair value model which was primarily the result of decreases in the risk-free rate and lower overall LIBOR rates. The gain for the six months endedJune 30, 2020 reflects a decrease in the fair value of the subordinated debt resulting from changes in inputs, other than the instrument-specific credit risk, to the Company's fair value model which were primarily a result of lower overall LIBOR rates. See "Debt" section below for further information.
Gain on Extinguishment of Debt not Allocated to Segments
For the six months endedJune 30, 2021 , gain on extinguishment of debt not allocated to segments consists of a$0.3 million gain (recorded in the first quarter) on forgiveness of the balance of the holding company's loan obtained through the PPP. See Note 11, "Debt," to the unaudited consolidated interim financial statements, for further discussion. Income Tax Benefit Income tax benefit for the second quarter of 2021 was$3.3 million compared to$0.3 million in the second quarter of 2020 ($3.7 million year to date compared to$0.1 million prior year to date). During the three months endedJune 30, 2021 , the Company recorded an income tax benefit of$2.9 million for the release of a liability that had been included in income taxes payable in the consolidated balance sheets. See Note 14, "Income Taxes," to the unaudited consolidated interim financial statements, for additional detail of the income tax benefit recorded for the three and six months endedJune 30, 2021 andJune 30, 2020 . 36
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Table of ContentsKINGSWAY 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 andArgo 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 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 June 30, 2021 % of Total 31, 2020 % of Total Fixed maturities:U.S. government, government agencies and authorities 10,490 10.3 % 10,104 8.8 % States, municipalities and political subdivisions 1,284 1.3 % 1,454 1.3 % Mortgage-backed 6,066 5.9 % 5,394 4.7 % Asset-backed 127 0.1 % - - % Corporate 3,635 3.6 % 3,764 3.3 % Total fixed maturities 21,602 21.2 % 20,716 18.1 % Equity investments: Common stock 193 0.2 % 155 0.1 % Warrants 32 0.0 % 289 0.3 % Total equity investments 225 0.2 % 444 0.4 % Limited liability investments 3,568 3.5 % 3,692 3.2 % Limited liability investments, at fair value 20,362 19.9 % 32,811 28.7 % Investments in private companies 790 0.7 % 790 0.7 % Real estate investments 10,662 10.4 % 10,662 9.3 % Other investments 288 0.3 % 294 0.2 % Short-term investments 157 0.2 % 157 0.1 % Total investments 57,654 56.4 % 69,566 60.7 % Cash and cash equivalents 17,093 16.7 % 14,374 12.6 % Restricted cash 27,540 26.9 % 30,571 26.7 % Total 102,287 100.0 % 114,511 100.0 %
Other-Than-Temporary Impairment
The Company performs a quarterly analysis of its investments classified as available-for-sale 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 2020 Annual Report. 37 --------------------------------------------------------------------------------
KINGSWAY FINANCIAL SERVICES INC.
As a result of the analysis performed, the Company recorded the following write downs for other-than-temporary impairment:
• Other investments: zero for the three months ended
2020 (zero and
30, 2020, respectively).
• Limited liability investments, at fair value: zero for the three months ended
months ended
included in gain (loss) on change in fair value of limited liability
investments, at fair value in the consolidated statements of operations.
