10-Q 1 emergent2q16form10-q.htm 10-Q Document


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
Form 10-Q
 
 
(Mark One)
ý    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2016

or

¨    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number: 001-35064

 
EMERGENT CAPITAL, INC.

(Exact name of registrant as specified in its charter)
 
 
Florida
 
30-0663473
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
5355 Town Center Road—Suite 701
Boca Raton, Florida 33486
(Address of principal executive offices, including zip code)

(561) 995-4200
 
 

Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ý    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ý    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
 
¨
 
Accelerated filer
 
ý
Non-accelerated filer
 
¨ (Do not check if a smaller reporting company)
 
Smaller reporting company
 
¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  ý

As of August 2, 2016, the Registrant had 27,785,535 shares of common stock outstanding.




EMERGENT CAPITAL, INC.
FORM 10-Q REPORT FOR THE QUARTER ENDED June 30, 2016

TABLE OF CONTENTS

 
Page No.
PART I — FINANCIAL INFORMATION
 
 
 
 
 
PART II — OTHER INFORMATION
 
 
 

2



“Forward Looking” Statements

This Quarterly Report on Form 10-Q contains forward-looking statements that are subject to risks and uncertainties. All statements other than statements of historical fact included in this Quarterly Report on Form 10-Q are forward-looking statements. Forward-looking statements give our current expectations and projections relating to our financial condition, results of operations, plans, objectives, future performance and business. You can identify forward-looking statements by the fact that they do not relate strictly to historical or current facts. These statements may include words such as “anticipate,” “estimate,” “expect,” “project,” “plan,” “intend,” “believe,” “may,” “will,” “should,” “can have,” “likely” and other words and terms of similar meaning in connection with any discussion of the timing or nature of future cash flows, operating or financial performance or other events. These forward-looking statements are not historical facts, and are based on current expectations, estimates and projections about our industry and Company, management’s beliefs and certain assumptions made by management, many of which, by their nature, are inherently uncertain and beyond our control. Accordingly, readers are cautioned that any such forward-looking statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict. Although we believe that the expectations reflected in such forward-looking statements are reasonable as of the date made, results may prove to be materially different. Unless otherwise required by law, we disclaim any obligation to update our view of any such risks or uncertainties or to announce publicly the result of any revisions to the forward-looking statements made in this report.

Factors that could cause our actual results to differ materially from those indicated in our forward-looking statements include, but are not limited to, the following:
 
our ability to obtain future financings on favorable terms, or at all;
our ability to receive distributions from policy proceeds from life insurance policies pledged as collateral under our revolving credit facilities;
our ability to meet our debt service obligations;
delays in the receipt of death benefits from our portfolio of life insurance policies;
costs related to obtaining death benefits from our portfolio of life insurance policies;
our ability to continue to comply with the covenants and other obligations, including the conditions precedent for additional fundings, under our revolving credit facilities;
increases in premiums on, or the cost of insurance of, life insurance policies that we own;
lack of mortalities of insureds of the life insurance policies that we own;
changes to actuarial life expectancy tables;
changes in general economic conditions, including inflation, changes in interest or tax rates;
our results of operations;
our ability to continue to make premium payments on the life insurance policies that we own;
continuing costs associated with an investigation by the U.S. Securities and Exchange Commission ("SEC") (the "SEC Investigation");
adverse developments, including financial ones, associated with the SEC Investigation, other litigation and judicial actions or similar matters;
inaccurate estimates regarding the likelihood and magnitude of death benefits related to life insurance policies that we own;
increases to the discount rates used to value the life insurance policies that we own;
changes in mortality rates and inaccurate assumptions about life expectancies;
changes in life expectancy calculation methodologies by third party medical underwriters;
the effect on our financial condition as a result of any lapse of life insurance policies;
our ability to sell the life insurance policies we own at favorable prices, if at all;
adverse developments in capital markets;

3



deterioration of the market for life insurance policies and life settlements;
increased carrier challenges to the validity of our life insurance policies;
adverse court decisions regarding insurable interest and the obligation of a life insurance carrier to pay death benefits or return premiums upon a successful rescission or contest;
challenges to the ownership of the policies in our portfolio;
changes in laws and regulations;
deterioration in the credit worthiness of the life insurance companies that issue the policies included in our portfolio;
regulation of life settlement transactions as securities;
liabilities associated with our legacy structured settlement business;
our failure to maintain the security of personally identifiable information pertaining to insureds and counterparties;
disruption of our information technology systems;
loss of the services of any of our executive officers; and
the effects of United States' involvement in hostilities with other countries and large-scale acts of terrorism, or the threat of hostilities or terrorist acts. 

All forward-looking statements are expressly qualified in their entirety by these cautionary statements. See “Risk Factors” included in our Annual Report on Form 10-K for the year ended December 31, 2015. You should evaluate all forward-looking statements made in this Form 10-Q in the context of these risks and uncertainties. The Company cautions you that the important factors referenced above may not contain all of the factors that are important to you.

As used in this Form 10-Q, "Emergent Capital," "Company, "we," "us," "its," or "our" refer to Emergent Capital, Inc. and its consolidated subsidiary companies, unless the context suggests otherwise.

4



Item 1        Financial Statements

Emergent Capital, Inc.
CONSOLIDATED BALANCE SHEETS

 
June 30,
2016
 
December 31,
2015*
 
(Unaudited)
 
 
 
(In thousands except share data)
ASSETS
 
 
 
Assets
 
 
 
Cash and cash equivalents
$
15,408

 
$
12,946

Cash and cash equivalents (VIE Note 4)
8,648

 
7,395

Certificates of deposit
7,504

 
2,501

Prepaid expenses and other assets
1,632

 
1,017

Deposits - other
1,347

 
1,347

Deposits - other (VIE Note 4)
210

 

Life settlements, at estimated fair value
12,348

 
11,946

Life settlements, at estimated fair value (VIE Note 4)
460,698

 
449,979

Receivable for maturity of life settlements (VIE Note 4)
14,295

 
18,223

Fixed assets, net
279

 
322

Investment in affiliates
2,384

 
2,384

Total assets
$
524,753

 
$
508,060

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Liabilities
 
 
 
Accounts payable and accrued expenses
$
3,212

 
$
3,051

Accounts payable and accrued expenses (VIE Note 4)
458

 
419

Other liabilities
411

 
360

Interest payable - Convertible Notes (Note 11)
2,272

 
2,272

Convertible Notes, net of discount and deferred debt costs (Note 11)
58,570

 
56,812

Interest payable - Senior Secured Notes (Note 12)
200

 

Senior Secured Notes, net of discount and deferred debt costs (Note 12)
29,125

 

White Eagle Revolving Credit Facility, at estimated fair value (VIE Note 4)
172,361

 
169,131

Red Falcon Revolving Credit Facility, at estimated fair value (VIE Note 4)
55,082

 
55,658

Total liabilities
321,691

 
287,703

Commitments and Contingencies (Note 16)

 

Stockholders’ Equity
 
 
 
Common stock (par value $0.01 per share, 80,000,000 authorized at June 30, 2016 and December 31, 2015; 28,393,535 issued and 27,785,535 outstanding as of June 30, 2016; 28,130,508 issued and 27,522,508 outstanding at December 31, 2015)
284

 
281

Preferred stock (par value $0.01 per share, 40,000,000 authorized; 0 issued and outstanding as of June 30, 2016 and December 31, 2015)

 

Treasury Stock, net of cost (608,000 shares as of June 30, 2016 and December 31, 2015)
(2,534
)
 
(2,534
)
Additional paid-in-capital
305,567

 
305,450

Accumulated deficit
(100,255
)
 
(82,840
)
Total stockholders’ equity
203,062

 
220,357

Total liabilities and stockholders’ equity
$
524,753

 
$
508,060

 *    Derived from audited consolidated financial statements.
The accompanying notes are an integral part of these financial statements.

5



Emergent Capital, Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

 
For the Three Months Ended
June 30,
 
For the Six Months Ended
June 30,
 
2016
 
2015
 
2016
 
2015
 
(in thousands, except share and per share data)
Income
 
 
 
 
Change in fair value of life settlements (Notes 8 & 14)
(15,813
)
 
28,002

 
(7,425
)
 
40,914

Other income
27

 
32

 
93

 
101

Total income (loss)
(15,786
)
 
28,034

 
(7,332
)
 
41,015

Expenses
 
 
 
 
 
 
 
Interest expense
7,385

 
6,600

 
13,435

 
12,877

Change in fair value of Revolving Credit Facilities (Notes 9, 10 & 14)
(19,667
)
 
13,552

 
(15,570
)
 
17,692

Personnel costs
2,274

 
1,752

 
3,830

 
3,480

Legal fees
1,710

 
3,214

 
3,528

 
6,975

Professional fees
1,568

 
1,382

 
3,211

 
3,705

Insurance
194

 
312

 
438

 
658

Other selling, general and administrative expenses
525

 
578

 
1,017

 
1,086

Total expenses
(6,011
)
 
27,390

 
9,889

 
46,473

Income (loss) from continuing operations before income taxes
(9,775
)
 
644

 
(17,221
)
 
(5,458
)
Benefit for income taxes

 
(322
)
 

 
(2,260
)
Net income (loss) from continuing operations
$
(9,775
)
 
$
966

 
$
(17,221
)
 
$
(3,198
)
Discontinued Operations:
 
 
 
 
 
 
 
Income (loss) from discontinued operations before income taxes
(127
)
 
(236
)
 
(194
)
 
(492
)
(Benefit) provision for income taxes

 
(91
)
 

 
(190
)
Net income (loss) from discontinued operations
(127
)
 
(145
)
 
(194
)
 
(302
)
Net income (loss)
$
(9,902
)
 
$
821

 
$
(17,415
)
 
$
(3,500
)
Basic and diluted income (loss) per share:
 
 
 
 
 
 
 
Continuing operations
$
(0.36
)
 
$
0.04

 
$
(0.63
)
 
$
(0.15
)
Discontinued operations
$

 
$

 
$
(0.01
)
 
$
(0.01
)
Net income (loss)
$
(0.36
)
 
$
0.04

 
$
(0.64
)
 
$
(0.16
)
Weighted average shares outstanding:
 
 
 
 
 
 
 
Basic
27,491,768

 
21,961,034

 
27,486,508

 
21,663,137

Diluted
27,491,768

 
21,964,904

 
27,486,508

 
21,663,137

The accompanying notes are an integral part of these financial statements.

6



Emergent Capital, Inc.
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (UNAUDITED)
For the Six Months Ended June 30, 2016

 
Common Stock
 
Treasury Stock
 
Additional
Paid-in Capital
 
Accumulated Deficit
 
Total
 
Shares
 
Amount
 
Shares
 
Amount
 
 
(in thousands, except share data)
Balance, January 1, 2016
28,130,508

 
$
281

 
608,000

 
$
(2,534
)
 
$
305,450

 
$
(82,840
)
 
$
220,357

Net income (loss)

 

 

 

 

 
(17,415
)
 
(17,415
)
Stock-based compensation
265,212

 
3

 

 

 
125

 

 
128

Retirement of common stock
(2,185
)
 

 

 

 
(8
)
 

 
(8
)
Balance, June 30, 2016
28,393,535

 
$
284

 
608,000

 
$
(2,534
)
 
$
305,567

 
$
(100,255
)
 
$
203,062

The accompanying notes are an integral part of these financial statements.


7


Emergent Capital, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

 
For the Six Months Ended
June 30,
 
2016
 
2015
 
(In thousands)
Cash flows from operating activities
 
 
 
Net income (loss)
$
(17,415
)
 
$
(3,500
)
Adjustments to reconcile net income (loss) to net cash used in operating activities:
 
 
 
Depreciation and amortization
52

 
49

Amortization of discount and deferred costs for Convertible Notes
1,758

 
1,464

Amortization of discount and deferred costs for 15.00% Senior Secured Notes
176

 

Amortization of discount and deferred costs for 12.875% Secured Notes

 
541

Stock-based compensation expense
128

 
368

Finance cost and fees withheld by borrower
420


3,688

Change in fair value of life settlements
7,425

 
(40,914
)
Unrealized change in fair value of structured settlements

 
(16
)
Change in fair value of Revolving Credit Facilities
(15,570
)
 
17,692

Interest income
(23
)
 
(64
)
Deferred income tax

 
(2,450
)
Change in assets and liabilities:
 
 
 
Deposits - other
(210
)
 
(654
)
Structured settlement receivables

 
100

Prepaid expenses and other assets
(461
)
 
(359
)
Accounts payable and accrued expenses
186

 
(1,431
)
Other liabilities
65

 
(805
)
Interest payable - Convertible Notes

 
143

Interest payable - 15.00% Senior Secured Notes
200

 

Net cash used in operating activities
(23,269
)
 
(26,148
)
Cash flows from investing activities
 
 
 
Purchase of fixed assets, net of disposals
(7
)
 
(10
)
Certificate of deposit
(5,000
)
 

Purchase of life settlements
(1,390
)
 
(25,905
)
Premiums paid on life settlements
(34,336
)
 
(31,417
)
Proceeds from maturity of life settlements
20,980

 
19,187

Deposits on purchase of life settlements

 
(808
)
Net cash used in investing activities
(19,753
)
 
(38,953
)
Cash flows from financing activities
 
 
 
Borrowings from White Eagle Revolving Credit Facility
25,238

 
22,225

Repayment of borrowings under White Eagle Revolving Credit Facility
(7,952
)
 
(18,577
)
Borrowings under Red Falcon Revolving Credit Facility
8,533

 

Repayment of borrowings under Red Falcon Revolving Credit Facility
(8,014
)


Proceeds from rights offering

 
38,458

Proceeds from 15.00% Senior Secured Notes
30,000

 

Proceeds from Secured Notes, net

 
23,750

Payment under finance lease obligations
(17
)
 
(17
)
15.00% Senior Secured Notes deferred cost
(1,051
)


12.875% Secured Notes deferred costs

 
(5
)
Net cash provided by financing activities
46,737

 
65,834

Net increase in cash and cash equivalents
3,715

 
733

Cash and cash equivalents, at beginning of the period
20,341

 
54,917

Cash and cash equivalents, at end of the period
$
24,056

 
$
55,650

Supplemental disclosures of cash flow information:
 
 
 
Cash paid for interest during the period
$
11,294

 
$
7,408

Supplemental disclosures of non-cash financing activities:
 
 
 
Interest payment and fees withheld from borrowings by lender
$
420

 
$
3,688

The accompanying notes are an integral part of these financial statements.

8



Emergent Capital, Inc.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
June 30, 2016

(1) Description of Business

Founded in December 2006 as a Florida limited liability company, Imperial Holdings, LLC, converted into Imperial Holdings, Inc. on February 3, 2011, in connection with the Company’s initial public offering. Effective September 1, 2015, the Company changed its name to Emergent Capital, Inc. (with its subsidiary companies, the “Company” or “Emergent Capital”).

Incorporated in Florida, Emergent Capital, through its subsidiary companies, owns a portfolio of 625 life insurance policies, also referred to as life settlements, with a fair value of $473.0 million and an aggregate death benefit of approximately $3.0 billion at June 30, 2016. The Company primarily earns income on these policies from changes in their fair value and through death benefits. 433 of these policies, with an aggregate death benefit of approximately $2.2 billion and a fair value of approximately $340.6 million at June 30, 2016 are pledged under a $250.0 million, revolving credit agreement (the “White Eagle Revolving Credit Facility”) entered into by the Company’s indirect subsidiary, White Eagle Asset Portfolio, LP (“White Eagle”). Additionally, 152 policies, with an aggregate death benefit of approximately $599.9 million and a fair value of approximately $120.1 million at June 30, 2016 were pledged as collateral under a $110.0 million, revolving credit agreement (the “Red Falcon Revolving Credit Facility” and, together with the White Eagle Revolving Credit Facility, the “Revolving Credit Facilities”) entered into by Red Falcon Trust (“Red Falcon”), a Delaware statutory trust formed by one of our subsidiary companies. At June 30, 2016, 40 policies owned by the Company, with an aggregate death benefit of approximately $186.3 million and a fair value of $12.3 million were not pledged as collateral under either of the Revolving Credit Facilities.

