Notes to Consolidated Financial Statements
NOTE 1 BUSINESS
Kingsway Financial Services Inc. (the "Company" or "Kingsway") was incorporated under the Business Corporations Act (Ontario) on September 19, 1989. Effective December 31, 2018, the Company changed its jurisdiction of incorporation from the province of Ontario, Canada, to the State of Delaware. Kingsway is a holding company with operating subsidiaries located in the United States. The Company owns or controls subsidiaries primarily in the extended warranty, business services, asset management and real estate industries.
NOTE 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) | Principles of consolidation: |
The accompanying information in the 2021 Annual Report has been prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP").
The accompanying consolidated financial statements include the accounts of Kingsway and its majority owned and controlled subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.
In addition, the Company evaluates its relationships or investments for consolidation pursuant to authoritative accounting guidance related to the consolidation of a variable interest entity ("VIE") under the Variable Interest Model prescribed by the Financial Accounting Standards Board ("FASB").
The Company’s investments include certain investments, primarily in limited liability companies and limited partnerships in which the Company holds a variable interest. The Company evaluates these investments for the characteristics of a VIE. The Variable Interest Model identifies the characteristics of a VIE to include investments (1) lacking sufficient equity to finance activities without additional subordinated support or (2) in which the holders of equity at risk in the investments lack characteristics of a controlling financial interest, such as the power to direct activities that most significantly impact the legal entity’s economic performance; the obligation to absorb the legal entity’s expected losses; or the right to receive the expected residual returns of the legal entity. The equity investors as a group are considered to lack the power to direct activities that most significantly impact the legal entity’s economic performance when (1) the voting rights of some investors are not proportional to their obligations to absorb the expected losses of the legal entity or their rights to receive the expected residual returns of the legal entity and (2) substantially all of the activities of the legal entity are conducted on behalf of an investor with disproportionately few voting rights. When evaluating whether an investment lacks characteristics of a controlling financial interest, the Company considers limited liability companies and limited partnerships to lack the power of a controlling financial interest if neither of the following exists: (1) a simple majority or lower threshold of partners or members with equity at risk are able to exercise substantive kick-out rights through voting interest over the general partner(s) or managing member(s) or (2) limited partners with equity at risk are able to exercise substantive participating rights over the general partner(s) or managing member(s).
If the characteristics of a VIE are met, the Company evaluates whether it meets the primary beneficiary criteria. The primary beneficiary is considered to be the entity holding a variable interest that has the power to direct activities that most significantly impact the economic performance of the VIE; the obligation to absorb losses of the VIE; or the right to receive benefits from the VIE that could potentially be significant to the VIE. In instances where the Company is considered to be the primary beneficiary, the Company consolidates the VIE. When the Company is not considered to be the primary beneficiary of the VIE, the VIE is not consolidated and the Company uses the equity method to account for the investment. Under this method, the carrying value is generally the Company’s share of the net asset value of the unconsolidated entity, and changes in the Company’s share of the net asset value are recorded in net investment income.
Certain prior year amounts have been reclassified to conform to current year presentation. Such reclassifications had no impact on previously reported net income (loss) or total shareholders' equity.
Subsidiaries
The Company's consolidated financial statements include the assets, liabilities, shareholders' equity, revenues, expenses and cash flows of the holding company and its subsidiaries and have been prepared in accordance with U.S. GAAP. A subsidiary is an entity controlled, directly or indirectly, through ownership of more than 50% of the outstanding voting rights, or where the Company has the power to govern the financial and operating policies so as to obtain benefits from its activities. Assessment of control is based on the substance of the relationship between the Company and the entity and includes consideration of both existing voting rights and, if applicable, potential voting rights that are currently exercisable and convertible. The operating results of subsidiaries that have been disposed are included up to the date control ceased, and any difference between the fair value of the consideration received and the carrying value of a subsidiary that has been disposed is recognized in the consolidated statements of operations. All intercompany balances and transactions are eliminated in full.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
The consolidated financial statements are prepared as of December 31, 2021 based on individual company financial statements at the same date, or in the case of certain limited liability companies that are consolidated, on a three-month lag basis. Accounting policies of subsidiaries have been aligned where necessary to ensure consistency with those of Kingsway.
The Company's subsidiaries Argo Holdings Fund I, LLC ("Argo Holdings"), Flower Portfolio 001, LLC ("Flower") and Net Lease Investment Grade Portfolio LLC ("Net Lease") meet the definition of an investment company and follow the accounting and reporting guidance in Financial Accounting Standards Codification Topic 946, Financial Services-Investment Companies.
Noncontrolling interests
The Company has noncontrolling interests attributable to certain of its subsidiaries. A noncontrolling interest arises where the Company owns less than 100% of the voting rights and economic interests in a subsidiary. A noncontrolling interest is initially recognized at the proportionate share of the identifiable net assets of the subsidiary at the acquisition date and is subsequently adjusted for the noncontrolling interest's share of the acquiree's net income (loss) and changes in capital. The effects of transactions with noncontrolling interests are recorded in shareholders' equity where there is no change of control.
The preparation of consolidated financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts and classification 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 critical accounting estimates and assumptions in the accompanying consolidated financial statements include, but are not limited to, 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 acquisition costs; fair value assumptions for subordinated debt obligations; fair value assumptions for stock-based compensation liabilities; contingent consideration and revenue recognition.
(c) | Business combinations and asset acquisitions: |
The Company evaluates acquisitions in accordance with Accounting Standards Codification ("ASC") 805, Business Combinations ("ASC 805"), to determine if a transaction represents an acquisition of a business or an acquisition of assets. The results of acquired subsidiaries are included in the consolidated statements of operations from the date of acquisition.
An acquisition of a business represents a business combination. The acquisition method of accounting is used to account for a business combination. The cost of an acquired business is measured as the fair value of the assets received, equity instruments issued and liabilities incurred or assumed at the date of exchange. Identifiable assets acquired and liabilities and contingent liabilities assumed in a business combination are measured initially at their fair values at the acquisition date, irrespective of the extent of any noncontrolling interest. The excess of the cost of an acquired business over the fair value of the Company's share of the identifiable net assets acquired is recorded as goodwill. If the cost of acquired business is less than the fair value of the net assets of the subsidiary acquired, the difference is recognized in the consolidated statements of operations. Noncontrolling interests in the net assets of consolidated entities are reported separately in shareholders' equity and initially measured at fair value. Acquisition costs related to a business combination are expensed as incurred.
When an acquisition does not meet the definition of a business combination either because: (i) substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset, or group of similar identified assets, or (ii) the acquired entity does not have an input and a substantive process that together significantly contribute to the ability to create outputs, the Company accounts for the acquisition as an asset acquisition. In an asset acquisition, goodwill is not recognized. Any excess of the total purchase price plus transaction costs over the fair value of the net assets acquired is allocated on a relative fair value basis to the identifiable net assets at the acquisition date.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
Investments in fixed maturities are classified as available-for-sale and reported at fair value. Unrealized gains and losses are included in accumulated other comprehensive income, net of tax, until sold or until an other-than-temporary impairment is recognized, at which point cumulative unrealized gains or losses are reclassified to the consolidated statements of operations.
Equity investments include common stocks and warrants and are reported at fair value. Changes in fair value of equity investments are recognized in net income (loss).
Limited liability investments include investments in limited liability companies and limited partnerships in which the Company's interests are not deemed minor and, therefore, are accounted for under the equity method of accounting. The most recently available financial statements are used in applying the equity method. The difference between the end of the reporting period of the limited liability entities and that of the Company is no more than three months. Income or loss from limited liability investments is recognized based on the Company's share of the earnings of the limited liability entities and is included in net investment income.
Limited liability investments, at fair value are accounted for at fair value with changes in fair value included in gain on change in fair value of limited liability investments, at fair value. 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. Changes in carrying value are included in net change in unrealized loss on private company investments.
Real estate investments are reported at fair value.
Other investments include collateral loans and are reported at their unpaid principal balance, which approximates fair value.
Short-term investments, which consist of investments with original maturities between three months and one year, are reported at cost, which approximates fair value.
Realized gains and losses on sales, determined on a first-in first-out basis, are included in net realized gains.
Dividends and interest income are included in net investment income. Investment income is recorded as it accrues.
The Company accounts for all financial instruments using trade date accounting.
The Company conducts a quarterly review to identify and evaluate investments that show objective indications of possible impairment. Impairment is charged to the consolidated statements of operations if the fair value of an instrument falls below its cost/amortized cost and the decline is considered other-than-temporary. Factors considered in determining whether a loss is other-than-temporary include the length of time and extent to which fair value has been below cost; the financial condition and near-term prospects of the issuer; and the Company's ability and intent to hold investments for a period of time sufficient to allow for any anticipated recovery.
(e) | Cash and cash equivalents: |
Cash and cash equivalents include cash and investments with original maturities of no more than three months when purchased that are readily convertible into cash.
Restricted cash represents certain cash and cash equivalent balances restricted as to withdrawal or use. The Company's restricted cash is comprised primarily of cash held for the payment of vehicle service agreement claims under the terms of certain contractual agreements, funds held in escrow, statutory deposits and amounts pledged to third-parties as deposits or to collateralize liabilities.
(g) | Service fee receivable: |
Service fee receivable includes balances due and uncollected from customers. Service fee receivable is reported net of an estimated allowance for doubtful accounts. The allowance for doubtful accounts is determined based on periodic evaluations of aged receivables, historical business data, management’s experience and current economic conditions.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
(h) | Deferred acquisition costs, net: |
Deferred acquisition costs represent the deferral of expenses the Company's incurs related to successful efforts to acquire new business or renew existing business. Acquisition costs, which are incremental costs to obtain or fulfill a contract with a customer and primarily include commissions and expenses incurred directly related to the acquisition of vehicle service agreements, are deferred and amortized over the expected customer relationship period consistent with the pattern in which the related revenues are earned. Changes in estimates, if any, are recorded in the accounting period in which they are determined. Anticipated investment income is included in determining the realizable value of the deferred acquisition costs.
(i) | Property and equipment: |
Property and equipment are reported in the consolidated financial statements at cost. Depreciation of property and equipment has been provided using the straight-line method over the estimated useful lives of such assets. Repairs and maintenance are recognized in operations during the period incurred. Land is not depreciated. The Company estimates useful life to be forty to forty-five years for buildings; seven to fifty years for site and tenant improvements; five to ten years for leasehold improvements; three to ten years for furniture and equipment; and three to five years for computer hardware.
(j) | Goodwill and intangible assets: |
When the Company acquires a subsidiary or other business where it exerts significant influence, the fair value of the net tangible and intangible assets acquired is determined and compared to the amount paid for the subsidiary or business acquired. Any excess of the amount paid over the fair value of those net assets is considered to be goodwill.
Goodwill is tested for impairment annually as of November 30, or more frequently if events or circumstances indicate that the carrying value may not be recoverable, to ensure that its fair value is greater than or equal to the carrying value. Any excess of carrying value over fair value is charged to the consolidated statements of operations in the period in which the impairment is determined.
When the Company acquires a subsidiary or other business where it exerts significant influence or acquires certain assets, intangible assets may be acquired, which are recorded at their fair value at the time of the acquisition. An intangible asset with a definite useful life is amortized in the consolidated statements of operations over its estimated useful life. The Company writes down the value of an intangible asset with a definite useful life when the undiscounted cash flows are not expected to allow for full recovery of the carrying value.
Intangible assets with indefinite useful lives are not subject to amortization and are tested for impairment annually as of November 30, or more frequently if events or circumstances indicate that the carrying value may not be recoverable, to ensure that fair values are greater than or equal to carrying values. Any excess of carrying value over fair value is charged to the consolidated statements of operations in the period in which the impairment is determined.
During the second quarter of 2021, the Company entered into a pay fixed, receive variable interest rate swap contract to reduce its exposure to changes in interest rates. The interest rate swap contract is measured and reported at fair value and is included in accrued expenses and other liabilities in the consolidated balance sheets. The Company has not elected hedge accounting for the interest rate swap, therefore changes in fair value are recorded in current period earnings and are included in interest expense not allocated to segments in the consolidated statement of operations.
Bank loans and notes payable are reported in the consolidated balance sheets at par value adjusted for unamortized discount or premium and unamortized issuance costs. Discounts, premiums, and costs directly related to the issuance of debt are capitalized and amortized through the maturity date of the debt using the effective interest rate method and are recorded in interest expense not allocated to segments in the consolidated statements of operations. Gains and losses on the extinguishment of debt are recorded in gain (loss) on extinguishment of debt, net.
The Company's subordinated debt is measured and reported at fair value. 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. These inputs include credit spread assumptions developed by a third-party and market observable swap rates. The portion of the change in fair value of subordinated debt related to the instrument-specific credit risk is recognized in other comprehensive (loss) income.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
(m) | Contingent consideration: |
The consideration for certain of the Company's acquisitions include future payments to former owners that are contingent upon the achievement of certain targets over future reporting periods. Liabilities for contingent consideration are measured and reported at fair value at the date of acquisition and are included in accrued expenses and other liabilities in the consolidated balance sheets. Changes in the fair value of contingent consideration liabilities can result from changes to one or multiple inputs, including adjustments to the discount rates or changes in the assumed achievement or timing of any targets. These fair value measurements are based on significant inputs not observable in the market. Changes in assumptions could have an impact on the payout of contingent consideration liabilities. Changes in fair value are reported in the consolidated statements of operations as other (expense) income.
The Company follows the asset and liability method of accounting for income taxes, whereby deferred income tax assets and liabilities are recognized for (i) the differences between the financial statement carrying amount of existing assets and liabilities and their respective tax bases and (ii) loss and tax credit carryforwards. Deferred income tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the date of enactment. Future tax benefits are recognized to the extent that realization of such benefits is more likely than not and a valuation allowance is established for any portion of a deferred tax asset that management believes will not be realized. Current federal income taxes are charged or credited to operations based upon amounts estimated to be payable or recoverable as a result of taxable operations for the current year. The Company accounts for uncertain tax positions in accordance with the income tax accounting guidance. The Company recognizes interest and penalties, if any, related to unrecognized tax benefits in income tax benefit.
The Company records a right of use asset and lease liability for all leases in which the estimated term exceeds twelve months. The Company treats contracts as a lease when the contract: (1) conveys the right to use a physically distinct property or equipment asset for a period of time in exchange for consideration, (2) the Company directs the use of the asset and (3) the Company obtains substantially all the economic benefits of the asset. Right-of-use assets and lease liabilities are measured and recognized based on the present value of the future minimum lease payments over the lease term at the commencement date. As the Company’s leases are office leases, the Company is unable to determine an implicit rate; therefore, the Company uses its incremental borrowing rate based on the information available at the lease commencement date in determining the present value of future payments for those leases. The Company includes options to extend or terminate the lease in the measurement of the right-of-use asset and lease liability when it is reasonably certain that such options will be exercised. Lease expense for minimum lease payments is recognized on a straight-line basis over the lease term.
The Company determines lease classification at the commencement date. Leases not classified as sales-type (lessor) or financing leases (lessor and lessee) are classified as operating leases. The primary accounting criteria the Company uses that results in operating lease classification are: (a) the lease does not transfer ownership of the underlying asset to the lessee by the end of the lease term, (b) the lease does not grant the lessee a purchase option that the lessee is reasonably certain to exercise, (c) using a seventy-five percent or more threshold in addition to other qualitative factors, the lease term is not for a major part of the remaining economic life of the underlying asset, (d) using a ninety percent or more threshold in addition to other qualitative factors, the present value of the sum of the lease payments and residual value guarantee from the lessee, if any, does not equal or substantially exceed the fair value of the underlying asset.
As an accounting policy, the Company has elected not to apply the recognition requirements in ASC 842 to short-term leases (generally those with terms of twelve months or less). Instead, the Company recognizes the lease payments as expense on a straight-line basis over the lease term and any variable lease payments in the period in which the obligation for those payments is incurred.
Rental income from operating leases in which the Company is the lessor is recognized on a straight-line basis, based on contractual lease terms with fixed and determinable increases over the non-cancellable term of the related lease when collectability is reasonably assured. Rental income recognized in excess of amounts contractually due and collected pursuant to the underlying lease is recorded in other receivables in the consolidated balance sheets.
Rental expense for operating leases is recognized on a straight-line basis over the lease term, net of any applicable lease incentive amortization. Above-market lease assets and below-market lease liabilities recorded in connection with acquisitions are amortized on a straight-line basis over the remaining terms of the applicable leases, as determined at the acquisition date. Above-market lease assets are included in intangible assets on the consolidated balance sheets and below-market lease liabilities are included in accrued expenses and other liabilities in the consolidated balance sheets. Amortization of above-market and below-market lease liabilities is included as an adjustment to rental revenue in the consolidated statements of operations.
Service fee and commission revenue and deferred service fees
Service fee and commission revenue represents vehicle service agreement fees, guaranteed asset protection products ("GAP") commissions, maintenance support service fees, warranty product commissions, homebuilder warranty service fees, homebuilder warranty commissions and business services consulting revenue based on terms of various agreements with credit unions, consumers, businesses and homebuilders. Customers either pay in full at the inception of a warranty contract, commission product sale or when consulting services are billed, or on terms subject to the Company’s customary credit reviews.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
Vehicle service agreement fees include the fees collected to cover the costs of future automobile mechanical breakdown claims and the associated administration of those claims. Vehicle service agreement fees are earned over the duration of the vehicle service agreement contracts as the single performance obligation is satisfied. Vehicle service agreement fees are initially recorded as deferred service fees. The Company compares the remaining deferred service fees balance to the estimated amount of expected future claims under the vehicle service agreement contracts and records an additional accrual if the deferred service fees balance is less than expected future claims costs.
In certain jurisdictions the Company is required to refund to a customer a pro-rata share of the vehicle service agreement fees if a customer cancels the agreement prior to the end of the term. Depending on the jurisdiction, the Company may be entitled to deduct from the refund a cancellation fee and/or amounts for claims incurred prior to cancellation. While refunds vary depending on the term and type of product offered, historically refunds have averaged 9% to 13% of the original amount of the vehicle service agreement fee. Revenues recorded by the Company are net of variable consideration related to refunds and the associated refund liability is included in accrued expenses and other liabilities. The Company estimates refunds based on the actual historical refund rates by warranty type taking into consideration current observable refund trends in estimating the expected amount of future customer refunds to be paid at each reporting period.
GAP commissions include commissions from the sale of GAP products. The Company acts as an agent on behalf of the third-party insurance company that underwrites and guaranties these GAP contracts. The Company receives a single commission fee as its transaction price at the time it sells a GAP contract to a customer. Each GAP contract contains two separate performance obligations - sale of a GAP contract and GAP claims administration. The first performance obligation is related to the sale of a GAP contract and is satisfied upon closing the sale. The second performance obligation is related to the administration of claims during the GAP contract period. The amount of revenue the Company recognizes is based the costs to provide services during the GAP contract period, including an appropriate estimate of profit margin.
Maintenance support service fees include the service fees collected to administer equipment breakdown and maintenance support services and are earned as services are rendered.
Warranty product commissions include the commissions from the sale of warranty contracts for certain new and used heating, ventilation, air conditioning ("HVAC"), standby generator, commercial LED lighting and commercial refrigeration equipment. The Company acts as an agent on behalf of the third-party insurance companies that underwrite and guaranty these warranty contracts. The Company does not guaranty the performance underlying the warranty contracts it sells. Warranty product commissions are earned at the time of the warranty product sales.
Homebuilder warranty service fees include fees collected from the sale of warranties issued by new homebuilders. The Company receives a single warranty service fee as its transaction price at the time it enters into a written contract with each of its builder customers. Each contract contains two separate performance obligations - warranty administrative services and other warranty services. Warranty administrative services include enrolling each home sold by the builder into the program and the warranty administrative system and delivering the warranty product. Other warranty services include answering builder or homeowner questions regarding the home warranty and dispute resolution services.
Standalone selling prices are not directly observable in the contract for each of the separate home warranty performance obligations. As a result, the Company has applied the expected cost plus a margin approach to develop models to estimate the standalone selling price for each of its performance obligations in order to allocate the transaction price to the two separate performance obligations identified.
