10-Q 1 f10q0617_gwgholdings.htm QUARTERLY REPORT

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

FORM 10-Q

 

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

 

For the quarterly period ended June 30, 2017

 

or

 

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

 

For the transition period from _________ to ________

 

Commission File Number: None

 

GWG HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

 

Delaware   26-2222607
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)

 

220 South Sixth Street, Suite 1200

Minneapolis, MN 55402

(Address of principal executive offices, including zip code)

 

(612) 746-1944

(Registrant’s telephone number, including area code)

 

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  ☐ 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  ☐ No

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer Accelerated filer
Non-accelerated filer ☐   (Do not check if a smaller reporting company) Smaller reporting company
    Emerging growth company

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

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

 

As of August 10, 2017, GWG Holdings, Inc. had 5,783,555 shares of common stock outstanding.

 

 

 

 

 

 

GWG HOLDINGS, INC.

 

Index to Form 10-Q

for the Quarter Ended June 30, 2017

 

    Page No.
PART I. FINANCIAL INFORMATION  
     
Item 1. Financial Statements 1
  Condensed Consolidated Balance Sheets as of June 30, 2017, and December 31, 2016 1
  Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2017 and 2016 2
  Condensed Consolidated Statements of Cash Flows for the three and six months ended June 30, 2017 and 2016 3
  Consolidated Statement of Changes in Stockholders’ Equity 5
  Notes to Condensed Consolidated Financial Statements 6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 28
Item 4. Controls and Procedures 58
     
PART II. OTHER INFORMATION  
     
Item 5. Other Information 59
Item 6. Exhibits 60
     
SIGNATURES 61

  

 

 

 

PART I—FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

 

  

June 30,
2017

(unaudited)

   December 31, 2016 
A S S E T S          
Cash and cash equivalents  $52,293,472   $78,486,982 
Restricted cash   46,159,631    37,826,596 
Investment in life insurance policies, at fair value   577,049,552    511,192,354 
Secured MCA advances   3,525,381    5,703,147 
Life insurance policy benefits receivable   6,970,000    5,345,000 
Deferred taxes, net   1,620,303    - 
Other assets   3,875,810    4,688,103 
TOTAL ASSETS  $691,494,149   $643,242,182 
           
L I A B I L I T I E S  &  S T O C K H O L D E R S’   E Q U I T Y          
LIABILITIES          
Senior Credit Facilities  $149,008,826   $156,064,818 
Series I Secured Notes   6,680,961    16,404,836 
L Bonds   400,832,308    381,312,587 
Accounts payable   4,160,097    2,226,712 
Interest payable   14,387,044    16,160,599 
Other accrued expenses   2,535,674    1,676,761 
Deferred taxes, net   -    2,097,371 
TOTAL LIABILITIES  577,604,910   575,943,684 
           
STOCKHOLDERS’ EQUITY          
           
CONVERTIBLE PREFERRED STOCK          
(par value $0.001; shares authorized 40,000,000; shares outstanding 2,671,663 and 2,640,521; liquidation preference of $20,037,000 and $19,804,000 as of June 30, 2017 and December 31, 2016, respectively)   19,732,262    19,701,133 
           
REDEEMABLE PREFERRED STOCK          
(par value $0.001; shares authorized 100,000; shares outstanding 99,127 and 59,183; liquidation preference of $99,127,000 and $59,183,000 as of June 30, 2017 and December 31, 2016, respectively)   97,728,821    59,025,164 
           
SERIES 2 REDEEMABLE PREFERRED STOCK          
(par value $0.001; shares authorized 150,000; shares outstanding 22,536 and 0; liquidation preference of $22,536,000 and $0 as of June 30, 2017 and December 31, 2016, respectively)   20,979,019    - 
           
COMMON STOCK          
(par value $0.001: shares authorized 210,000,000; shares issued and outstanding 5,783,555 and 5,980,190 as of June 30, 2017 and December 31, 2016, respectively)   5,784    5,980 
Additional paid-in capital   -    7,383,515 
Accumulated deficit   (24,556,647)   (18,817,294)
TOTAL STOCKHOLDERS’ EQUITY   113,889,239    67,298,498 
           