• Investments in private companies: zero for the three months ended
2021 and
30, 2021 and
unrealized loss on private company investments in the consolidated statements
of operations. There were no write-downs recorded for other-than-temporary impairments related to available-for sale investments or limited liability investments for the three and six months endedJune 30, 2021 andJune 30, 2020 . 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. AtJune 30, 2021 andDecember 31, 2020 , the gross unrealized losses for fixed maturities amounted to less than$0.1 million , and there were no unrealized losses attributable to non-investment grade fixed maturities. At each ofJune 30, 2021 andDecember 31, 2020 , 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 Bank Loans OnOctober 12, 2017 , the Company borrowed a principal amount of$5.0 million from a bank to partially finance its acquisition of PWSC (the "PWSC Loan"). The PWSC Loan was scheduled to mature onOctober 12, 2022 ; however, the principal was fully repaid onJanuary 30, 2020 . In 2019, the Company formed KWH, whose subsidiaries include IWS, Geminus and Trinity. OnMarch 1, 2019 , KWH borrowed a principal amount of$10.0 million from a bank to finance its acquisition of Geminus (the "2019 KWH Loan"). The 2019 KWH Loan had an annual interest rate equal to LIBOR, having a floor of 2.00%, plus 9.25%. The 2019 KWH Loan was scheduled to mature onMarch 1, 2024 ; however, the principal was fully repaid onDecember 1, 2020 . 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 3.00% 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 . See Note 11, "Debt," to the unaudited consolidated interim financial statements for further details. 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. Notes Payable As part of its acquisition of CMC inJuly 2016 , the Company assumed a mortgage ("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 . See Note 21(a), "Commitments and Contingencies - Legal proceedings," to the unaudited consolidated interim financial statements for further discussion of the CMC litigation settlement agreement. 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 11, "Debt," to the unaudited consolidated interim financial statements for further details. 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. 38
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Table of ContentsKINGSWAY FINANCIAL SERVICES INC. OnOctober 15, 2015 , Net Lease assumed a$9.0 million mezzanine debt in conjunction with the purchase of investment real estate properties ("theNet Lease Note "). The Net Lease Note matured onNovember 1, 2020 and had a fixed interest rate of 10.25%. The Net Lease Note is carried in the consolidated balance sheet atDecember 31, 2020 at its unpaid principal balance. In conjunction with the maturity of the Net Lease Note onNovember 1, 2020 , Net Lease explored alternatives to maximize the value of its investment portfolio. As a result of this process, Net Lease elected to sell one of its three investment real estate properties while refinancing the remaining properties and the existing financing was repaid. Each of these transactions closed onOctober 30, 2020 , however because the Company reports Net Lease on a three-month lag, the consolidated balance sheet atDecember 31, 2020 continued to report the$9.0 million mezzanine debt. 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 . The carrying value of the PPP atDecember 31, 2020 represents its unpaid principal balance. 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. AtJune 30, 2021 andDecember 31, 2020 , deferred interest payable of$16.4 million and$14.1 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. AtJune 30, 2021 , the carrying value of the subordinated debt is$58.2 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 19, "Fair Value of Financial Instruments," to the unaudited consolidated interim financial statements. During the six months endedJune 30, 2021 , the market observable swap rates changed, and the Company experienced a decrease 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 six months endedJune 30, 2021 , along with the passage of time, contributed to the$7.3 million increase in fair value of the Company's subordinated debt betweenDecember 31, 2020 andJune 30, 2021 . Of the$7.3 million increase in fair value of the Company's subordinated debt betweenDecember 31, 2020 andJune 30, 2021 ,$5.5 million is reported as increase in fair value of debt attributable to instrument-specific credit risk in the Company's unaudited consolidated statements of comprehensive (loss) income and$1.8 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.
For a description of each of the Company's six subsidiary trusts, see Note 11, "Debt," to the unaudited consolidated interim financial statements.
RECENTLY ISSUED ACCOUNTING STANDARDS
See Note 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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Table of ContentsKINGSWAY 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 income and other returns received on investments or from the sale of investments. Cash provided from these sources is used primarily for making investments and for warranty expenses and loss and loss adjustment expense payments, debt servicing and other operating expenses. The timing and amount of payments for loss and loss adjustment expenses may differ materially from our provisions for unpaid loss and loss adjustment expenses, which may create increased liquidity requirements. Cash Flows During the six months endedJune 30, 2021 , the Company reported$11.5 million of net cash used in operating activities, primarily due to$10.6 million prepaid management fees recorded during the second quarter of 2021. The$10.6 million was only paid because of the gross proceeds received under the Additional Mortgage (see explanation of cash provided by financing activities below), of which the Company retained$2.7 million . During the six months endedJune 30, 2021 , the net cash provided by investing activities was$11.9 million . This source of cash was primarily attributed to a distribution received by Net Lease from one of its limited liability investment companies of$12.9 million during the first quarter of 2021, partially offset by purchases of fixed maturities in excess of proceeds from sales and maturities of fixed maturities. During the six months endedJune 30, 2021 , the net cash used in financing activities was$0.7 million . This use of cash was primarily attributed to principal repayment on bank loan of$2.2 million and principal repayments of$11.3 million on the notes payable, of which$9.0 million relates to the repayment of Net Lease's$9.0 million mezzanine loan and$2.3 million relating to principal paydowns on the Mortgage, Additional Mortgage and the Flower Note; partially offset by net proceeds from notes payable of$13.3 million related to the Additional Mortgage. 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. AtJune 30, 2021 , Amigo was restricted from making any dividend payments to the holding company without regulatory approval pursuant to domiciliary insurance regulations. The Company's Extended Warranty subsidiaries fund their obligations primarily through service fee and commission revenue. The Company'sLeased Real Estate subsidiary funds its obligations through rental revenue.
