Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk
We are exposed to interest rate risk related to borrowings in various businesses. These risks result primarily from changes in LIBOR rates and the spread over LIBOR rates related to the credit risks of our businesses.
For fixed rate debt, interest rate fluctuations generally affect the fair value of our liabilities, but do not impact our earnings. Therefore, interest rate risk does not have a significant impact on our fixed rate debt obligations until such obligations mature or until we elect to prepay and refinance such obligations. If interest rates have risen at the time our fixed rate debt matures or is refinanced, our future earnings could be adversely affected by additional borrowing costs. Conversely, lower interest rates at the time of maturity or refinancing may lower our overall interest expense. As of December 31, 2020, the Company had $125 million of general purpose fixed rate debt outstanding maturing in 2057.
For general purpose floating rate debt, interest rate fluctuations primarily affect interest expense and cash flows. If market interest rates rise, our earnings could be adversely affected by an increase in interest expense. In contrast, lower interest rates may reduce our interest expense and improve our earnings, except to the extent that our borrowings are subject to interest rate floors. The floating interest rate risk of asset based financing is generally offset as the financing and the purchased financial asset are generally subject to the same interest rate risk. For floating rate risk of other asset based financing such as borrowings to finance acquisitions of real estate, we generally hedge our exposure to the variability of the benchmark index with an interest rate swap.
As of December 31, 2020, we had $120.3 million of general purpose floating rate debt with a weighted average rate of 7.8%. A 100 basis point change in interest rates would increase interest expense by $1.2 million and decrease interest rate expense by $0.0 million (including the effect of applicable minimum interest rates) on an annualized basis. As of December 31, 2019, we had $68.2 million of general purpose floating rate debt with a weighted average rate of 7.2%. A 100 basis point change in interest rates would increase interest expense by $0.5 million and decrease interest rate expense by $0.2 million (including the effect of applicable minimum interest rates) on an annualized basis.
Our consolidated results include investments in bonds, loans or other interest bearing instruments. The fair values of such investments fluctuate in response to changes in market interest rates. Increases and decreases in interest rates generally translate into decreases and increases in fair values of these instruments. Some of these investments bear a floating rate of interest which subjects the Company to cash flow risk based upon changes in the underlying interest rate index. As noted above in the discussion of risks related to floating rate borrowings, the Company mitigates a significant amount of our floating rate risk by matching the funding of such investments with borrowings based upon the same interest rate index. Additionally, fair values of interest rate sensitive instruments may be affected by the creditworthiness of the issuer, prepayment options, relative values of alternative investments, the liquidity of the instrument and other general market conditions.
As of December 31, 2020, we had $510 million invested in interest bearing instruments, which represents 63% of the total investments portfolio. The estimated effects of a hypothetical increase in interest rates of 100 bps would result in a decrease to the fair value of the portfolio by $14.2 million. As of December 31, 2019, we had $385 million invested in interest bearing instruments, which represents 52% of the total investments portfolio. The estimated effects of a hypothetical increase in interest rates of 100 bps would result in a decrease to the fair value of the portfolio by $8.2 million.
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Credit Risk
We are exposed to credit risk in the form of available for sale securities, investments in loans, and other investments as follows:
($ in thousands) As of December 31,
2020 2019
Available for sale securities, at fair value (1)
Obligations of state and political subdivisions
$ 44,350 $ 46,338
Corporate securities 94,941 51,231
Asset backed securities 36,192 44,018
Certificates of deposit
1,355 896
Obligations of foreign governments 3,992 1,119
Loans, at fair value (2)
Corporate loans 7,795 9,787
Non-performing loans — 387
Other investments (3)
Corporate bonds, at fair value 105,777 20,705
Debentures 17,703 15,423
Other 802 6,956
Total $ 312,907 $ 196,860
(1) The Company also holds investments in U.S. Treasury securities and obligations of U.S. government authorities and agencies of $196.3 million and $191.6 million as of December 31, 2020 and 2019, respectively. These investments do not represent a credit risk and are excluded.
(2) The Company also holds investments in mortgage loans held for sale of $82.9 million and $95.7 million as of December 31, 2020 and 2019, respectively. These investments do not represent a credit risk and are excluded.