TOTAL LIABILITIES & EQUITY  $691,494,149   $643,242,182 

 

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

 

 - 1 - 

 

 

 GWG HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

 

   Three Months Ended   Six Months Ended 
   June 30,
2017
   June 30,
2016
   June 30,
2017
   June 30,
2016
 
REVENUE                
Gain on life insurance policies, net  $11,296,266   $20,383,347   $30,696,086   $38,097,059 
MCA income   133,583    223,255    380,159    368,216 
Interest and other income   237,737    170,880    679,686    216,100 
TOTAL REVENUE   11,667,586    20,777,482    31,755,931    38,681,375 
                     
EXPENSES                    
Interest expense   12,246,025    9,764,657    25,490,241    18,913,811 
Employee compensation and benefits   3,741,299    3,071,507    6,904,360    5,537,705 
Legal and professional fees   1,330,589    1,304,353    2,276,937    2,510,481 
Provision for MCA advances   878,000    300,000    878,000    400,000 
Other expenses   2,883,098    2,032,685    5,663,420    4,344,845 
TOTAL EXPENSES   21,079,011    16,473,202    41,212,958    31,706,842 
                     
INCOME (LOSS) BEFORE INCOME TAXES   (9,411,425)   4,304,280    (9,457,027)   6,974,533 
INCOME TAX EXPENSE (BENEFIT)   (3,717,174)   1,822,030    (3,717,674)   2,906,747 
                     
NET INCOME (LOSS)  (5,694,251)  2,482,250   (5,739,353)  4,067,786 
                     
Preferred stock dividends   2,031,097    600,924    3,898,857    1,112,155 
NET INCOME (LOSS) ATTRIBUTABLE TO COMMON SHAREHOLDERS  $(7,725,348)  $1,881,326   $(9,638,210)  $2,955,631 
NET INCOME (LOSS) PER SHARE                    
Basic  $(1.34)  $0.32   $(1.69)  $0.50 
Diluted  $(1.34)  $0.30   $(1.69)  $0.49 
                     
WEIGHTED AVERAGE SHARES OUTSTANDING                    
Basic   5,777,724    5,967,098    5,710,909    5,954,944 
Diluted   5,777,724    8,017,349    5,710,909    8,002,335 

 

 The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

 

 - 2 - 

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS

(unaudited)

 

   Three Months Ended   Six Months Ended 
   June 30,
2017
   June 30,
2016
   June 30,
2017
   June 30,
2016
 
CASH FLOWS FROM OPERATING ACTIVITIES                
Net income (loss)  $(5,694,251)  $2,482,250   $(5,739,353)  $4,067,786 
Adjustments to reconcile net income (loss) to net cash flows from operating activities:                    
Change in fair value of life insurance policies   (15,235,502)   (21,241,376)   (29,119,335)   (32,772,929)
Amortization of deferred financing and issuance costs   1,497,948    2,527,974    4,164,151    3,312,162 
Deferred income taxes   (3,717,174)   1,851,018    (3,717,674)   2,906,747 
Preferred stock dividends payable   363,959    166,472    700,748    330,049 
(Increase) decrease in operating assets:                    
Life insurance policy benefits receivable   2,005,000    9,083,817    (1,625,000)   (6,829,022)
Other assets   (557,988)   (1,210,892)   868,330    (1,037,466)
Increase (decrease) in operating liabilities:                    
Due to related party   (1,970)   (1,814,173)   (9,785)   (101,781)
Accounts payable and other accrued expenses   1,038,855    (775,213)   2,256,087    1,192,756 
NET CASH FLOWS USED IN OPERATING ACTIVITIES   (20,301,123)   (8,930,123)   (32,221,831)   (28,931,698)
                     