For the model related to the warranty administrative services performance obligation, the Company makes judgments about which of its actual costs are associated with enrolling each home sold by the builder into the program and the warranty administrative system and delivering the warranty product. For the model related to the other warranty services performance obligation, the Company makes judgments about which of its actual costs are associated with activities, such as answering builder or homeowner questions regarding the home warranty and dispute resolution services, which are performed over the life of the warranty coverage period. The relative percentage of expected costs plus a margin associated with the warranty administrative services performance obligation is applied to the transaction price to determine the estimated standalone selling price of the warranty administrative services performance obligation, which the Company recognizes as earned at the time the home is enrolled and the warranty product is delivered. The relative percentage of expected costs plus a margin associated with the other warranty services performance obligation is applied to the transaction price to determine the estimated standalone selling price of the other warranty services performance obligation, which the Company recognizes as earned as services are performed over the warranty coverage period.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
For the other warranty services performance obligation, the Company applies an input method of measurement, based on the expected costs plus a margin of providing services, to determine the transfer of its services over the warranty coverage period. The Company uses historical data regarding the number of calls it receives and activities performed, in addition to the number of homes enrolled, to estimate the number of complaints and dispute resolution requests to be received by year until coverage expires, which allows the Company to develop a revenue recognition pattern that it believes provides a faithful depiction of the transfer of services over time for the other warranty services performance obligation.
Homebuilder warranty commissions include commissions from the sale of warranty contracts for those builders who have requested and receive insurance backing of their warranty obligations. The Company acts as an agent on behalf of the third-party insurance company that underwrites and guaranties these warranty contracts. Homebuilder warranty commissions are earned on the certification date, which is typically the date of the closing of the sale of the home to the buyer. The Company also earns fees to manage remediation or repair services related to claims on insurance-backed warranty obligations, which are earned when the claims are closed.
Kingsway Search Xcelerator consulting revenue includes the revenue from providing outsourced finance and human resources consulting services. The Company invoices for business services consulting revenue based on contracted rates. Revenue is earned as services are provided.
(q) | Stock-based compensation: |
The Company uses the fair-value method of accounting for stock-based compensation awards granted to employees. Expense is recognized on a straight-line basis over the requisite service period during which awards are expected to vest, with a corresponding increase to either additional paid-in capital for equity-classified awards or to a liability for liability-classified awards. Liability-classified awards, included in accrued expenses and other liabilities in the consolidated balance sheets, are measured and reported at fair value on the date of grant and are remeasured each reporting period. Compensation expense related to the change in fair value for liability-classified awards is reported in the consolidated statements of operations as general and administrative expenses. For awards with a graded vesting schedule, expense is recognized on a straight-line basis over the requisite service period for each separately vesting portion of the award. For awards subject to a performance condition, expense is recognized when the performance condition has been satisfied or is probable of being satisfied. Forfeitures are recognized in the period that the award is forfeited.
(r) | Fair value of financial instruments: |
The fair values of the Company's investments in fixed maturities and equity investments, limited liability investments, at fair value, real estate investments, subordinated debt, warrant liability, stock-based compensation liabilities, derivative contracts and contingent consideration are estimated using a fair value hierarchy to categorize the inputs it uses in valuation techniques. Fair values for other investments approximate their unpaid principal balance. The carrying amounts reported in the consolidated balance sheets approximate fair values for cash and cash equivalents, restricted cash, short-term investments and certain other assets and other liabilities because of their short-term nature.
(s) | Holding company liquidity: |
The Company's Extended Warranty and Kingsway Search Xcelerator subsidiaries fund their obligations primarily through service fee and commission revenue. The Company's Leased Real Estate subsidiaries fund their 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; certain debt and associated interest; 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; distributions from the Company’s Extended Warranty subsidiaries, subject to certain restrictions; 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 is currently not 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. At December 31, 2021, Kingsway Amigo Insurance Company ("Amigo") was restricted from making any dividend payments to the holding company without regulatory approval pursuant to domiciliary state insurance regulations.
Historically, dividends from the Leased Real Estate segment were not generally considered a source of liquidity for the holding company, except upon the occurrence of certain events that would trigger payment of service fees. However, as more fully described in Note 25, "Commitments and Contingent Liabilities," 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, the Leased 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 12, "Debt," for further information about this borrowing.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
The holding company’s liquidity, defined as the amount of cash in the bank accounts of Kingsway Financial Services Inc. and Kingsway America Inc. ("KAI"), was $2.2 million (approximately five months of recurring operating cash outflows) and $1.1 million at December 31, 2021 and December 31, 2020, 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 $12.6 million and $14.4 million reported at December 31, 2021 and December 31, 2020, respectively, on the Company’s consolidated balance sheets.
As of December 31, 2021, 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") at a redemption value of $6.5 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 $18.7 million at December 31, 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 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 $6.5 million, as of December 31, 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 continues to explore the following opportunities: negotiating with the holders of the Preferred Shares with respect to 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.
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 the Company’s Extended Warranty segment. Consumer spending was initially impacted, including a decline in the purchase of new and used vehicles, and many businesses through which the Company distributes its products remained closed or were open but with capacity restraints. 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, the Company experienced an initial reduction in new enrollments in its 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 the COVID-19 pandemic, 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 2021 Annual Report. Actual results may differ materially from the Company’s current estimates as the scope of the COVID-19 pandemic evolves or if the duration of business disruptions is longer than initially anticipated.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
NOTE 3 RECENTLY ISSUED ACCOUNTING STANDARDS
| (a) | Adoption of New Accounting Standards: |
Effective January 1, 2021, the Company adopted Accounting Standards Update ("ASU") 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. ASU 2019-12 is intended to simplify accounting for income taxes by eliminating certain exceptions to the guidance in ASC Topic 740, Income Taxes, related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period, and the recognition of deferred tax liabilities for outside basis differences. ASU 2019-12 also simplifies aspects of the accounting for franchise taxes and enacted changes in tax laws or rates and clarifies the accounting for transactions that result in a step-up in the tax basis of goodwill. Further, ASU 2019-12 clarifies that single-member limited liability companies and similar disregarded entities that are not subject to income tax are not required to recognize an allocation of consolidated income tax expense in their separate financial statements, but they could elect to do so. The adoption of ASU 2019-12 did not have a material effect on the Company’s consolidated financial statements.
Effective January 1, 2021, the Company adopted ASU 2020-01, Investments-Equity Securities (Topic 321), Investments-Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815) - Clarifying the Interactions between Topic 321, Topic 323, and Topic 815. ASU 2020-01 clarifies the interaction between accounting standards related to equity securities (ASC 321), equity method investments (ASC 323), and certain derivatives (ASC815). The adoption of ASU 2020-01 did not have an impact on the Company's consolidated financial statements.
Effective October 1, 2021, the Company early adopted ASU 2021-08, Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers ("ASU 2021-08"). ASU 2021-08 requires that an entity (acquirer) recognize and measure contract assets and contract liabilities acquired in a business combination in accordance with ASU 2014-09, Revenue from Contracts with Customers ("Topic 606"). Under the new guidance, at the acquisition date, an acquirer should account for the related revenue contracts in accordance with Topic 606 as if it had originated the contracts. Generally, this should result in an acquirer recognizing and measuring the acquired contract assets and contract liabilities consistent with how they were recognized and measured in the acquiree’s financial statements. Under current GAAP, an acquirer generally recognizes assets acquired and liabilities assumed in a business combination, including contract assets and contract liabilities arising from revenue contracts with customers, at fair value on the acquisition date. The Company will apply this guidance prospectively to all business combinations that occur on or after October 1, 2021. The adoption of ASU 2021-08 did not have an impact on the Company's consolidated financial statements.
| (b) | Accounting Standards Not Yet Adopted: |
In June 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments ("ASU 2016-13"). ASU 2016-13 replaces the current incurred loss model used to measure impairment losses with an expected loss model for trade, reinsurance, and other receivables as well as financial instruments measured at amortized cost. ASU 2016-13 will require a financial asset measured at amortized cost, including reinsurance balances recoverable, to be presented at the net amount expected to be collected by means of an allowance for credit losses that runs through net income (loss). Credit losses relating to available-for-sale debt securities will also be recorded through an allowance for credit losses. However, the amendments would limit the amount of the allowance to the amount by which fair value is below amortized cost. The measurement of credit losses on available-for-sale investments is similar under current GAAP, but the update requires the use of the allowance account through which amounts can be reversed, rather than through irreversible write-downs. On November 15, 2019, the FASB issued ASU 2019-10, which (1) provides a framework to stagger effective dates for future major accounting standards and (2) amends the effective dates for certain major new accounting standards to give implementation relief to certain types of entities. Specifically, per ASU 2019-10 the Company would adopt ASU 2016-13 beginning January 1, 2023, as the Company is a smaller reporting company. The Company is currently evaluating ASU 2016-13 to determine the potential impact that adopting this standard will have on its consolidated financial statements.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
In May 2021, the FASB issued ASU 2021-04, Earnings Per Share (Topic 260), Debt—Modifications and Extinguishments (Subtopic 470-50), Compensation—Stock Compensation (Topic 718), and Derivatives and Hedging—Contracts in Entity’s Own Equity (Subtopic 815-40): Issuer’s Accounting for Certain Modifications or Exchanges of Freestanding Equity-Classified Written Call Options (a consensus of the FASB Emerging Issues Task Force) ("ASU 2021-04"). ASU 2021-04 clarifies and reduces diversity in an issuer’s accounting for modifications or exchanges of freestanding equity-classified written call options (for example, warrants) that remain equity classified after modification or exchange. ASU 2021-04 provides guidance that will clarify whether an issuer should account for a modification or an exchange of a freestanding equity-classified written call option that remains equity classified after modification or exchange as (1) an adjustment to equity and, if so, the related earnings per share (EPS) effects, if any, or (2) an expense and, if so, the manner and pattern of recognition. The new guidance is effective for annual and interim periods beginning after December 15, 2021, and early adoption is permitted, including adoption in an interim period. The Company notes that ASU 2021-04 only applies to modifications or exchanges of freestanding equity-classified written call options, which historically the Company has not done.
In August 2021, the FASB issued ASU 2021-06, Presentation of Financial Statements (Topic 205), Financial Services—Depository and Lending (Topic 942), and Financial Services—Investment Companies (Topic 946): Amendments to SEC Paragraphs Pursuant to SEC Final Rule Releases No. 33-10786, Amendments to Financial Disclosures about Acquired and Disposed Businesses, and No. 33-10835, Update of Statistical Disclosures for Bank and Savings and Loan Registrants. This ASU incorporates recent SEC rule changes into the FASB Codification, including SEC Final Rule Releases No. 33-10786, Amendments to Financial Disclosures about Acquired and Disposed Businesses, and No. 33-10835, Update of Statistical Disclosures for Bank and Savings and Loan Registrants ("ASU 2021-06"). ASU 2021-06 amends the SEC sections of the Codification related to SEC Final Rule Releases No. 33-10786, Amendments to Financial Disclosures about Acquired and Disposed Businesses, and No. 33-10835, Update of Statistical Disclosures for Bank and Savings and Loan Registrants. The new guidance is effective upon its addition to the FASB codification. The Company is assessing the impact of ASU 2021-06 and its impact on its disclosure.
NOTE 4 ACQUISITIONS
| (a) | Business Combinations |
During the years ended December 31, 2021 and December 31, 2020, the Company incurred acquisition expenses related to business combinations of $0.4 million and $0.4 million, respectively, which are included in general and administrative expenses in the consolidated statements of operations.
PWI Holdings, Inc.
On December 1, 2020, the Company acquired 100% of the outstanding shares of PWI Holdings, Inc. for cash consideration of $24.4 million. The final purchase price was subject to a working capital true-up that was finalized during the first quarter of 2021 of $0.1 million. PWI Holdings, Inc., through its subsidiaries Preferred Warranties, Inc., Superior Warranties, Inc., Preferred Warranties of Florida, Inc., and Preferred Nationwide Reinsurance Company, Ltd. (collectively, "PWI"), markets, sells and administers vehicle service agreements in all fifty states, primarily through a network of automobile dealer partners. As further discussed inNote 22, "Segmented Information," PWI is included in the Extended Warranty segment. This acquisition allows the Company to grow its portfolio of warranty companies and further expand into the vehicle service agreement business.
This acquisition was accounted for as a business combination using the acquisition method of accounting. The purchase price was provisionally allocated to the assets acquired and liabilities assumed based upon their estimated fair values at the date of acquisition and were subject to adjustment during a measurement period subsequent to the acquisition date, not to exceed one-year as permitted under U.S. GAAP. During the third quarter of 2021, the Company finalized its fair value analysis of the assets acquired and liabilities assumed with the assistance of a third-party.
The Company records measurement period adjustments in the period in which the adjustments occur. During the third quarter of 2021, the Company recorded a cumulative net measurement period adjustment that decreased goodwill by $18.8 million compared to the amount recorded at December 31, 2020. The measurement period adjustments reflect changes in the estimated fair values of certain assets and liabilities, and the working capital true-up, as follows:
| | • | $19.6 million of separately identifiable intangible assets were recognized resulting from acquired customer relationships ($15.0 million) and trade name ($4.6 million); |
| | • | A $3.6 million decrease to deferred service fees; |
| | • | Deferred income tax liabilities of $4.2 million were recognized, primarily related to the measurement period adjustments for intangible assets and deferred service fees; |
| | • | An increase to accrued expenses and other liabilities of $0.1 million; and |
| | • | An increase to the final purchase price of $0.1 million related to the working capital true-up. |
The measurement period adjustment related to the customer relationships intangible asset also resulted in an increase in amortization expense and accumulated amortization of $1.9 million that was recorded during the third quarter of 2021, of which:
| | • | $0.6 million relates to the three months ended September 30, 2021; |
| | • | $0.6 million relates to the three months ended June 30, 2021; |
| | • | $0.6 million relates to the three months ended March 31, 2021; and |
| | • | $0.1 million relates to the year ended December 31, 2020. |
The measurement period adjustment related to deferred service fees also resulted in a decrease service fee and commission revenue of $1.9 million that was recorded during the third quarter of 2021, of which:
| | • | $0.4 million relates to the three months ended September 30, 2021; |
| | • | $0.5 million relates to the three months ended June 30, 2021; |
| | • | $0.7 million relates to the three months ended March 31, 2021; and |
| | • | $0.3 million relates to the year ended December 31, 2020. |
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
The Company notes that had ASU 2021-08 (see Note 3, "Recently Issued Accounting Standards") been applicable to the PWI acquisition, the Company would not have recorded the $3.6 million reduction to deferred service fees and would not have recorded the $1.9 million reduction to service fee and commission revenue during the third quarter of 2021.
Refer toNote 9, "Intangible Assets," for further disclosure of the intangible assets related to this acquisition. The goodwill of $20.2 million represents the premium paid over the fair value of the net tangible and intangible assets acquired, which the Company paid to grow its portfolio of warranty companies and acquire an assembled workforce. The goodwill is not deductible for tax purposes.
The following table summarizes the finalized allocation recorded during the third quarter of 2021 of the PWI assets acquired and liabilities assumed at the date of acquisition:
| (in thousands) | | | | |
| | | December 1, 2020 | |
| Cash and cash equivalents | | $ | 90 | |
| Restricted cash | | | 21,578 | |
| Service fee receivable | | | 1,459 | |
| Other receivables | | | 2,748 | |
| Income taxes recoverable | | | 60 | |
| Property and equipment, net | | | 175 | |
| Right-of-use asset | | | 254 | |
| Goodwill | | | 20,238 | |
| Intangible asset subject to amortization - customer relationships | | | 15,000 | |
| Intangible asset subject to amortization - trade name | | | 4,550 | |
| Other assets | | | 1,321 | |
| Total assets | | $ | 67,473 | |
| | | | | |
| Accrued expenses and other liabilities | | $ | 8,165 | |
| Lease liability | | | 255 | |
| Net deferred income tax liabilities | | | 4,229 | |
| Deferred service fees | | | 30,400 | |
| Total liabilities | | $ | 43,049 | |
| | | | | |
| Purchase price | | $ | 24,424 | |
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
Ravix Financial, Inc.
On October 1, 2021, the Company acquired 100% of the outstanding equity interests of Ravix Financial, Inc. ("Ravix"). Ravix, based in San Jose, California, provides outsourced financial services and human resources consulting for short or long duration engagements. As further discussed in Note 22, "Segmented Information," Ravix is included in the Kingsway Seach Xcelerator segment, which was created as a result of the Ravix acquisition. This acquisition was the Company’s first acquisition under its novel CEO Accelerator program and further expands the Company’s portfolio of businesses with recurring revenue and low capital intensity.
The Company acquired Ravix for aggregate cash consideration of approximately $10.9 million, less certain escrowed amounts for purposes of indemnification claims. The final purchase price is subject to a working capital true-up of $0.1 million that will be settled during the first quarter of 2022. The Company will also pay additional contingent consideration, only to the extent earned, in an aggregate amount of up to $4.5 million, which is subject to certain conditions, including the successful achievement of gross profit for Ravix during the three-year period commencing on the first full calendar month following the acquisition date.
This acquisition was accounted for as a business combination using the acquisition method of accounting. The purchase price was provisionally allocated to the assets acquired and liabilities assumed based on their estimated fair values at the date of acquisition and are subject to adjustment during a measurement period subsequent to the acquisition date, not to exceed one-year as permitted under U.S. GAAP. The Company expects to complete its purchase price allocation in early 2022. These estimates, allocations and calculations are subject to change as we obtain further information; therefore, the final fair values of the assets acquired and liabilities assumed could change from the estimates included in these consolidated financial statements.
Refer to Note 9, "Intangible Assets," for further disclosure of the intangible assets related to this acquisition. The goodwill of $7.9 million represents the premium paid over the fair value of the net tangible and intangible assets acquired, which the Company paid to grow its portfolio of companies and acquire an assembled workforce. The goodwill is not deductible for tax purposes. The estimated fair value of the contingent consideration obligation at the acquisition date of $2.2 million was determined using a Monte Carlo simulation based on forecasted future results, and is recorded in accrued expenses and other liabilities on the consolidated balance sheets. See Note 23, "Fair Value of Financial Instruments," for further discussion related to the contingent consideration.
The following table summarizes the purchase price of Ravix:
| (in thousands) | | | | |
| Purchase price: | | October 1, 2021 | |
| Cash paid at closing | | $ | 10,930 | |
| Working capital adjustment | | | 83 | |
| Contingent consideration | | | 2,195 | |
| Total purchase price | | $ | 13,208 | |
The following table summarizes the preliminary estimated allocation of the Ravix assets acquired and liabilities assumed at the date of acquisition:
| (in thousands) | | |
| | October 1, 2021 |
| Cash and cash equivalents | $ | 225 |
| Restricted cash | | 752 |
| Service fee receivable | | 1,031 |
| Other receivables | | 17 |
| Right-of-use asset | | 116 |
| Goodwill | | 7,905 |
| Intangible asset subject to amortization - customer relationships | | 4,000 |
| Intangible asset not subject to amortization - trade name | | 2,500 |
| Other assets | | 133 |
| Total assets | $ | 16,679 |
| | | |
| Accrued expenses and other liabilities | $ | 1,546 |
| Income taxes payable | | 13 |
| Lease liability | | 116 |
| Net deferred income tax liabilities | | 1,796 |
| Total liabilities | $ | 3,471 |
| | | |
| Purchase price | $ | 13,208 |
The consolidated statements of operations include the earnings of Ravix from the date of acquisition. From the date of acquisition through December 31, 2021, Ravix earned revenue of $3.5 million and net loss of $0.2 million.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
Unaudited Pro Forma Summary
The following unaudited pro forma summary presents the Company's consolidated financial statements for the year ended December 31, 2021 and December 31, 2020 as if Ravix and PWI had been acquired on January 1 of the year prior to the acquisitions. The pro forma summary is presented for illustrative purposes only and does not purport to represent the results of our operations that would have actually occurred had the acquisitions occurred as of the beginning of the period presented or project our results of operations as of any future date or for any future period, as applicable. The pro forma results primarily include purchase accounting adjustments related to the acquisition of Ravix, interest expense and the amortization of debt issuance costs and discount associated with the related financing obtained in connection with the Ravix and PWI acquisitions (see Note 12, "Debt"), tax related adjustments and acquisition-related expenses. Purchase accounting adjustments related to the acquisition of PWI were not included in the pro forma information below for the year ended December 31, 2020 since the fair value analysis of the assets acquired and liabilities assumed was not finalized until the third quarter of 2021.
| (in thousands, except per share data) | | Years ended December 31, |
| | | 2021 | | 2020 |
| Revenues | | $ 101,662 | | $ 100,458 |
| Loss from continuing operations attributable to common shareholders | | $ (770) | | $ (3,554) |
| Basic loss per share - continuing operations | | $ (0.03) | | $ (0.16) |
| Diluted loss per share - continuing operations | | $ (0.03) | | $ (0.16) |
RoeCo Lafayette, LLC
On December 30, 2021, the Company acquired 100% of the outstanding membership interests of RoeCo Lafayette, LLC ("RoeCo") from a current holder of the Company’s Preferred Shares, for cash consideration of approximately $2.4 million. Refer toNote 24, "Related Parties," for further disclosure. RoeCo 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 Louisiana (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 in the principal amount of $13.5 million (the "RoeCo Mortgage") at the date of acquisition plus a premium of $3.5 million. As further discussed in Note 22, "Segmented Information" RoeCo is included in the Leased Real Estate segment.