(2) Principles of Consolidation and Basis of Presentation

The accompanying consolidated financial statements include the accounts of the Company, all of its wholly-owned subsidiary companies and its special purpose entities, with the exception of Imperial Settlements Financing 2010, LLC (“ISF 2010”), an unconsolidated special purpose entity which is accounted for using the cost method of accounting. The special purpose entity has been created to fulfill specific objectives. All significant intercompany balances and transactions have been eliminated in consolidation, including income from services performed by subsidiary companies in connection with the Revolving Credit Facilities. Notwithstanding consolidation, as referenced above, White Eagle is the owner of 433 policies, with an aggregate death benefit of approximately $2.2 billion and an estimated fair value of approximately $340.6 million and Red Falcon is the owner of 152 policies with an aggregate death benefit of approximately $599.9 million and an estimated fair value of approximately $120.1 million, in each case, at June 30, 2016.

The unaudited consolidated financial statements have been prepared in conformity with the rules and regulations of the SEC for Form 10-Q and therefore do not include certain information, accounting policies, and footnote disclosures information or footnotes necessary for a complete presentation of financial position, results of operations and cash flows in conformity with generally accepted accounting principles. However, all adjustments (consisting of normal recurring accruals), which, in the opinion of management, are necessary for a fair presentation of the financial statements, have been included. Operating results for the three months and six months ended June 30, 2016 are not necessarily indicative of the results that may be expected for future periods or for the year ended December 31, 2016. These interim financial statements should be read in conjunction with the Consolidated Financial Statements and Notes thereto included in Emergent Capital's Annual Report on Form 10-K for the fiscal year ended December 31, 2015.

Discontinued Operations

On October 25, 2013, the Company sold substantially all of the assets comprising its structured settlement business for $12.0 million. As a result, the Company has discontinued segment reporting and classified its operating results of the structured settlement business, net of income taxes, as discontinued operations. The accompanying consolidated balance sheets of the Company as of June 30, 2016 and December 31, 2015, and the related consolidated statements of operations for the three months and six months ended June 30, 2016 and 2015, and the related notes to the consolidated financial statements reflect the classification of its structured settlement business operating results, net of tax, as discontinued operations. See Note 7, “Discontinued Operations,” for further information. Unless otherwise noted, the following notes refer to the Company’s continuing operations.



9



Derivative Instrument

In February 2014, the Company issued and sold $70.7 million in aggregate principal amount of 8.50% senior unsecured convertible notes due 2019 (the "Convertible Notes"). Prior to shareholder approval on June 5, 2014 to issue shares of common stock upon conversion of the Convertible Notes in excess of New York Stock Exchange limits for share issuances without shareholder approval, the Convertible Notes contained an embedded derivative feature. In accordance with Accounting Standards Codification (“ASC”) 815, Derivatives and Hedging, derivative instruments are recognized as either assets or liabilities on the Company’s balance sheet and are measured at fair value with gains or losses recognized in earnings. Embedded derivatives that are not clearly and closely related to the host contract, such as the Convertible Notes, are bifurcated and recognized at fair value with changes in fair value recognized as either a gain or loss in earnings if they can be reliably measured. The Company determined the fair value of its embedded derivative based upon available market data and unobservable inputs using a Black Scholes pricing model. In accordance with ASC 815, upon receipt of shareholder approval on June 5, 2014, the Company reclassified the embedded derivative to equity along with unamortized transaction costs proportionate to the allocation of the initial debt discount and the principal amount of the Convertible Notes. The Convertible Notes are recorded at accreted value and will continue to be accreted up to the par value of the Convertible Notes at maturity. See Note 11, "8.50% Senior Unsecured Convertible Notes."

Foreign Currency

The Company owns certain foreign subsidiary companies formed under the laws of Ireland, Bahamas and Bermuda. These foreign subsidiary companies utilize the U.S. dollar as their functional currency. The foreign subsidiary companies' financial statements are denominated in U.S. dollars and therefore, there are no translation gains and losses resulting from translating the financial statements at exchange rates other than the functional currency. Any gains and losses resulting from foreign currency transactions (transactions denominated in a currency other than the subsidiary companies' functional currency) are included in income. These gains and losses are immaterial to the Company’s financial statements.

Use of Estimates

The preparation of consolidated financial statements, in conformity with accounting principles generally accepted in the United States of America (“GAAP”), requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the reporting period. Actual results could differ from these estimates and such differences could be material. Significant estimates made by management include income taxes, the valuation of life settlements, the valuation of the debt owing under the Revolving Credit Facilities, the valuation of equity awards and the valuation of the conversion derivative liability formerly embedded within the Convertible Notes.

Reclassification

Certain reclassification of the prior period amounts and presentation have been made to conform to the presentation of the current period. This reclassification relates primarily to the adoption of ASU No. 2015-03, “Interest—Imputation of Interest (Subtopic 835-30)” which provides guidance on the balance sheet presentation for debt issuance costs and impacts the Convertible Notes.

Change in Accounting Principle and Accounting for Debt Issuance Costs

The Company adopted ASU No. 2015-03, “Interest—Imputation of Interest (Subtopic 835-30)” on January 1, 2016. Upon adoption of ASU No. 2015-03, deferred debt issuance costs related to the Convertible Notes previously presented in the Company's consolidated balance sheet as an asset have been reclassified as a direct deduction to the carrying amount of the liability. The adoption of this ASU did not result in changes to the consolidated statements of operations, stockholders' equity, or statement of cash flows. In transitioning the application of this guidance, retrospective application to all periods presented in the consolidated financial statements has been performed as follows (in thousands):


10



 
As reported under previous accounting guidance
 
As reported under ASU 2015-03
 
Effect of change
Balance Sheet
 
 
 
 
 
December 31, 2015
 
 
 
 
 
Assets:
 
 
 
 
 
Deferred debt costs
$
1,797

 
$

 
$
(1,797
)
Total assets
$
509,857

 
$
508,060

 
$
(1,797
)
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
Convertible Notes, net of discount
58,609

 
56,812

 
(1,797
)
Total liabilities
289,500

 
287,703

 
(1,797
)
 
 
 
 
 
 
Total stockholders' equity
220,357

 
220,357

 

 
 
 
 
 
 
Total liabilities and stockholders' equity
$
509,857

 
$
508,060

 
$
(1,797
)
 
 
 
 
 
 
Net effect
$

 
$

 
$


(3) Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-09, "Revenue from Contracts with Customers," which converges the FASB and the International Accounting Standards Board (“IASB”) standard on revenue recognition. Areas of revenue recognition that will be affected include, but are not limited to, transfer of control, variable consideration, allocation of transfer pricing, licenses, time value of money, contract costs and disclosures. In April 2015, the FASB voted to defer the effective date of the new revenue recognition standard by one year. As a result, the provisions of this ASU are effective for interim and annual periods beginning after December 15, 2017. Following the deferral, in March 2016 the FASB issued ASU No. 2016-08, "Principal versus Agent Considerations (Reporting Revenue Gross versus Net)" which aims to clarify the implementation guidance on principal versus agent considerations. The amendments in this Update do not change the core principle of the guidance in No. 2014-09. The effective date and transition requirements of ASU No. 2016-08 are the same as the effective date and transitions requirements of Update 2014-09. The Company does not expect that this guidance will have a material impact on its financial position, results of operations or cash flows.

In August 2014, the FASB issued ASU No. 2014-15, "Disclosures of Uncertainties About an Entity’s Ability to Continue as a Going Concern." The standard provides guidance around management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. The standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. Early adoption is permitted. The Company does not expect that this guidance will have a material impact on its financial position, results of operations or cash flows.

In February 2015, the FASB issued ASU No. 2015-02, "Consolidation (Topic 810): Amendments to the Consolidation Analysis." This guidance focuses on a reporting company’s consolidation evaluation to determine whether they should consolidate certain legal entities. This guidance is effective for annual periods beginning after December 15, 2015. Early adoption is permitted, including adoption in an interim period. The Company has determined that this guidance does not have an impact on its consolidated financial statements.

In April 2015, the FASB issued ASU No. 2015-03, "Interest—Imputation of Interest (Subtopic 835-30)." This standard provides guidance on the balance sheet presentation for debt issuance costs and debt discounts and debt premiums. To simplify the presentation of debt issuance costs, this standard requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability. This ASU is effective for fiscal years beginning after December 15, 2015. The Company adopted this guidance on January 1, 2016. The adoption of this ASU did not result in changes to the consolidated statements of operations, stockholders' equity, or statement of cash flows. In

11



transitioning the application of this guidance, retrospective application to all periods presented in the consolidated financial statements has been performed.

In November 2015, the FASB issued ASU No. 2015-17, "Income Taxes (Topic 740): Balance Sheet Classifications of Deferred Taxes," which aligns the FASB and the IASB standard for financial statement presentation of deferred income taxes. To simplify the presentation of deferred income taxes, this standard requires that deferred tax assets and liabilities be presented as noncurrent on the balance sheet. This ASU is effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. Early adoption is permitted, including adoption in an interim period. The Company does not expect that this guidance will have a material impact on its consolidated financial statements.

In March 2016, the FASB issued ASU No. 2016-06, "Derivatives and Hedging (Topic 815): Contingent Put and Call Options in Debt Instruments." Topic 815 requires that embedded derivatives be separated from the host contract and accounted for separately as derivatives if certain criteria are met. One of those criteria is that the economic characteristics and risks of the embedded derivatives are not clearly and closely related to the economic characteristics and risks of the host contract (the "clearly and closely related" criterion). The guidance in this ASU intends to resolve the diversity in practice resulting from the application of the existing four-step decision sequence defined in ASC 815-15-25-42 to call (put) options that can accelerate the repayment of principal on a debt instrument if they meet the clearly and closely related criterion by clarifying that an entity is required to perform only the four-step decision sequence. The entity does not have to separately assess whether the event that triggers its ability to exercise the contingent option is itself indexed only to interest rates or credit risk. This ASU is effective for annual periods beginning after December 15, 2017, and interim periods beginning after December 15, 2018. Early adoption is permitted including adoption in an interim period, as long as any adjustment is reflected as of the beginning of the fiscal year that includes the interim period. We are currently evaluating the impact that the adoption of ASU 2016-06 will have on our consolidated financial statements or related disclosures.

In March 2016, the FASB issued ASU No. 2016-09, "Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting" as part of its Simplification Initiative. The guidance simplifies several aspects of the accounting for share-based payment transactions including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. For public business entities, these amendments are effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. Early adoption is permitted including adoption in an interim period, as long as any adjustment is reflected as of the beginning of the fiscal year that includes the interim period. We are currently evaluating the impact that the adoption of ASU 2016-09 will have on our consolidated financial statements or related disclosures.

(4) Consolidation of Variable Interest Entities

The Company evaluates its interests in variable interest entities ("VIEs") on an ongoing basis and consolidates those VIEs in which it has a controlling financial interest and is thus deemed to be the primary beneficiary. A controlling financial interest has both of the following characteristics: (i) the power to direct the activities of the VIE that most significantly impact its economic performance; and (ii) the obligation to absorb losses of the VIE that could potentially be significant to it or the right to receive benefits from the VIE that could be potentially significant to the VIE.

The following table presents the consolidated assets and consolidated liabilities of VIEs for which the Company has concluded that it is the primary beneficiary and which are consolidated in the Company’s financial statements as of June 30, 2016 as well as non-consolidated VIEs for which the Company has determined it is not the primary beneficiary (in thousands):
 
Primary Beneficiary
 
Not Primary
Beneficiary
 
Consolidated VIEs
 
Non-consolidated VIEs
 
Assets
 
Liabilities
 
Total
Assets
 
Maximum
Exposure
To Loss
June 30, 2016
$
483,851

 
$
227,901

 
$
2,384

 
$
2,384

December 31, 2015
$
475,597

 
$
225,208

 
$
2,384

 
$
2,384


As of June 30, 2016, 433 life insurance policies owned by White Eagle with an aggregate death benefit of approximately $2.2 billion and an estimated fair value of approximately $340.6 million were pledged as collateral under the White Eagle Revolving Credit Facility. In accordance with ASC 810, Consolidation, the Company consolidated White Eagle in its financial statements for the six months ended June 30, 2016 and 2015, and the year ended December 31, 2015.


12



As of June 30, 2016, 152 life insurance policies owned by Red Falcon with an aggregate death benefit of approximately $599.9 million and an estimated fair value of approximately $120.1 million were pledged as collateral under the Red Falcon Revolving Credit Facility. In accordance with ASC 810, Consolidation, the Company consolidated Red Falcon in its financial statements for the six months ended June 30, 2016 and the year ended December 31, 2015.

(5) Earnings Per Share

As of June 30, 2016 and 2015, there were 28,393,535 and 28,130,508 shares of common stock issued, respectively, and 27,785,535 and 28,130,508 shares of common stock outstanding, respectively. Outstanding shares as of June 30, 2016 have been adjusted to reflect 608,000 treasury shares. There were no treasury shares as of June 30, 2015.

Basic net income per share is computed by dividing the net earnings attributable to common shareholders by the weighted average number of common shares outstanding during the period.

Diluted earnings per share is computed by dividing net income attributable to common shareholders by the weighted average number of common shares outstanding, increased to include the number of additional common shares that would have been outstanding if the dilutive potential common shares had been issued. Conversion or exercise of the potential common shares is not reflected in diluted earnings per share unless the effect is dilutive. The dilutive effect, if any, of outstanding common share equivalents is reflected in diluted earnings per share by application of the treasury stock method, as applicable.

The following table reconciles actual basic and diluted earnings per share for the three months and six months ended June 30, 2016 and 2015 (in thousands except share and per share data).
 
For the Three Months Ended
June 30,
 
For the Six Months Ended June 30,
 
2016(1)
 
2015(2)
 
2016(1)
 
2015(3)
Income (loss) per share:
 
 
 
 
 
 
 
Numerator:
 
 
 
 
 
 
 
Net income (loss) from continuing operations
$
(9,775
)
 
$
966

 
$
(17,221
)
 
$
(3,198
)
Net income (loss) from discontinued operations
(127
)
 
(145
)
 
(194
)
 
(302
)
Net income (loss)
$
(9,902
)
 
$
821

 
$
(17,415
)
 
$
(3,500
)
Basic and diluted income (loss) per common share:
 
 
 
 
 
 
 
Basic and diluted income (loss) from continuing operations
$
(0.36
)
 
$
0.04

 
$
(0.63
)
 
$
(0.15
)
Basic and diluted income (loss) from discontinued operations

 

 
(0.01
)
 
(0.01
)
Basic and diluted income (loss) per share available to common shareholders
$
(0.36
)
 
$
0.04

 
$
(0.64
)
 
$
(0.16
)
Denominator:
 
 
 
 
 
 
 
Basic
27,491,768

 
21,961,034

 
27,486,508

 
21,663,137

Add: Restricted stock

 
3,870

 

 

Diluted
27,491,768

 
21,964,904

 
27,486,508

 
21,663,137


(1)
The computation of diluted EPS does not include 265,212 shares of restricted stock, 763,594 options, 6,240,521 warrants, up to 10,738,165 shares of underlying common stock issuable upon conversion of the Convertible Notes, as the effect of their inclusion would have been anti-dilutive.
(2)
The computation of diluted EPS includes 3,870 incremental shares of restricted stock, but does not include 794,617 options, 6,240,521 warrants, up to 10,738,165 shares of underlying common stock issuable upon conversion of the Convertible Notes and 323,500 performance shares for the three months ended June 30, 2015, as the effect of their inclusion would have been anti-dilutive.
(3)
The computation of diluted EPS did not include 41,259 shares of restricted stock, 794,617 options, 6,240,521 warrants, up to 10,738,165 shares of underlying common stock issuable upon conversion of the Convertible Notes and 323,500 performance shares, as the effect of their inclusion would have been anti-dilutive.

(6) Stock-based Compensation

On May 28, 2015, the Company amended and restated its 2010 Omnibus Incentive Plan (the “Omnibus Plan”). Awards under the Omnibus Plan may consist of incentive awards, stock options, stock appreciation rights, performance shares,

13



performance units, and shares of common stock, restricted stock, restricted stock units or other stock-based awards as determined by the compensation committee of the Company's board of directors. The Omnibus Plan provides for an aggregate of 2,700,000 shares of common stock to be reserved for issuance under the Omnibus Plan, subject to adjustment as provided in the Omnibus Plan.


Options

As of December 31, 2015, all options to purchase shares of common stock issued by the Company were fully vested. The Company recognized approximately $104,000 and $237,000 in stock-based compensation expense relating to stock options during the three months and six months ended June 30, 2015, respectively.