CASH FLOWS FROM INVESTING ACTIVITIES                    
Investment in life insurance policies   (19,432,338)   (24,373,714)   (42,121,671)   (48,700,036)
Carrying value of matured life insurance policies   3,014,834    1,691,764    5,383,808    6,302,243 
Investment in Secured MCA advances   (39,671)   (1,293,829)   (39,671)   (5,647,414)
Proceeds from Secured MCA advances   653,315    907,649    1,423,702    1,025,792 
NET CASH FLOWS USED IN INVESTING ACTIVITIES   (15,803,860)   (23,068,130)   (35,353,832)   (47,019,415)
                     
CASH FLOWS FROM FINANCING ACTIVITIES                    
Net borrowings on (repayments of) Senior Credit Facilities   (3,845,037)   (3,000,000)   (7,099,537)   17,000,000 
Payments for issuance of senior debt   (1,076,118)   -    (1,190,412)   - 
Payments for redemption of Series I Secured Notes   (4,348,372)   (485,350)   (9,798,261)   (5,722,743)
Proceeds from issuance of L Bonds   31,875,811    36,757,771    56,744,470    71,126,660 
Payments for issuance and redemption of L Bonds   (15,025,566)   (11,753,782)   (39,197,163)   (22,663,475)

Transfer from (payments to) restricted cash

   1,931,958    8,667,826    (8,333,035)   (8,818,894)
Issuance (repurchase) of common stock   4    166,125    (1,603,556)   212,670 
Proceeds from issuance of preferred stock   34,301,747    9,472,673    61,480,941    10,501,209 
Payment for issuance and redemption of preferred stock   (3,318,211)   (845,361)   (5,722,437)   (1,617,914)
Payment of preferred stock dividends   (2,031,097)   (600,924)   (3,898,857)   (1,112,155)
NET CASH FLOWS PROVIDED BY FINANCING ACTIVITIES   38,465,119    38,378,978    41,382,153    58,905,358 
                     
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS   2,360,136    6,380,725    (26,193,510)   (17,045,755)
                     
CASH AND CASH EQUIVALENTS                    
BEGINNING OF PERIOD   49,933,336    10,998,625    78,486,982    34,425,105 
END OF PERIOD  $52,293,472   $17,379,350   $52,293,472   $17,379,350 

 

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

 

 - 3 - 

 

 

 GWG HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS – CONTINUED

(unaudited)

 

   Three Months Ended   Six Months Ended 
   June 30,
2017
   June 30,
2016
   June 30,
2017
   June 30,
2016
 
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION                
Interest paid  $14,323,000   $10,294,000   $26,548,000   $16,399,000 
Premiums paid  $11,646,000   $8,995,000   $22,606,000   $17,441,000 
Stock-based compensation  $89,000   $41,000   $406,000   $50,000 
NON-CASH INVESTING AND FINANCING ACTIVITIES                    
Series I Secured Notes:                    
Conversion of accrued interest and commissions payable to principal  $-   $142,000   $-   $187,000 
L Bonds:                    
Conversion of accrued interest and commissions payable to principal  $397,000   $370,000   $905,000   $661,000 
Series A Preferred Stock:                    
Issuance of Series A Preferred Stock in lieu of cash dividends  $166,000   $171,000   $337,000   $339,000 
Investment in life insurance policies included in accounts payable  $1,296,000   $780,000   $1,296,000   $780,000 

 

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

 

 - 4 - 

 

 

 GWG HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

(unaudited)

 

   Preferred Stock   Preferred   Common  

Common

Stock

  

Additional

Paid-in

   Accumulated   Total 
   Shares   Stock   Shares   (par)   Capital   Deficit   Equity 
                             
Balance, December 31, 2015   2,781,735   $20,784,841    5,941,790   $5,942   $14,563,834   $(19,209,203)  $16,145,414 
                                    
Net income (loss)   -    -    -    -    -    391,909    391,909 
                                    
Issuance of common stock   -    -    36,450    36    244,149    -    244,185 
                                    
Redemption of Series A Preferred Stock   (239,749)   (1,788,451)   1,950    2    19,498    -    (1,768,951)
                                    
Issuance of Series A Preferred Stock   98,535    704,743    -    -    -    -    704,743 
                                    
Issuance of Redeemable Preferred Stock   59,183    59,025,164              (4,133,525)        54,891,639 
                                    
