AM Best has maintained the under review with negative implications status for the Financial Strength Rating of A- (Excellent) and the Long-Term Issuer Credit Ratings (Long-Term ICR) of “a-” of Watford Re Ltd. (Watford Re) (Bermuda) and its subsidiaries, Watford Insurance Company Europe Limited (WICE) (Gibraltar), Watford Insurance Company (WIC) (New Jersey) and Watford Specialty Insurance Company (WSIC) (New Jersey). In addition, AM Best has maintained the under review with negative implications status for the Long-Term ICR of “bbb-” and the Long-Term Issue Credit Rating of “bb” on the $225 million ($52 million outstanding) 8.5% cumulative preference shares of Watford Holdings Ltd. (Watford) (Bermuda) [NASDAQ: WTRE], the group’s ultimate holding company.
This Credit Rating (rating) action considers the recent announcement that Arch Capital Group Ltd. (Arch) [NASDAQ: ACGL] has revised its merger agreement with Watford to an all-cash offer of $35 per share. The revised offer is valued at approximately $700 million and represents a premium of approximately 96% to Watford’s unaffected closing common share price on Sept. 8, 2020, the last trading day prior to media reports about the possibility of a transaction between Watford and Arch. The rating action also considers Watford’s progress to date in limiting the group’s exposure to investment volatility through de-risking its investment portfolio, which incurred sizable losses during the first quarter of 2020.
AM Best acknowledges that the proposed transaction with Arch could benefit the Watford group through potential further de-risking of its investment portfolio, removing the burden of public company status, and possible rating enhancement stemming from being a member of a very large, well-diversified group. However, AM Best has maintained the under review with negative implications status given Watford’s significant, albeit somewhat improved, exposure to investment losses stemming mostly from its non-investment grade bond portfolio, which is subject to significant unrealized losses if credit spreads widen.
In the first quarter of 2020, the Watford group incurred investment losses of about $300 million due to investment market volatility following the COVID-19 pandemic related economic shutdowns mandated by governments around the world. This loss materially impacted the group’s risk adjusted capital position and operating performance. Following that first quarter investment loss, Watford continues to take steps to lower the risk profile on its investment portfolio. However, the investment portfolio’s exposure to unrealized losses may still have a substantial impact on Watford’s financial performance, the probability of which is uncertain due to the pandemic and the impact that resulting economic shut-downs may have on credit spreads. Through the third quarter of 2020, the group’s year-to-date investment income has improved to approximately $29 million.
AM Best will reassess the under review implications status as the group continues to de-risk. The transaction is expected to close in the first quarter of 2021 and remains subject to customary conditions, including regulatory and shareholder approval. Arch expects to assign its interests and obligations under the merger agreement to a newly formed entity under which Arch will own approximately a 40% stake, with funds managed by Warburg Pincus LLC and Kelso & Company each owning approximately 30%.
The under review status is expected to be resolved when the transaction closes and AM Best has met with management and analyzed the group's business plans, including an analysis of future investment risk, financial projections and operating structure within the Arch group. AM Best will continue to evaluate Watford’s balance sheet strength, operating performance and enterprise risk management to assess that it stays in line with projected amounts.
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Senior Financial Analyst
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