As of June 30, 2016, options to purchase 763,594 shares of common stock were outstanding under the Omnibus Plan at a weighted average exercise price of $8.52 per share. The following table presents the activity of the Company’s outstanding stock options of common stock for the six months ended June 30, 2016:
Common Stock Options
 
Number of
Shares
 
Weighted
Average Price
per Share
 
Weighted
Average
Remaining
Contractual
Term
 
Aggregate
Intrinsic
Value
Options outstanding, January 1, 2016
 
774,394

 
$
8.50

 
3.47

 
$

Options granted
 

 


 


 


Options exercised
 

 


 


 


Options forfeited
 
(10,800
)
 
$
7.22

 

 


Options expired
 

 


 


 


Options outstanding, June 30, 2016
 
763,594

 
$
8.52

 
2.97

 
$

Exercisable at June 30, 2016
 
763,594

 
$
8.52

 
2.97

 


Unvested at June 30, 2016
 

 

 

 
$


As of June 30, 2016, all outstanding stock options had an exercise price above the fair market value of the common stock on that date. There are no remaining unamortized amounts to be recognized on these options.


Restricted Stock

The Company incurred additional stock-based compensation expense of approximately $68,000 and $71,000 relating to restricted stock granted to its board of directors and certain employees during the three months ended June 30, 2016 and 2015, respectively, and approximately $128,000 and $131,000 during the six months ended June 30, 2016 and 2015, respectively.

Under the Omnibus Plan, 41,060 shares of restricted stock granted to the Company’s directors during 2014 vested during the quarter ended June 30, 2015. The fair value of the vested restricted stock was approximately $255,000 based on the closing price of the Company’s shares on the day prior to the grant date. The Company incurred additional stock-based compensation expense of approximately $49,000 and $108,000, respectively, related to these 41,060 shares of restricted stock during the three months and six months ended June 30, 2015.

Under the Omnibus Plan, 41,259 shares of restricted stock granted to the Company’s directors during 2015 vested during the quarter ended June 30, 2016. The fair value of the vested restricted stock was valued at approximately $255,000 based on the closing price of the Company’s shares on the day prior to the grant date. The Company incurred stock-based compensation expense of approximately $43,000 and $22,000 related to these 41,259 shares of restricted stock during the three months ended June 30, 2016 and 2015, respectively, and $103,000 and $22,000 during the six months ended June 30, 2016 and 2015, respectively.

During the quarter ended June 30, 2016, the Company granted 65,212 shares of restricted stock to its directors under the Omnibus Plan, which are subject to a one year vesting period that commenced on the date of grant. The fair value of the unvested restricted stock was valued at approximately $255,000 based on the closing price of the Company’s shares on the day prior to the grant date. The Company incurred stock-based compensation expense of approximately $19,000 related to these 65,212 shares of restricted stock during the three months and six months ended June 30, 2016.

14




During the quarter ended June 30, 2016, the Company granted 200,000 shares of restricted stock units to certain employees under the Omnibus Plan, which are subject to a two year vesting period that commenced on the date of grant. The fair value of the unvested restricted stock was valued at approximately $674,000 based on the closing price of the Company’s shares on the day prior to the grant date. The Company incurred stock-based compensation expense of approximately $6,000, related to these 200,000 shares of restricted stock during the three months and six months ended June 30, 2016.

The following table presents the activity of the Company’s unvested shares of restricted stock for the six months ended June 30, 2016:
Common Unvested Shares
Number of
Shares
Outstanding January 1, 2016
41,259

Granted
265,212

Vested
(41,259
)
Forfeited

Outstanding June 30, 2016
265,212


The aggregate intrinsic value of the awards of 65,212 and 200,000 is $218,000 and $672,000, respectively, and the remaining weighted average life of these awards is 0.92 years and 1.98 years, respectively as of June 30, 2016.

Performance Shares

During 2014, the Company awarded 323,500 target performance shares for restricted common stock to its directors and certain employees, of which 150,000 shares were subject to shareholder approval of the Omnibus Plan, which was obtained at the Company’s 2015 annual meeting on May 28, 2015. The issuance of the performance shares was contingent on the Company’s financial performance, as well as the performance of the Company’s common stock through June 30, 2016, with the actual shares to be issued ranging between 0150% of the target performance shares. During the year ended December 31, 2015, 4,000 of the performance shares were forfeited. At June 30, 2016 and 2015, the Company determined that it was not probable that the performance conditions would be achieved and no related expense was recognized for the three months and six months ended June 30, 2016 and 2015, respectively. Given that the Company's financial performance goal was not achieved at June 30, 2016, the performance shares have been forfeited.

The following table presents the activity of the Company’s performance share awards for the six months ended June 30, 2016:
Performance Shares
Number of
Shares
Outstanding January 1, 2016
319,500

Awarded

Vested

Forfeited
(319,500
)
Outstanding June 30, 2016


Warrants

On February 11, 2011, three shareholders received warrants that may be exercised for up to a total of 4,240,521 shares of the Company’s common stock at a weighted average exercise price of $14.51 per share. The warrants will expire seven years after the date of issuance and are exercisable as they are fully vested. At June 30, 2016, all 4,240,521 warrants remained outstanding.

In connection with a settlement of class action litigation arising in connection with the investigation by the U.S. Attorney's Office for District of New Hampshire ("USAO") into the Company's now legacy premium finance business (the "USAO Investigation"), the Company issued warrants to purchase two million shares of the Company’s stock into an escrow account in April of 2014. The estimated fair value as of the measurement date of such warrants was $5.4 million, which is included in stockholders’ equity. The warrants were distributed in October 2014 and have a five-year term from the date they were distributed to the class participants with an exercise price of $10.75. The Company is obligated to file a registration statement to register the shares underlying the warrants with the SEC if shares of the Company’s common stock have an

15



average daily trading closing price of at least $8.50 per share for a 45 day period. The warrants will be exercisable upon effectiveness of the registration statement.

(7) Discontinued Operations

On October 25, 2013, the Company sold substantially all of the operating assets comprising its structured settlement business to Majestic Opco L.L.C pursuant to an Asset Purchase Agreement. No structured settlement receivables were sold and no on-balance sheet liabilities were transferred in connection with the sale.

As a result of the sale of its structured settlements business, the Company reclassified its structured settlement business operating results as discontinued operations in the accompanying Consolidated Statements of Operations for all periods presented.

Operating results related to the Company’s discontinued structured settlement business are as follows:
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
2016
 
2015
 
2016
 
2015
Total income (loss)
$
3

 
$
38

 
$
6

 
$
73

Total expenses
(130
)
 
(274
)
 
(200
)
 
(565
)
Income (loss) before income taxes
(127
)
 
(236
)
 
(194
)
 
(492
)
Income tax benefit

 
(91
)
 

 
(190
)
Net income (loss) from discontinued operations, net of income taxes
$
(127
)
 
$
(145
)
 
$
(194
)
 
$
(302
)

(8Life Settlements (Life Insurance Policies)

The Company accounts for policies it acquires using the fair value method in accordance with ASC 325-30-50 Investments-Other-Investment in Insurance Contracts. Under the fair value method, the Company recognizes the initial investment at the purchase price. For policies that were relinquished in satisfaction of premium finance loans at maturity, the initial investment is the loan carrying value. For policies purchased in the secondary or tertiary markets, the initial investment is the amount of cash outlay at the time of purchase. At each reporting period, the Company re-measures the investment at fair value in its entirety and recognizes changes in the Statements of Operations in the periods in which the changes occur.

As of June 30, 2016 and December 31, 2015, the Company owned 625 and 632 policies, respectively, with an aggregate estimated fair value of life settlements of $473.0 million and $461.9 million, respectively.

The weighted average life expectancy calculated based on death benefit of insureds in the policies owned by the Company at June 30, 2016 was 9.4 years. The following table describes the Company’s life settlements as of June 30, 2016 (dollars in thousands):
Remaining Life Expectancy (In Years)*
Number of
Life Settlement
Contracts
 
Estimated Fair
Value
 
Face
Value
0 - 1
2

 
$
9,657

 
$
11,631

1 - 2
18

 
52,326

 
77,733

2 - 3
10

 
27,945

 
48,890

3 - 4
25

 
29,125

 
82,332

4 - 5
36

 
50,540

 
146,546

Thereafter
534

 
303,453

 
2,599,256

Total
625

 
$
473,046

 
$
2,966,388

*Based on remaining life expectancy at June 30, 2016 derived from reports of third party life expectancy providers, and does not indicate the timing of expected death benefits. See Note 14, "Fair Value Measurements—Life Settlements."


16



The weighted average life expectancy calculated based on death benefit of insureds in the policies owned by the Company at December 31, 2015 was 9.9 years. The following table describes the Company’s life settlements as of December 31, 2015 (dollars in thousands):
Remaining Life Expectancy (In Years)*
Number of
Life Settlement
Contracts
 
Estimated Fair
Value
 
Face
Value
0-1

 
$

 
$

1-2
12

 
28,873

 
42,988

2-3
17

 
47,272

 
84,497

3-4
18

 
24,450

 
58,154

4-5
31

 
42,304

 
124,720

Thereafter
554

 
319,026

 
2,668,993

Total
632

 
$
461,925

 
$
2,979,352

*Based on remaining life expectancy at December 31, 2015 derived from reports of third party life expectancy providers, and does not indicate the timing of expected death benefits. See Note 14, "Fair Value Measurements—Life Settlements."

Estimated premiums to be paid for each of the five succeeding fiscal years and thereafter to keep the life insurance policies in force as of June 30, 2016, are as follows (in thousands):
 
 
Remainder of 2016
$
36,830

2017
80,448

2018
83,506

2019
90,751

2020
95,012

Thereafter
972,026

 
$
1,358,573


The amount of $1.36 billion noted above represents the estimated total future premium payments required to keep the life insurance policies in force during the life expectancies of all the underlying insured lives and does not give effect to projected receipt of death benefits. The estimated total future premium payments could increase or decrease significantly to the extent that insurance carriers increase the cost of insurance on their issued policies or that actual mortalities of insureds differs from the estimated life expectancies.

(9) White Eagle Revolving Credit Facility

Effective April 29, 2013, White Eagle entered into a 15-year revolving credit agreement with LNV Corporation, as initial lender, Imperial Finance & Trading, LLC, as servicer and portfolio manager and CLMG Corp., as administrative agent. Proceeds from the initial advance under the facility were used, in part, to retire a bridge facility and to fund a payment to the lender protection insurance provider to release subrogation rights in certain of the policies pledged as collateral for the White Eagle Revolving Credit Facility. On May 16, 2014, White Eagle Asset Portfolio, LLC converted from a Delaware limited liability company to White Eagle Asset Portfolio, LP, a Delaware limited partnership (the “Conversion”) and all of its ownership interests were transferred to an indirect, wholly-owned Irish subsidiary of the Company. In connection with the Conversion, the White Eagle Revolving Credit Facility was amended and restated among White Eagle, as borrower, Imperial Finance and Trading, LLC, as the initial servicer, the initial portfolio manager and guarantor, Lamington Road Bermuda Ltd., as portfolio manager, LNV Corporation, as initial lender, the other financial institutions party thereto as lenders, and CLMG Corp., as administrative agent for the lenders. On November 9, 2015, the White Eagle Revolving Credit Facility ("White Eagle Amendment") was amended. As amended, the White Eagle Revolving Credit Facility may provide earlier participation in the portfolio cash flows if certain loan to value (“LTV”) ratios are achieved as more fully described below under “Amortization & Distributions.” Additionally, the maximum facility limit was reduced from $300.0 million to $250.0 million, and will generally be reduced annually by $25.0 million beginning on April 29, 2019. Additionally, the interest rate under the facility was increased by 50 basis points.
 
General & Security. The White Eagle Revolving Credit Facility provides for an asset-based revolving credit facility backed by White Eagle’s portfolio of life insurance policies with an aggregate lender commitment of up to $250.0 million,

17



subject to borrowing base availability. 433 life insurance policies with an aggregate death benefit of approximately $2.2 billion and an estimated fair value of approximately $340.6 million are pledged as collateral under the White Eagle Revolving Credit Facility at June 30, 2016. In addition, the equity interests in White Eagle have been pledged under the White Eagle Revolving Credit Facility.

Borrowing Base. Borrowing availability under the White Eagle Revolving Credit Facility is subject to a borrowing base, which at any time is equal to the lesser of (A) the sum of all of the following amounts that have been funded or are to be funded through the next distribution date (i) the initial advance and all additional advances to acquire additional pledged policies or that are not for ongoing maintenance advances, plus (ii) 100% of the sum of the ongoing maintenance costs, plus (iii) 100% of accrued and unpaid interest on borrowings (excluding the rate floor portion described below), plus (iv) 100% of any other fees and expenses funded and to be funded as approved by the required lenders, less (v) any required payments of principal and interest previously distributed and to be distributed through the next distribution date; (B) 75% of the valuation of the policies pledged as collateral as determined by the lenders; (C) 50% of the aggregate face amount of the policies pledged as collateral (excluding certain specified life insurance policies); and (D) the then applicable facility limit. At June 30, 2016, $60.3 million was undrawn and $2.8 million was available to borrow under the White Eagle Revolving Credit Facility. This amount available to borrow is calculated based on and limited to the premium payments and expenses if any, that are due as of the calculation date. In essence, what is available, is what is required to pay expenses and keep the policies in force as of the calculation date.

Amortization & Distributions. Proceeds from the maturity of the policies pledged as collateral under the White Eagle Revolving Credit Facility are distributed pursuant to a waterfall. After premium payments, fees to service providers and payments of interest, a percentage of the collections from policy proceeds are to be paid to the lenders, which will vary depending on the then LTV ratio as follows: (1) if the LTV is equal to or greater than 50%, all remaining proceeds will be directed to the lenders to repay the then outstanding principal balance; (2) if the LTV is less than 50% but greater than or equal to 25%, 65% of the remaining proceeds will be directed to the lenders to repay the then outstanding principal balance; or (3) if the LTV is less than 25%, 35% of the remaining proceeds will be directed to the lenders to repay the then outstanding principal balance, in each case, with remaining proceeds (“Excess LTV Payments”) directed to White Eagle for so long as the “Net Total Investment Percentage” exceeds 15% and there are at least 75 policies pledged under the White Eagle Revolving Credit Facility representing 75 distinct insured with any such proceeds to White Eagle decreasing the $76.1 million preference amount (the “preference amount”) that would have been distributed to White Eagle prior to the November 9, 2015 amendment upon the pay down of outstanding indebtedness. Following the satisfaction of the remaining preference payment, 50% of the remaining proceeds will generally be directed to the lenders with the remainder paid to White Eagle and for any unpaid fees to service providers. As of any calculation date, the “Net Total Investment Percentage” is determined by dividing the difference between the preference amount and the aggregate Excess LTV Payments by the outstanding principal amount under the White Eagle Revolving Credit Facility. With respect to approximately 25% of the face amount of policies pledged as collateral under the White Eagle Revolving Credit Facility, White Eagle has agreed that if policy proceeds that are otherwise due are not paid by an insurance carrier, the foregoing distributions will be altered such that the lenders will receive any “catch-up” payments with respect to amounts that they would have received in the waterfall prior to distributions being made to White Eagle. During the continuance of events of default or unmatured events of default, the amounts from collections of policy proceeds that might otherwise be paid to White Eagle will instead be held in a designated account controlled by the lenders and may be applied to fund operating and third party expenses, interest and principal, “catch-up” payments or percentage payments that would go to the lenders as described above.

Use of Proceeds. Generally, ongoing advances may be made for paying premiums on the life insurance policies pledged as collateral and to pay the fees of service providers. Effective with the White Eagle Amendment on November 9, 2015, ongoing advances may no longer be used to pay interest, which will now be paid by White Eagle if there is not otherwise sufficient amounts available from policy proceeds to be distributed to pay interest expense pursuant to the waterfall described above in "Amortization and Distributions." Subsequent advances and the use of proceeds from those advances in respect of newly pledged policies are at the discretion of the lenders.

Interest. Borrowings under the White Eagle Revolving Credit Facility bear interest at a rate equal to LIBOR or, if LIBOR is unavailable, the base rate, in each case plus an applicable margin of 4.50%, which was increased from 4.00% pursuant to the November 9, 2015 amendment, and subject to a rate floor component equal to the greater of LIBOR (or the applicable rate) and 1.5%. The base rate under the White Eagle Revolving Credit Facility equals the sum of (i) the weighted average of the interest rates on overnight federal funds transactions or, if unavailable, the average of three federal funds quotations received by the Agent plus 0.75% and (ii) 0.5%. The effective rate at June 30, 2016 and 2015 was 6.0% and 5.5%, respectively.