Preferred stock dividends                       (3,537,288)        (3,537,288)
                                    
Issuance of stock options   -    -    -    -    226,847    -    226,847 
Balance, December 31, 2016   2,699,704   $78,726,297    5,980,190   $5,980   $7,383,515   $(18,817,294)  $67,298,498 
                                    
Net income (loss)   -    -    -    -    -    (5,739,353)   (5,739,353)
                                    
Redemption of common stock   -    -    (200,445)   (200)   (1,603,360)   -    (1,603,560)
                                    
Redemption of Series A Preferred Stock   (17,033)   (126,997)   3,810    4    -    -    (126,993)
                                    
Issuance of Series A Preferred Stock   48,175    210,230              -         210,230 
                                    
Issuance of Redeemable Preferred Stock and Series 2 Redeemable Preferred Stock, net of costs   63,041    60,247,764              (2,017,487)        58,230,277 
                                    
Redemption of Redeemable Preferred Stock and Series 2 Redeemable Preferred Stock   (561)   (561,277)                       (561,277)
                                    
Preferred stock dividends*        (122,323)             (3,776,534)        (3,898,857)
                                    
Issuance of stock options        66,408              13,866         80,274 
Balance, June 30, 2017   2,793,326   $138,440,102    5,783,555   $5,784   $-   $(24,556,647)  $113,889,239 

 

*Preferred stock dividends were paid from additional paid-in capital until the latter was exhausted in the second quarter of 2017. Subsequent dividends were charged against the carrying values of the respective series of the Company’s preferred stock resulting in a difference between the Company’s preferred stock book balances and liquidation preference of the respective series of preferred stock.

 

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

 

 - 5 - 

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

(1)Nature of Business and Summary of Significant Accounting Policies

 

Nature of Business – We are a financial services company committed to finding new ways of disrupting and transforming the life insurance and related industries. We built our business by creating opportunities for consumers to obtain significantly more value for their life insurance policies as compared to the traditional options offered by the insurance industry by creating a secondary market. We are enhancing and extending these activities through innovation in our products and services, business processes, financing strategies, and advanced epigenetic technologies. At the same time, we are creating opportunities for investors to receive income and capital appreciation from our investment activities in the life insurance and related industries.

 

GWG Holdings, Inc. and all of its subsidiaries are incorporated and organized in Delaware. Unless the context otherwise requires or we specifically so indicate, all references in these footnotes to “we,” “us,” “our,” “our Company,” “GWG,” or the “Company” refer to GWG Holdings, Inc. and its subsidiaries collectively and on a consolidated basis. References to the full names of particular entities, such as “GWG Holdings, Inc.” or “GWG Holdings,” are meant to refer only to the particular entity referenced.

 

On December 7, 2015, GWG Holdings formed a wholly owned subsidiary, GWG MCA, LLC. On January 13, 2016, GWG MCA, LLC was converted to a corporation and became GWG MCA Capital, Inc. GWG MCA Capital, Inc. (“GWG MCA”) was formed to provide cash advances to small businesses.

 

On August 25, 2016, GWG Holdings formed a wholly owned subsidiary, Actüa Life & Annuity Ltd. (“Actüa”), to engage in various life insurance related businesses and activities related to its exclusive license for “DNA Methylation Based Predictor of Mortality” technology.

 

Use of Estimates – The preparation of our consolidated financial statements in conformity with GAAP requires management to make significant estimates and assumptions affecting the reported amounts of assets and liabilities at the date of the consolidated financial statements, as well as the reported amounts of revenue during the reporting period. We regularly evaluate estimates and assumptions, which are based on current facts, historical experience, management’s judgment, and various other factors that we believe to be reasonable under the circumstances. Our actual results may differ materially and adversely from our estimates. The most significant estimates with regard to these consolidated financial statements relate to (1) the determination of the assumptions used in estimating the fair value of our investments in life insurance policies, and (2) the value of our deferred tax assets and liabilities.