This transaction was accounted for as an asset acquisition as substantially all the fair value of the gross assets acquired is concentrated in a single asset comprised of land, building and improvements. The total purchase price, including the transaction costs, has been allocated to the individual net assets acquired based on their relative fair values. In connection with the acquisition, the Company recorded an above-market lease intangible asset of $0.8 million and in-place and other lease intangible assets of $2.1 million. Refer to Note 9, "Intangible Assets," for further disclosure of the intangible assets related to this acquisition.
The following table summarizes the allocation of the purchase price to the net assets of RoeCo at the date of acquisition:
| (in thousands) | | | | |
| Purchase price: | | December 30, 2021 | |
| Cash | | $ | 2,386 | |
| Acquisition costs | | | 249 | |
| Liabilities assumed | | | 16,983 | |
| Total purchase price | | $ | 19,618 | |
| | | | | |
| Fair value of net assets acquired: | | December 30, 2021 | |
| Cash and cash equivalents | | $ | 365 | |
| Other receivables | | | 133 | |
| Property and equipment, net | | | 16,466 | |
| Intangible asset subject to amortization - Above-market lease | | | 835 | |
| Intangible asset subject to amortization - In-place and other lease assets | | | 2,114 | |
| Accrued expenses and other liabilities | | | (50 | ) |
| Net deferred income tax liabilities | | | (245 | ) |
| Total fair value of net assets acquired | | $ | 19,618 | |
Since RoeCo was acquired on December 30, 2021, the consolidated statement of operations does not include any revenue or earnings of RoeCo, as such items are immaterial.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
NOTE 5 VARIABLE INTEREST ENTITIES
Argo Holdings Fund I, LLC
The Company held a 43.4% investment in Argo Holdings at December 31, 2021 and December 31, 2020. Argo Holdings makes investments, primarily in established lower middle market companies based in North America, through investments in search funds. The managing member of Argo Holdings is Argo Management Group, LLC ("Argo Management"), a wholly owned subsidiary of the Company. Argo Holdings is considered to be a VIE as the members holding equity at risk lack characteristics of a controlling financial interest. The Company holds a variable interest in Argo Holdings due to its right to absorb significant economics in Argo Holdings and through its controlling interest in Argo Management, through which the Company holds the power to direct the significant activities of Argo Holdings. As such, the Company was the primary beneficiary of Argo Holdings and consolidated Argo Holdings at December 31, 2021 and December 31, 2020.
Net Lease Investment Grade Portfolio, LLC
The Company held a 71.0% investment in Net Lease at December 31, 2021 and December 31, 2020. Net Lease holds one commercial property under a triple net lease as of December 31, 2021 (three commercials properties held as of December 31, 2020). The current property is encumbered by a mortgage loan. Net Lease is considered to be a VIE as the members holding equity at risk lack characteristics of a controlling financial interest. The Company holds a variable interest in Net Lease due to its right to absorb significant economics in Net Lease and to control the management decisions of Net Lease, which allows the Company to hold the power to direct the significant activities of Net Lease. As such, the Company is the primary beneficiary of Net Lease and consolidated Net Lease at December 31, 2021 and December 31, 2020.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
The following table summarizes the assets and liabilities related to VIEs consolidated by the Company at December 31, 2021 and December 31, 2020:
| (in thousands) | | December 31, | |
| | | 2021 | | | 2020 | |
| Assets | | | | | | | | |
| Limited liability investments, at fair value | | $ | 18,826 | | | $ | 32,811 | |
| Cash and cash equivalents | | | 944 | | | | 538 | |
| Accrued investment income | | | 716 | | | | 454 | |
| Total Assets | | | 20,486 | | | | 33,803 | |
| Liabilities | | | | | | | | |
| Accrued expenses and other liabilities | | | 250 | | | | 352 | |
| Notes payable | | | — | | | | 9,000 | |
| Total Liabilities | | $ | 250 | | | $ | 9,352 | |
No arrangements exist requiring the Company to provide additional funding to the consolidated VIEs in excess of the Company’s unfunded commitments to its consolidated VIEs. At December 31, 2021 and December 31, 2020, the Company had no unfunded commitments. There are no restrictions on assets consolidated by these VIEs. There are no structured settlements of liabilities consolidated by these VIEs. Creditors have no recourse to the general credit of the Company as the primary beneficiary of these VIEs.
| (b) | Non-Consolidated VIEs |
The Company’s investments include certain non-consolidated investments, primarily in limited liability companies and limited partnerships in which the Company holds variable interests, that are considered VIEs due to the legal entities holding insufficient equity; the holders of equity at risk in the legal entities lacking controlling financial interests; and/or the holders of equity at risk having non-proportional voting rights.
The Company’s risk of loss associated with its non-consolidated VIEs is limited and depends on the investment. Limited liability investments accounted for under the equity method are limited to the Company’s initial investments. At December 31, 2021 and December 31, 2020, the Company had no unfunded commitments to its non-consolidated VIEs.
The following table summarizes the carrying value and maximum loss exposure of the Company’s non-consolidated VIEs at December 31, 2021 and December 31, 2020:
| (in thousands) | | December 31, | |
| | | 2021 | | | 2020 | |
| | | | | | | Maximum Loss | | | | | | | Maximum Loss | |
| | | Carrying Value | | | Exposure | | | Carrying Value | | | Exposure | |
| Investments in non-consolidated VIEs | | $ | 1,514 | | | $ | 1,514 | | | $ | 2,940 | | | $ | 2,940 | |
The following table summarizes the Company’s non-consolidated VIEs by category at December 31, 2021 and December 31, 2020:
| (in thousands) | | December 31, | |
| | | 2021 | | | 2020 | |
| | | Carrying | | | | | | | Carrying | | | | | |
| | | Value | | | Percent of total | | | Value | | | Percent of total | |
| Investments in non-consolidated VIEs: | | | | | | | | | | | | | | | | |
| Real estate related | | $ | 628 | | | | 41.5 | % | | $ | 1,610 | | | | 54.8 | % |
| Non-real estate related | | | 886 | | | | 58.5 | % | | | 1,330 | | | | 45.2 | % |
| Total investments in non-consolidated VIEs | | $ | 1,514 | | | | 100.0 | % | | $ | 2,940 | | | | 100.0 | % |
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
The following table presents aggregated summarized financial information of the Company’s non-consolidated VIEs at December 31, 2021 and December 31, 2020. For certain of the non-consolidated VIEs, the financial information is presented on a lag basis, consistent with how the changes in the Company’s share of the net asset values of these equity method investees are recorded in net investment income. The difference between the end of the reporting period of an equity method investee and that of the Company is typically no more than three months.
| (in thousands) | | December 31, | |
| | | 2021 | | | 2020 | |
| Assets | | $ | 283,432 | | | $ | 325,215 | |
| Liabilities | | $ | 299,340 | | | $ | 307,464 | |
| Equity | | $ | (15,908 | ) | | $ | 17,751 | |
| (in thousands) | | December 31, | |
| | | 2021 | | | 2020 | |
| Net income | | $ | 18,647 | | | $ | 27,419 | |
NOTE 6 INVESTMENTS
PWI, which was acquired by the Company in December 2020, began investing a substantial portion of its restricted cash during 2021. Previously, PWI had not held a substantial amount of investments.
The amortized cost, gross unrealized gains and losses, and estimated fair value of the Company's available-for-sale investments at December 31, 2021 and December 31, 2020 are summarized in the tables shown below:
| (in thousands) | | December 31, 2021 | |
| | | | | | | Gross | | | Gross | | | | | |
| | | Amortized | | | Unrealized | | | Unrealized | | | Estimated Fair | |
| | | Cost | | | Gains | | | Losses | | | Value | |
| Fixed maturities: | | | | | | | | | | | | | | | | |
| U.S. government, government agencies and authorities | | $ | 16,276 | | | $ | 31 | | | $ | 84 | | | $ | 16,223 | |
| States, municipalities and political subdivisions | | | 1,880 | | | | 3 | | | | 5 | | | | 1,878 | |
| Mortgage-backed | | | 7,679 | | | | 18 | | | | 68 | | | | 7,629 | |
| Asset-backed | | | 449 | | | | — | | | | 4 | | | | 445 | |
| Corporate | | | 9,605 | | | | 15 | | | | 129 | | | | 9,491 | |
| Total fixed maturities | | $ | 35,889 | | | $ | 67 | | | $ | 290 | | | $ | 35,666 | |
| (in thousands) | | December 31, 2020 | |
| | | | | | | Gross | | | Gross | | | | | |
| | | Amortized | | | Unrealized | | | Unrealized | | | Estimated Fair | |
| | | Cost | | | Gains | | | Losses | | | Value | |
| Fixed maturities: | | | | | | | | | | | | | | | | |
| U.S. government, government agencies and authorities | | $ | 9,999 | | | $ | 105 | | | $ | — | | | $ | 10,104 | |
| States, municipalities and political subdivisions | | | 1,447 | | | | 7 | | | | — | | | | 1,454 | |
| Mortgage-backed | | | 5,334 | | | | 66 | | | | 6 | | | | 5,394 | |
| Corporate | | | 3,708 | | | | 56 | | | | — | | | | 3,764 | |
| Total fixed maturities | | $ | 20,488 | | | $ | 234 | | | $ | 6 | | | $ | 20,716 | |
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
The table below summarizes the Company's fixed maturities at December 31, 2021 by contractual maturity periods. Actual results may differ as issuers may have the right to call or prepay obligations, with or without penalties, prior to the contractual maturity of these obligations.
| (in thousands) | | December 31, 2021 | |
| | | | | | | Estimated Fair | |
| | | Amortized Cost | | | Value | |
| Due in one year or less | | $ | 8,424 | | | $ | 8,450 | |
| Due after one year through five years | | | 22,371 | | | | 22,174 | |
| Due after five years through ten years | | | 1,831 | | | | 1,823 | |
| Due after ten years | | | 3,263 | | | | 3,219 | |
| Total | | $ | 35,889 | | | $ | 35,666 | |
The following tables highlight the aggregate unrealized loss position, by security type, of available-for-sale investments in unrealized loss positions as of December 31, 2021 and December 31, 2020. The tables segregate the holdings based on the period of time the investments have been continuously held in unrealized loss positions.
| (in thousands) | | | | | | | | | | | | | | | | | | December 31, 2021 | |
| | | Less than 12 Months | | | Greater than 12 Months | | | Total | |
| | | Estimated | | | Unrealized | | | Estimated | | | Unrealized | | | Estimated | | | Unrealized | |
| | | Fair Value | | | Loss | | | Fair Value | | | Loss | | | Fair Value | | | Loss | |
| Fixed maturities: | | | | | | | | | | | | | | | | | | | | | | | | |
| U.S. government, government agencies and authorities | | $ | 12,077 | | | $ | 84 | | | $ | — | | | $ | — | | | $ | 12,077 | | | $ | 84 | |
| States, municipalities and political subdivisions | | | 846 | | | | 5 | | | | — | | | | — | | | | 846 | | | | 5 | |
| Mortgage-backed | | | 5,388 | | | | 68 | | | | — | | | | — | | | | 5,388 | | | | 68 | |
| Asset-backed | | | 445 | | | | 4 | | | | — | | | | — | | | | 445 | | | | 4 | |
| Corporate | | | 7,542 | | | | 129 | | | | — | | | | — | | | | 7,542 | | | | 129 | |
| Total fixed maturities | | $ | 26,298 | | | $ | 290 | | | $ | — | | | $ | — | | | $ | 26,298 | | | $ | 290 | |
| (in thousands) | | | | | | | | | | | | | | | | | | December 31, 2020 | |
| | | Less than 12 Months | | | Greater than 12 Months | | | Total | |
| | | Estimated | | | Unrealized | | | Estimated | | | Unrealized | | | Estimated | | | Unrealized | |
| | | Fair Value | | | Loss | | | Fair Value | | | Loss | | | Fair Value | | | Loss | |
| Fixed maturities: | | | | | | | | | | | | | | | | | | | | | | | | |
| U.S. government, government agencies and authorities | | $ | 511 | | | $ | — | | | $ | — | | | $ | — | | | $ | 511 | | | $ | — | |
| Mortgage-backed | | | 834 | | | | 6 | | | | — | | | | — | | | | 834 | | | | 6 | |
| Total fixed maturities | | $ | 1,345 | | | $ | 6 | | | $ | — | | | $ | — | | | $ | 1,345 | | | $ | 6 | |
There are approximately 138 and 5 individual available-for-sale investments that were in unrealized loss positions as of December 31, 2021 and December 31, 2020, respectively.
The establishment of an other-than-temporary impairment on an investment requires a number of judgments and estimates. The Company performs a quarterly analysis of the individual investments to determine if declines in market value are other-than-temporary. Refer to "Significant Accounting Policies and Critical Estimates" section of Management's Discussion & Analysis for further information regarding the Company's detailed analysis and factors considered in establishing an other-than-temporary impairment on an investment.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
As a result of the analysis performed by the Company to determine declines in market value that are other-than-temporary, the Company recorded write downs for other-than-temporary impairment related to other investments of zero and $0.1 million for the years ended December 31, 2021 and December 31, 2020, respectively. There were no write-downs recorded for other-than-temporary impairments related to available-for sale investments or limited liability investments for the years ended December 31, 2021 and December 31, 2020.
The Company has reviewed currently available information regarding investments with estimated fair values less than their carrying amounts and believes these unrealized losses are not other-than-temporary and are primarily due to temporary market and sector-related factors rather than to issuer-specific factors. The Company does not intend to sell those investments, and it is not likely it will be required to sell those investments before recovery of its amortized cost.
The Company does not have any exposure to subprime mortgage-backed investments.
As of December 31, 2021 and December 31, 2020, the carrying value of limited liability investments totaled $1.9 million and $3.7 million, respectively. At December 31, 2021, the Company has no unfunded commitments related to limited liability investments. The decrease in the carrying value is primarily attributable to the sale of three limited liability company investments during 2021.
Limited liability investments, at fair value represents the underlying investments of Net Lease and Argo Holdings. As of December 31, 2021 and December 31, 2020, the carrying value of the Company's limited liability investments, at fair value was $18.8 million and $32.8 million, respectively. The decrease in the carrying value is primarily attributable to the sale of two of Net Lease's investment properties during 2021, as further discussed below. The Company recorded impairments related to limited liability investments, at fair value of $0.1 million and $0.1 million for the years ended December 31, 2021 and December 31, 2020, respectively, which are included in gain on change in fair value of limited liability investments, at fair value in the consolidated statements of operations. At December 31, 2021, the Company has no unfunded commitments related to limited liability investments, at fair value.
The Company consolidates the financial statements of Net Lease on a three-month lag. Net Lease owns investments in limited liability companies that hold investment properties. During 2021, one of Net Lease’s limited liability companies sold their investment property for $14.3 million. A portion of the proceeds from the sale were distributed to Net Lease. As a result of the distribution, Net Lease recorded a gain of $0.8 million related to its investment in the limited liability company, with an offsetting change in unrealized gain of $0.8 million, which collectively are included in net investment income in the consolidated statement of operations for the year ended December 31, 2021. During the fourth quarter of 2020, one of Net Lease's limited liability companies sold their investment property. As a result of the three-month lag, the Company recorded this transaction in its first quarter 2021 financial statements. A portion of the proceeds from the sale were distributed to Net Lease who used them primarily to repay their $9.0 million mezzanine loan. As a result of the distribution, Net Lease recorded a gain of $1.2 million related to its investment in the limited liability company, with an offsetting change in unrealized gain of $1.2 million, which collectively are included in net investment income in the consolidated statement of operations for the for the year ended December 31, 2021.
As of December 31, 2021 and December 31, 2020, the carrying value of the Company's investments in private companies totaled $0.8 million. For the years ended December 31, 2021 and December 31, 2020, the Company did not record any adjustments to the fair value of its investments in private companies for observable price changes.
The Company performs a quarterly impairment analysis of its investments in private companies. As a result of the analysis performed, the Company recorded impairments related to investments in private companies of zero and $0.7 million for the years ended December 31, 2021 and December 31, 2020, respectively, which are included in net change in unrealized loss on private company investments in the consolidated statements of operations. The impairments recorded for the year ended December 31, 2020 are a result of the impact of the COVID-19 pandemic on the investments' underlying business.
The Company previously had issued promissory notes (the "Notes") to five former employees (the "Debtors"), which were recorded as other investments in the consolidated balance sheets prior to December 31, 2020. During the third and fourth quarters of 2020, the Company agreed to accept partial payment from the Debtors as full satisfaction of the Debtors' obligations under the Notes and recognized a loss of $0.2 million for the year ended December 31, 2020, which is included in net realized gains in the consolidated statements of operations. During the year ended December 31, 2020, the Company recorded a write-down of $0.1 million for other-than-temporary impairment related to the Notes for one of the Debtors. The remaining principal amount outstanding on the Notes was zero as of December 31, 2021 and December 31, 2020.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
Net investment income for the years ended December 31, 2021 and December 31, 2020, respectively, is comprised as follows:
| (in thousands) | | Years ended December 31, | |
| | | 2021 | | | 2020 | |
| Investment income | | | | | | | | |
| Interest from fixed maturities | | $ | 242 | | | $ | 310 | |
| Dividends | | | 125 | | | | 153 | |
| Income from limited liability investments | | | 27 | | | | 30 | |
| Income from limited liability investments, at fair value | | | 106 | | | | 937 | |
| Income from real estate investments | | | 800 | | | | 800 | |
| Other | | | 364 | | | | 461 | |
| Gross investment income | | | 1,664 | | | | 2,691 | |
| Investment expenses | | | (89 | ) | | | (66 | ) |
| Net investment income | | $ | 1,575 | | | $ | 2,625 | |
Gross realized gains and losses on available-for-sale investments, limited liability investments, limited liability investments, at fair value and investments in private companies for the years ended December 31, 2021 and December 31, 2020 is comprised as follows:
| (in thousands) | | Years ended December 31, | |
| | | 2021 | | | 2020 | |
| Gross realized gains | | $ | 1,917 | | | $ | 806 | |
| Gross realized losses | | | (108 | ) | | | (226 | ) |
| Net realized gains | | $ | 1,809 | | | $ | 580 | |
(Loss) gain on change in fair value of equity investments for the years ended December 31, 2021 and December 31, 2020 is comprised as follows:
| (in thousands) | | Years ended December 31, | |
| | | 2021 | | | 2020 | |
| Net gain recognized on equity investments sold during the period | | $ | 13 | | | $ | 1,506 | |
| Change in unrealized losses on equity investments held at end of the period | | | (255 | ) | | | (239 | ) |
| (Loss) gain on change in fair value of equity investments | | $ | (242 | ) | | $ | 1,267 | |
Impact of the COVID-19 Pandemic 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.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
NOTE 7 DEFERRED ACQUISITION COSTS
The components of deferred acquisition costs and the related amortization expense for the years ended December 31, 2021 and December 31, 2020 are comprised as follows:
| (in thousands) | | Years ended December 31, | |
| | | 2021 | | | 2020 | |
| Balance at January 1, net | | $ | 8,835 | | | $ | 8,604 | |
| Additions | | | 8,702 | | | | 4,896 | |
| Amortization | | | (6,607 | ) | | | (4,665 | ) |
| Balance at December 31, net | | $ | 10,930 | | | $ | 8,835 | |
There were no impairment losses recorded in 2021 or 2020 related to deferred acquisition costs.