Interest paid during the period is recorded in the Company’s consolidated financial statements. Accrued interest is reflected as a component of the estimated fair value of the White Eagle Revolving Credit Facility debt. Effective with the White Eagle Amendment on November 9, 2015, interest is no longer withheld from borrowings by the lender and, therefore, $2.8

18



million was paid by White Eagle during the three months ended June 30, 2016 compared to interest expense of $2.3 million during the three months ended June 30, 2015, which included $1.7 million withheld from borrowings by the lender and $622,000 paid by White Eagle. During the six months ended June 30, 2016, approximately $5.2 million in interest expense was paid by White Eagle, compared to interest expense of $4.6 million for the six months ended June 30, 2015 which included $3.3 million withheld from borrowings by the lender and $1.2 million paid by White Eagle.

Maturity. The term of the White Eagle Revolving Credit Facility expires April 28, 2028, which is also the scheduled commitment termination date (though the lenders’ commitments to fund borrowings may terminate earlier in an event of default). The lenders’ interests in and rights to a portion of the proceeds of the policies does not terminate with the repayment of the principal borrowed and interest accrued thereon, the termination of the White Eagle Revolving Credit Facility or expiration of the lenders’ commitments.

Covenants/Events of Defaults. The White Eagle Revolving Credit Facility contains covenants and events of default that are customary for asset-based credit agreements of this type, but also include cross defaults under the servicing, account control, contribution and pledge agreements entered into in connection with the White Eagle Revolving Credit Facility (including in relation to breaches by third parties thereunder), certain changes in law, changes in control of or insolvency or bankruptcy of the Company and relevant subsidiary companies and performance of certain obligations by certain relevant subsidiary companies, White Eagle and third parties. The White Eagle Revolving Credit Facility does not contain any financial covenants, but does contain certain tests relating to asset maintenance, performance and valuation, the satisfaction of which will be determined by the lenders with a high degree of discretion.

Remedies. The White Eagle Revolving Credit Facility and ancillary transaction documents afford the lenders a high degree of discretion in their selection and implementation of remedies, including strict foreclosure, in relation to any event of default, including a high degree of discretion in determining whether to foreclose upon and liquidate all or any pledged policies, the interests in White Eagle, and the manner of any such liquidation. White Eagle has limited ability to cure events of default through the sale of policies or the procurement of replacement financing.

The Company elected to account for the debt under the White Eagle Revolving Credit Facility, which includes the 50% interest in policy proceeds to the lender, using the fair value method. The fair value of the debt is the amount the Company would have to pay to transfer the debt to a market participant in an orderly transaction. The Company calculated the fair value of the debt using a discounted cash flow model taking into account the stated interest rate of the credit facility and probabilistic cash flows from the pledged policies. Considerable judgment is required in interpreting market data to develop the estimates of fair value. Accordingly, the Company’s estimates are not necessarily indicative of the amounts that the Company, or holders of the instruments, could realize in a current market exchange. The most significant assumptions are the estimates of life expectancy of the insured and the discount rate. The use of different assumptions and/or estimation methodologies could have a material effect on the estimated fair values.

At June 30, 2016, the fair value of the outstanding debt was $172.4 million and the borrowing base was approximately $192.4 million, which includes $189.7 million of outstanding principal.

There are no scheduled repayments of principal prior to maturity although payments are due upon the next distribution date following the receipt of death benefits and distributed pursuant to the waterfall as described above. At June 30, 2016, approximately $5.5 million included in restricted cash was on account with White Eagle waiting distribution through the waterfall.

(10) Red Falcon Revolving Credit Facility

Effective July 16, 2015, Red Falcon Trust ("Red Falcon"), a Delaware statutory trust formed by Blue Heron Designated Activity Company (“Blue Heron”), a wholly-owned Irish subsidiary of the Company, entered into a revolving loan and security agreement (together with its ancillary documents, the “Red Falcon Revolving Credit Facility”) with LNV Corporation, as initial lender, the other lenders party thereto from time to time, Imperial Finance & Trading, LLC, as guarantor, Blue Heron as portfolio administrator and CLMG Corp., as administrative agent (the "Agent").
General & Security. The Red Falcon Revolving Credit Facility provides for a revolving credit facility backed by Red Falcon’s portfolio of life insurance policies with an initial aggregate lender commitment of up to $110.0 million, subject to borrowing base availability. As of June 30, 2016, 152 life insurance policies owned by Red Falcon with an aggregate death benefit of approximately $599.9 million and an estimated fair value of approximately $120.1 million are pledged as collateral

19



under the Red Falcon Revolving Credit Facility. In connection with the Red Falcon Revolving Credit Facility, the residual interests in Red Falcon have also been pledged.
Borrowing Base & Availability. Revolving credit borrowings are permitted for a five-year period with the loans under the Red Falcon Revolving Credit Facility maturing on July 15, 2022. Borrowing availability under the Red Falcon Revolving Credit Facility is subject to a borrowing base, which at any time is equal to the lesser of (A) the sum of all of the following amounts that have been funded or are to be funded through the next distribution date (i) the initial advance and all additional advances in respect of newly pledged policies that are not for ongoing maintenance advances, plus (ii) 100% of the sum of the ongoing maintenance costs, less (iii) any required amortization payments previously distributed and to be distributed through the next distribution date; (B) 60% of the valuation of the policies pledged as collateral as determined by the lenders; (C) 45% of the aggregate face amount of the policies pledged as collateral; and (D) $110.0 million. At June 30, 2016, $54.0 million was undrawn and $307,000 was available to borrow under the Red Falcon Revolving Credit Facility. The amount available to borrow is calculated based on and limited to the premium payments and expenses if any, that are due as of the calculation date. In essence, what is available, is what is required to pay expenses and keep the policies in force as of the calculation date.
Amortization & Distributions. Proceeds from the policies pledged as collateral under the Red Falcon Revolving Credit Facility are distributed pursuant to a waterfall with, subject to yield maintenance provisions, 5% of policy proceeds directed to the lenders. Thereafter proceeds are directed to pay fees to service providers and premiums with any remaining proceeds directed to pay outstanding interest and required amortization of 8% per annum on the greater of the then outstanding balance of the loan or the initial advance. Generally, after payment of interest and required amortization, a percentage of the collections from policy proceeds are to be paid to the lenders, which will vary depending on the then LTV as follows: (1) if the LTV is equal to or greater than 50%, all remaining proceeds will be directed to the lenders to repay the then outstanding principal balance; (2) if the LTV is less than 50% but greater than or equal to 25%, 65% of the remaining proceeds will be directed the lenders to repay the then outstanding principal balance; or (3) if the LTV is less than 25%, 35% of the remaining proceeds will be directed to the lenders to repay the then outstanding principal balance, in each case, with remaining proceeds directed to Red Falcon. To the extent there are not sufficient remaining proceeds in the waterfall to satisfy the amount of required interest and amortization then due, Red Falcon will be required to pay any such shortfall amount.
Initial Advance and Use of Proceeds. Amounts advanced to Red Falcon following effectiveness of the Red Falcon Revolving Credit Facility were approximately $54.0 million with certain of the proceeds used to pay transaction expenses and to purchase the policies pledged as collateral under the Red Falcon Revolving Credit Facility from certain affiliates of the Company, who then made a distribution to the Company which was used to redeem the Company's 12.875% Secured Notes. Generally, ongoing advances may be made for paying premiums on the life insurance policies pledged as collateral, and to pay the fees of service providers. Subsequent advances in respect of newly pledged policies are at the discretion of the lenders.
Interest. Borrowings under the Red Falcon Revolving Credit Facility bear interest at a rate equal to LIBOR or, if LIBOR is unavailable, the base rate, in each case plus an applicable margin of 4.50% and subject to a rate floor of 1.0%. The base rate under the Red Falcon Revolving Credit Facility equals the sum of (i) the weighted average of the interest rates on overnight federal funds transactions or, if unavailable, the average of three federal funds quotations received by the Agent plus 0.75% and (ii) 0.5%. The effective interest rate at June 30, 2016 was 5.5%.
Interest expense for the cash portion of interest paid during the period is recorded in the Company’s consolidated financial statements. Accrued interest is reflected as a component of the estimated fair value of the Red Falcon Revolving Credit Facility. Interest expense on the facility was $939,000 for the three months ended June 30, 2016 and $1.9 million for the six months ended June 30, 2016.
Maturity. The term of the Red Falcon Revolving Credit Facility expires July 15, 2022.
Covenants/Events of Defaults. The Red Falcon Revolving Credit Facility contains covenants and events of default, including those that are customary for asset-based credit facilities of this type and including cross defaults under the servicing, portfolio management and sales agreements entered into in connection with the Red Falcon Revolving Credit Facility, changes in control of or insolvency or bankruptcy of the Company and relevant subsidiary companies and performance of certain obligations by certain relevant subsidiary companies, Red Falcon and third parties. The Red Falcon Revolving Credit Facility does not contain any financial covenants, but does contain certain tests relating to asset maintenance, performance and valuation with determinations as to the satisfaction of such tests involving determinations made by the lenders with a high degree of discretion.
The Company elected to account for the debt under the Red Falcon Revolving Credit Facility using the fair value method. The fair value of the debt is the amount the Company would have to pay to transfer the debt to a market participant in an

20



orderly transaction. The Company calculated the fair value of the debt using a discounted cash flow model taking into account the stated interest rate of the credit facility and probabilistic cash flows from the pledged policies. Considerable judgment is required in interpreting market data to develop the estimates of fair value. Accordingly, the Company’s estimates are not necessarily indicative of the amounts that the Company, or holders of the instruments, could realize in a current market exchange. The most significant assumptions are the estimates of life expectancy of the insured and the discount rate. The use of different assumptions and/or estimation methodologies could have a material effect on the estimated fair values.
At June 30, 2016, the fair value of the outstanding debt was $55.1 million and the borrowing base was approximately $56.3 million, which includes $56.0 million of outstanding principal.

Subsequent to the quarter end, Red Falcon entered into an amendment to its revolving loan and security agreement. Pursuant to the amendment, six additional policies and additional portions of 20 policies that were previously pledged in part as collateral under the initial credit agreement were pledged in an additional policy advance. See Note 19, "Subsequent Event."

(11) 8.50% Senior Unsecured Convertible Notes

In February 2014, the Company issued $70.7 million in an aggregate principal amount of 8.50% senior unsecured convertible notes due 2019. The Convertible Notes were issued pursuant to an indenture dated February 21, 2014, between the Company and U.S. Bank National Association, as trustee. Two members of the Company’s Board of Directors, Messrs. Dakos and Goldstein, are affiliated with Bulldog Investors, LLC, who purchased $9.2 million of the Convertible Notes.

The Convertible Notes are general senior unsecured obligations and rank equally in right of payment with all of the Company’s other existing and future senior unsecured indebtedness. The Convertible Notes are effectively subordinate to all of the Company’s secured indebtedness to the extent of the value of the assets collateralizing such indebtedness. The Convertible Notes are not guaranteed by the Company’s subsidiaries.

The maturity date of the Convertible Notes is February 15, 2019. The Convertible Notes accrue interest at the rate of 8.50% per annum on the principal amount of the Convertible Notes, payable semi-annually in arrears on August 15 and February 15 of each year.

The Convertible Notes are convertible into shares of common stock at any time prior to the close of business on the second scheduled trading day immediately preceding the maturity date. Initially, the Convertible Notes were convertible into shares of common stock at a conversion rate of 147.9290 shares of common stock per $1,000 principal amount of Convertible Notes (equivalent to a conversion price of $6.76 per share of common stock). In the second quarter of 2015, the conversion rate was adjusted to 151.7912 shares of common stock per $1,000 principal amount of Convertible Notes (equivalent to a conversion price of $6.59 per share of common stock) in connection with anti-dilution adjustment triggered by a rights offering that resulted in the issuance of 6,688,433 shares of the Company’s common stock.

The Company may not redeem the Convertible Notes prior to February 15, 2017. On and after such date, and prior to the maturity date, the Company may redeem for cash all, but not less than all, of the Convertible Notes if the last reported sale price of the Company’s common stock equals or exceeds 130% of the applicable conversion price for at least 20 trading days during the 30 consecutive trading day period ending on the trading day immediately prior to the date the Company delivers notice of the redemption. The redemption price will be equal to 100% of the principal amount of the Convertible Notes, plus any accrued and unpaid interest to, but excluding, the redemption date. In addition, if the Company calls the Convertible Notes for redemption, a make-whole fundamental charge will be deemed to occur. As a result, the Company will, in certain circumstances, increase the conversion rate by a number of additional shares of common stock for holders who convert their notes prior to the redemption date.

The Company determined that an embedded conversion option existed in the Convertible Notes that was required to be separately accounted for as a derivative under ASC 815 which required the Company to bifurcate the embedded conversion option, record it as a liability at fair value and record a debt discount by an equal amount. Upon receipt of shareholder approval to issue shares of common stock upon conversion of the Convertible Notes in an amount that exceeded applicable New York Stock Exchange limits for issuances without shareholder approval, the Company reclassified the embedded conversion derivative liability to equity. The Convertible Notes are recorded at accreted value and will continue to be accreted up to the par value of the Convertible Notes at maturity.


21



As of June 30, 2016, the carrying value of the Convertible Notes was $58.6 million, net of unamortized debt discounts and origination costs of $10.6 million and $1.6 million, respectively. These are being amortized over the remaining life of the Convertible Notes using the effective interest method.

The Company recorded $2.4 million and $2.3 million of interest expense on the Convertible Notes, including $1.5 million, $782,000 and $116,000 and $1.5 million, $661,000 and $98,000 from interest, amortizing debt discounts and origination costs, during the three months ended June 30, 2016 and 2015, respectively.

The Company recorded $4.8 million and $4.5 million of interest expense on the Convertible Notes, including $3.0 million, $1.5 million and $227,000 and $3.0 million, $1.3 million and $189,000 from interest, amortizing debt discounts and origination costs, during the six months ended June 30, 2016 and 2015, respectively.

During the six months ended June 30, 2016 the Company adopted ASU No. 2015-03, "Interest-Imputation of Interest (Subtopic 835-30)." This standard provides guidance on the balance sheet presentation of debt issuance cost, discount and premiums. See Note 2 "Principles of Consolidation and Basis of Presentation."

(12) 15.00% Senior Secured Notes

On March 11, 2016 (the "Initial Closing Date"), the Company, as issuer, entered into an indenture with Wilmington Trust Company, as indenture trustee. The indenture provides for the issuance of up to $30.0 million in senior secured notes (the "Senior Secured Notes"), of which approximately $21.2 million were issued on the Initial Closing Date with an additional $8.8 million issued on March 24, 2016. The Senior Secured Notes were purchased in private transactions exempt from the registration requirements of the Securities Act of 1933, as amended, under the note purchase agreements with certain accredited investors and/or non U.S. persons, including certain members of the Company's board of directors, management and their affiliates, who purchased approximately $3.3 million of the Senior Secured Notes issued on the Initial Closing Date.

Interest on the Senior Secured Notes accrues at 15.0% per annum payable quarterly and all Senior Secured Notes will mature on September 14, 2018 (the "Maturity Date"). The Senior Secured Notes may be optionally redeemed in full at any time and must be redeemed in full upon additional issuances of debt by Emergent Capital, Inc., in each case, at a price equal to 100% of the principal amount redeemed plus (i) accrued and unpaid interest on the Senior Secured Notes redeemed up to the date of redemption, and (ii) the present value, as of the date of redemption of all remaining interest payments to the Maturity Date using a discount rate equal to the yield to maturity at the time of computation on the US treasury security with a constant maturity most nearly equal to the period from the redemption date to the Maturity Date plus 50 basis points. Upon a change of control, the Company will be required to make an offer to holders of the Senior Secured Notes to repurchase the Senior Secured Notes at a price equal to 107.5% of their principal amount.

The Senior Secured Notes contain negative covenants restricting additional debt incurred by Emergent Capital, Inc., creation of liens on the collateral securing the Senior Secured Notes, and restrictions on dividends and stock repurchases. The Senior Secured Notes are secured by settlement proceeds, if any, received from certain litigation involving the Company, certain notes issued to the Company and a pledge of 65% of the equity interests in Blue Heron Designated Activity Company, OLIPP IV, LLC and Red Reef Alternative Investments, LLC.

During the three months ended June 30, 2016, the Company adopted ASU No. 2015-03, "Interest - Imputation of Interest (Subtopic 835-30)." This standard provides guidance on the balance sheet presentation of debt issuance cost, discount and premiums.