 

Cash and Cash Equivalents – We consider cash in demand deposit accounts and temporary investments purchased with an original maturity of three months or less to be cash equivalents. We maintain our cash and cash equivalents with highly rated financial institutions. The balances in our bank accounts may exceed Federal Deposit Insurance Corporation limits. We periodically evaluate the risk of exceeding insured levels and may transfer funds as we deem appropriate.

 

Life Insurance Policies – Accounting Standards Codification 325-30, Investments in Insurance Contracts (“ASC 325-30”), permits a reporting entity to account for its investments in life insurance policies using either the investment method or the fair value method. We elected to use the fair value method to account for our life insurance policies. We initially record our purchase of life insurance policies at the transaction price, which is the amount paid for the policy, inclusive of all external fees and costs associated with the acquisition. At each subsequent reporting period, we re-measure the investment at fair value in its entirety and recognize the change in fair value as unrealized gain (revenue) in the current period, net of premiums paid.

 

In a case where our acquisition of a policy is not complete as of a reporting date, but we have nonetheless advanced direct costs and deposits for the acquisition, those costs and deposits are recorded as “other assets” on our balance sheet until the acquisition is complete and we have secured title to the policy. On June 30, 2017 and December 31, 2016, a total of $339,000 and $42,000, respectively, of our “other assets” comprised direct costs and deposits that we had advanced for policy acquisitions.

 

We also recognize realized gain (or loss) from a life insurance policy upon one of the two following events: (1) our receipt of notice or verified mortality of the insured; or (2) our sale of the policy, filing of change-of-ownership forms and receipt of payment. In the case of mortality, the gain (or loss) we recognize is the difference between the policy benefits and the carrying values of the policy once we determine that collection of the policy benefits is realizable and reasonably assured. In the case of a policy sale, the gain (or loss) we recognize is the difference between the sale price and the carrying value of the policy on the date we receive sale proceeds.

 

 - 6 - 

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Other Assets – Actüa is engaged in various life insurance related businesses and activities related to its exclusive license for the “DNA Methylation Based Predictor of Mortality” technology for the life insurance industry. The cost of entering into this license agreement is listed as “other assets.”

 

Stock-Based Compensation – We measure and recognize compensation expense for all stock-based payments at fair value over the requisite service period. We use the Black-Scholes option pricing model to determine the weighted-average fair value of options. For restricted stock grants, fair value is determined as of the closing price of our common stock on the date of grant. Stock-based compensation expense is recorded in general and administrative expenses based on the classification of the employee or vendor. The determination of fair value of stock-based payment awards on the date of grant using an option-pricing model is affected by our stock price as well as by assumptions regarding a number of subjective variables. These variables include, but are not limited to, the expected stock price volatility over the term of the awards, and actual and projected employee stock option exercise behaviors.

 

The expected terms of the options are based on evaluations of historical and expected future employee exercise behavior. The risk-free interest rate is based on the U.S. Treasury rates at the date of grant with maturity dates approximately equal to the expected life at grant date. Volatility is based on the standard deviation of the average continuously compounded rate of return of five selected comparable companies over the previous 52 weeks. We have not historically issued any common stock dividends and do not expect to do so in the foreseeable future. Forfeitures for both option and restricted stock grants are estimated at the time of the grant and revised in subsequent periods if actual forfeitures differ from estimates. 


Deferred Financing and Issuance Costs – Loans advanced to us under our senior credit facilities, as described in Notes 5 and 6, are reported net of financing costs, including issuance costs, sales commissions and other direct expenses, which are amortized using the straight-line method over the term of the facility.  The Series I Secured Notes and L Bonds, as respectively described in Notes 7 and 8, are reported net of financing costs, which are amortized using the interest method over the term of those borrowings. The Series A Convertible Preferred Stock (“Series A”), as described in Note 9, is reported net of financing costs (including the fair value of warrants issued), all of which were fully amortized using the interest method as of June 30, 2017. Selling and issuance costs of Redeemable Preferred Stock (“RPS”) and Series 2 Redeemable Preferred Stock (“RPS 2”), described in Notes 10 and 11, are netted against additional paid-in-capital and against the principal balance of the preferred stock.