NOTE 8 GOODWILL
The following table summarizes goodwill activity for the years ended December 31, 2021 and December 31, 2020:
| | | | | | | | | | | | | | | | | | | | | |
| (in thousands) | | Extended Warranty | | | Leased Real Estate | | | Kingsway Search Xcelerator | | | Corporate | | | Total | |
| Balance, December 31, 2019 | | $ | 20,389 | | | $ | 60,983 | | | $ | — | | | $ | 732 | | | $ | 82,104 | |
| Acquisition | | | 39,026 | | | | — | | | | — | | | | — | | | | 39,026 | |
| Balance, December 31, 2020 | | | 59,415 | | | | 60,983 | | | | — | | | | 732 | | | | 121,130 | |
| Acquisition | | | — | | | | — | | | | 7,905 | | | | — | | | | 7,905 | |
| Measurement period adjustment | | | (18,788 | ) | | | — | | | | — | | | | — | | | | (18,788 | ) |
| Balance, December 31, 2021 | | $ | 40,627 | | | $ | 60,983 | | | $ | 7,905 | | | $ | 732 | | | $ | 110,247 | |
As further discussed inNote 4, "Acquisitions," during 2021, the Company recorded goodwill of$7.9 million related to the acquisition of Ravix on October 1, 2021. The goodwill related to this acquisition is provisional and subject to adjustment during the measurement period. The Company expects to complete its purchase price allocation in early 2022. The estimates, allocations and calculations recorded at December 31, 2021 are subject to change as we obtain further information; therefore, the final fair values of the assets acquired and liabilities assumed may not agree with the estimates included in these consolidated financial statements.
In 2020, the Company recorded goodwill of $39.0 million related to the acquisition of PWI on December 1, 2020 which was provisional and subject to adjustment during the measurement period. As further discussed inNote 4, "Acquisitions," during the third quarter of 2021, the Company recorded a cumulative net measurement period adjustment, related to the acquisition of PWI, that decreased goodwill by $18.8 million.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
Goodwill is assessed for impairment annually as of November 30, or more frequently if events or circumstances indicate that the carrying value may not be recoverable. The Company tested goodwill for recoverability at November 30, 2021 and December 31, 2020. Based on the assessment performed, no goodwill impairments were recognized in 2021 and 2020.
For Leased Real Estate, the Company models a hypothetical sale of the underlying asset in order to arrive at fair value, which, due to the unique nature of Leased Real Estate, the Company views as a technique consistent with the objective of measuring fair value. The estimated fair value of Leased Real Estate is highly sensitive to discount rates applied and changes in the underlying assumptions in the future could differ materially due to the inherent uncertainty in making such estimates. Additionally, estimates regarding future sales proceeds and timing of such proceeds could also have a significant impact on the fair value. The Company performed a Step 1 impairment assessment for Leased Real Estate at June 30, 2021, due to the sensitivity of interest rates in determining fair value and the impact that the additional borrowing may have on the determination of fair value. The results of this assessment indicated the fair value exceeded carrying value for Leased Real Estate. However, if there were sustained increases in the underlying interest rates used in our analysis then the fair value could be reduced to a level that could indicate impairment. See Note 12, "Debt," for further information regarding the additional borrowing.
Although the Company believes its estimates of fair value are reasonable, actual financial results could differ from those estimates due to the inherent uncertainty involved in making such estimates. Changes in assumptions concerning future financial results or other underlying assumptions could have a significant impact on either the fair value of the reporting units, the amount of the goodwill impairment charge, or both.
NOTE 9 INTANGIBLE ASSETS
Intangible assets at December 31, 2021 and December 31, 2020 are comprised as follows:
| (in thousands) | | | | | | December 31, 2021 | |
| | | Gross Carrying | | | Accumulated | | | Net Carrying | |
| | | Value | | | Amortization | | | Value | |
| Intangible assets subject to amortization | | | | | | | | | | | | |
| Database | | $ | 4,918 | | | $ | 4,488 | | | $ | 430 | |
| Vehicle service agreements in-force | | | 3,680 | | | | 3,680 | | | | — | |
| Customer relationships | | | 31,645 | | | | 11,598 | | | | 20,047 | |
| In-place and other lease assets | | | 3,238 | | | | 343 | | | | 2,895 | |
| Above-market lease | | | 835 | | | | — | | | | 835 | |
| Non-compete | | | 266 | | | | 224 | | | | 42 | |
| Intangible assets not subject to amortization | | | | | | | | | | | | |
| Tenant relationship | | | 73,667 | | | | — | | | | 73,667 | |
| Trade names | | | 10,314 | | | | — | | | | 10,314 | |
| Total | | $ | 128,563 | | | $ | 20,333 | | | $ | 108,230 | |
| (in thousands) | | | | | | December 31, 2020 | |
| | | Gross Carrying | | | Accumulated | | | Net Carrying | |
| | | Value | | | Amortization | | | Value | |
| Intangible assets subject to amortization | | | | | | | | | | | | |
| Database | | $ | 4,918 | | | $ | 3,997 | | | $ | 921 | |
| Vehicle service agreements in-force | | | 3,680 | | | | 3,680 | | | | — | |
| Customer relationships | | | 12,646 | | | | 7,305 | | | | 5,341 | |
| In-place lease | | | 1,125 | | | | 281 | | | | 844 | |
| Non-compete | | | 266 | | | | 170 | | | | 96 | |
| Intangible assets not subject to amortization | | | | | | | | | | | — | |
| Tenant relationship | | | 73,667 | | | | — | | | | 73,667 | |
| Trade names | | | 3,264 | | | | — | | | | 3,264 | |
| Total | | $ | 99,566 | | | $ | 15,433 | | | $ | 84,133 | |
As further discussed in Note 4, "Acquisitions," during the third quarter of 2021, the Company completed and finalized its fair value analysis of the assets acquired and liabilities assumed related to the Company's acquisition of PWI on December 1, 2020. As a result, during the third quarter of 2021, the Company recorded $19.6 million of separately identifiable intangible assets, related to acquired customer relationships and trade name, as part of the acquisition of PWI. The customer relationships intangible asset of $15.0 million is being amortized over nine years based on the pattern in which the economic benefits of the intangible asset are expected to be consumed. The trade name intangible asset of $4.6 million is deemed to have an indefinite useful life and is not amortized.
As further discussed inNote 4, "Acquisitions," during the fourth quarter of 2021, the Company recorded $6.5 million of separately identifiable intangible assets, related to acquired customer relationships and trade name, as part of the acquisition of Ravix on October 1, 2021. The customer relationships intangible asset of $4.0 million is being amortized over seven years based on the pattern in which the economic benefits of the intangible asset are expected to be consumed. The trade name intangible asset of $2.5 million is deemed to have indefinite useful life and is not amortized. The intangible assets related to this acquisition are provisional and subject to adjustment during the measurement period. The Company expects to complete its purchase price allocation in early 2022. The estimates, allocations and calculations recorded at December 31, 2021 are subject to change as we obtain further information; therefore, the final fair values of the assets acquired and liabilities assumed may not agree with the estimates included in these consolidated financial statements.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
As further discussed in Note 4, "Acquisitions," during the fourth quarter of 2021, the Company recorded $2.9 million of separately identifiable intangible assets, related to above-market lease and in-place and other lease assets, as part of the acquisition of RoeCo on December 30, 2021. The above-market lease intangible asset of $0.8 million resulted from the terms of the acquired operating lease contract being favorable relative to market terms of comparable leases on the date of acquisition. The in-place and other lease intangible assets of $2.1 million are estimated based on the costs avoided in originating leases comparable to the acquired in-place lease as well as the value associated with lost rental revenue during the assumed lease-up period. The above-market and in-place and other lease assets are amortized on a straight-line basis over the remaining lease term, which expires in September 2036.
The Company's other intangible assets with definite useful lives are amortized either based on the patterns in which the economic benefits of the intangible assets are expected to be consumed or using the straight-line method over their estimated useful lives, which range from 5 to 18 years. Amortization of intangible assets was$4.9 million and $2.3 million for the years ended December 31, 2021 and December 31, 2020, respectively. The estimated aggregate future amortization expense of all intangible assets is $5.8 million for 2022, $4.4 million for 2023, $3.4 million for 2024, $2.6 million for 2025 and $1.9 million for 2026.
The measurement period adjustment recorded during the third quarter of 2021 related to the PWI customer relationships intangible asset resulted in an increase in amortization expense of $1.9 million that was recorded during the third quarter of 2021. Refer to Note 4, "Acquisitions," for further detail.
The tenant relationship and trade names intangible assets have indefinite useful lives and are not amortized. All intangible assets with indefinite useful lives are reviewed annually by the Company for impairment. No impairment charges were taken on intangible assets in 2021 or 2020.
NOTE 10 PROPERTY AND EQUIPMENT
Property and equipment at December 31, 2021 and December 31, 2020 are comprised as follows:
| (in thousands) | | | | | | December 31, 2021 | |
| | | Total Property and Equipment | |
| | | | | | | Accumulated | | | | | |
| | | Cost | | | Depreciation | | | Carrying Value | |
| Land | | $ | 25,623 | | | $ | — | | | $ | 25,623 | |
| Site and tenant improvements | | | 92,047 | | | | 21,910 | | | | 70,137 | |
| Buildings | | | 11,805 | | | | 79 | | | | 11,726 | |
| Leasehold improvements | | | 286 | | | | 163 | | | | 123 | |
| Furniture and equipment | | | 562 | | | | 442 | | | | 120 | |
| Computer hardware | | | 2,488 | | | | 1,630 | | | | 858 | |
| Total | | $ | 132,811 | | | $ | 24,224 | | | $ | 108,587 | |
| (in thousands) | | | | | | December 31, 2020 | |
| | | Total Property and Equipment | |
| | | | | | | Accumulated | | | | | |
| | | Cost | | | Depreciation | | | Carrying Value | |
| Land | | $ | 21,120 | | | $ | — | | | $ | 21,120 | |
| Site improvements | | | 91,308 | | | | 18,428 | | | | 72,880 | |
| Buildings | | | 580 | | | | 65 | | | | 515 | |
| Leasehold improvements | | | 296 | | | | 125 | | | | 171 | |
| Furniture and equipment | | | 1,223 | | | | 1,074 | | | | 149 | |
| Computer hardware | | | 4,929 | | | | 4,749 | | | | 180 | |
| Total | | $ | 119,456 | | | $ | 24,441 | | | $ | 95,015 | |
During the fourth quarter of 2021, the Company recorded land of $4.5 million, site and tenant improvements of $0.7 million and building of $11.2 million as part of the acquisition of RoeCo on December 30, 2021.
For the years ended December 31, 2021 and December 31, 2020, depreciation expense on property and equipment of $3.7 million and $4.4 million, respectively, is included in general and administrative expenses in the consolidated statements of operations.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
NOTE 11 DERIVATIVES
On April 1, 2021, the Company entered into an interest rate swap agreement with CIBC Bank USA to convert the variable London interbank offered interest rate for three-month U.S. dollar deposits ("LIBOR") interest rate on a portion of its 2020 KWH Loan (as defined below in Note 12, "Debt") to a fixed interest rate of 1.18%. The interest rate swap had an initial notional amount of $11.9 million and matures on February 29, 2024.
The purpose of this interest rate swap, which is not designated as a cash flow hedge, is to reduce the Company's exposure to variability in cash flows from interest payments attributable to fluctuations in the variable interest rate associated with the 2020 KWH Loan. The Company has not elected hedge accounting for the interest rate swap. The interest rate swap is recorded in the consolidated balance sheet at fair value with changes in fair value recorded in the consolidated statement of operations.
The notional amount of the interest rate swap contract is $10.5 million at December 31, 2021. At December 31, 2021, the fair value of the interest rate swap contract was a liability of less than $0.1 million, which is included in accrued expenses and other liabilities in the consolidated balance sheet. During the year ended December 31, 2021, the Company recognized a loss of less than $0.1 million related to the change in fair value of the interest rate swap, which is included in interest expense not allocated to segments in the consolidated statement of operations and within cash flows from operating activities in the consolidated statement of cash flows. Net cash payments of less than $0.1 million were made during the year ended December 31, 2021, to settle a portion of the liabilities related to the interest rate swap agreement. These payments are reflected as cash outflows in the consolidated statements of cash flows within net cash used in operating activities.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
NOTE 12 DEBT
Debt consists of the following instruments at December 31, 2021 and December 31, 2020:
| (in thousands) | | December 31, 2021 | | | December 31, 2020 | |
| | | Principal | | | Carrying Value | | | Fair Value | | | Principal | | | Carrying Value | | | Fair Value | |
| Bank loans: | | | | | | | | | | | | | | | | | | | | | | | | |
| Ravix Loan | | $ | 6,000 | | | $ | 5,847 | | | $ | 5,936 | | | $ | — | | | $ | — | | | $ | — | |
| 2020 KWH Loan | | | 21,186 | | | | 20,870 | | | | 20,815 | | | | 25,700 | | | | 25,303 | | | | 25,893 | |
| Total bank loans | | | 27,186 | | | | 26,717 | | | | 26,751 | | | | 25,700 | | | | 25,303 | | | | 25,893 | |
| Notes payable: | | | | | | | | | | | | | | | | | | | | | | | | |
| Mortgage | | | 161,998 | | | | 168,730 | | | | 182,128 | | | | 166,106 | | | | 173,696 | | | | 194,158 | |
| Additional Mortgage | | | 14,514 | | | | 12,901 | | | | 15,104 | | | | — | | | | — | | | | — | |
| LA Mortgage | | | 13,463 | | | | 16,983 | | | | 16,437 | | | | — | | | | — | | | | — | |
| Flower Note | | | 6,411 | | | | 6,411 | | | | 7,101 | | | | 6,885 | | | | 6,885 | | | | 7,863 | |
| Net Lease Note | | | — | | | | — | | | | — | | | | 9,000 | | | | 9,000 | | | | 9,054 | |
| PPP | | | — | | | | — | | | | — | | | | 2,476 | | | | 2,476 | | | | 2,476 | |
| Total notes payable | | | 196,386 | | | | 205,025 | | | | 220,770 | | | | 184,467 | | | | 192,057 | | | | 213,551 | |
| Subordinated debt | | | 90,500 | | | | 60,973 | | | | 60,973 | | | | 90,500 | | | | 50,928 | | | | 50,928 | |
| Total | | $ | 314,072 | | | $ | 292,715 | | | $ | 308,494 | | | $ | 300,667 | | | $ | 268,288 | | | $ | 290,372 | |
Subordinated debt mentioned above consists of the following trust preferred debt instruments:
| | | Principal | | | | |
| Issuer | | (in thousands) | | Issue date | Interest | Redemption date |
| Kingsway CT Statutory Trust I | | $ | 15,000 | | 12/4/2002 | annual interest rate equal to LIBOR, plus 4.00% payable quarterly | 12/4/2032 |
| Kingsway CT Statutory Trust II | | $ | 17,500 | | 5/15/2003 | annual interest rate equal to LIBOR, plus 4.10% payable quarterly | 5/15/2033 |
| Kingsway CT Statutory Trust III | | $ | 20,000 | | 10/29/2003 | annual interest rate equal to LIBOR, plus 3.95% payable quarterly | 10/29/2033 |
| Kingsway DE Statutory Trust III | | $ | 15,000 | | 5/22/2003 | annual interest rate equal to LIBOR, plus 4.20% payable quarterly | 5/22/2033 |
| Kingsway DE Statutory Trust IV | | $ | 10,000 | | 9/30/2003 | annual interest rate equal to LIBOR, plus 3.85% payable quarterly | 9/30/2033 |
| Kingsway DE Statutory Trust VI | | $ | 13,000 | | 12/16/2003 | annual interest rate equal to LIBOR, plus 4.00% payable quarterly | 1/8/2034 |
Ravix
As part of the acquisition of Ravix on
October 1, 2021, Ravix became a wholly owned subsidiary of Ravix 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 LIBOR, having a floor of
0.75%, plus
3.00%. A
t
December 31, 2021
, the interest rate was 3.75%. The revolver matures on October 1, 2023 and the term loan matures on October 1, 2017. During the fourth quarter of 2021, Ravix borrowed under the revolver. The carrying value at
December 31, 2021
includes $5.7 million related to the term loan and
$0.1 million related to revolver.
The Company also recorded as a discount to the carrying value of the Ravix Loan issuance costs of $0.2 million specifically related to the Ravix Loan. The Ravix Loan is carried in the consolidated balance sheet at
December 31, 2021
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 fair value of the Ravix Loan disclosed in the table above is derived from quoted market prices of
B and BB minus rated industrial bonds with similar maturities and is categorized within Level 2 of the fair value hierarchy. The Ravix Loan is secured by certain of the equity interests and assets of Ravix.
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.
KWH
In 2019, the Company formed Kingsway Warranty Holdings LLC ("KWH"), whose original subsidiaries included IWS Acquisition Corporation ("IWS"), Geminus Holdings Company, Inc. ("Geminus") and Trinity Warranty Solutions LLC ("Trinity"). As part of the acquisition of PWI on December 1, 2020, PWI became a wholly owned subsidiary of KWH, which borrowed a principal amount of $25.7 million from a bank, consisting of a $24.7 million term loan and a $1.0 million revolving credit facility (the "2020 KWH Loan"). The proceeds from the 2020 KWH Loan were used to partially fund the acquisition of PWI and to fully repay the prior outstanding loan at KWH, which occurred on December 1, 2020.
The 2020 KWH Loan has an annual interest rate equal to LIBOR having a floor of 0.75%, plus 3.00%. At December 31, 2021, the interest rate was 3.75%. The 2020 KWH Loan matures on December 1, 2025. The Company also recorded as a discount to the carrying value of the 2020 KWH Loan issuance costs of $0.4 million specifically related to the 2020 KWH Loan. The 2020 KWH Loan 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 fair value of the 2020 KWH Loan disclosed in the table above is derived from quoted market prices of B and BB minus rated industrial bonds with similar maturities and is categorized within Level 2 of the fair value hierarchy. The 2020 KWH Loan is secured by certain of the equity interests and assets of KWH and its subsidiaries.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
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.
CMC Industries
As part of the acquisition of CMC Industries, Inc. ("CMC") in July 2016, the Company assumed a mortgage, which is recorded as note payable in the consolidated balance sheets ("the Mortgage"). The Mortgage was recorded 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 on May 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. The fair value of the Mortgage disclosed in the table above is derived from quoted market prices of A-rated industrial bonds with similar maturities and is categorized within Level 2 of the fair value hierarchy.
On June 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 25(a), "Commitments and Contingent Liabilities - Legal proceedings," for further discussion of the CMC litigation settlement agreement. In the consolidated statement of cash flows for the year ended December 31, 2021, the additional borrowing of $15.0 million is shown as a cash inflow in the net cash provided by financing activities and the prepayment of the management fee, net of amortization, of $10.2 million is shown as an outflow in the net cash used in operating activities.
The Additional Mortgage matures on May 15, 2034 and has a fixed interest rate of 3.20%. The Company recorded as a discount to the carrying value of the Additional Mortgage issuance costs of $1.7 million specifically related to the Additional Mortgage. 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. The fair value of the Additional Mortgage disclosed in the table above is derived from quoted market prices of A-rated industrial bonds with similar maturities and is categorized within Level 2 of the fair value hierarchy.
Both the Mortgage and the Additional Mortgage are nonrecourse indebtedness with respect to CMC and its subsidiaries, and the Mortgage and Additional Mortgage are not, nor will it be, guaranteed by Kingsway or its affiliates. The Mortgage and Additional Mortgage are collateralized by a parcel of real property consisting of approximately 192 acres located in the State of Texas (the "Real Property") and the assignment of leases and rents related to a long-term triple net lease agreement with an unrelated third-party.