As of June 30, 2016, the carrying value of the Senior Secured Notes was $29.1 million, net of unamortized debt origination costs of $875,000, which is being amortized over the remaining life of the Senior Secured Notes using the effective interest method.
The Company recorded approximately $1.2 million of interest expense on the Senior Secured Notes, which includes $1.1 million of interest and $111,000 of amortizing debt issuance costs, during the three months ended June 30, 2016.
The Company recorded approximately $1.5 million of interest expense on the Senior Secured Notes, which includes $1.4 million of interest and $176,000 of amortizing debt issuance costs, during the six months ended June 30, 2016.

22




(13) 12.875% Senior Secured Notes

On November 10, 2014 and January 21, 2015, the Company issued an aggregate of $50.0 million in 12.875% Senior Secured Notes (the "Secured Notes") in two $25.0 million tranches. The Secured Notes were issued at 96% of their face amount. Fees and expenses paid by the Company in connection with the initial and subsequent issuances were approximately $1.8 million and $305,000, respectively.
All Secured Notes issued under the indenture were scheduled to mature on November 10, 2017. On July 16, 2015, the Company redeemed all of the outstanding Secured Notes at 106% of their principal amount plus interest up to November 10, 2015. Approximately $8.8 million was expensed as extinguishment related to the early repayment of the facility in July 2015, including $5.2 million, $171,000, $1.7 million and $1.7 million related to interest and prepayment penalties, unused fees, a write off of debt discounts and write off of issuance costs, respectively.
For the three months ended June 30, 2015, the Company recorded $2.0 million of interest expense on the Secured Notes, including $1.6 million, $126,000, $147,000 and $149,000 for interest, unused fees, amortizing debt discounts and issuance costs, respectively.
For the six months ended June 30, 2015, the Company recorded $3.8 million of interest expense on the Secured Notes, including $3.0 million, $255,000, $264,000 and $277,000 for interest, unused fees, amortizing debt discounts and issuance costs, respectively.

(14) Fair Value Measurements

The Company carries life settlements and debt under the Revolving Credit Facilities at fair value as shown in the consolidated balance sheets. Fair value is defined as an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. As such, fair value is a market based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. Fair value measurements are classified based on the following fair value hierarchy:

Level 1-Valuation is based on unadjusted quoted prices in active markets for identical assets and liabilities that are accessible at the reporting date. Since valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these products does not entail a significant degree of judgment.

Level 2-Valuation is determined from pricing inputs that are other than quoted prices in active markets that are either directly or indirectly observable as of the reporting date. Observable inputs include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, and interest rates and yield curves that are observable at commonly quoted intervals.

Level 3-Valuation is based on inputs that are both significant to the fair value measurement and unobservable. Level 3 inputs include situations where there is little, if any, market activity for the financial instrument. The inputs into the determination of fair value generally require significant management judgment or estimation.

Assets and liabilities measured at fair value on a recurring basis

The balances of the Company’s assets measured at fair value on a recurring basis as of June 30, 2016, are as follows (in thousands):
 
Level 1
 
Level 2
 
Level 3
 
Total
Fair Value
Assets:
 
 
 
 
 
 
 
Life settlements
$

 
$

 
$
473,046

 
$
473,046

 
$

 
$

 
$
473,046

 
$
473,046



23



The balances of the Company’s liabilities measured at fair value on a recurring basis as of June 30, 2016 are as follows (in thousands):
 
Level 1
 
Level 2
 
Level 3
 
Total
Fair Value
Liabilities:
 
 
 
 
 
 
 
White Eagle Revolving Credit Facility
$

 
$

 
$
172,361

 
$
172,361

Red Falcon Revolving Credit Facility

 

 
55,082

 
55,082

 
$

 
$

 
$
227,443

 
$
227,443


The balances of the Company’s assets measured at fair value on a recurring basis as of December 31, 2015, are as follows (in thousands):
 
Level 1
 
Level 2
 
Level 3
 
Total Fair
Value
Assets:
 
 
 
 
 
 
 
Life settlements
$

 
$

 
$
461,925

 
$
461,925

 
$

 
$

 
$
461,925

 
$
461,925


The balances of the Company’s liabilities measured at fair value on a recurring basis as of December 31, 2015, are as follows (in thousands):
 
Level 1
 
Level 2
 
Level 3
 
Total Fair
Value
Liabilities:
 
 
 
 
 
 
 
White Eagle Revolving Credit Facility
$

 
$

 
$
169,131

 
$
169,131

Red Falcon Revolving Credit Facility






$
55,658


$
55,658

 
$

 
$

 
$
224,789

 
$
224,789


The Company categorizes its investment in life settlement portfolio in two classes, non-premium financed and premium financed. In considering the categories, historically, it has generally believed that market participants would require a lower risk premium for policies that were non-premium financed, while a higher risk premium would be required for policies that were premium financed; the Company believes that this risk premium has been declining.
($ in thousands)
Quantitative Information about Level 3 Fair Value Measurements
 
 
Fair Value
at 6/30/16
 
Aggregate
death benefit
at 6/30/16
 
Valuation Technique
 
Unobservable Input (s)
 
Range
(Weighted Average)
Non-premium financed
$
101,757

 
$335,203
 
Discounted cash flow
 
Discount rate
 
15.00%
-
21.00%
 
 
 
 
 
 
 
Life expectancy evaluation
 
(5.9 years)
Premium financed
$
371,289

 
$2,631,185
 
Discounted cash flow
 
Discount rate
 
16.00%
-
22.00%
 
 
 
 
 
 
 
Life expectancy evaluation
 
(9.8 years)
Life settlements
$
473,046

 
$2,966,388
 
Discounted cash flow
 
Discount rate
 
16.49%
 
 
 
 
 
 
 
Life expectancy evaluation
 
(9.4 years)
White Eagle Revolving Credit Facility
$
172,361

 
$2,180,147
 
Discounted cash flow
 
Discount rate
 
19.90%
 
 
 
 
 
 
 
Life expectancy evaluation
 
(9.3 years)
Red Falcon Revolving Credit Facility
$
55,082

 
$599,947
 
Discounted cash flow
 
Discount Rate
 
11.06%
 
 
 
 
 
 
 
Life expectancy evaluation
 
(8.9 years)

Following is a description of the methodologies used to estimate the fair values of assets and liabilities measured at fair value on a recurring basis and within the fair value hierarchy.

Life settlements—The Company has elected to account for the life settlement policies it acquires using the fair value method. The Company uses a present value technique to estimate the fair value of its life settlements, which is a Level 3 fair

24



value measurement as the significant inputs are unobservable and require significant management judgment or estimation. The Company currently uses a probabilistic method of valuing life insurance policies, which the Company believes to be the preferred valuation method in the industry. The most significant assumptions are the estimates of life expectancy of the insured and the discount rate.

The Company provides medical records for each insured to independent life expectancy providers (each, an "LE provider"). Each LE provider reviews and analyzes the medical records and identifies all medical conditions it feels are relevant to the life expectancy determination of the insured. Debits and credits are assigned by each LE provider to the individual’s health based on identified medical conditions, which are derived from the experience of mortality attributed to relevant conditions in the portfolio of lives that the LE provider monitors. The health of the insured is summarized by the LE provider into a life assessment of the individual’s life expectancy expressed both in terms of months and in mortality factor. The mortality factor represents the degree to which the given life can be considered more or less impaired than a life having similar characteristics (e.g. gender, age, smoking, etc.). For example, a standard insured (the average life for the given mortality table) would carry a mortality rating of 100%. A similar but impaired life bearing a mortality rating of 200% would be considered to have twice the chance of dying earlier than the standard life relative to the LE provider’s population. Since each provider’s mortality factor is based on its own mortality table, the Company calculates its own factors to apply to the table selected by the Company.

The Company calculates mortality factors so that when applied to the mortality table selected by the Company, the resulting LE equals the LE provided by each LE provider. The resulting mortality factors are then blended to determine a factor for each insured.

A mortality curve is then generated based on the calculated mortality factors and the rates from the Company selected mortality table to generate the best estimated probabilistic cash flow stream. The net present value of the cash flows is then calculated to determine the policy value.

If the insured dies earlier than expected, the return will be higher than if the insured dies when expected or later than expected. The calculation allows for the possibility that if the insured dies earlier than expected, the premiums needed to keep the policy in force will not have to be paid. Conversely, the calculation also considers the possibility that if the insured lives longer than expected, more premium payments will be necessary.

Since the quarter ended September 30, 2012, and prior to June 30, 2016, the Company used the 2008 Valuation Basic tables, smoker distinct ("2008 VBT"), mortality tables developed by the U.S. Society of Actuaries (the "SOA"). The mortality tables are created based on the expected rates of death among different groups categorized by factors such as age and gender.

During 2015, the U.S. Society of Actuaries released new versions of the Valuation Basic Tables, the ("2015 VBT"). The 2015 VBT has a significant increase in exposure and number of claims over the 2008 VBT and is believed to be a better fit for the life settlement industry and is becoming more widely accepted. During the quarter ended June 30, 2016, the Company changed its valuation technique and decided to adopt the 2015 VBT, smoker and gender distinct tables, to determine the value of the policies. The table shows lower mortality rates in the earlier select periods at most ages, so while the Company continues to fit the life expectancies from the LE providers to the 2015 VBT, the change in the mortality curve changes the timing of the Company’s expected cash flow streams. The resulting impact is approximately $17.6 million reduction in the fair value of our life settlements.

Future changes in the life expectancies could have a material adverse effect on the fair value of the Company’s life settlements, which could have a material adverse effect on its business, financial condition and results of operations

Life expectancy sensitivity analysis

If all of the insured lives in the Company’s life settlement portfolio live six months shorter or longer than the life expectancies provided by these third parties, the change in estimated fair value would be as follows (dollars in thousands):

Life Expectancy Months Adjustment
Value
 
Change in Value
+6
$
394,432

 
$
(78,614
)
-
$
473,046

 

-6
$
557,416

 
$
84,370


25




Discount rate

The discount rate incorporates current information about market interest rates, the credit exposure to the insurance company that issued the life insurance policy and our estimate of the risk premium an investor in the policy would require.

The Company re-evaluates its discount rates at the end of every reporting period in order to reflect the estimated discount rates that could reasonably be used in a market transaction involving the Company’s portfolio of life insurance policies. In doing so, the Company relies on management insight, engages third party consultants to corroborate its assessment, engages in discussions with other market participants and extrapolates the discount rate underlying actual sales of policies.

At one time, due to the Company’s association with the USAO Investigation and certain civil litigation involving the Company, the Company believed that, when given the choice to invest in a policy that was associated with the Company’s premium finance business and a similar policy without such an association, all else being equal, an investor would have generally opted to invest in the policy that was not associated with the Company’s premium finance business. However, since the Company entered into a non-prosecution agreement, investors have required less of a risk premium to transact in policies associated with the Company’s legacy premium finance business. With passage of time, and resolution of litigations, the Company now believes investors no longer require a greater risk premium for policies associated with the Company's premium finance business than the risk premium otherwise required for policies that were premium financed. In general, the Company believes that the risk premium an investor would require to transact in a policy that has been premium financed versus a policy without premium financing is lessening in the current market environment and further expects that, with the passage of time, investors will continue to require less of a risk premium to transact in policies associated that had been premium financed.

Credit exposure of insurance company

The Company considers the financial standing of the issuer of each life insurance policy. Typically, we seek to hold policies issued by insurance companies that are rated investment grade by the top three credit rating agencies. At June 30, 2016, the Company had 19 life insurance policies issued by three carriers that were rated non-investment grade as of that date. In order to compensate a market participant for the perceived credit and challenge risks associated with these policies, the Company applied an additional 300 basis point risk premium.

The following table provides information about the life insurance issuer concentrations that exceed 10% of total death benefit and 10% of total fair value of the Company’s life settlements as of June 30, 2016:
Carrier
Percentage of
Total
Fair Value
 
Percentage of
Total Death
Benefit
 
Moody's
Rating
 
S&P
Rating
Transamerica Life Insurance Company
17.9
%
 
20.5
%
 
A1

AA-
Lincoln National Life Insurance Company
23.5
%
 
19.6
%
 
A1

AA-

Estimated risk premium

As of June 30, 2016, the Company owned 625 policies with an estimated fair value of $473.0 million. Of these 625 policies, 540 were previously premium financed and are valued using discount rates that range from 16.00% to 22.00%. The remaining 85 policies, which are non-premium financed, are valued using discount rates that range from 15.00% to 21.00%. As of June 30, 2016, the weighted average discount rate calculated based on death benefit used in valuing the policies in the Company’s life settlement portfolio was 16.49%.

The discount rate incorporates current information about market interest rates, the credit exposure to the insurance company that issued the life insurance policy and our estimate of the risk premium an investor in the policy would require. The extent to which the fair value could vary in the near term has been quantified by evaluating the effect of changes in the weighted average discount rate on the death benefit used to estimate the fair value. If the weighted average discount rate was increased or decreased by 1/2 of 1% and the other assumptions used to estimate fair value remained the same, the change in estimated fair value would be as follows (dollars in thousands):


26



Market interest rate sensitivity analysis

Weighted Average Rate Calculated Based on
 
 
 
 
 
Death Benefit
Rate Adjustment
 
Value
 
Change in Value
15.99%
-0.50%

 
$
486,171

 
$
13,125

16.49%

 
$
473,046

 
$

16.99%
+0.50%

 
$
460,480

 
$
(12,566
)

Future changes in the discount rates we use to value life insurance policies could have a material effect on the yield on life settlement transactions, which could have a material adverse effect on our business, financial condition and results of our operations.

At the end of each reporting period we re-value the life insurance policies using our valuation model in order to update our estimate of fair value for investments in policies held on our balance sheet. This includes reviewing our assumptions for discount rates and life expectancies as well as incorporating current information for premium payments and the passage of time.

White Eagle Revolving Credit Facility— In connection with the White Eagle Revolving Credit Facility, 433 policies are pledged by White Eagle to serve as collateral for its obligations under the facility. Absent an event of default under the White Eagle Revolving Credit Facility, ongoing borrowings will be used to pay the premiums on these policies and certain approved third party expenses. As more fully described in Note 9, "White Eagle Revolving Credit Facility," proceeds from the policies pledged as collateral will be distributed pursuant to a waterfall with 50% of the proceeds remaining following the Excess LTV Payments and/or preference amount, as the case may be, being directed to the lenders with the remainder paid to White Eagle. We have elected to account for this long-term debt, which includes the lender’s interest in policy proceeds, using the fair value method. The fair value of the debt is the amount the Company would have to pay to transfer the debt to a market participant in an orderly transaction. We calculated the fair value of the debt using a discounted cash flow model taking into account the stated interest rate of the White Eagle Revolving Credit Facility and probabilistic cash flows from the pledged policies. Accordingly, our estimates are not necessarily indicative of the amounts that we, or holders of the instruments, could realize in a current market exchange. The most significant assumptions are the estimates of life expectancy of the insured and the discount rate. The use of different assumptions and/or estimation methodologies could have a material effect on the estimated fair values.

During the quarter ended June 30, 2016, the Company changed its valuation technique by adopting the 2015 VBT, smoker and gender distinct tables, to determine the value of the life insurance policies pledged as collateral in the facility. The table shows lower mortality rates in the earlier select periods at most ages, so while the Company continues to fit the life expectancies from the LE providers to the 2015 VBT, the change in the mortality curve changes the timing of the Company’s expected cash flow streams, which resulted in an increase in borrowings. The resulting impact is approximately $14.7 million positive change in fair value of the White Eagle Revolving Credit Facility.

Life expectancy sensitivity analysis of the White Eagle Revolving Credit Facility

A considerable portion of the fair value of the White Eagle Revolving Credit Facility is determined by the timing of receipt of future policy proceeds. Should life expectancies lengthen such that policy proceeds are collected further into the future, the fair value of this debt will decline. Conversely, should life expectancies shorten, the fair value of this debt will increase. Considerable judgment is required in interpreting market data to develop the estimates of fair value.

If all of the insured lives in the life settlement portfolio pledged under the White Eagle Revolving Credit Facility live six months shorter or longer than the life expectancies used to calculate the estimated fair value of the White Eagle Revolving Credit Facility debt, the change in estimated fair value would be as follows (dollars in thousands):
Life Expectancy Months Adjustment
Fair Value of White Eagle
Revolving Credit
Facility
 
Change in Value
+6
$
141,389

 
$
(30,972
)
 
$
172,361

 

-6
$
204,533

 
$
32,172



27



Future changes in the life expectancies could have a material effect on the fair value of the White Eagle Revolving Credit Facility, which could have a material adverse effect on its business, financial condition and results of operations.

Discount rate of the White Eagle Revolving Credit Facility

The discount rate incorporates current information about market interest rates, credit exposure to insurance companies and the Company’s estimate of the return a lender lending against the policies would require.