(3) The Company also holds other investments of $95.4 million and $94.4 million as of December 31, 2020 and 2019, respectively, primarily comprised of vessels. These investments do not represent a credit risk and are excluded.
Credit risk within the Company’s investments represents the exposure to the adverse changes in the creditworthiness of individual investment holdings, issuers, groups of issuers, industries, and countries. As of December 31, 2020 and 2019, 62% and 72%, respectively, of the investments subject to credit risk had investment grade ratings. A widening of credit spreads by 100 bps for the investments subject to credit risk would result in a decrease of $5.9 million and $5.0 million to the fair value of the portfolio as of December 31, 2020 and 2019, respectively.
In addition, our mortgage business also underwrites mortgage loans for the purpose of selling them into the secondary market. Due to the relatively short holding period, the credit risk associated with mortgage loans held for sale is not expected to be significant.
See Note (6) Investments to the consolidated financial statements for more information regarding our investments in loans by type.
Market Risk
We are primarily exposed to market risk related to the following investments:
($ in thousands) As of December 31, 2020 As of December 31, 2019
Insurance Tiptree Capital - Other Total Insurance Tiptree Capital - Other Total
Invesque
$ 5,370 $ 25,708 $ 31,078 $ 19,376 $ 92,562 $ 111,938
Fixed income exchange traded fund 63,875 — 63,875 25,039 — 25,039
Other equity securities 28,885 — 28,885 18,401 — 18,401
Total equity securities $ 98,130 $ 25,708 $ 123,838 $ 62,816 $ 92,562 $ 155,378
A 10% increase or decrease in the fair value of such investments would result in $12.3 million and $15.5 million of unrealized gains and losses as of December 31, 2020 and 2019, respectively.
As of December 31, 2020 and 2019, we owned 17.0 million and 16.6 million shares of common stock, respectively, or approximately 31%, of Invesque, a real estate investment company that specializes in health care real estate and senior living property investment throughout North America. The value of our Invesque shares is reported at fair market value on a quarterly basis and fluctuates. Invesque historically paid monthly dividends until April 2020, when dividends were
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discontinued. A loss in the fair market value of our Invesque shares or a reduction or discontinuation in the dividends paid on our Invesque shares could have a material adverse effect on our financial condition and results of operations. Until August 2019, the Company’s investment in Invesque was subject to certain contractual and functional sale restrictions. As of December 31, 2020 and 2019, the fair value of the Invesque shares was based on the market price.
See “Risk Factors — Risks Related to our Business - Our investment in Invesque shares is subject to market volatility and the risk that Invesque changes its dividend policy”.
Counterparty Risk
We are subject to counterparty risk to the extent that we engage in derivative activities for hedging or other purposes. As of December 31, 2020 and 2019, the total fair value of derivative assets subject to counterparty risk, including the effect of any legal right of offset, totaled $11.5 million and $7.5 million, respectively. We generally manage our counterparty risk to derivative counterparties by entering into contracts with counterparties of high credit quality.
Total reinsurance receivables were $728.0 million and $539.8 million as of December 31, 2020 and 2019, respectively. Of those amounts, $442.2 million and $309.0 million, respectively, related to contracts with third-party captives in which we hold collateral or receive letters of credit in excess of the reinsurance receivables. The remainder is held with high quality reinsurers, substantially all of which have a rating of A or better by A.M. Best. As of December 31, 2020, 4 counterparties constituted more than 10% of the uncollateralized reinsurance receivable exposure, ranging from 10% to 16%, with ratings ranging from A- to A+.
We were also exposed to counterparty risk of approximately $131.8 million and $105.4 million as of December 31, 2020 and 2019, respectively, related to our retrospective commission arrangements; associated risks are offset by the Company’s contractual ability to withhold future commissions against the retrospective balances. In addition, we are exposed to counterparty risk of approximately $62.1 million and $42.2 million as of December 31, 2020 and 2019, respectively, related to our premium financing business. The risk associated with such arrangements is mitigated by the fact that we have the contractual ability to cancel the insurance policy and have premiums refunded to us by the insurer in the event of a counterparty default.
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