RoeCo
As part of its acquisition of RoeCo on December 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 LA Mortgage is nonrecourse indebtedness with respect to the assets of RoeCo, and the LA Mortgage is not, nor will it be, guaranteed by Kingsway or its affiliates unless RoeCo acts in bad-faith or commits intentional acts with respect to the LA Mortgage. Refer to Note 25, "Commitments and Contingent Liabilities," for further disclosure. The LA Mortgage is collateralized by a parcel of real property and a single tenant building located in the state of Louisiana (the "LA Real Property") and the assignment of a lease and rent related to a long-term lease agreement with an unrelated third-party. 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, which has unpaid principal of $6.6 million at December 31, 2021, matures on September 14, 2036 and has a fixed interest rate of 3.75%. The senior interest only note, which has unpaid principal of $5.0 million at December 31, 2021, matures on October 14, 2036 and has a fixed interest rate of 5.682%. The junior note, which has unpaid principal of $1.9 million at December 31, 2021, matures on September 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 sheet at December 31, 2021 at its aggregate unpaid principal balance. The fair value of the LA Mortgage disclosed in the table above is derived from quoted market prices of bonds backed by loans to hospitals and guaranteed by the U.S. Government and A-rated industrial bonds with similar maturities and is categorized within Level 2 of the fair value hierarchy.
Flower
On January 5, 2015, Flower assumed a $9.2 million mortgage in conjunction with the purchase of investment real estate properties, which is recorded as note payable in the consolidated balance sheets ("the Flower Note"). The Flower Note requires monthly payments of principal and interest and is secured by certain investments of Flower. The Flower Note matures on December 10, 2031 and has a fixed interest rate of 4.81%. The carrying value of the Flower Note at December 31, 2021 of $6.4 million represents its unpaid principal balance. The fair value of the Flower Note disclosed in the table above is derived from quoted market prices of A and BBB rated industrial bonds with similar maturities and is categorized within Level 2 of the fair value hierarchy.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
Net Lease
On October 15, 2015, Net Lease assumed a $9.0 million mezzanine debt in conjunction with the purchase of investment real estate properties, which is recorded as note payable in the consolidated balance sheet at December 31, 2020 ("the Net Lease Note"). The Net Lease Note required monthly payments of interest and was secured by certain investments of Net Lease. The Net Lease Note matured on November 1, 2020 and had a fixed interest rate of 10.25%.
In conjunction with the maturity of the Net Lease Note on November 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 on October 30, 2020; however, because the Company reports Net Lease on a three-month lag, the consolidated balance sheet at December 31, 2020 continued to report the $9.0 million mezzanine debt, which represents its unpaid principal balance. The fair value of the Net Lease Note disclosed in the table above is derived from quoted market prices of B and B minus rated industrial bonds with similar maturities and is categorized within Level 2 of the fair value hierarchy.
Paycheck Protection Program
In April 2020, certain subsidiaries of the Company received loan proceeds under the Paycheck Protection Program ("PPP"), totaling $2.9 million with a stated annual interest rate of 1.00%. The PPP, established as part of the Coronavirus Aid, Relief, and Economic Security Act and administered by the U.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 the Company were to be audited and receive an adverse outcome in such an audit, it could be required to return the full amount of the PPP Loan and may potentially be subject to civil and criminal fines and penalties.
On December 21, 2020 the SBA approved the forgiveness of the full amount of one of the five PPP loans. The forgiveness included principal and interest of $0.4 million. In January 2021 and March 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 loan forgiveness is included in gain (loss) on extinguishment of debt, net in the consolidated statements of operations for the years ended December 31, 2021 and December 31, 2020. The carrying value of the PPP at December 31, 2020 of $2.5 million represents its unpaid principal balance.
Between December 4, 2002 and December 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 by KAI 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.
The subordinated debt is carried in the consolidated balance sheets at fair value. See Note 23, "Fair Value of Financial Instruments," for further discussion of the subordinated debt. The portion of the change in fair value of subordinated debt related to the instrument-specific credit risk is recognized in other comprehensive (loss) income. Of the $10.0 million increase in fair value of the Company’s subordinated debt between December 31, 2020 and December 31, 2021, $6.8 million is reported as increase in fair value of debt attributable to instrument-specific credit risk in the Company's consolidated statements of comprehensive loss and $3.2 million is reported as loss on change in fair value of debt in the Company’s consolidated statements of operations. Of the $3.7 million decrease in fair value of the Company’s subordinated debt between December 31, 2019 and December 31, 2020, $2.6 million is reported as decrease in fair value of debt attributable to instrument-specific credit risk in the Company's consolidated statements of comprehensive loss and $1.2 million is reported as gain on change in fair value of debt in the Company’s consolidated statements of operations.
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. At December 31, 2021 and December 31, 2020, deferred interest payable of $18.7 million and $14.1 million, respectively, is included in accrued expenses and other liabilities in the consolidated balance sheets.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
The agreements governing the 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.
NOTE 13 LEASES
The Company has operating leases for office space that include fixed base rent payments, as well as variable rent payments to reimburse the landlord for operating expenses and taxes. The Company’s variable lease payments do not depend on a published index or rate, and therefore, are expensed as incurred. The Company includes only fixed payments for lease components in the measurement of the right-of-use asset and lease liability. There are no residual value guarantees.
Operating lease costs and variable lease costs included in selling and administrative costs for the year ended December 31, 2021 were $1.0 million and $0.1 million, respectively.
The annual maturities of lease liabilities as of December 31, 2021 were as follows:
| (in thousands) | | Lease Commitments | |
| 2022 | | $ | 982 | |
| 2023 | | | 638 | |
| 2024 | | | 550 | |
| 2025 | | | 381 | |
| 2026 | | | 165 | |
| 2027 and thereafter | | | — | |
| Total undiscounted lease payments | | | 2,716 | |
| Imputed interest | | | 237 | |
| Total lease liabilities | | $ | 2,479 | |
The weighted-average remaining lease term for operating leases was 3.68 years as of December 31, 2021. The weighted average discount rate of operating leases was 5.14% as of December 31, 2021. Cash paid for amounts included in the measurement of lease liabilities was $1.0 million and $0.7 million for the years ended December 31, 2021 and December 31, 2020, respectively.
Supplemental non-cash information related to leases for the year ended December 31, 2021 includes right-of-use assets of $0.1 million acquired in exchange for $0.1 million of lease obligations.
The Company owns the Real Property that is subject to a long-term triple net lease agreement with an unrelated third-party. The lease provides for future rent escalations and renewal options. The initial lease term ends in May 2034. The lessee bears the cost of maintenance and property taxes. Rental income from operating leases is recognized on a straight-line basis, based on contractual lease terms with fixed and determinable increases over the non-cancellable term of the related lease when collectability is reasonably assured. Rental revenue includes amortization of below-market lease liabilities related to the Real Property of $0.1 million and $0.1 million for the years ended December 31, 2021 and December 31, 2020, respectively. The estimated aggregate future amortization of below-market lease liabilities is $0.1 million for 2022, $0.1 million for 2023, $0.1 million for 2024, $0.1 million for 2025 and $0.1 million for 2026. Realization of the residual values of the assets under lease is dependent on the future ability to market the assets under prevailing market conditions. The lease is classified as an operating lease and the underlying leased assets are included in property and equipment in the consolidated balance sheets. Refer to Note 10, "Property and Equipment".
The Company acquired the LA Property on December 30, 2021. The LA Real Property is subject to a long-term lease agreement with an unrelated third-party. The lease provides for future rent decreases. The initial lease term ends in March 2035. The lessee bears the cost of maintenance and property taxes. Rental income from operating leases is recognized on a straight-line basis, based on contractual lease terms with fixed and determinable increases over the non-cancellable term of the related lease when collectability is reasonably assured. Rental revenue does not include any amortization of above-market lease asset related to the LA Property for the year ended December 31, 2021 due to RoeCo being acquired on December 30, 2021. The estimated aggregate future amortization of above-market lease asset is $0.1 million for 2022, $0.1 million for 2023, $0.1 million for 2024, $0.1 million for 2025 and $0.1 million for 2026. Realization of the residual values of the assets under lease is dependent on the future ability to market the assets under prevailing market conditions. The lease is classified as an operating lease and the underlying leased assets are included in property and equipment in the consolidated balance sheets. Refer to Note 10, "Property and Equipment".
Lease revenue related to operating leases was $13.4 million for each of the years ended December 31, 2021 and December 31, 2020.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
The following table provides the net book value of operating lease property included in property and equipment in the consolidated balance sheets:
| (in thousands) | | December 31, 2021 | | | December 31, 2020 | |
| | | | | | | | | |
| Land | | $ | 25,623 | | | $ | 21,120 | |
| Site and tenant improvements | | | 92,047 | | | | 91,308 | |
| Buildings | | | 11,805 | | | | 580 | |
| Gross property and equipment leased | | | 129,475 | | | | 113,008 | |
| Accumulation depreciation | | | (21,989 | ) | | | (18,493 | ) |
| Net property and equipment leased | | $ | 107,486 | | | $ | 94,515 | |
As of December 31, 2021, future undiscounted cash flows to be received in each of the next five years and thereafter, on non-cancelable operating leases are as follows:
| (in thousands) | | | | |
| 2022 | | $ | 13,912 | |
| 2023 | | | 14,190 | |
| 2024 | | | 14,475 | |
| 2025 | | | 14,766 | |
| 2026 | | | 14,883 | |
| Thereafter | | | 119,590 | |
NOTE 14 REVENUE FROM CONTRACTS WITH CUSTOMERS
Revenue from contracts with customers relates to the Extended Warranty and Kingsway Search Xcelerator segments and includes: vehicle service agreement fees, GAP commissions, maintenance support service fees, warranty product commissions, homebuilder warranty service fees, homebuilder warranty commissions and business services consulting revenue. Revenue is based on terms of various agreements with credit unions, consumers, businesses and homebuilders. Customers either pay in full at the inception of a warranty contract, commission product sale, or when consulting services are billed, or on terms subject to the Company’s customary credit reviews.
The following table disaggregates revenues from contracts with customers by revenue type:
| (in thousands) | | | Years ended December 31, | |
| | | | 2021 | | | 2020 | |
| | | | | | | | | | |
| Vehicle service agreement fees and GAP commissions | IWS, Geminus and PWI | | $ | 57,756 | | | $ | 33,137 | |
| Maintenance support service fees | Trinity | | | 4,871 | | | | 3,457 | |
| Warranty product commissions | Trinity | | | 4,317 | | | | 3,622 | |
| Homebuilder warranty service fees | PWSC | | | 7,099 | | | | 6,290 | |
| Homebuilder warranty commissions | PWSC | | | 876 | | | | 1,101 | |
| Business services consulting fees | Ravix | | | 3,482 | | | | — | |
| Service fee and commission revenue | | $ | 78,401 | | | $ | 47,607 | |
Receivables from contracts with customers are reported as service fee receivable, net in the consolidated balance sheets and at December 31, 2021 and December 31, 2020 were$6.7 million and $4.8 million, respectively.
The Company records deferred service fees resulting from contracts with customers when payment is received in advance of satisfying the performance obligations. Deferred service fees were $89.2 million and $87.9 million at December 31, 2021 and December 31, 2020, respectively. The increase in deferred service fees during the year ended December 31, 2021 is primarily due to additions to deferred service fees in excess of deferred service fees recognized during the year ended December 31, 2021, that was partially offset by the adjustment recorded in the third quarter of 2021 of $3.6 million to reduce PWI’s acquisition date deferred revenue to fair value.
The Company expects to recognize within one year as service fee and commission revenue approximately 49.1% of the deferred service fees as of December 31, 2021. Approximately $44.2 million and $23.5 million of service fee and commission revenue recognized during the years ended December 31, 2021 and December 31, 2020 was included in deferred service fees as of December 31, 2020 and December 31, 2019, respectively.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
NOTE 15 INCOME TAXES
The Company and all of its eligible U.S. subsidiaries file a U.S. consolidated federal income tax return ("KFSI Tax Group"). The method of allocating federal income taxes among the companies in the KFSI Tax Group is subject to written agreement, approved by each company's Board of Directors. The allocation is made primarily on a separate return basis, with current credit for any net operating losses or other items utilized in the consolidated federal income tax return. The Company’s non-U.S. subsidiaries file separate foreign income tax returns.
Income tax benefit consists of the following:
| (in thousands) | | Years ended December 31, | |
| | | 2021 | | | 2020 | |
| | | | | | | | | |
| Current income tax (benefit) expense | | $ | (2,372 | ) | | $ | 345 | |
| Deferred income tax benefit | | | (5,272 | ) | | | (1,460 | ) |
| Income tax benefit | | $ | (7,644 | ) | | $ | (1,115 | ) |
Income tax benefit varies from the amount that would result by applying the applicable U.S. corporate income tax rate of 21% to loss from continuing operations before income tax benefit. The following table summarizes the differences:
| (in thousands) | | Years ended December 31, | |
| | | 2021 | | | 2020 | |
| Income tax benefit at U.S. statutory income tax rate | | $ | (1,215 | ) | | $ | (1,373 | ) |
| Valuation allowance | | | (4,822 | ) | | | (322 | ) |
| Indefinite life intangibles | | | 215 | | | | 215 | |
| Change in unrecognized tax benefits | | | (2,811 | ) | | | 244 | |
| Non-deductible compensation | | | 649 | | | | 220 | |
| Investment income | | | (253 | ) | | | (269 | ) |
| State income tax | | | 372 | | | | 192 | |
| Indemnification receivable | | | 590 | | | | (51 | ) |
| Non-taxable income | | | (524 | ) | | | (80 | ) |
| Other | | | 155 | | | | 109 | |
| Income tax benefit for continuing operations | | $ | (7,644 | ) | | $ | (1,115 | ) |
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
The tax effects of temporary differences that give rise to significant portions of the deferred income tax assets and liabilities are presented as follows:
| (in thousands) | | December 31, | |
| | | 2021 | | | 2020 | |
| Deferred income tax assets: | | | | | | | | |
| Losses carried forward | | $ | 181,096 | | | $ | 184,130 | |
| Unpaid loss and loss adjustment expenses and unearned premiums | | | 3,864 | | | | 3,911 | |
| Intangible assets | | | 1,050 | | | | 1,705 | |
| Debt issuance costs | | | 789 | | | | 835 | |
| Investments | | | 1,198 | | | | 145 | |
| Deferred rent | | | 586 | | | | 624 | |
| Deferred revenue | | | 1,603 | | | | 1,350 | |
| Management fees | | | — | | | | 550 | |
| Compensation | | | 520 | | | | 265 | |
| Other | | | 131 | | | | 660 | |
| Valuation allowance | | | (169,678 | ) | | | (173,202 | ) |
| Deferred income tax assets | | $ | 21,159 | | | $ | 20,973 | |
| Deferred income tax liabilities: | | | | | | | | |
| Indefinite life intangibles | | $ | (19,179 | ) | | $ | (17,483 | ) |
| Depreciation and amortization | | | (14,485 | ) | | | (14,632 | ) |
| Fair value of debt | | | (4,048 | ) | | | (6,716 | ) |
| Land | | | (4,482 | ) | | | (4,435 | ) |
| Intangible assets | | | (3,698 | ) | | | (452 | ) |
| Deferred revenue | | | (1,443 | ) | | | (1,239 | ) |
| Investments | | | (35 | ) | | | (1,716 | ) |
| Deferred acquisition costs | | | (2,295 | ) | | | (1,855 | ) |
| Other | | | (47 | ) | | | — | |
| Deferred income tax liabilities | | $ | (49,712 | ) | | $ | (48,528 | ) |
| Net deferred income tax liabilities | | $ | (28,553 | ) | | $ | (27,555 | ) |
The Company maintains a valuation allowance for its gross deferred income tax assets of $169.7 million (U.S. operations - $169.7 million; Other - less than $0.1 million) and $173.2 million (U.S. operations - $173.2 million; Other - less than $0.1 million) at December 31, 2021 and December 31, 2020, respectively. The Company's businesses have generated substantial operating losses in prior years. These losses can be available to reduce income taxes that might otherwise be incurred on future taxable income; however, it is uncertain whether the Company will generate the taxable income necessary to utilize these losses or other reversing temporary differences. This uncertainty has caused management to place a full valuation allowance on its December 31, 2021 and December 31, 2020 net deferred income tax assets, excluding the deferred income tax asset and liability amounts set forth in the paragraph below.
In 2021, the Company (i) released into income $2.0 million of its valuation allowance associated with business interest expense carryforwards with an indefinite life; (ii) released into income $3.3 million and $0.8 million of its valuation allowance, as a result of its acquisitions of PWI and Ravix, respectively, due to net deferred income tax liabilities that are expected to reverse during the period in which the Company will have deferred income tax assets available; and (iii) charged to expense $0.5 million for an increase in its valuation allowance, as a result of its acquisition of CMC, due to net deferred income tax liabilities that are not expected to reverse during the period in which the Company will have deferred income tax assets available.
In2020, the Company released into income $1.3 million of its valuation allowance associated with business interest expense carryforwards with an indefinite life and also released into income $0.5 million of its valuation allowance, as a result of its acquisition of CMC, due to net deferred income tax liabilities that are expected to reverse during the period in which the Company will have deferred income tax assets available.
The Company carries net deferred income tax liabilities of$28.6 million and $27.6 million at December 31, 2021 and December 31, 2020, respectively, that consists of:
| | • | $8.2 million and $7.6 million of deferred income tax liabilities that are scheduled to reverse in periods after the expiration of the KFSI Tax Group's consolidated U.S. net operating loss carryforwards; |
| | • | $23.8 million and $21.9 million of deferred income tax liabilities related to land and indefinite life intangible assets; |
| | • | $3.3 million and $1.3 million of deferred income tax assets associated with business interest expense carryforwards with an indefinite life; |
| | • | $0.5 million and $0.6 million of deferred state income tax assets; and |
| | • | $0.4 million and zero of deferred state income tax liabilities. |
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
The Tax Cuts and Jobs Act (the "Tax Act") modified the U.S. net operating loss deduction, effective with respect to losses arising in tax years beginning after December 31, 2017. The Tax Act, however, did not limit the utilization, in 2018 and later tax years, of U.S. net operating losses generated in 2017 and prior tax years.
Amounts, originating dates and expiration dates of the KFSI Tax Group's consolidated U.S. net operating loss carryforwards, totaling $824.4 million, are as follows:
| | | | | Net operating loss | |
| Year of net operating loss | | Expiration date | | (in thousands) | |
| | | | | | | |
| 2007 | | 2027 | | $ | 35,890 | |
| 2008 | | 2028 | | | 53,895 | |
| 2009 | | 2029 | | | 496,889 | |
| 2010 | | 2030 | | | 92,058 | |
| 2011 | | 2031 | | | 39,865 | |
| 2012 | | 2032 | | | 30,884 | |
| 2013 | | 2033 | | | 30,779 | |
| 2014 | | 2034 | | | 7,245 | |
| 2016 | | 2036 | | | 16,006 | |
| 2017 | | 2037 | | | 20,848 | |
In addition, not reflected in the table above, are net operating loss carryforwards of (i) $10.1 million relating to losses generated in separate U.S. tax return years, which losses will expire over various years through 2037 and (ii) $0.5 million relating to operations in Barbados, which losses will expire over various years through 2028.
A reconciliation of the beginning and ending unrecognized tax benefits, exclusive of interest and penalties, is as follows:
| (in thousands) | | December 31, | |
| | | 2021 | | | 2020 | |
| Unrecognized tax benefits - beginning of year | | $ | 1,381 | | | $ | 1,381 | |
| Gross additions | | | — | | | | — | |
| Gross reductions | | | — | | | | — | |
| Impact due to expiration of statute of limitations | | | (1,316 | ) | | | — | |
| Unrecognized tax benefits - end of year | | $ | 65 | | | $ | 1,381 | |
The amount of unrecognized tax benefits that, if recognized as of December 31, 2021 and December 31, 2020 would affect the Company's effective tax rate, was a benefit of $2.8 million and an expense of $0.2 million, respectively.