Market interest rate sensitivity analysis of the White Eagle Revolving Credit Facility

The extent to which the fair value of the White Eagle Revolving Credit Facility could vary in the near term has been quantified by evaluating the effect of changes in the weighted average discount. If the weighted average discount rate were increased or decreased by 1/2 of 1% and the other assumptions used to estimate fair value remained the same, the change in estimated fair value of the White Eagle Revolving Credit Facility as of June 30, 2016 would be as follows (dollars in thousands):
Discount Rate
Rate Adjustment
 
Fair Value of White Eagle
Revolving Credit
Facility
 
Change in Value
19.40%
-0.50
 %
 
$
176,692

 
$
4,331

19.90%

 
$
172,361

 
$

20.40%
+0.50
 %
 
$
168,194

 
$
(4,167
)

Future changes in the discount rates could have a material effect on the fair value of the White Eagle Revolving Credit Facility, which could have a material adverse effect on its business, financial condition and results of its operations.

At June 30, 2016, the fair value of the debt was $172.4 million and the outstanding principal was approximately $189.7 million.
Red Falcon Revolving Credit Facility— In connection with the Red Falcon Revolving Credit Facility, 152 policies are pledged by Red Falcon to serve as collateral for its obligations under the facility. Proceeds from the policies pledged as collateral under the Red Falcon Credit Facility are distributed pursuant to a waterfall with, subject to yield maintenance provisions, 5% of policy proceeds directed to the lenders. Thereafter proceeds are directed to pay fees to service providers and premiums with any remaining proceeds directed to pay outstanding interest and required amortization of 8% per annum on the loan. Generally, after payment of interest and required amortization, a percentage of the collections from policy proceeds are to be paid to the lenders to repay the then outstanding principal balance, which will vary depending on the then loan to value ratio as more fully described in Note 10, "Red Falcon Revolving Credit Facility." The Company has elected to account for this long-term debt using the fair value method. The fair value of the debt is the amount the Company would have to pay to transfer the debt to a market participant in an orderly transaction. The Company calculated the fair value of the debt using a discounted cash flow model taking into account the stated interest rate of the Red Falcon Revolving Credit Facility and probabilistic cash flows from the pledged policies. Accordingly, the Company’s estimates are not necessarily indicative of the amounts that the Company, or holders of the instruments, could realize in a current market exchange. The most significant assumptions are the estimates of life expectancy of the insured and the discount rate. The use of different assumptions and/or estimation methodologies could have a material effect on the estimated fair values.

During the quarter ended June 30, 2016, the Company changed its valuation technique by adopting the 2015 VBT, smoker and gender distinct tables, to determine the value of the life insurance policies pledged as collateral in the facility. The table shows lower mortality rates in the earlier select periods at most ages, so while the Company continues to fit the life expectancies from the LE providers to the 2015 VBT, the change in the mortality curve changes the timing of the Company’s expected cash flow streams, which resulted in an increase in borrowings. The resulting impact is approximately $1.0 million positive change in fair value of the Red Falcon Revolving Credit Facility.

28



Life expectancy sensitivity analysis of the Red Falcon Revolving Credit Facility

A considerable portion of the fair value of the Red Falcon Revolving Credit Facility is determined by the timing of receipt of future policy proceeds. Should life expectancies lengthen such that policy proceeds are collected further into the future, the fair value of this debt will decline. Conversely, should life expectancies shorten; the fair value of this debt will increase. Considerable judgment is required in interpreting market data to develop the estimates of fair value.

If all of the insured lives in the life settlement portfolio pledged under the Red Falcon Credit Facility live six months shorter or longer than the life expectancies used to calculate the estimated fair value of the Red Falcon Revolving Credit Facility, the change in estimated fair value would be as follows (dollars in thousands):

Life Expectancy Months Adjustment
Fair Value of Red Falcon
Revolving Credit
Facility
 
Change in Value
+6
$
52,375

 
$
(2,707
)
 
$
55,082

 

-6
$
57,062

 
$
1,980


Future changes in the life expectancies could have a material effect on the fair value of the Red Falcon Revolving Credit Facility, which could have a material adverse effect on its business, financial condition and results of operations.

Discount rate of the Red Falcon Revolving Credit Facility

The discount rate incorporates current information about market interest rates, credit exposure to insurance companies and the Company’s estimate of the return a lender lending against the policies would require.

Market interest rate sensitivity analysis of the Red Falcon Revolving Credit Facility

The extent to which the fair value of the Red Falcon Revolving Credit Facility could vary in the near term has been quantified by evaluating the effect of changes in the weighted average discount. If the weighted average discount rate were increased or decreased by 1/2 of 1% and the other assumptions used to estimate fair value remained the same, the change in estimated fair value of the Red Falcon Revolving Credit Facility as of June 30, 2016 would be as follows (dollars in thousands):
Discount Rate
Rate Adjustment
 
Fair Value of Red Falcon
Revolving Credit
Facility
 
Change in Value
10.56%
-0.50
 %
 
$
55,950

 
$
868

11.06%

 
$
55,082

 
$

11.56%
+0.50
 %
 
$
54,236

 
$
(846
)

Future changes in the discount rates could have a material effect on the fair value of the Red Falcon Revolving Credit Facility, which could have a material adverse effect on its business, financial condition and results of its operations.

At June 30, 2016, the fair value of the debt was $55.1 million and the outstanding principal was approximately $56.0 million.

Convertible Notes—The Company determined that an embedded conversion option in the Convertible Notes was required to be separately accounted for as a derivative under Accounting Standards Codification 815, Derivatives and Hedging ("ASC 815"). ASC 815 required the Company to bifurcate the embedded conversion option and record it as a liability at fair value and reduce the debt liability by a corresponding discount of an equivalent amount. The Company used a Black Scholes pricing model that incorporates present valuation techniques and reflect both the time value and the intrinsic value of the embedded conversion option to approximate the fair value of the conversion derivative liability at the end of each reporting period. This model required assumptions as to expected volatility, dividends, terms, and risk free rates.


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In accordance with ASC 815, upon receipt of shareholder approval the Company reclassified the embedded derivative to stockholders’ equity along with unamortized transaction costs proportionate to the allocation of the initial debt discount and the principal amount of the Convertible Notes. The Convertible Notes continue to be recorded at accreted value up to the par value of the Convertible Notes at maturity. See Note 11, "8.50% Senior Unsecured Convertible Notes." Although the Company believes its valuation method is appropriate, the use of different methodologies or assumptions to determine the fair value could result in different fair values.

Changes in Fair Value

The following table provides a roll-forward in the changes in fair value for six months ended June 30, 2016, for all assets for which the Company determines fair value using a material level of unobservable (Level 3) inputs, which consists solely of life settlements (in thousands):
Life Settlements:
 
Balance, January 1, 2016
$
461,925

Purchase of policies
16

Retained death benefits acquisitions
1,374

Change in fair value*
(7,425
)
Matured/lapsed/sold policies
(17,180
)
Premiums paid
34,336

Transfers into level 3

Transfer out of level 3

Balance, June 30, 2016
$
473,046

Changes in fair value included in earnings for the period relating to assets held at June 30, 2016
$
(18,182
)

*Change in the mortality curve after adoption of 2015 VBT resulted in approximately $17.6 million reduction in the fair value of our life settlements.

The following table provides a roll-forward in the changes in fair value for six months ended June 30, 2016, for the White Eagle Revolving Credit Facility for which the Company determines fair value using a material level of unobservable (Level 3) inputs (in thousands):
White Eagle Revolving Credit Facility:
 
Balance, January 1, 2016
$
169,131

Draws under the White Eagle Revolving Credit Facility
25,587

Payments on White Eagle Revolving Credit Facility
(7,952
)
Unrealized change in fair value
(14,405
)
Transfers into level 3

Transfer out of level 3

Balance, June 30, 2016
$
172,361

Changes in fair value included in earnings for period relating to liabilities held at June 30, 2016
$
(14,405
)

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The following table provides a roll-forward in the changes in fair value for six months ended June 30, 2016, for the Red Falcon Revolving Credit Facility for which the Company determines fair value using a material level of unobservable (Level 3) inputs (in thousands):
Red Falcon Revolving Credit Facility:
 
Balance, January 1, 2016
$
55,658

Draws under the Red Falcon Revolving Credit Facility
8,603

Payments on Red Falcon Revolving Credit Facility
(8,014
)
Unrealized change in fair value
(1,165
)
Transfers into level 3

Transfer out of level 3

Balance, June 30, 2016
$
55,082

Changes in fair value included in earnings for period relating to liabilities held at June 30, 2016
$
(1,165
)

The following table provides a roll-forward in the changes in fair value for six months ended June 30, 2015, for all assets for which the Company determines fair value using a material level of unobservable (Level 3) inputs, which consist solely of life settlements (in thousands):
Life Settlements:
 
Balance, January 1, 2015
$
388,886

Purchase of policies
27,535

Change in fair value
40,914

Matured/sold policies
(49,766
)
Premiums paid
31,417

Transfers into level 3

Transfer out of level 3

Balance, June 30, 2015
$
438,986

Changes in fair value included in earnings for the period relating to assets held at June 30, 2015
$
2,598


The following tables provide a roll-forward in the changes in fair value for the six months ended June 30, 2015, for the White Eagle Revolving Credit Facility for which the Company determines fair value using a material level of unobservable (Level 3) inputs (in thousands):
White Eagle Revolving Credit Facility:
 
Balance, January 1, 2015
$
145,831

Draws under the White Eagle Revolving Credit Facility
25,912

Payments on White Eagle Revolving Credit Facility
(18,577
)
Unrealized change in fair value
17,692

Transfers into level 3

Transfer out of level 3

Balance, June 30, 2015
$
170,858

Changes in fair value included in earnings for the period relating to liabilities held at June 30, 2015
$
17,692


There were no transfers of financial assets or liabilities between levels of the fair value hierarchy during the six months ended June 30, 2016 and 2015.

Other Fair Value Considerations - Carrying value of certificate of deposits, prepaid expenses and other assets, receivable for maturity of life settlements, investment in affiliates, Senior Secured Notes, accounts payable and accrued expenses approximate fair value due to their short-term maturities and/or low credit risk.


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(15) Segment Information

On October 25, 2013, the Company sold its structured settlement business, which was previously reported as an operating segment. The operating results related to the Company’s structured settlement business have been included in discontinued operations in the Company’s Consolidated Statements of Operations for all periods presented and the Company has discontinued segment reporting.

(16) Commitments and Contingencies

Lease Agreements

The Company leases office space under a lease that commenced on October 1, 2014. The lease expires on September 30, 2020. The annual base rent is $231,900, with a provision for a 3% increase on each anniversary of the rent commencement date. Rent expense was approximately $104,000 and $103,000 for the three months ended June 30, 2016 and 2015, respectively. Future minimum lease payments for the remainder of 2016 are approximately $118,000.

Employment Agreements

The Company has entered into employment agreements with certain of its officers, including with its chief executive officer, whose agreement provides for substantial payments in the event that the executive terminates his employment with the Company due to a material change in the geographic location where the chief executive officer performs his duties or upon a material diminution of his base salary or responsibilities, with or without cause. These payments are equal to three times the sum of the chief executive officer’s base salary and the average of the preceding three years’ annual cash bonus.

The Company does not have any general policies regarding the use of employment agreements, but has and may, from time to time, enter into such a written agreement to reflect the terms and conditions of employment of a particular named executive officer, whether at the time of hire or thereafter.

Separation Agreement

On April 26, 2012, the Company entered into a Separation Agreement and General Release of Claims (the "Separation Agreement") with its former chief operating officer, Jonathan Neuman. The Separation Agreement obligates the Company to indemnify Mr. Neuman for his legal expenses including expenses incurred as part of the USAO Investigation and SEC investigation. The Company recognized indemnification expenses of $251,000 and $822,000 during the three months ended June 30, 2016 and 2015, respectively, and $429,000 and $1.5 million during the six months ended June 30, 2016 and 2015. On December 31, 2015, the Company received a letter from the USAO indicating that the USAO had concluded the USAO Investigation. Accordingly, the Company does not expect to incur advancement or indemnification expenses related to the USAO Investigation going forward.

Litigation

In accordance with applicable accounting guidance, the Company establishes an accrued liability for litigation and regulatory matters when those matters present loss contingencies that are both probable and estimable. In such cases, there may be an exposure to loss in excess of any amounts accrued. When a loss contingency is not both probable and estimable, the Company does not establish an accrued liability. As a litigation or regulatory matter develops, the Company, in conjunction with any outside counsel handling the matter, evaluates on an ongoing basis whether such matter presents a loss contingency that is probable and estimable. If, at the time of evaluation, the loss contingency related to a litigation or regulatory matter is not both probable and estimable, the matter will continue to be monitored for further developments that would make such loss contingency both probable and estimable. When a loss contingency related to a litigation or regulatory matter is deemed to be both probable and estimable, the Company will establish an accrued liability with respect to such loss contingency and record a corresponding amount of litigation-related expense. The Company will then continue to monitor the matter for further developments that could affect the amount of any such accrued liability.

Non-Prosecution Agreement & Indemnification Obligations

On September 27, 2011, the Company was informed that it was being investigated by the U.S. Attorney’s Office for the District of New Hampshire in connection with the Company’s now legacy premium finance loan business. On April 30, 2012, the Company entered into a Non-Prosecution Agreement (the "Non-Prosecution Agreement") with the USAO.


32



The Non-Prosecution Agreement had a term of three years and expired in accordance with its terms on April 30, 2015. While the Non-Prosecution Agreement effectively resolved the USAO Investigation as it pertained to the Company, the Company had continuing cooperation obligations to the USAO and, since entering the Non-Prosecution Agreement, the USAO had been to investigating certain individuals and entities formerly associated with the Company’s legacy premium finance business. Settlements of certain civil litigation with the Company’s director and officer liability insurance carriers related to the USAO Investigation and other contractual obligations required the Company to advance legal fees to and indemnify these individuals and entities. On December 31, 2015, the Company received a letter from the USAO indicating that the USAO Investigation had formally concluded, that the Company fully complied with all of its obligations under the Non-Prosecution Agreement and that the Company was released from any further obligations under the Non-Prosecution Agreement. Accordingly, the Company does not expect to incur advancement or indemnification expenses related to the USAO Investigation going forward.

SEC Investigation

On February 17, 2012, the Company received an initial subpoena issued by the staff of the SEC seeking documents from 2007 through the date of the subpoena, generally related to the Company’s premium finance business and corresponding financial reporting. The SEC is investigating whether any violations of federal securities laws have occurred and the Company has been cooperating with the SEC regarding this matter. The Company is unable to predict what action, if any, might be taken in the future by the SEC or its staff as a result of the investigation or what impact, if any, the cost of responding to the SEC might have on the Company’s financial position, results of operations, or cash flows. The Company has not established any provision for losses in respect of this matter.

Sun Life

On April 18, 2013, Sun Life Assurance Company of Canada ("Sun Life") filed a complaint against the Company and several of its affiliates in the United States District Court for the Southern District of Florida, entitled Sun Life Assurance Company of Canada v. Imperial Holdings, Inc., et al. ("Sun Life Case"), asserting, among other things, that at least 28 life insurance policies issued by Sun Life and owned by the Company through certain of its subsidiary companies were invalid. The Sun Life complaint, as amended, asserted the following claims: (1) violations of the federal Racketeer Influenced and Corrupt Organizations ("RICO") Act, (2) conspiracy to violate the RICO Act, (3) common law fraud, (4) aiding and abetting fraud, (5) civil conspiracy to commit fraud, (6) tortious interference with contractual obligations, and (7) a declaration that the policies issued were void. Following the filing of a motion by the Company to dismiss the Sun Life Case, on December 9, 2014, counts (2), (4), (5), (6) and (7) of the Sun Life Case were dismissed with prejudice. The Company then filed a motion for summary judgment on the remaining counts. On February 4, 2015, the Court issued an order (the "Order") granting the Company’s motion for summary judgment on counts (1) and (3), resulting in the Company prevailing on all counts in the Sun Life Case.