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 generate 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 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. 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 as borrowers under the 2020 KWH Loan. Pursuant to satisfying the covenants under the 2020 KWH Loan, IWS, Trinity, Geminus and PWI are permitted to make distributions to the holding company in an aggregate amount not to exceed$1.5 million in any 12-month period (which is the same amount as under the predecessor loan). Separately, pursuant to covenants under the PWSC Loan secured to partially finance the acquisition of PWSC onOctober 12, 2017 , PWSC was not permitted to make distributions to the holding company without the consent of the lender. The PWSC Loan was scheduled to mature onOctober 12, 2022 ; however, the remaining principal totaling$0.3 million was fully repaid onJanuary 30, 2020 and, as such, PWSC is no longer subject to such restrictions. Historically, dividends from theLeased Real Estate segment were not generally considered a source of liquidity for the holding company. However, as more fully described in Note 21, "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 lease (or any borrowings against such increased rental payments). In the second quarter of 2021, theLeased Real Estate segment completed a borrowing against the increased rental payments and, as a result, the holding company received a dividend of$2.7 million . Refer to Note 11, "Debt," to the unaudited consolidated interim financial statements, for further information about this borrowing. OnJuly 16, 2018 , the Company announced it had entered into a definitive agreement to sell its non-standard automobile insurance companiesMendota Insurance Company ,Mendakota Insurance Company andMendakota Casualty Company (collectively "Mendota"). OnOctober 18, 2018 , the Company completed the previously announced sale of Mendota. As part of the transaction, the Company will indemnify the buyer for any loss and loss adjustment expenses with respect to open claims and certain specified claims in excess of Mendota's carried unpaid loss and loss adjustment expenses atJune 30, 2018 . The maximum obligation to the Company with respect to the open claims is$2.5 million . 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, is collateral for the Company's payment of obligations with respect to the open claims. There is no maximum obligation to the Company with respect to the specified claims. The holding company's liquidity, defined as the amount of cash in the bank accounts ofKingsway Financial Services Inc. andKingsway America Inc. , was$5.6 million (approximately twelve months of operating cash outflows) and$1.1 million atJune 30, 2021 andDecember 31, 2020 , respectively. The amount as ofJune 30, 2021 excludes$1.8 million of cash proceeds received inJuly 2021 related to the exercise of 350,000 warrants and 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$17.1 million and$14.4 million reported atJune 30, 2021 andDecember 31, 2020 , respectively, on the Company's consolidated balance sheets. 40 --------------------------------------------------------------------------------
KINGSWAY FINANCIAL SERVICES INC. As of the filing date of this report on Form 10-Q for the three and six months endedJune 30, 2021 , the holding company's liquidity of$7.0 million represented approximately 17 months of regularly recurring operating expenses before any transaction-related expenses, any new holding company investments or any other extraordinary demands on the holding company. The holding company's liquidity atJune 30, 2021 and as of the filing date of this report on Form 10-Q for the three and six months endedJune 30, 2021 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 subsidiaries as described above. While these sources do not represent cash of the holding company as of the filing date of this report on Form 10-Q for the three and six months endedJune 30, 2021 , they do represent future sources of liquidity. As ofJune 30, 2021 , there are 182,876 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 onApril 1, 2021 ("Redemption Date") at a redemption value of$6.7 million , 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$16.4 million atJune 30, 2021 , 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 underDelaware law and, as such, (a) the interest on the trust preferred securities remains on deferral as permitted under the indentures and (b) in accordance withDelaware law the Preferred Shares were not redeemed on the Redemption Date and instead remain outstanding with a redemption value of$6.8 million as ofJune 30, 2021 , 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 Inthe United States , a risk-based capital ("RBC") formula is used by theNational 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, atDecember 31 are subject to varying levels of regulatory action, including discontinuation of operations. As ofDecember 31, 2020 , 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. InApril 2013 , Kingsway filed a comprehensive run-off plan with theFlorida 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 inBarbados , is required by the regulator inBarbados 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.
OFF-BALANCE SHEET ARRANGEMENTS
The Company has off-balance sheet arrangements related to guarantees, which are further described in Note 21, "Commitments and Contingent Liabilities," to the unaudited consolidated interim financial statements.
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