During the year ended December 31, 2021, the Company recorded an income tax benefit of $2.8 million for the release of a liability for unrecognized tax benefits (including interest and penalties) that had been included in income taxes payable in the consolidated balance sheets. The Company carried a liability for unrecognized tax benefits of $0.1 million and $1.4 million as of December 31, 2021 and December 31, 2020, respectively, that is included in income taxes payable in the consolidated balance sheets. The Company classifies interest and penalty accruals, if any, related to unrecognized tax benefits as income tax expense. During the years ended December 31, 2021 and December 31, 2020, the Company recognized a benefit of $1.5 million and an expense of $0.2 million, respectively, for interest and penalties. At December 31, 2021 and December 31, 2020, the Company carried an accrual for the payment of interest and penalties of $0.1 million and $1.6 million respectively, that is included in income taxes payable in the consolidated balance sheets.
The federal income tax returns of the Company's U.S. operations for the years through 2017 are closed for Internal Revenue Service ("IRS") examination. The Company's federal income tax returns are not currently under examination by the IRS for any open tax years. The federal income tax returns of the Company's Canadian operations for the years through 2016 are closed for Canada Revenue Agency ("CRA") examination. The Company's Canadian federal income tax returns are not currently under examination by the CRA for any open tax years.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
NOTE 16 LOSS FROM CONTINUING OPERATIONS PER SHARE
The following table sets forth the reconciliation of numerators and denominators for the basic and diluted loss from continuing operations per share computation for the years ended December 31, 2021 and December 31, 2020:
| (in thousands, except per share data) | | Years ended December 31, | |
| | | 2021 | | | 2020 | |
| Numerator: | | | | | | | | |
| Income (loss) from continuing operations | | $ | 1,860 | | | $ | (5,422 | ) |
| Less: net income attributable to noncontrolling interests | | | (2,202 | ) | | | (1,309 | ) |
| Less: dividends on preferred stock, net of tax | | | (494 | ) | | | (1,066 | ) |
| Loss from continuing operations attributable to common shareholders | | $ | (836 | ) | | $ | (7,797 | ) |
| Denominator: | | | | | | | | |
| Weighted average basic shares | | | | | | | | |
| Weighted average common shares outstanding | | | 22,537 | | | | 22,176 | |
| Weighted average diluted shares | | | | | | | | |
| Weighted average common shares outstanding | | | 22,537 | | | | 22,176 | |
| Effect of potentially dilutive securities (a) | | | — | | | | — | |
| Total weighted average diluted shares | | | 22,537 | | | | 22,176 | |
| Basic loss from continuing operations per share | | $ | (0.04 | ) | | $ | (0.35 | ) |
| Diluted loss from continuing operations per share | | $ | (0.04 | ) | | $ | (0.35 | ) |
| | (a) | Potentially dilutive securities consist of unvested restricted stock awards, warrants and convertible preferred stock. Because the Company is reporting a loss from continuing operations attributable to common shareholders for the years ended December 31, 2021 and December 31, 2020, all potentially dilutive securities outstanding were excluded from the calculation of diluted loss from continuing operations per share since their inclusion would have been anti-dilutive. |
Basic loss from continuing operations per share is calculated using weighted-average common shares outstanding. Diluted loss from continuing operations per share is calculated using weighted-average diluted shares. Weighted-average diluted shares is calculated by adding the effect of potentially dilutive securities to weighted-average common shares outstanding.
The following weighted-average potentially dilutive securities are not included in the diluted loss from continuing operations per share calculations above because they would have had an antidilutive effect on the loss from continuing operations per share:
| (in thousands) | | Years ended December 31, | |
| | | 2021 | | | 2020 | |
| Unvested restricted stock awards | | | 1,252,754 | | | | 500,000 | |
| Warrants | | | 4,573,765 | | | | 4,923,765 | |
| Convertible preferred stock | | | 1,060,831 | | | | 1,142,975 | |
| Total | | | 6,887,350 | | | | 6,566,740 | |
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
NOTE 17 STOCK-BASED COMPENSATION
On September 21, 2020, the Company's shareholders approved the 2020 Equity Incentive Plan (the "2020 Plan"). The 2020 Plan replaced the Company's previous 2013 Equity Incentive Plan (the "2013 Plan") with respect to the granting of future equity awards. The 2020 Plan permits the grant of Nonqualified Stock Options, Incentive Stock Options, Stock Appreciation Rights, Restricted Shares, Restricted Stock Units, Performance Share Awards, Dividend Equivalent Rights, Other Stock-Based Awards and Cash-Based Awards (collectively "Awards"). Under the 2020 Plan, an aggregate of 1.6 million common shares will be available for all Awards, subject to adjustment in the event of certain corporate transactions.
| (a) | Restricted Stock Awards of the Company |
Under the 2013 Plan, the Company made grants of restricted common stock awards to certain officers of the Company on March 28, 2014 (the "2014 Restricted Stock Awards"). On February 28, 2020, the Company executed an Employment Separation Agreement and Release ("2020 Separation Agreement") with a former officer. Under the terms of the 2020 Separation Agreement, the former officer forfeited 93,713 shares of the 2014 Restricted Stock Awards. The Company’s accounting policy is to account for forfeitures when they occur. As a result, the Company reversed during the first quarter of 2020 $0.2 million of compensation expense previously recognized from March 28, 2014 through February 28, 2020. The former officer's remaining 135,787 shares of the original 2014 Restricted Stock Awards became fully vested on February 28, 2020. There are no 2014 Restricted Stock Awards outstanding at December 31, 2021 and December 31, 2020.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
On September 5, 2018, the Company granted 500,000 restricted common stock awards to an officer (the "2018 Restricted Stock Award"). The 2018 Restricted Stock Award shall become fully vested and the restriction period shall lapse as of March 28, 2024 subject to the officer's continued employment through the vesting date. The 2018 Restricted Stock Award is amortized on a straight-line basis over the requisite service period. The grant-date fair value of the 2018 Restricted Stock Award was determined using the closing price of Kingsway common stock on the date of grant. Total unamortized compensation expense related to unvested 2018 Restricted Stock Award at December 31, 2021 was $0.8 million.
Under the 2020 Plan, the Company granted 1,092,754 restricted common stock awards to certain officers of the Company during 2021 (the "2021 Restricted Stock Awards"). The 2021 Restricted Stock Awards vest according to a graded vesting schedule and shall become fully vested subject to the officers' continued employment through the applicable vesting dates. The 2021 Restricted Stock Awards are amortized on a straight-line basis over the requisite service periods. The grant-date fair values of the 2021 Restricted Stock Awards were determined using the closing price of Kingsway common stock on the date of grant. During the year ended December 31, 2021, 340,000 shares of the 2021 Restricted Stock Awards became fully vested. Total unamortized compensation expense related to unvested 2021 Restricted Stock Awards at December 31, 2021 was $3.3 million.
The following table summarizes the activity related to unvested 2021 Restricted Stock Awards and 2018 Restricted Stock Award (collectively "Restricted Stock Awards") during the year ended December 31, 2021:
| | | | | | | Weighted-Average | |
| | | Number of Restricted | | | Grant Date Fair Value | |
| | | Stock Awards | | | (per Share) | |
| Unvested at December 31, 2020 | | | 500,000 | | | $ | 5.73 | |
| Granted | | | 1,092,754 | | | | 4.66 | |
| Vested | | | (239,402 | ) | | | 4.64 | |
| Cancelled for Tax Withholding | | | (100,598 | ) | | | 4.64 | |
| Unvested at December 31, 2021 | | | 1,252,754 | | | $ | 5.09 | |
The unvested balance at December 31, 2021 in the table above is comprised of 752,754 shares of the 2021 Restricted Stock Awards and 500,000 shares of the 2018 Restricted Stock Award.
| (b) | Restricted Stock Awards of PWSC |
PWSC granted 1,000 restricted Class B common stock awards ("2018 PWSC RSA") to an officer of PWSC pursuant to an agreement dated September 7, 2018. The 2018 PWSC RSA contains both a service and a performance condition that affects vesting. On December 18, 2020, the 2018 PWSC RSA was amended to modify the vesting terms related to the service and performance condition ("Modified PWSC RSA").
PWSC granted 250 restricted Class B common stock awards to an officer of PWSC pursuant to an agreement dated December 18, 2020 ("2020 PWSC RSA"). The 2020 PWSC RSA contains both a service and a performance condition that affects vesting.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
The service condition for the Modified PWSC RSA and the 2020 PWSC RSA vest according to a graded vesting schedule and shall become fully vested on February 20, 2022 subject to the officer's continued employment through the applicable vesting dates. The performance condition vests on February 20, 2022 and is based on the internal rate of return of PWSC. The grant-date fair value of the Modified PWSC RSA and the 2020 PWSC RSA were estimated using an internal valuation model. See Note 23, "Fair Value of Financial Instruments," for further discussion related to the valuation of the Modified PWSC RSA and the 2020 PWSC RSA.
The Modified PWSC RSA and the 2020 PWSC RSA include a noncontingent put option that is exercisable between February 20, 2022 and February 20, 2023. Since the put option is exercisable less than six months after the vesting of certain shares, the compensation expense related to these shares is classified as a liability and included in accrued expenses and other liabilities in the consolidated balance sheets. The fair value of the liability classified portion of the Modified PWSC RSA and the 2020 PWSC RSA is re-evaluated each reporting period.
At December 31, 2021, both the service condition and performance condition of the Modified PWSC RSA were probable of vesting. At December 31, 2021 and December 31, 2020, there were 437.5 and 625.0 unvested shares, respectively, of the Modified PWSC RSA with a weighted-average grant date fair value of $1,672 per share. During the year ended December 31, 2021,187.50 shares of the Modified RSA vested. Total unamortized compensation expense related to unvested equity-classified portion of the Modified PWSC RSA at December 31, 2021 was less than $0.1 million.
At December 31, 2021, both the service condition and performance condition of the 2020 PWSC RSA were probable of vesting. At December 31, 2021 and December 31, 2020, there were 109.38 and 156.25 unvested shares, respectively, of the 2020 PWSC RSA with a weighted-average grant date fair value of $1,672 per share. During the year ended December 31, 2021, 46.88 shares of the 2020 PWSC RSA vested. Total unamortized compensation expense related to unvested equity-classified portion of the 2020 PWSC RSA at December 31, 2021 was zero.
| (c) | Restricted Common Unit Awards of Ravix |
Ravix LLC granted 199,000 restricted Class B common unit awards to an officer of Ravix pursuant to an agreement dated October 1, 2021 ("2021 Ravix RUA"). The 2021 Ravix RUA contains both a service and a performance condition that affects vesting.
On October 1, 2021, 83,333 shares, representing one half of the service condition for the 2021 Ravix RUA, became fully vested. The remainder of the service condition vests according to a graded vesting schedule and shall become fully vested on October 1, 2025 subject to the officer's continued employment through the applicable vesting dates. The performance condition vests on October 1, 2025 and is based on the internal rate of return of Ravix. The grant-date fair value of the 2021 Ravix RUA was estimated using the Black-Scholes option pricing model, using the following assumptions: expected term of four years, expected volatility of 75%, expected dividend yield of zero, and risk-free interest rate of 0.93%.
At December 31, 2021, both the service condition and performance condition of the 2021 Ravix RUA were probable of vesting. At December 31, 2021, there were 115,667 unvested shares of the 2021 Ravix RUA with a weighted-average grant date fair value of $3.08 per share. Total unamortized compensation expense related to unvested 2021 Ravix RUA at December 31, 2021 was $0.2 million.
Total stock-based compensation expense, inclusive of Restricted Stock Awards, Restricted Stock Awards of PWSC and Restricted Unit Awards of Ravix described above, net of forfeitures, was $3.6 million and $1.4 million for the years ended December 31, 2021 and December 31, 2020, respectively.
| (d) | Employee Share Purchase Plan |
The Company has an employee share purchase plan ("ESPP Plan") whereby qualifying employees can choose each year to have up to 5% of their annual base earnings withheld to purchase the Company's common shares. After one year of employment, the Company matches 100% of the employee contribution amount, and the contributions vest immediately. All contributions are used by the plan administrator to purchase common shares in the open market. The Company's contribution is expensed as paid and for the years ended December 31, 2021 and December 31, 2020 totaled $0.2 million and $0.1 million, respectively.
NOTE 18 EMPLOYEE BENEFIT PLAN
The Company maintains a defined contribution plan in the United States for all of its qualified employees. Qualifying employees can choose to voluntarily contribute up to 60% of their annual earnings subject to an overall limitation of $19,500 in both 2021 and 2020, respectively. The Company matches an amount equal to 50% of each participant's contribution, limited to the lesser of contributions up to 5% of a participant's earnings or $7,250.
The contributions for the plan vest based on years of service with 100% vesting after five years of service. The Company's contribution is expensed as paid and for the years ended December 31, 2021 and December 31, 2020 totaled $0.4 million and $0.2 million, respectively. All Company obligations to the plans were fully funded as of December 31, 2021.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
NOTE 19 REDEEMABLE CLASS A PREFERRED STOCK
On May 13, 2013, the Company's shareholders approved an amendment to the Company's Articles of Incorporation to create an unlimited number of zero par value class A preferred shares. The Company's Board of Directors have the ability to fix the designation, rights, privileges, restrictions and conditions attaching to the shares of each series of preferred shares. The preferred shares have priority over the common shares.
There were 169,733 and 182,876 shares of Preferred Shares outstanding at December 31, 2021 and December 31, 2020, respectively. Each Preferred Share is convertible into 6.25 common shares at a conversion price of $4.00 per common share any time at the option of the holder prior to the redemption date. During 2021 and 2020, 13,143 and 40,000 Preferred Shares, respectively, were converted into 82,143 and 250,000 common shares, respectively, at the conversion price of $4.00 per common share, or $0.3 million and $1.0 million, respectively, at the option of the holders. As of December 31, 2021, the maximum number of common shares issuable upon conversion of the Preferred Shares is 1,060,831 common shares.
The Preferred Shares are not entitled to vote. The holders of the Preferred Shares are entitled to receive fixed, cumulative, preferential cash dividends at a rate of $1.25 per Preferred Share per year. The cash dividend rate shall be revised to $1.875 per Preferred Share per year if the dividend accumulates for a period greater than 30 consecutive months from the date of the most recent dividend payment. On and after February 3, 2016, the Company may redeem all or any part of the then outstanding Preferred Shares for the price of $28.75 per Preferred Share, plus accrued but unpaid dividends thereon, whether or not declared, up to and including the date specified for redemption. The Company will redeem any Preferred Shares not previously converted into common shares, and which remain outstanding on the redemption date, for the price of $25.00 per Preferred Share, plus accrued but unpaid dividends, whether or not declared, up to and including the date specified for redemption.
As discussed in "Note 2(s), "Summary of Significant Accounting Policies - Holding company liquidity," 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, 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 $6.5 million as of December 31, 2021. None of the terms of the Preferred Shares have changed after the Redemption Date. The Preferred Shares continue to be convertible into common shares 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 accrues dividends through additional paid-in-capital at the stated coupon. At December 31, 2021 and December 31, 2020, accrued dividends of $2.3 million and $2.1 million were included in Class A preferred stock in the consolidated balance sheets. The redemption amount of the Preferred Shares was $6.5 million and $6.7 million at December 31, 2021 and December 31, 2020, respectively.
In accordance with FASB ASC Topic 480-10-S99-3A, SEC Staff Announcement: Classification and Measurement of Redeemable Securities, redemption features not solely within the control of the issuer are required to be presented outside of permanent equity on the consolidated balance sheets. As described above, the holder has the option to convert the Preferred Shares at any time; however, if not converted, they are required to be redeemed when the Company has sufficient legally available funds and is not otherwise prohibited from doing so. As such, the Preferred Shares are presented in temporary or mezzanine equity on the consolidated balance sheets.
NOTE 20 SHAREHOLDERS' EQUITY
The Company is authorized to issue 50,000,000 shares of zero par value common stock. There were 22,882,614 and 22,211,069 shares of common stock outstanding at December 31, 2021 and December 31, 2020, respectively.
There were no dividends declared during the years ended December 31, 2021 and December 31, 2020.
As described inNote 19, "Redeemable Class A Preferred Stock", during 2021 and 2020, 13,143 and 40,000 Preferred Shares, respectively, were converted into 82,143 and 250,000 common shares, respectively. As a result, $0.3 million and $1.0 million was reclassified from redeemable Class A preferred stock to additional paid-in capital on the consolidated balance sheets at December 31, 2021 and December 31, 2020, respectively.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
There were 247,450 shares of treasury stock outstanding at December 31, 2021 and December 31, 2020. The Company records treasury stock at cost.
The Company has warrants outstanding, recorded in shareholders' equity, that will entitle each subscriber to purchase one common share of Kingsway for each warrant. During 2021, warrants to purchase 350,000 shares of common stock were exercised, resulting in cash proceeds of $1.8 million. The following table summarizes information about warrants outstanding at December 31, 2021:
| December 31, 2021 | |
| | | | | | | Remaining Contractual | | | Number | |
| Exercise Price | | Date of Issue | Expiry Date | | Life (in years) | | | Outstanding | |
| $ | 5.00 | | 16-Sep-13 | 15-Sep-23 | | | 1.71 | | | | 2,930,790 | |
| $ | 5.00 | | 3-Feb-14 | 15-Sep-23 | | | 1.71 | | | | 1,642,975 | |
| | | | | Total: | | | 1.71 | | | | 4,573,765 | |
NOTE 21 ACCUMULATED OTHER COMPREHENSIVE INCOME
The table below details the change in the balance of each component of accumulated other comprehensive income, net of tax, for the years ended December 31, 2021 and December 31, 2020 as it relates to shareholders' equity attributable to common shareholders on the consolidated balance sheets.
| (in thousands) | | | | | | | | | | | | | | | | |
| | | | | | | | | | | Change in | | | | | |
| | | | | | | | | | | Fair Value of | | | | | |
| | | Unrealized | | | | | | | Debt | | | | | |
| | | Gains | | | | | | | Attributable | | | Total | |
| | | (Losses) on | | | Foreign | | | to | | | Accumulated | |
| | | Available- | | | Currency | | | Instrument- | | | Other | |
| | | for-Sale | | | Translation | | | Specific | | | Comprehensive | |
| | | Investments | | | Adjustments | | | Credit Risk | | | Income (Loss) | |
| Balance, December 31, 2019 | | $ | 59 | | | $ | (3,286 | ) | | $ | 38,574 | | | $ | 35,347 | |
| | | | | | | | | | | | | | | | | |
| Other comprehensive income arising during the period | | | 93 | | | | — | | | | 2,555 | | | | 2,648 | |
| Amounts reclassified from accumulated other comprehensive income | | | 64 | | | | — | | | | — | | | | 64 | |
| Net current-period other comprehensive income | | | 157 | | | | — | | | | 2,555 | | | | 2,712 | |
| Balance, December 31, 2020 | | $ | 216 | | | $ | (3,286 | ) | | $ | 41,129 | | | $ | 38,059 | |
| | | | | | | | | | | | | | | | | |
| Other comprehensive loss arising during the period | | | (463 | ) | | | — | | | | (6,844 | ) | | | (7,307 | ) |
| Amounts reclassified from accumulated other comprehensive income | | | 27 | | | | — | | | | — | | | | 27 | |
| Net current-period other comprehensive loss | | | (436 | ) | | | — | | | | (6,844 | ) | | | (7,280 | ) |
| Balance, December 31, 2021 | | $ | (220 | ) | | $ | (3,286 | ) | | $ | 34,285 | | | $ | 30,779 | |
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
It should be noted that the consolidated statements of comprehensive loss present the components of other comprehensive (loss) income, net of tax, only for the years ended December 31, 2021 and December 31, 2020 and inclusive of the components attributable to noncontrolling interests in consolidated subsidiaries.
Components of accumulated other comprehensive income were reclassified to the following lines of the consolidated statements of operations for the years ended December 31, 2021 and December 31, 2020:
| (in thousands) | | Years ended December 31, | |
| | | 2021 | | | 2020 | |
| Reclassification of accumulated other comprehensive income from unrealized gains (losses) on available-for-sale investments to: | | | | | | | | |
| Net realized gains | | $ | (27 | ) | | $ | (64 | ) |
| Other-than-temporary impairment loss | | | — | | | | — | |
| Loss from continuing operations before income tax benefit | | | (27 | ) | | | (64 | ) |
| Income tax benefit | | | — | | | | — | |
| Income (loss) from continuing operations | | | (27 | ) | | | (64 | ) |
| Net income (loss) | | $ | (27 | ) | | $ | (64 | ) |
NOTE 22 SEGMENTED INFORMATION
The Company reports segment information based on the "management" approach. The management approach designates the internal reporting used by management for making decisions and assessing performance as a source of the Company’s reportable operating segments. The Company conducts its business through the following three reportable segments - Extended Warranty, Leased Real Estate and Kingsway Search Xcelerator.