On July 29, 2013, the Company filed a separate complaint against Sun Life in United States District Court for the Southern District of Florida, entitled Imperial Premium Finance, LLC v. Sun Life Assurance Company of Canada ("Imperial Case"), which was subsequently consolidated with the Sun Life Case. The Imperial complaint asserts claims against Sun Life for breach of contract, breach of the covenant of good faith and fair dealing, and fraud, and seeks a judgment declaring that Sun Life is obligated to comply with the promises made by it in certain insurance policies. The complaint also seeks compensatory damages of no less than $30.0 million in addition to an award of punitive damages. On August 23, 2013, Sun Life moved to dismiss the complaint, which was denied by the Court as part of the Order. On February 26, 2015, Sun Life filed a Notice of Appeal from the Order to the United States Court of Appeals for the Eleventh Circuit, which had denied Sun Life’s motion to dismiss. On December 17, 2015, after the matter was fully briefed, the Circuit Court issued an order granting the Company’s motion to dismiss and sent the case back to the District Court. The District Court lifted the stay and ordered Sun Life to file its Answer to the Imperial Case by January 22, 2016. On February 3, 2016, the District Court set a trial date of the Imperial Case for October 31, 2016.


33



IRS Investigation

The Internal Revenue Service (“IRS”) Criminal Investigation Division notified the Company in February 2014 that it was conducting an investigation related to the Company and its legacy structured settlements business (the "IRS Investigation"). On May 3, 2016, the Company was informed that the IRS Investigation has been closed. The IRS may still refer any civil aspects of this matter to its Collection and Examination functions. If any such referral is made and results in a determination by the IRS that the Company had failed to comply with any of its obligations under the Internal Revenue Code or regulations thereunder, the Company could incur additional tax liability, restitution payment obligations, penalties, and fines or other liabilities, that could have a material adverse effect on the Company, its personnel, its financial condition, cash flows and its financial results of operations. The Company has not established any provision for losses related to this matter.


Other Litigation

A complaint was filed against the Company’s subsidiary, styled Kenneth Jennings v. Washington Square Financial, LLC d/b/a Imperial Structured Settlements ("Washington Square"), and is currently pending in the United States District Court for the Northern District of Illinois. The plaintiff seeks, in a purported class action, to represent all individuals who sold all or a part of a structured settlement annuity to Washington Square under the Illinois Structured Settlement Protections Act (the “Illinois Act”), where the underlying annuity contract contained an anti-assignment clause, and where a court issued an order under the Illinois Act approving the transaction. The complaint seeks, among other things, a declaration that all such transactions are void and compensatory and punitive damages. To date, the District Court has made no rulings with respect to whether the claims raised in the complaint state a cause of action. The Company has not established any provision for losses in respect of this matter.

The Company is party to various other legal proceedings that arise in the ordinary course of business. Due to the inherent difficulty of predicting the outcome of litigation and other legal proceedings, the Company cannot predict the eventual outcome of these matters, and it is reasonably possible that some of them could be resolved unfavorably to the Company. As a result, it is possible that the Company’s results of operations or cash flows in a particular fiscal period could be materially affected by an unfavorable resolution of pending litigation or contingencies. However, the Company believes that the resolution of these other proceedings will not, based on information currently available, have a material adverse effect on the Company’s financial position or results of operations.

(17) Stockholders’ Equity

During the second quarter of 2015, the Company issued 6,688,433 shares of common stock pursuant to a rights offering at a price of $5.75 per share.

In connection with the settlement of class litigation, the Company issued warrants to purchase two million shares of the Company’s stock into an escrow account in April 2014 and were distributed in October 2014. The estimated fair value at the measurement date of such warrants was $5.4 million, which is included in stockholder’s equity. The warrants have a five-year term from the date of their distribution with an exercise price of $10.75. The Company is obligated to file a registration statement to register the shares underlying the warrants with the SEC if shares of the Company’s common stock have an average daily trading closing price of at least $8.50 per share for a 45 day period. The warrants will be exercisable upon effectiveness of the registration statement.

The Company has reserved an aggregate of 2,700,000 shares of common stock under its Omnibus Plan, of which 763,594 options to purchase shares of common stock granted to existing employees were outstanding as of June 30, 2016, and 116,871 shares of restricted stock had been granted to directors under the plan with 265,212 shares subject to vesting. There were 1,754,323 securities remaining for future issuance under the Omnibus Plan as of June 30, 2016.

On September 1, 2015, the Company announced that its Board of Directors authorized a $10.0 million share and note repurchase program. The program has a two-year expiration date, and authorizes the Company to repurchase up to $10.0 million of its common stock and/or its Convertible Notes due 2019. During 2015, the Company purchased 608,000 shares for a total cost of approximately $2.5 million, which is an average cost of $4.17 per share, including transaction fees. There were no purchases during three months ended June 30, 2016 or six months ended June 30, 2016. As of June 30, 2016, the Company may purchase up to approximately $7.5 million of additional common stock or Convertible Notes under its board authorized plan. However, the Company's Senior Secured Notes restrict the Company from repurchasing its common stock if the Company has less than $20 million in cash and cash equivalents.


34



On March 14, 2016, the Company filed a prospectus supplement with the SEC related to the offer and sale from time to time of the Company's common stock at an aggregate offering price of up to $50.0 million through FBR Capital Markets & Co. and MLV & Co. LLC, as distribution agents. Sales of shares of the Company's common stock under the prospectus supplement and the equity distribution agreement entered into with the distribution agents, if any, may be made in negotiated transactions or transactions that are deemed to be "at the market" offerings as defined in Rule 415 under the Securities Act of 1933. The Company has agreed to pay the distribution agents a commission rate of up to 3% of the gross proceeds from the sale of any shares of common stock sold through the equity distribution agreement. There were no shares of common stock sold under this prospectus supplement during the three months and six months ended June 30, 2016.

(18) Income Taxes

The Company’s provision for income taxes from continuing operations is estimated to result in an annual effective tax rate of approximately 0.0% for the six month period ended June 30, 2016 as compared to 41.2% during the same period in 2015. The Company’s quarterly effective income tax rates are based upon the Company’s current estimated annual rate. The Company’s annual effective income tax rate varies based upon the Company’s taxable earnings, as well as on a mix of taxable earnings in the various state and foreign jurisdictions.
In December 2015, based on the Company's evaluation, a deferred tax valuation allowance was established against its net deferred tax assets. In its evaluation, management considers taxable loss carryback availability, expectations of sufficient future taxable income, trends in earnings, existence of taxable income in recent years, the future reversal of temporary differences, and available tax planning strategies that could be implemented, if required. Valuation allowances are established based on the consideration of all available evidence using a more likely than not standard. This valuation allowance was determined to be necessary as an offset to the full amount of the federal and state deferred tax asset. During the six month period ended June 30, 2016, the Company does not expect that position to change and therefore is not recording any benefit.

In March of 2014, the Company was notified by the IRS of its intention to examine our tax returns for the years ended 2012 and 2013. Tax years prior to 2012 are no longer subject to IRS examination. Various state jurisdiction tax years remain open to examination.

The Company and its subsidiary companies are subject to U.S. federal income tax, as well as to income tax in Florida and other states and foreign jurisdictions in which it operates.


(19) Subsequent Events

Effective July 15, 2016, Red Falcon entered into a first amendment to its revolving loan and security agreement with LNV Corporation, as initial lender, the other lenders party thereto from time to time, Imperial Finance & Trading, LLC, as guarantor, Blue Heron as portfolio administrator and CLMG Corp., as administrative agent.  Upon the closing of the amendment, six additional policies and additional portions of 20 policies that were previously pledged in part as collateral under the initial credit agreement were pledged for an additional policy advance.  Amounts advanced to Red Falcon following effectiveness of the amendment to the credit agreement were approximately $3.0 million.
On August 1, 2016, the Company initiated a formal process to explore strategic alternatives in response to receiving a number of unsolicited inquiries from several interested parties. The Company’s Board of Directors has formed a special committee whose mandate is to review and consider strategic alternatives and to make recommendations to the full Board of Directors. Some of the possible strategic alternatives the special committee may consider are a sale of the Company, a merger or other business combination, a sale of all or a material portion of the Company’s assets, a joint venture, and a recapitalization. In addition, FBR Capital Markets & Co. has been engaged as financial advisor to the Company.





35




Item 2.        Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion summarizes the significant factors affecting the consolidated operating results, financial condition, liquidity, and cash flows of our Company as of and for the periods presented below and should be read in conjunction with the financial statements and accompanying notes included with this Quarterly Report on Form 10-Q. This discussion contains forward-looking statements that are based on the beliefs of our management, as well as assumptions made by, and information currently available to, our management. Actual results could differ materially from those discussed in or implied by forward-looking statements as a result of various factors. See “Forward-Looking Statements.”

Business Overview

Incorporated in Florida, Emergent Capital owns a portfolio of 625 life insurance policies, also referred to as life settlements, with a fair value of approximately $473.0 million and an aggregate death benefit of approximately $3.0 billion at June 30, 2016. The Company primarily earns income on these policies from changes in their fair value and through death benefits.

Our indirect subsidiary, White Eagle, is the owner of 433 of these life insurance policies with an aggregate death benefit of approximately $2.2 billion and a fair value of approximately $340.6 million at June 30, 2016. White Eagle pledged its policies as collateral to secure borrowings made under the White Eagle Revolving Credit Facility, which is used, among other things, to pay premiums on the life insurance policies owned by White Eagle. Additionally, 152 policies, with an aggregate death benefit of approximately $599.9 million and a fair value of approximately $120.1 million at June 30, 2016 were pledged as collateral under the Red Falcon Revolving Credit Facility entered into by Red Falcon, a Delaware statutory trust formed by one of our subsidiary companies. Borrowings under the Revolving Credit Facilities fund the payment of premiums on the life insurance policies that have been pledged as collateral for the respective facilities. See Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.

During the six months ended June 30, 2016, eight life insurance policies with face amounts totaling $17.2 million matured, resulting in a net gain of approximately $10.8 million. The gains related to these maturities are included in income from changes in the fair value of life settlements in the consolidated statements of operations for the six months ended June 30, 2016. Of these maturities, four served as collateral under the White Eagle Revolving Credit Facility and four served as collateral under the Red Falcon Revolving Credit Facility. Proceeds from maturities totaling $21.0 million were received during the six months ended June 30, 2016. Of this amount, approximately $7.6 million was utilized to repay borrowings, interest and expenses under the Red Falcon Revolving Credit facility and $8.3 million under the White Eagle Revolving Credit Facility during the six months ended June 30, 2016. We continue to believe that there are accretive opportunities to grow our existing portfolio of life settlements and intend, subject to our liquidity needs, to selectively deploy capital in both the secondary and tertiary life settlement markets. As we acquire more policies and available cash, our premium payments will increase. Assuming we recognize no policy maturities, our estimated premiums for the remainder of 2016 would be $37.5 million. White Eagle and Red Falcon would be eligible to borrow approximately $35.4 million of this amount under the Revolving Credit Facilities to pay premiums on policies secured by the Revolving Credit Facilities with approximately $2.1 million in estimated premiums required to maintain the policies not pledged as collateral under the Revolving Credit Facilities as of June 30, 2016.

Subsequent to the period ended, Red Falcon entered into an amendment to its revolving loan and security agreement. With the amendment, six additional policies and additional portions of 20 policies that were previously pledged in part as collateral under the initial Credit Agreement were pledged in an additional policy advance. This has reduced the Company's portion of estimated premiums for the remainder of 2016 by $532,000. See Note 19, "Subsequent Event."

During the three months ended June 30, 2016, two of our policies became subject to a cost of insurance increase, resulting in a total of 24 polices impacted since the third quarter of 2015. For the three and six months ended June 30, 2016, cost of insurance increase for these additional policies caused the fair value of our life settlements to decrease by approximately $1.3 million and $3.2 million, respectively and approximately $7.6 million since the third quarter of 2015. Further cost of insurance increases may cause our projected premium payments to significantly increase, adversely affect the loan to value ratios under the Revolving Credit Facilities and otherwise could have an adverse, material effect on our business, results of operations and the value of any affected policies.

During 2015, the U.S. Society of Actuaries released new versions of the Valuation Basic Tables, the ("2015 VBT"). The 2015 VBT has a significant increase in exposure and number of claims over the 2008 VBT and is believed to be a better fit for the life settlement industry and is becoming more widely accepted. During the quarter ended June 30, 2016, the Company

36



changed its valuation technique and decided to adopt the 2015 VBT, smoker and gender distinct tables, to determine the value of the policies. The table shows lower mortality rates in the earlier select periods at most ages, so while the Company continues to fit the life expectancies from the LE providers to the 2015 VBT, the change in the mortality curve changes the timing of the Company’s expected cash flow streams for both the life settlement assets and the revolving credit facilities. The resulting impact is approximately $17.6 million reduction in the fair value of the life settlements, and approximately $15.7 million gain for the change in fair value of the Revolving Credit Facilities with a net impact on the consolidated statement of operations of approximately $1.9 million for the three months ended June 30, 2016.

This reduction in cash flows may reduce funds available to us from policy proceeds, including from White Eagle and Red Falcon, and may adversely affect our ability to service our indebtedness. Future changes in life expectancies or actuarial tables could have a material adverse effect on the fair value of our life settlements, which could have a material adverse effect on our business, financial condition and results of operations.


Critical Accounting Policies

Critical Accounting Estimates

The preparation of the financial statements requires us to make judgments, estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the reporting period. We base our judgments, estimates and assumptions on historical experience and on various other factors that are believed to be reasonable under the circumstances. Actual results could differ materially from these estimates under different assumptions and conditions. We evaluate our judgments, estimates and assumptions on a regular basis and make changes accordingly. We believe that the judgments, estimates and assumptions involved in the accounting for income taxes, the valuation of life settlements, the valuation of the debt owing under the Revolving Credit Facilities and the valuation of our conversion derivative liability formerly embedded within the Convertible Notes have the greatest potential impact on our financial statements and accordingly believe these to be our critical accounting estimates.

Fair Value Measurement Guidance

We follow ASC 820, Fair Value Measurements and Disclosures, which defines fair value as an exit price representing the amount that would be received if an asset were sold or that would be paid to transfer a liability in an orderly transaction between market participants at the measurement date. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, the guidance establishes a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. Level 1 relates to quoted prices in active markets for identical assets or liabilities. Level 2 relates to observable inputs other than quoted prices included in Level 1. Level 3 relates to unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Our investments in life insurance policies and Revolving Credit Facility debt are considered Level 3 as there is currently no active market where we are able to observe quoted prices for identical assets/liabilities and our valuation model incorporates significant inputs that are not observable. See Note 14, "Fair Value Measurements" of the notes to Consolidated Financial Statements for a discussion of our fair value measurement.

Fair Value Option

We have elected to account for life settlements using the fair value method. The fair value of the asset is the estimated amount that would be received to sell an asset in an orderly transaction between market participants at the measurement date. We calculate the fair value of the asset using a present value technique to estimate the fair value of its life settlements. The Company currently uses a probabilistic method of valuing life insurance policies, which the Company believes to be the preferred valuation method in the industry. The most significant assumptions are the estimates of life expectancy of the insured and the discount rate. See Note 8, "Life Settlements (Life Insurance Policies)" and Note 14, "Fair Value Measurements."

We have elected to account for the debt under the Revolving Credit Facilities, which includes the interest in policy proceeds to the lender, using the fair value method. The fair value of the debt is the estimated amount that would have to be paid to transfer the debt to a market participant in an orderly transaction. We calculated the fair value of the debt using a discounted cash flow model taking into account the stated interest rate of the credit facilities and probabilistic cash flows from the pledged policies. Considerable judgment is required in interpreting market data to develop the estimates of fair value. Accordingly, our estimates are not necessarily indicative of the amounts that we, or holders of the instruments, could realize in a current market exchange. The most significant assumptions are the estimates of life expectancy of the insured and the

37



discount rate. The use of assumptions and/or estimation methodologies could have a material effect on the estimated fair values.

The Company determined that an embedded conversion option existed in the Convertible Notes, prior to June 5, 2014, that was required to be separately accounted for as a derivative under Accounting Standards Codification ("ASC") 815, Derivatives and Hedging. On June 5, 2014, the Company obtained shareholder approval to issue shares of common stock upon conversion of the Convertible Notes in an amount that exceeded the New York Stock Exchange limits for issuances without shareholder approval. In accordance with ASC 815, the Company reclassified the conversion derivative liability to stockholders’ equity along with unamortized transaction costs proportionate to the allocation of the initial debt discount and the principal amount of the Convertible Notes. In subsequent reporting periods, the Convertible Notes will continue to be recorded at accreted value up to the par value of the Convertible Notes at maturity. The debt discount will be amortized into interest expense using the interest method, in an aggregate amount equal to the amount of the conversion derivative liability reclassified into equity along with any unamortized transaction costs. See Note 11, "8.50% Senior Unsecured Convertible Notes."