Extended Warranty Segment
Extended Warranty includes the following subsidiaries of the Company: IWS, Geminus, PWI, PWSC and Trinity (collectively, "Extended Warranty").
IWS is a licensed motor vehicle service agreement company and is a provider of after-market vehicle protection services distributed by credit unions in 25 states and the District of Columbia to their members, with customers in all 50 states.
Geminus primarily sells vehicle service agreements to used car buyers across the United States, through its subsidiaries, Penn and 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 American Auto Shield in three states with a "white label" agreement. PWI also has a "white label" agreement with a third-party that sells and administers a GAP product in certain states.
PWSC sells home warranty products and provides administration services to homebuilders and homeowners across the United States. PWSC distributes its products and services through an in house sales team and through insurance brokers and insurance carriers throughout all states except Alaska and Louisiana.
Trinity sells 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.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
Leased Real Estate Segment
Leased Real Estate includes the Company's subsidiaries, CMC and RoeCo.
CMC owns the Real Property that is leased to a third-party pursuant to a long-term triple net lease with a single customer. For the year ended December 31, 2021, revenue of $13.4 million from this single customer represents more than 10% of the Company’s consolidated revenues. The Real Property is also subject to the Mortgage. When assessing and measuring the operational and financial performance of the Leased Real Estate segment, interest expense related to the Mortgage is included in Leased Real Estate's segment operating income.
RoeCo owns the LA Real Property that is leased to a third-party pursuant to a long-term lease with a single customer. The LA Real Property is also subject to the LA Mortgage. The Company acquired RoeCo on December 30, 2021, therefore the Leased Real Estate segment operating income does not include any financial results related to RoeCo for the year ended December 31, 2021.
Kingsway Search Xcelerator Segment
Kingsway Search Xcelerator includes the Company's subsidiary, Ravix. Ravix provides outsourced financial services and human resources consulting for short or long duration engagements for customers in21 states and 5 countries. All services are delivered by employees who are located in the United States.
Revenues and Operating Income by Reportable Segment
Results for the Company's reportable segments are based on the Company's internal financial reporting systems and are consistent with those followed in the preparation of the consolidated financial statements. The following tables provide financial data used by management. Segment assets are not allocated for management use and, therefore, are not included in the segment disclosures below.
Revenues by reportable segment reconciled to consolidated revenues for the years ended December 31, 2021 and December 31, 2020 were:
| (in thousands) | | Years ended December 31, | |
| | | 2021 | | | 2020 | |
| Revenues: | | | | | | | | |
| Extended Warranty: | | | | | | | | |
| Service fee and commission revenue | | $ | 74,919 | | | $ | 47,607 | |
| Total Extended Warranty | | | 74,919 | | | | 47,607 | |
| Leased Real Estate: | | | | | | | | |
| Rental revenue | | | 13,365 | | | | 13,365 | |
| Total Leased Real Estate | | | 13,365 | | | | 13,365 | |
| Kingsway Search Xcelerator: | | | | | | | | |
| Service fee and commission revenue | | | 3,482 | | | | — | |
| Total Kingsway Search Xcelerator | | | 3,482 | | | | — | |
| Total revenues | | $ | 91,766 | | | $ | 60,972 | |
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
The operating income (loss) by reportable segment in the following table is before income taxes and includes revenues and direct segment costs. Total segment operating income reconciled to the consolidated income (loss) from continuing operations for the years ended December 31, 2021 and December 31, 2020 were:
| (in thousands) | | Years ended December 31, | |
| | | 2021 | | | 2020 | |
| Segment operating income (loss) | | | | | | | | |
| Extended Warranty (a) | | $ | 12,636 | | | $ | 6,604 | |
| Leased Real Estate (b) | | | 909 | | | | (504 | ) |
| Kingsway Search Xcelerator | | | 484 | | | | — | |
| Total segment operating income | | | 14,029 | | | | 6,100 | |
| Net investment income | | | 1,575 | | | | 2,625 | |
| Net realized gains | | | 1,809 | | | | 580 | |
| (Loss) gain on change in fair value of equity investments | | | (242 | ) | | | 1,267 | |
| Gain on change in fair value of limited liability investments, at fair value | | | 2,391 | | | | 4,046 | |
| Net change in unrealized loss on private company investments | | | — | | | | (744 | ) |
| Other-than-temporary impairment loss | | | — | | | | (117 | ) |
| Interest expense not allocated to segments | | | (6,161 | ) | | | (7,719 | ) |
| Other revenue and expenses not allocated to segments, net | | | (11,395 | ) | | | (10,606 | ) |
| Amortization of intangible assets | | | (4,900 | ) | | | (2,291 | ) |
| (Loss) gain on change in fair value of debt | | | (3,201 | ) | | | 1,173 | |
| Gain (loss) on extinguishment of debt not allocated to segments | | | 311 | | | | (851 | ) |
| Loss from continuing operations before income tax benefit | | | (5,784 | ) | | | (6,537 | ) |
| Income tax benefit | | | (7,644 | ) | | | (1,115 | ) |
| Income (loss) from continuing operations | | $ | 1,860 | | | $ | (5,422 | ) |
| | (a) | For the years ended December 31, 2021 and December 31, 2020, Extended Warranty segment operating income includes gain on extinguishment of debt of $2.2 million and $0.4 million, respectively, related to PPP loan forgiveness directly associated with the respective warranty businesses. The gain of $0.4 million for the year ended December 31, 2020 was reclassified to segment operating income from gain (loss) on extinguishment of debt not allocated to segments to be consistent with current year presentation. Extended Warranty segment operating income before the gain on extinguishment of debt totaled $10.5 million and $6.2 million for the years ended December 31, 2021 and December 31, 2020, respectively. See Note 12, "Debt," for further discussion. |
| | (b) | For the year ended December 31, 2021, includes $2.9 million expense due to the release of an indemnification receivable, which is exactly offset in net income (loss) (not shown here) by 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. |
NOTE 23 FAIR VALUE OF FINANCIAL INSTRUMENTS
Fair value is the price that would be received upon sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best evidenced by quoted bid or ask price, as appropriate, in an active market. Where bid or ask prices are not available, such as in an illiquid or inactive market, the closing price of the most recent transaction of that instrument subject to appropriate adjustments as required is used. Where quoted market prices are not available, the quoted prices of similar financial instruments or valuation models with observable market-based inputs are used to estimate the fair value. These valuation models may use multiple observable market inputs, including observable interest rates, foreign exchange rates, index levels, credit spreads, equity prices, counterparty credit quality, corresponding market volatility levels and option volatilities. Minimal management judgment is required for fair values calculated using quoted market prices or observable market inputs for models. Greater subjectivity is required when making valuation adjustments for financial instruments in inactive markets or when using models where observable parameters do not exist. Also, the calculation of estimated fair value is based on market conditions at a specific point in time and may not be reflective of future fair values. For the Company's financial instruments carried at cost or amortized cost, the book value is not adjusted to reflect increases or decreases in fair value due to market fluctuations, including those due to interest rate changes, as it is the Company's intention to hold them until there is a recovery of fair value, which may be to maturity.
The Company employs a fair value hierarchy to categorize the inputs it uses in valuation techniques to measure the fair value. The following fair value hierarchy is used in selecting inputs, with the highest priority given to Level 1:
| | • | Level 1 – Quoted prices for identical instruments in active markets. |
| | • | Level 2 – Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs are observable in active markets. |
| | • | Level 3 – Valuations derived from valuation techniques in which one or more significant inputs are not observable. |
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
The Company classifies its investments in fixed maturities as available-for-sale and reports these investments at fair value. The Company's equity investments, limited liability investments, at fair value, real estate investments, subordinated debt, warrant liability and stock-based compensation liabilities, derivative contracts (interest rate swap) and contingent consideration are measured and reported at fair value.
Fixed maturities - Fair values of fixed maturities for which no active market exists are derived from quoted market prices of similar instruments or other third-party evidence. All classes of the Company’s fixed maturities, primarily consisting of investments in US. Treasury bills and government bonds; obligations of states, municipalities and political subdivisions; mortgage-backed securities; and corporate securities, are classified as Level 2. Level 2 is applied to valuations based upon quoted prices for similar assets in active markets; quoted prices for identical or similar assets in markets that are inactive; or valuations based on models where the significant inputs are observable or can be corroborated by observable market data.
The Company engages a third-party vendor who utilizes third-party pricing sources and primarily employs a market approach to determine the fair values of our fixed maturities. The market approach includes primarily obtaining prices from independent third-party pricing services as well as, to a lesser extent, quotes from broker-dealers. Our third-party vendor also monitors market indicators, as well as industry and economic events, to ensure pricing is appropriate. All classes of our fixed maturities are valued using this technique. The Company has obtained an understanding of our third-party vendor’s valuation methodologies and inputs. Fair values obtained from our third-party vendor are not adjusted by the Company.
The following is a description of the significant inputs, by asset class, used by the third-party pricing services to determine the fair values of our fixed maturities included in Level 2:
| | • | U.S. government, government agencies and authorities are generally priced using the market approach. Inputs generally consist of trades of identical or similar securities, quoted prices in inactive markets and maturity. |
| | • | States, municipalities and political subdivisions are generally priced using the market approach. Inputs generally consist of trades of identical or similar securities, quoted prices in inactive markets, new issuances and credit spreads. |
| | • | Mortgage-backed securities are generally priced using the market approach. Inputs generally consist of trades of identical or similar securities, quoted prices in inactive markets, expected prepayments, expected credit default rates, delinquencies and issue specific information including, but not limited to, collateral type, seniority and vintage. |
| | • | Corporate securities are generally priced using the market approach using pricing vendors. Inputs generally consist of trades of identical or similar securities, quoted prices in inactive markets, issuer rating, benchmark yields, maturity and credit spreads. |
Equity investments - Fair values of equity investments, including warrants, reflect quoted market values based on latest bid prices, where active markets exist, or models based on significant market observable inputs, where no active markets exist.
Limited liability investments, at fair value - Limited liability investments, at fair value include the underlying investments of Net Lease and Argo Holdings. Net Lease owns investments in limited liability companies that hold investment properties. Argo Holdings makes investments in limited liability companies and limited partnerships that hold investments in search funds and private operating companies.
| | • | The fair value of Net Lease's investments in limited liability companies is based upon the net asset values of the underlying investments in companies as a practical expedient to estimate fair value. The Company applies the net asset value practical expedient to Net Lease's limited liability investments on an investment-by-investment basis unless it is probable that the Company will sell a portion of an investment at an amount different from the net asset value of the investment. Investments that are measured at fair value using the net asset value practical expedient are not required to be classified using the fair value hierarchy. |
| | • | The fair value of Argo Holdings' limited liability investments that hold investments in search funds is based on the initial investment in the search funds. The fair value of Argo Holdings' limited liability investments that hold investments in private operating companies is valued using a market approach including valuation multiples applied to corresponding performance metrics, such as earnings before interest, tax, depreciation and amortization; revenue; or net earnings. The selected valuation multiples were estimated using multiples provided by the investees and review of those multiples in light of investor updates, performance reports, financial statements and other relevant information. These investments are categorized in Level 3 of the fair value hierarchy. |
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
Real estate investments - The fair value of real estate investments involves a combination of the market and income valuation techniques. Under this approach, a market-based capitalization rate is derived from comparable transactions, adjusted for any unique characteristics of each asset, and applied to the asset under consideration. The cap rates used during underwriting and subsequent valuation incorporate the consideration of risks of vacancy and collection loss, administrative costs of owning net leased assets and possible capital expenditures that could be determined a landlord expense. These investments are categorized in Level 3 of the fair value hierarchy.
Subordinated debt - 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. These inputs include credit spread assumptions developed by a third-party and market observable swap rates. The subordinated debt is categorized in Level 2 of the fair value hierarchy.
Warrant liability- The Company issued the KWH Warrants on March 1, 2019. On December 1, 2020, the Company repurchased the KWH Warrants. The KWH Warrants were measured and reported at fair value. The fair value of the warrant liability was estimated using an internal model without relevant observable market inputs. The significant inputs used in the model include an enterprise value multiple applied to earnings before interest, tax, depreciation and amortization. The implied enterprise value was reduced by the remaining debt associated with the 2019 KWH Loan to determine an implied equity value. The liability classified warrants were categorized in Level 3 of the fair value hierarchy.
Stock-based compensation liabilities - As described in Note 17, "Stock-Based Compensation," certain of the restricted stock awards granted by PWSC are classified as a liability. Liability-classified awards are measured and reported at fair value and are included in accrued expenses and other liabilities in the consolidated balance sheets. The fair value of the restricted stock awards granted by PWSC are estimated using an internal valuation model without relevant observable market inputs. The significant inputs used in the model include a valuation multiple applied to trailing twelve month earnings before interest, tax, depreciation and amortization. Liability-classified restricted stock awards are categorized in Level 3 of the fair value hierarchy.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
Derivative contracts - As described inNote 11, "Derivatives," the Company entered into an interest rate swap agreement effective April 1, 2021 to convert the variable interest rate on a portion of the 2020 KWH Loan to a fixed interest rate. The interest rate swap contract is measured and reported at fair value and is included in accrued expenses and other liabilities in the consolidated balance sheets. The fair value of the interest rate swap contract is estimated using inputs which the Company obtains from the counterparty and is determined using a discounted cash flow analysis on the expected cash flows of the derivative. The discounted cash flow valuation technique reflects the contractual term of the derivative contract, including the period to maturity, and uses observable market based inputs, including quoted mid-market prices or third-party consensus pricing, interest rate curves and implied volatilities. The interest rate swap contract is categorized in Level 2 of the fair value hierarchy.
Contingent consideration - The consideration for Company's acquisition of Ravix includes future payments to the former owners that are contingent upon the achievement of certain targets over future reporting periods. Liabilities for contingent consideration are measured and reported at fair value and are included in accrued expenses and other liabilities in the consolidated balance sheets. The fair value of the Company's contingent consideration liability is estimated by applying the Monte Carlo simulation method to forecast achievement of gross profit which may result in up to $4.5 million in total payments to the former owners of Ravix through October 2024. Key inputs in the valuation include forecasted gross profit, gross profit volatility, discount rate and discount term. Contingent consideration liabilities are revalued each reporting period. Changes in the fair value of contingent consideration liabilities can result from changes to one or multiple inputs, including adjustments to the discount rates or changes in the assumed achievement or timing of any targets. Any changes in fair value are reported in the consolidated statements of operations as other (expense) income. The contingent consideration liability is categorized in Level 3 of the fair value hierarchy.
Assets and Liabilities Measured at Fair Value on a Recurring Basis
The balances of the Company's financial assets and liabilities measured at fair value on a recurring basis by level within the fair value hierarchy as of December 31, 2021 and December 31, 2020 are as follows. Certain investments in limited liability companies that are measured at fair value using the net asset value practical expedient are not required to be classified using the fair value hierarchy, but are presented in the following tables to permit reconciliation of the fair value hierarchy to the amounts presented in the consolidated balance sheets:
| (in thousands) | | | | | | | | | | December 31, 2021 | |
| | | Fair Value Measurements at the End of the Reporting Period Using | |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | | | Quoted | | | | | | | | | | | | | |
| | | | | | | Prices in | | | | | | | | | | | | | |
| | | | | | | Active | | | Significant | | | | | | | | | |
| | | | | | | Markets for | | | Other | | | Significant | | | | | |
| | | | | | | Identical | | | Observable | | | Unobservable | | | Measured at | |
| | | | | | | Assets | | | Inputs | | | Inputs | | | Net Asset | |
| | | Total | | | (Level 1) | | | (Level 2) | | | (Level 3) | | | Value | |
| Recurring fair value measurements | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Assets: | | | | | | | | | | | | | | | | | | | | |
| Fixed maturities: | | | | | | | | | | | | | | | | | | | | |
| U.S. government, government agencies and authorities | | $ | 16,223 | | | $ | — | | | $ | 16,223 | | | $ | — | | | $ | — | |
| States, municipalities and political subdivisions | | | 1,878 | | | | — | | | | 1,878 | | | | — | | | | — | |
| Mortgage-backed | | | 7,629 | | | | — | | | | 7,629 | | | | — | | | | — | |
| Asset-backed | | | 445 | | | | — | | | | 445 | | | | — | | | | — | |
| Corporate | | | 9,491 | | | | — | | | | 9,491 | | | | — | | | | — | |
| Total fixed maturities | | | 35,666 | | | | — | | | | 35,666 | | | | — | | | | — | |
| Equity investments: | | | | | | | | | | | | | | | | | | | | |
| Common stock | | | 171 | | | | 171 | | | | — | | | | — | | | | — | |
| Warrants | | | 8 | | | | — | | | | 8 | | | | — | | | | — | |
| Total equity investments | | | 179 | | | | 171 | | | | 8 | | | | — | | | | — | |
| Limited liability investments, at fair value | | | 18,826 | | | | — | | | | — | | | | 4,022 | | | | 14,804 | |
| Real estate investments | | | 10,662 | | | | — | | | | — | | | | 10,662 | | | | — | |
| Total assets | | $ | 65,333 | | | $ | 171 | | | $ | 35,674 | | | $ | 14,684 | | | $ | 14,804 | |
| | | | | | | | | | | | | | | | | | | | | |
| Liabilities: | | | | | | | | | | | | | | | | | | | | |
| Subordinated debt | | $ | 60,973 | | | $ | — | | | $ | 60,973 | | | $ | — | | | $ | — | |
| Contingent consideration | | | 2,458 | | | | — | | | | — | | | | 2,458 | | | | — | |
| Stock-based compensation liabilities | | | 1,402 | | | | — | | | | — | | | | 1,402 | | | | — | |
| Derivative contract - interest rate swap | | | 14 | | | | — | | | | 14 | | | | — | | | | — | |
| Total liabilities | | $ | 64,847 | | | $ | — | | | $ | 60,987 | | | $ | 3,860 | | | $ | — | |
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
| (in thousands) | | | | | | | | | | December 31, 2020 | |
| | | Fair Value Measurements at the End of the Reporting Period Using | |
| | | | | | | | | | | | | | | | | | | | | |
| | | | | | | Quoted | | | | | | | | | | | | | |
| | | | | | | Prices in | | | | | | | | | | | | | |
| | | | | | | Active | | | Significant | | | | | | | | | |
| | | | | | | Markets for | | | Other | | | Significant | | | | | |
| | | | | | | Identical | | | Observable | | | Unobservable | | | Measured | |
| | | | | | | Assets | | | Inputs | | | Inputs | | | at Net | |
| | | Total | | | (Level 1) | | | (Level 2) | | | (Level 3) | | | Asset Value | |
| Recurring fair value measurements | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
| Assets: | | | | | | | | | | | | | | | | | | | | |
| Fixed maturities: | | | | | | | | | | | | | | | | | | | | |
| U.S. government, government agencies and authorities | | $ | 10,104 | | | $ | — | | | $ | 10,104 | | | $ | — | | | $ | — | |
| States, municipalities and political subdivisions | | | 1,454 | | | | — | | | | 1,454 | | | | — | | | | — | |
| Mortgage-backed | | | 5,394 | | | | — | | | | 5,394 | | | | — | | | | — | |
| Corporate | | | 3,764 | | | | — | | | | 3,764 | | | | — | | | | — | |
| Total fixed maturities | | | 20,716 | | | | — | | | | 20,716 | | | | — | | | | — | |
| Equity investments: | | | | | | | | | | | | | | | | | | | | |
| Common stock | | | 155 | | | | 155 | | | | — | | | | — | | | | — | |
| Warrants | | | 289 | | | | 17 | | | | 272 | | | | — | | | | — | |
| Total equity investments | | | 444 | | | | 172 | | | | 272 | | | | — | | | | — | |
| Limited liability investments, at fair value | | | 32,811 | | | | — | | | | — | | | | 3,263 | | | | 29,548 | |
| Real estate investments | | | 10,662 | | | | — | | | | — | | | | 10,662 | | | | — | |
| Total assets | | $ | 64,633 | | | $ | 172 | | | $ | 20,988 | | | $ | 13,925 | | | $ | 29,548 | |
| | | | | | | | | | | | | | | | | | | | | |
| Liabilities: | | | | | | | | | | | | | | | | | | | | |
| Subordinated debt | | $ | 50,928 | | | $ | — | | | $ | 50,928 | | | $ | — | | | $ | — | |
| Stock-based compensation liabilities | | | 443 | | | | — | | | | — | | | | 443 | | | | — | |
| Total liabilities | | $ | 51,371 | | | $ | — | | | $ | 50,928 | | | $ | 443 | | | $ | — | |
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
The following table provides a reconciliation of the fair value of recurring Level 3 fair value measurements for the years ended December 31, 2021 and December 31, 2020:
| (in thousands) | | Years ended December 31, | |
| | | 2021 | | | 2020 | |
| Assets: | | | | | | | | |
| Limited liability investments, at fair value: | | | | | | | | |
| Beginning balance | | $ | 3,263 | | | $ | 4,392 | |
| Purchases | | | — | | | | 21 | |
| Distributions received | | | (658 | ) | | | (808 | ) |
| Realized gains included in net income (loss) | | | 631 | | | | 474 | |
| Change in fair value of limited liability investments, at fair value included in net income (loss) | | | 786 | | | | (816 | ) |
| Ending balance | | $ | 4,022 | | | $ | 3,263 | |
| Unrealized lossses (gains) on limited liability investments, at fair value held at end of period: | | | | | | | | |
| Included in net income (loss) | | $ | 786 | | | $ | (816 | ) |
| Included in other comprehensive (loss) income | | $ | — | | | $ | — | |
| Real estate investments: | | | | | | | | |
| Beginning balance | | $ | 10,662 | | | $ | 10,662 | |
| Change in fair value of real estate investments included in net income (loss) | | | — | | | | — | |
| Ending balance | | $ | 10,662 | | | $ | 10,662 | |
| Unrealized gains recognized on real estate investments held at end of period: | | | | | | | | |
| Included in net income (loss) | | | — | | | | — | |
| Included in other comprehensive (loss) income | | | — | | | | — | |
| Ending balance - assets | | $ | 14,684 | | | $ | 13,925 | |
| Liabilities: | | | | | | | | |
| Contingent consideration: | | | | | | | | |
| Beginning balance | | $ | — | | | $ | — | |
| Issuance of contingent consideration in connection with acquisition | | | 2,195 | | | | — | |
| Change in fair value of contingent consideration included in net income (loss) | | | 263 | | | | — | |
| Ending balance | | $ | 2,458 | | | $ | — | |
| Unrealized losses recognized on contingent consideration liability held at end of period: | | | | | | | | |
| Included in net income (loss) | | $ | 263 | | | $ | — | |
| Included in other comprehensive (loss) income | | $ | — | | | $ | — | |
| Warrant liability: | | | | | | | | |
| Beginning balance | | $ | — | | | $ | 249 | |
| Termination of warrants | | | — | | | | (336 | ) |
| Change in fair value of warrant liability included in net loss | | | — | | | | 87 | |
| Ending balance | | $ | — | | | $ | — | |
| Unrealized losses recognized on warrant liability held at end of period: | | | | | | | | |
| Included in net income (loss) | | $ | — | | | $ | 87 | |
| Included in other comprehensive (loss) income | | $ | — | | | $ | — | |
| Stock-based compensation liabilities: | | | | | | | | |
| Beginning balance | | $ | 443 | | | $ | — | |
| Issuance of stock-based compensation awards | | | — | | | | 443 | |
| Change in fair value of stock-based compensation liabilities included in net income (loss) | | | 959 | | | | — | |
| Ending balance | | $ | 1,402 | | | $ | 443 | |
| Unrealized losses recognized on stock-based compensation liabilities held at end of period: | | | | | | | | |
| Included in net income (loss) | | $ | 959 | | | $ | — | |
| Included in other comprehensive (loss) income | | $ | — | | | $ | — | |
| Ending balance - liabilities | | $ | 3,860 | | | $ | 443 | |
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
The following table summarizes the valuation techniques and significant unobservable inputs utilized in determining fair values for the Company's investments that are categorized as Level 3 at December 31, 2021:
| Categories | | Fair Value | | Valuation Techniques | Unobservable Inputs | | Input Value(s) | |
| Limited liability investments, at fair value | | $ | 4,022 | | Market approach | Valuation multiples | | 1.0x - 8.0x | |
| Real estate investments | | $ | 10,662 | | Market and income approach | Cap rates | | | 7.5 | % |
| Contingent consideration | | $ | 2,458 | | Option-based income approach | Discount rate | | | 4.0 | % |
| | | | | | | Risk-free rate | | 0.49 | % |
| | | | | | | Expected volatility | | 15.0 | % |
| Stock-based compensation liabilities | | $ | 1,402 | | Market approach | Valuation multiple | | 6.0x | |
The following table summarizes the valuation techniques and significant unobservable inputs utilized in determining fair values for the Company's investments that are categorized as Level 3 at December 31, 2020:
| Categories | | Fair Value | | Valuation Techniques | Unobservable Inputs | | Input Value(s) | |
| Limited liability investments, at fair value | | $ | 3,263 | | Market approach | Valuation multiples | | 3.1x - 8.0x | |
| Real estate investments | | $ | 10,662 | | Market and income approach | Cap rates | | | 7.5 | % |
| Stock-based compensation liabilities | | $ | 443 | | Market approach | Valuation multiple | | 6.0x | |
Investments Measured Using the Net Asset Value per Share Practical Expedient
The following table summarizes investments for which fair value is measured using the net asset value per share practical expedient at December 31, 2021:
| | | Fair Value | | | | | | | | | | | Redemption | |
| Category | | (in thousands) | | | Unfunded Commitments | | | Redemption Frequency | | | Notice Period | |
| Limited liability investments, at fair value | | $ | 14,804 | | | | n/a | | | | n/a | | | | n/a | |
The following table summarizes investments for which fair value is measured using the net asset value per share practical expedient at December 31, 2020:
| | | Fair Value | | | | | | | | | | | Redemption | |
| Category | | (in thousands) | | | Unfunded Commitments | | | Redemption Frequency | | | Notice Period | |
| Limited liability investments, at fair value | | $ | 29,548 | | | | n/a | | | | n/a | | | | n/a | |
Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
Certain assets and liabilities are measured at fair value on a nonrecurring basis, including assets that are adjusted for observable price changes or written down to fair value as a result of an impairment. For the years ended December 31, 2021 and December 31, 2020, the Company did not record any adjustments to the fair value of its investments in private companies for observable price changes. The Company recorded impairments related to investments in private companies of zero and $0.7 million for the years ended December 31, 2021 and December 31, 2020, respectively, which are included in net change in unrealized loss on private company investments in the consolidated statements of operations. The impairments recorded for the year ended December 31, 2020 are a result of the impact of the COVID-19 pandemic on the investments' underlying business. To determine the fair value of investments in these private companies, the Company considered rounds of financing and third-party transactions, discounted cash flow analyses and market-based information, including comparable transactions, trading multiples and changes in market outlook, among other factors. The Company has classified the fair value measurements of these investments in private companies as Level 3 because they involve significant unobservable inputs.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
As further discussed in Note 4, "Acquisitions," the Company acquired PWI on December 1, 2020 and finalized the related purchase price allocation during the third quarter of 2021. The fair values of intangible assets and deferred service fees associated with the acquisition of PWI were determined to be Level 3 under the fair value hierarchy.
The following table summarizes the valuation techniques and significant unobservable inputs utilized in determining fair values for these Level 3 measurements:
| Categories | | Fair Value | | Valuation Techniques | Unobservable Inputs | | Input Value(s) | |
| Customer relationships | | $ | 15,000 | | Multi-period excess earnings | Growth rate | | | 3.0 | % |
| | | | | | | Attrition rate | | | 12.3 | % |
| | | | | | | Discount rate | | | 29.5 | % |
| Trade name | | $ | 4,550 | | Relief from royalty | Royalty rate | | | 4.0 | % |
| | | | | | | Discount rate | | | 29.5 | % |
| Deferred service fees | | $ | 3,626 | | Cost build-up | Normal profit margin | | | 17.8%-21.1% | |
| | | | | | | Discount rate | | | 2.5 | % |
As further discussed in Note 4, "Acquisitions," the Company acquired Ravix on October 1, 2021 and provisionally allocated the purchase price to the assets acquired and liabilities assumed. The fair values of intangible assets associated with the acquisition of Ravix were determined to be Level 3 under the fair value hierarchy.
The following table summarizes the valuation techniques and significant unobservable inputs utilized in determining fair values for these Level 3 measurements:
| Categories | | Fair Value | | Valuation Techniques | | Unobservable Inputs | | Input Value(s) |
| Customer relationships | | $ 4,000 | | Multi-period excess earnings | | Growth rate | | 3.0% |
| | | | | | | Attrition rate | | 15.0% |
| | | | | | | Discount rate | | 21.0% |
| Trade name | | $ 2,500 | | Relief from royalty | | Royalty rate | | 3.0% |
| | | | | | | Discount rate | | 21.0% |
NOTE 24 RELATED PARTIES
Related party transactions, including services provided to or received by the Company's subsidiaries, are measured in part by the amount of consideration paid or received as established and agreed by the parties. Except where disclosed elsewhere in these consolidated financial statements, the following is a summary of related party relationships and transactions.
| (a) | Argo Management Group, LLC |
The Company acquired Argo Management in April 2016. Argo Management's primary business is to act as Managing Member of Argo Holdings. At December 31, 2021 and December 31, 2020, each of the Company, John T. Fitzgerald ("Fitzgerald"), the Company's Chief Executive Officer and President, and certain of Fitzgerald’s immediate family members owns equity interests in Argo Holdings, all of which interests were acquired prior to the Company’s acquisition of Argo Management. Subject to certain limitations, Argo Holdings' governing documents require all individuals and entities owning an equity interest in Argo Holdings to fund upon request his/her/its pro rata share of any funding requirements of Argo Holdings up to an aggregate maximum amount equal to his/her/its total capital commitment (each request for funds being referred to as a "Capital Call"). Argo Holdings made no Capital Calls during the years ended December 31, 2021 and December 31, 2020.
On December 30 2021, the Company closed on an agreement to acquire 100% of the membership interests in RoeCo from a current holder of the Company’s Preferred Shares (refer to Note 4, "Acquisitions", for further detail). The Company determined the acquisition was an arms-length transaction based upon the purchase price paid compared to the pricing of similar third-party transactions.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
NOTE 25 COMMITMENTS AND CONTINGENT LIABILITIES
CMC Industries
In April 2018, TRT, an indirect subsidiary of Kingsway, was named as a defendant in a lawsuit filed in the United States District Court for the Southern District of New York relating to CMC and its subsidiaries. Kingsway indirectly, through its indirect, wholly-owned subsidiary, CMC Acquisition, LLC ("CMCA"), owns 81% of CMC. TRT (an indirect, wholly-owned subsidiary of CMC) entered into a Management Services Agreement (the "MSA") with DGI-BNSF Corp. ("DGI") (an affiliate of CRIC TRT Acquisition, LLC ("CRIC"), the entity that owns the remaining 19% of CMC) in July 2016 pursuant to which, among other things, DGI agreed to provide services to TRT in exchange for the fees specified in the MSA. The complaint filed by DGI alleged that DGI was owed certain fees under the MSA that had not been paid.
In March 2021, DGI, TRT and various other entities affiliated with each of them entered into a settlement agreement with respect to such litigation and certain other matters ("CMC Settlement Agreement"). Pursuant to the CMC Settlement Agreement, the parties agreed that proceeds from increased rental payments due to an earlier amendment to the lease of the Real Property (or any borrowings against such increased rental payments) would be split 80% to DGI as a management fee under the MSA and 20% to CMCA as a priority distribution on its ownership of CMC, after CMCA received a priority payment of $1.5 million. The parties also agreed that net proceeds from an eventual sale or renewal of the lease of the Real Property (after repayment of outstanding indebtedness and various other fees and expenses) would be split as follows:
(a) if such net proceeds are equal to or greater than $72 million, (i) CMCA would receive the first $40 million as a distribution of a preferred return on its ownership of CMC, (ii) CRIC would receive the next $9.4 million as a distribution on its ownership of CMC, (iii) DGI would receive the next $30.6 million as a management fee under the MSA, and (iv) the remainder of such net proceeds (if any) would be split 48.6% to CMCA as a distribution in respect of its ownership of CMC, 40% to DGI in the form of a management fee under the MSA, and 11.4% to CRIC s a distributions in respect of its ownership of CMC; or
(b) if such net proceeds are less than $72 million, (i) 55% to CMCA as a distribution of a preferred return on its ownership of CMC, (ii) 12.9% to CRIC as a distribution on its ownership of CMC, and (iii) 32.1% to DGI in the form of a management fee to DGI under the MSA. In connection with the CMC Settlement Agreement, the Company recorded a liability of $2.6 million for the 80% management fee due to DGI at December 31, 2020, which is included in general and administrative expenses in its consolidated statement of operations for the year ended December 31, 2020.
On June 2, 2021, TRT borrowed $15.0 million under the Additional Mortgage. The Company distributed $10.6 million to DGI during the second quarter of 2021 as a prepaid management fee, representing 80% of the net proceeds from the Additional Mortgage, and $2.7 million (20%) to CMCA as a priority distribution on its ownership of CMC.
Aegis
In May 2016, Aegis Security Insurance Company ("Aegis") filed a complaint for breach of contract and declaratory relief against the Company in the Eastern District of Pennsylvania alleging, among other things, that the Company breached a contractual obligation to indemnify Aegis for certain customs bond losses incurred by Aegis under the indemnity and hold harmless agreements provided by the Company to Aegis for certain customs bonds reinsured by Lincoln General Insurance Company ("Lincoln General") during the period of time that Lincoln General was a subsidiary of the Company. Lincoln General was placed into liquidation in November 2015 and Aegis subsequently invoked its rights to indemnity under the indemnity and hold harmless agreements. Effective January 20, 2020, Aegis and the Company entered into a Settlement Agreement with respect to such litigation pursuant to which the Company agreed to pay Aegis a one-time settlement amount of $0.9 million, which the Company reported in its consolidated statement of operations during the first quarter of 2020, and to reimburse Aegis for 60% of future losses that Aegis may sustain in connection with such customs bonds, up to a maximum reimbursement amount of $4.8 million. During the third and fourth quarters of 2020, the Company made reimbursement payments to Aegis of $0.5 million in connection with the Settlement Agreement. The Company reported the payments to Aegis in general and administrative expenses in its consolidated statement of operations for the year ended December 31, 2020. During the third quarter of 2021, the Company made a reimbursement payment to Aegis of $0.1 million in connection with the Settlement Agreement, which is included in general and administrative expenses in its consolidated statement of operations for the year ended December 31, 2021. The Company’s potential exposure under these agreements was not reasonably determinable at December 31, 2021, and no liability has been recorded in the in the consolidated financial statements at December 31, 2021.
Mendota
As part of the October 18, 2018 transaction to sell Mendota Insurance Company, Mendakota Insurance Company and Mendakota Casualty Company (collectively "Mendota"), 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 were no payments made related to the open claims during the years ended December 31, 2021 and December 31, 2020. The Company's potential exposure under these agreements was not reasonably determinable at December 31, 2021, and no liability has been recorded in the consolidated financial statements at December 31, 2021.
CMC Industries
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. The guarantee fee was recorded as a debt issuance cost related to the Additional Mortgage.
KINGSWAY FINANCIAL SERVICES INC.
Notes to Consolidated Financial Statements
RoeCo
The LA Mortgage is nonrecourse indebtedness with respect to the assets of RoeCo, and the LA Mortgage is not, nor will it be, guaranteed by Kingsway or its affiliates unless RoeCo acts in bad-faith or commits intentional acts with respect to the LA Mortgage. The LA Mortgage is secured in part by a guaranty of recourse liabilities, whereby KAI, as guarantor, would become liable for the recourse liabilities if RoeCo, as borrower, violates certain terms of the loan agreement. Under the guarantee, the lender can recover losses from the guarantor for certain bad-faith or other intentional acts of the borrower, such as rents retained by the borrower in violation of the loan documents, fraud or intentional misrepresentation, changes to the lease without the lender's consent, willful misconduct, criminal acts and environmental losses sustained by lender. In addition, the guarantee provides that the LA Mortgage will be the full personal recourse obligation of the guarantor, for certain actions, such as prohibited transfers of the collateral or bankruptcy of the borrower.
| (c) | Collateral pledged and restricted cash: |
Short-term investments with an estimated fair value of $0.2 million at December 31, 2021 and December 31, 2020, were on deposit with state regulatory authorities.
The Company also has restricted cash of $17.3 million and $30.6 million at December 31, 2021 and December 31, 2020, respectively. Included in restricted cash are:
| | • | $12.6 million and $27.7 million at December 31, 2021 and December 31, 2020, respectively, held as deposits by IWS, Geminus, PWI, PWSC and Ravix. PWI, which was acquired by the Company in December 2020, began investing a substantial portion of its restricted cash during 2021; |
| | • | $1.9 million at December 31, 2021 and December 31, 2020, on deposit with state regulatory authorities; and |
| | • | $2.8 million and $1.0 million at December 31, 2021 and December 31, 2020, respectively, pledged to third-parties as deposits or to collateralize liabilities. Collateral pledging transactions are conducted under terms that are common and customary to standard collateral pledging and are subject to the Company's standard risk management controls. |
NOTE 26 REGULATORY CAPITAL REQUIREMENTS AND RATIOS
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. As of December 31, 2012, Amigo’s RBC was 157%. 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. As of December 31, 2021, Amigo's RBC was 8,417%.
Kingsway Reinsurance Corporation ("Kingsway Re"), which is domiciled in Barbados, is required by the regulator in Barbados to maintain minimum capital levels. As of December 31, 2021, the capital maintained by Kingsway Re was in excess of the regulatory capital requirements in Barbados.
NOTE 27 STATUTORY INFORMATION AND POLICIES
The Company's insurance subsidiary, Amigo, prepares statutory basis financial statements in accordance with accounting practices prescribed or permitted by the Florida Office of Insurance Regulation. "Prescribed" statutory accounting practices include state laws, regulations and general administrative rules, as well as a variety of publications of the NAIC. "Permitted" statutory accounting practices encompass all accounting practices that are not prescribed. Such practices may differ from state to state; may differ from company to company within a state; and may change in the future.
Amigo is required to report results of operations and financial position to insurance regulatory authorities based upon statutory accounting practices. In converting from statutory to U.S. GAAP, typical adjustments include the inclusion of statutory non-admitted assets in the balance sheets and the inclusion of changes in deferred tax assets and liabilities in net loss.
Statutory capital and surplus and statutory net loss for Amigo are:
| (in thousands) | | December 31, | |
| | | 2021 | | | 2020 | |
| Net loss, statutory basis | | $ | (22 | ) | | $ | (138 | ) |
| Capital and surplus, statutory basis | | $ | 1,965 | | | $ | 1,987 | |
Amigo is required to hold minimum levels of statutory capital and surplus to satisfy regulatory requirements. The minimum statutory capital and surplus, or company action level RBC, necessary to satisfy regulatory requirements for Amigo was less than $0.1 million at December 31, 2021. Company action level RBC is the level at which an insurance company is required to file a corrective action plan with its regulators and is equal to 200% of the authorized control level RBC.
Dividends paid by Amigo are restricted by regulatory requirements of the Florida Office of Insurance Regulation. The maximum amount of dividends that can be paid to shareholders by insurance companies domiciled in the state of Florida without prior regulatory approval is generally limited to the greater of (i) 10% of a company's statutory capital and surplus at the end of the previous year or (ii) 100% of the company's net income for the previous year and is generally required to be paid out of an insurance company's unassigned funds.
At December 31, 2021, Amigo was restricted from making any dividend payments to the holding company without regulatory approval.
KINGSWAY FINANCIAL SERVICES INC.