Income Recognition

Our primary sources of income are in the form of changes in fair value of life settlements and gains on life settlements, net. Our income recognition policies for this source of income is as follows:
 
Changes in Fair Value of Life Settlements—When we acquire certain life insurance policies, we initially record these investments at the transaction price, which is the fair value of the policy for those acquired upon relinquishment or the amount paid for policies acquired for cash. The fair value of the investment in insurance policies is evaluated at the end of each reporting period. Changes in the fair value of the investment based on evaluations are recorded as changes in fair value of life settlements in our consolidated statement of operations. The fair value is determined on a discounted cash flow basis that incorporates current life expectancy assumptions. The discount rate incorporates current information about market interest rates, the credit exposure to the insurance company that issued the life insurance policy and our estimate of the risk premium an investor in the policy would require. We recognize income from life settlement maturities upon receipt of death notice or verified obituary of the insured. This income is the difference between the death benefits and fair values of the policy at the time of maturity.

Deferred Debt Costs

Deferred debt costs include costs incurred in connection with acquiring and maintaining debt arrangements. These costs are directly deducted from the carrying amount of the liability in the consolidated balance sheets, are amortized over the life of the related debt using the effective interest method and are classified as interest expense in the accompanying consolidated statement of operations. These deferred costs are related to the Company's Convertible Notes and Senior Secured Notes. The Company did not recognize any deferred debt costs on the Revolving Credit Facilities given all costs were expensed due to electing the fair value option in valuing the Revolving Credit Facilities.

Income Taxes

We account for income taxes in accordance with ASC 740, Income Taxes. Under ASC 740, deferred income taxes are determined based on the estimated future tax effects of differences between the financial statement and tax basis of assets and liabilities given the provisions of enacted tax laws. Deferred income tax provisions and benefits are based on changes to the assets or liabilities from year to year. In providing for deferred taxes, we consider tax regulations of the jurisdictions in which we operate, estimates of future taxable income and available tax planning strategies. If tax regulations, operating results or the ability to implement tax-planning strategies varies, adjustments to the carrying value of the deferred tax assets and liabilities may be required. Valuation allowances are based on the "more likely than not" criteria of ASC 740.

Our provision for income taxes from continuing operations results in an annual effective tax rate of 0.0% and 41.2% in 2016 and 2015, respectfully, except as noted below. The accounting for uncertain tax positions guidance under ASC 740 requires that we recognize the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit. For tax positions meeting the more-likely-than-not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement with the relevant tax authority. We recognize interest and penalties (if any) on uncertain tax positions as a component of income tax expense.

In December of 2015, based on the Company’s evaluation, a deferred tax valuation allowance was established against its net deferred tax assets. In its evaluation, management considers taxable loss carryback availability, expectations of sufficient

38



future taxable income, trends in earnings, existence of taxable income in recent years, the future reversal of temporary differences, and available tax planning strategies that could be implemented, if required. Valuation allowances are established based on the consideration of all available evidence using a more likely than not standard. This valuation allowance was determined to be necessary as an offset to the full amount of the federal and state deferred tax asset. During the second quarter of 2016 the Company does not expect that position to change and therefore is not recording any benefit.

In March of 2014, the Company was notified by the IRS of its intention to examine our tax returns for the years ended 2012 and 2013. Tax years prior to 2012 are no longer subject to IRS examination. Various state jurisdiction tax years remain open to examination.

Stock-Based Compensation

We have adopted ASC 718, Compensation—Stock Compensation. ASC 718 addresses accounting for share-based awards, including stock options, restricted stock, performance shares and warrants, with compensation expense measured using fair value and recorded over the requisite service or performance period of the award. The fair value of equity instruments will be determined based on a valuation using an option pricing model that takes into account various assumptions that are subjective. Key assumptions used in the valuation will include the expected term of the equity award taking into account both the contractual term of the award, the effects of expected exercise and post-vesting termination behavior, expected volatility, expected dividends and the risk-free interest rate for the expected term of the award. Compensation expense associated with performance shares is only recognized to the extent that it is probable the performance measurement will be met.

Held-for-sale and discontinued operations

The Company reports a business as held-for-sale when management has approved or received approval to sell the business and is committed to a formal plan, the business is available for immediate sale, the business is being actively marketed, the sale is anticipated to occur during the ensuing year and certain other specified criteria are met. A business classified as held-for-sale is recorded at the lower of its carrying amount or estimated fair value less cost to sell. If the carrying amount of the business exceeds its estimated fair value, a loss is recognized. Depreciation is not recorded on assets of a business classified as held-for-sale. Assets and liabilities related to a business classified as held-for-sale are segregated in the Consolidated Balance Sheet and major classes are separately disclosed in the notes to the Consolidated Financial Statements commencing in the period in which the business is classified as held-for-sale. The Company reports the results of operations of a business as discontinued operations if the business is classified as held-for-sale, the operations and cash flows of the business have been or will be eliminated from the ongoing operations of the Company as a result of a disposal transaction and the Company will not have any significant continuing involvement in the operations of the business after the disposal transaction. The results of discontinued operations are reported in Discontinued Operations in the Consolidated Statement of Operations for current and prior periods commencing in the period in which the business meets the criteria of a discontinued operation, and include any gain or loss recognized on closing or adjustment of the carrying amount to fair value less cost to sell. During the fourth quarter of 2013, the Company sold substantially all of our structured settlements business. As a result, the Company has classified its structured settlement operating results as discontinued operations.

Foreign Currency

The Company owns certain foreign subsidiaries formed under the laws of Ireland, Bahamas and Bermuda. These foreign subsidiaries utilize the U.S. dollar as their functional currency. The foreign subsidiaries' financial statements are denominated in U.S. dollars and therefore, there are no translation gains and losses resulting from translating the financial statements at exchange rates other than the functional currency. Any gains and losses resulting from foreign currency transactions (transactions denominated in a currency other than the subsidiaries' functional currency) are included in income. These gains and losses are immaterial to the Company's financial statements.

Accounting Changes

Note 3, "Recent Accounting Pronouncements," of the Notes to Consolidated Financial Statements discusses accounting standards adopted in 2016, as well as accounting standards recently issued but not yet required to be adopted and the expected impact of these changes in accounting standards. Any material impact of adoption is discussed in Management’s Discussion and Analysis of Financial Condition and Results of Operations and in the Notes to the Consolidated Financial Statements.


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Selected Operating Data (dollars in thousands):
 
Three Months Ended June 30,
Six Months Ended June 30,
 
2016
 
2015
2016
 
2015
Period Acquisitions — Policies Owned
 
 
 
 
 
 
Number of policies acquired
1

 
8

1

 
38

Average age of insured at acquisition
90.3

 
79.7

90.3

 
85.0

Average life expectancy — Calculated LE (Years)
2.3

 
7.2

2.3

 
5.4

Average death benefit
$
690

 
$
2,105

$
690

 
$
2,652

Aggregate purchase price
$
16

 
$
2,125

$
16

 
$
27,535

End of Period — Policies Owned
 
 
 
 
 
 
Number of policies owned
625

 
633

625

 
633

Average Life Expectancy — Calculated LE (Years)
9.4

 
10.2

9.4

 
10.2

Aggregate Death Benefit
$
2,966,388

 
$
2,982,416

$
2,966,388

 
$
2,982,416

Aggregate fair value
$
473,046

 
$
438,986

$
473,046

 
$
438,986

Monthly premium — average per policy
$
10.3

 
$
8.4

$
10.3

 
$
8.4

Period Maturities
 
 
 
 
 
 
Number of policies matured
2

 
7

8

 
12

Average age of insured at maturity
88.9

 
84.2

85.9

 
83.9

Average life expectancy - Calculated LE (Years)
3.7

 
6.7

5.1

 
7.5

Aggregate death benefit
$
4,200

 
$
36,580

$
17,180

 
$
49,768

Gains on maturity
$
2,485

 
$
26,134

$
10,764

 
$
37,820

Proceeds collected
$
5,500

 
$
6,187

$
20,980

 
$
19,187

 
 
 
 
 
 
 

Results of Operations

The following is our analysis of the results of operations for the periods indicated below. This analysis should be read in conjunction with our financial statements, including the related notes to the financial statements. Our results of operations are discussed below in two parts: (i) our consolidated results of continuing operations and (ii) our results of discontinued operations.

Results of Continuing Operations

Three Months Ended June 30, 2016 Compared to Three Months Ended June 30, 2015

Net loss from continuing operations for the quarter ended June 30, 2016 was $9.8 million as compared to net income of $1.0 million for the same period last year, an increase in net loss of $10.7 million. Our net income for the quarter ended June 30, 2015 includes approximately $322,000 in income tax benefit.

During the quarter ended June 30, 2016, total income from continuing operations was a loss of $15.8 million compared to total income from continuing operations of $28.0 million during the same period in 2015, a decrease of $43.8 million.

Income for the three months ended June 30, 2015 was higher due to the maturity of seven policies with a net gain of approximatively $26.1 million compared to two policies with a net gain of approximatively $2.5 million for three months ended June 30, 2016.

Our income for the three months ended June 30, 2016 was significantly impacted by the adoption of the 2015 VBT, which resulted in a reduction in the fair value of life settlements of approximately $17.6 million.

Total expenses from continuing operations resulted in income of $6.0 million for the quarter ended June 30, 2016 due to a $19.7 million gain for the change in fair value of the Revolving Credit Facilities, a decrease of $33.4 million compared to total expenses from continuing operations of $27.4 million incurred during the same period in 2015.


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Our expense for the three months ended June 30, 2016 was significantly impacted by a $15.7 million gain for the change in fair value of the Revolving Credit Facilities which is associated with the adoption of the 2015 VBT.

Change in fair value of life settlements. Change in fair value of life settlements was a loss of approximately $15.8 million for the quarter ended June 30, 2016 compared to a gain of $28.0 million for the same period in 2015, a decrease of $43.8 million.

During the quarter ended June 30, 2016, two life insurance policies with face amounts totaling $4.2 million matured compared to seven policies with face amounts of $36.6 million for the same period in 2015. The net gain of these maturities was $2.5 million and $26.1 million and is recorded as a change in fair value of life settlements in the consolidated statements of operations for the quarter ended June 30, 2016 and 2015, respectively. Of these maturities, both served as collateral under the White Eagle Revolving Credit Facility. Proceeds from maturities totaling $5.5 million were received during the quarter ended June 30, 2016. Approximately $3.7 million and $8.3 million in policy proceeds received during the first quarter of 2016 was utilized to repay borrowings, interest and credit facility expenses under the Red Falcon and White Eagle Revolving Credit Facilities, respectively, during the quarter ended June 30, 2016. The Company recorded a $14.3 million receivable for maturity of life settlements at June 30, 2016 relating to the Revolving Credit Facilities.

During the quarter ended June 30, 2016, the Company changed its valuation technique and decided to adopt the 2015 VBT, smoker and gender distinct tables, to determine the value of the policies. The table shows lower mortality rates in the earlier select periods at most ages, so while the Company continues to fit the life expectancies from the LE providers to the 2015 VBT, the change in the mortality curve changes the timing of the Company’s expected cash flow streams. This change in the mortality curve resulted in a reduction in the fair value of the life settlements of approximately $17.6 million for the three months ended June 30, 2016.

Other items impacting the change in fair value include updated life expectancies procured by the Company in respect to the insured lives and maturities. The updated life expectancy reports implied that in aggregate, the insureds’ health improved therefore lengthening their life expectancies relative to the prior life expectancies.

The change in fair value was positively impacted due to a reduction in estimated risk premium which drives our discount rate. The Company re-evaluates its discount rates at the end of each reporting period in order to reflect the estimated discount rates that could reasonably be used in a market transaction involving the Company's portfolio of life settlements. In doing so, consideration is given to the various factors influencing the rates, including credit exposure of the insurance company that issued the life insurance policy, our estimated risk premium an investor in the policy would require among other factors. In considering these factors, at June 30, 2016, the Company determined that the weighted average discount rate calculated based on death benefit was 16.49%, compared to 17.02% at December 31, 2015 and 16.92% at March 31, 2016, this resulted in a positive impact for the change in fair value of our life settlement for the three months ended June 30, 2016.

As of June 30, 2016, we owned 625 policies with an estimated fair value of $473.0 million compared to 632 policies with an estimated fair value of $461.9 million at December 31, 2015, an increase in estimated fair value of $11.1 million or 2%. Of the 625 policies, 433 policies were pledged to the White Eagle Revolving Credit Facility and 152 policies were pledged to the Red Falcon Revolving Credit Facility. We acquired one life insurance policy that resulted in a gain of approximately $262,000 during the quarter ended June 30, 2016, compared to eight life insurance policies during the same period in 2015 that resulted in a gain of approximately $975,000. As of June 30, 2016, the aggregate death benefit of our life settlements was approximately $3.0 billion.

Of these 625 policies owned as of June 30, 2016, 540 were previously premium financed and are valued using discount rates that range from 16.00%22.00%. The remaining 85 policies are valued using discount rates that range from 15.00%21.00%.

See Note 14, "Fair Value Measurements," to the accompanying consolidated financial statements.


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Expenses

Interest expense. Interest expense increased to $7.4 million during the quarter ended June 30, 2016, compared to $6.6 million during the same period in 2015, an increase of $785,000 as the Company's outstanding debt increased from $288.7 million at June 30, 2015 to $346.4 million at June 30, 2016. The increase in interest expense is primarily due to the interest expense on the Red Falcon Revolving Credit Facility and the Senior Secured Notes in 2016. Outstanding debt for the quarter ended June 30, 2016 included $189.7 million of outstanding principal on the White Eagle Revolving Credit Facility, $56.0 million on the Red Falcon Revolving Credit Facility, $70.7 million of Convertible Notes and $30.0 million of Senior Secured Notes.
Of the interest expense of $7.4 million for the three months ended June 30, 2016, approximately $2.8 million represents interest paid on the White Eagle Revolving Credit Facility and approximately $939,000 was attributable to the Red Falcon Revolving Credit Facility. Interest expense on the Convertible Notes totaled $2.4 million, including $1.5 million, $782,000 and $116,000 representing interest, amortization of debt discount and issuance costs, respectively. The Company recorded approximately $1.2 million of interest expense on the 15.00% Senior Secured Notes, including $1.1 million and $111,000 from interest and amortizing debt issuance costs, respectively, during the quarter ended June 30, 2016.
Of the interest expense of $6.6 million for three months ended June 30, 2015, approximately $2.3 million represents interest paid on the White Eagle Revolving Credit Facility which included $1.7 million withheld from borrowings by the lender and $622,000 paid by White Eagle. Interest expense on the Convertible Notes totaled $2.3 million including $1.5 million, $661,000 and $98,000 representing interest, amortization of debt discount and issuance costs, respectively. The Company recorded $2.0 million of interest expense on the 12.875% Senior Secured Notes, including $1.6 million, $126,000, $147,000 and $149,000 from interest, unused fees, amortizing debt discounts and issuance costs, respectively.
See Notes 9, "White Eagle Revolving Credit Facility," 10, "Red Falcon Revolving Credit Facility," 11, "8.50% Senior Unsecured Convertible Notes," 12, "15.00% Senior Secured Notes," and 13, "12.875% Senior Secured Notes," to the accompanying consolidated financial statements.

Change in fair value of Revolving Credit Facilities. Change in fair value of the Revolving Credit Facilities was a gain of $19.7 million for the quarter ended June 30, 2016 compared to a loss of $13.6 million for the quarter ended June 30, 2015. The change in fair value of Revolving Credit Facilities includes a gain of approximately $17.5 million attributable to the White Eagle Revolving Credit Facility for the period ended June 30, 2016 compared to a $13.6 million loss for the same period in 2015.

During the quarter ended June 30, 2016, the Company changed its valuation technique by adopting the 2015 VBT, smoker and gender distinct tables, to determine the value of the life insurance policies pledged as collateral in the facility. The table shows lower mortality rates in the earlier select periods at most ages, so while the Company continues to fit the life expectancies from the LE providers to the 2015 VBT, the change in the mortality curve changes the timing of the Company’s expected cash flow streams, which resulted in increase in borrowings. The resulting impact is a positive change in fair value for the White Eagle Revolving Credit Facility of approximately $14.7 million, and is shown as a reduction to our expenses on the statement of operations for the three months ended June 30, 2016. The White Eagle Revolving Credit Facility is valued at June 30, 2016 using a discount rate of 19.90% compared to 23.64% for the quarter ended June 30, 2015.

Change in fair value of Revolving Credit Facilities also includes a gain of $2.2 million attributable to the Red Falcon Revolving Credit Facility for the quarter ended June 30, 2016.

The change resulting from the Company's adoption of the 2015 VBT resulted in a positive chan