 

Earnings (loss) per Share – Basic earnings (loss) per share attributable to common shareholders are calculated using the weighted-average number of shares outstanding during the reported period. Diluted earnings (loss) per share are calculated based on the potential dilutive impact of our Series A, RPS, RPS 2, warrants and stock options. Due to our net loss for the three and six months ended June 30, 2017, there are no dilutive securities.

 

Recently Issued Accounting Pronouncements – On April 7, 2015, the FASB issued Accounting Standards Update No. 2015-03, Simplifying the Presentation of Debt Issuance Costs (“ASU 2015-03”), as part of its simplification initiative. ASU 2015-03 changes the presentation of debt issuance costs by presenting those costs in the balance sheet as a direct deduction from the related debt liability. Amortization of the costs is reported as interest expense. We adopted ASU 2015-03 effective January 1, 2016, as required for public reporting entities.

 

On February 25, 2016, the FASB issued Accounting Standards Update 2016-02 Leases (“ASU 2016-02”). The new guidance is effective for fiscal years beginning after December 15, 2018. ASU 2016-02 provides more transparency and comparability in the financial statements of lessees by recognizing all leases with a term greater than twelve months on the balance sheet. Lessees will also be required to disclose key information about their leases. Early adoption is permitted. We are currently evaluating the impact of the adoption of this pronouncement and have not yet adopted ASU 2016-02 as of June 30, 2017.

 

In March 2016, the FASB issued Accounting Standards Update 2016-09 (“ASU 2016-09”) to simplify the accounting for stock compensation related to the following items: income tax accounting, award classification, estimation of forfeitures, and cash flow presentation. The new guidance is effective for fiscal years beginning after December 15, 2016. We are currently in the process of adopting this pronouncement.

 

(2)Restrictions on Cash

 

Under the terms of our senior credit facilities (discussed in Notes 5 and 6), we are required to maintain collection and escrow accounts that are used to fund the acquisition of policies, pay annual policy premiums, pay interest and other charges under the facility, and collect policy benefits. The agents for the lenders authorize disbursements from these accounts. At June 30, 2017 and December 31, 2016, there was a balance of $46,160,000, and $37,827,000, respectively, in these restricted cash accounts.

 

 - 7 - 

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

(3)Investment in Life Insurance Policies

 

Life insurance policies are valued based on unobservable inputs that are significant to their overall fair value. Changes in the fair value of these policies are recorded as gain or loss on life insurance policies, net of premiums paid on those policies, in our consolidated statements of operations. Fair value is determined on a discounted cash flow basis that incorporates life expectancy assumptions generally derived from reports obtained from widely accepted life expectancy providers, other than insured lives covered under small face amount policies (i.e., $1 million in face value benefits or less), assumptions relating to cost-of-insurance (premium) rates and other assumptions. The discount rate we apply incorporates current information about discount rates applied by other reporting companies owning portfolios of life insurance policies, the discount rates observed in the life insurance secondary market, market interest rates, the credit exposure to the insurance companies that issued the life insurance policies and management’s estimate of the risk premium a purchaser would require to receive the future cash flows derived from our portfolio as a whole. Management has discretion regarding the combination of these and other factors when determining the discount rate. As a result of management’s analysis, a discount rate of 10.81% was applied to our portfolio as of June 30, 2017 as compared to 10.96% as of December 31, 2016.

 

A summary of our policies, organized according to their estimated life expectancy dates as of the reporting date, is as follows:

 

   As of June 30, 2017   As of December 31, 2016 
Years Ending December 31,  Number of Policies   Estimated Fair Value   Face Value   Number of Policies   Estimated Fair Value   Face Value 
2017   4   $3,044,000   $3,375,000    11   $14,837,000   $16,939,000 
2018   11    16,462,000    20,853,000    23    30,830,000    42,564,000 
2019   61    64,377,000    92,676,000    55    57,556,000    88,858,000 
2020   96    92,535,000    159,203,000    93    85,414,000    159,814,000 
2021   85    71,872,000    142,961,000    86    73,825,000    158,744,000 
2022   88    80,308,000    184,162,000    66    56,909,000    147,222,000 
2023   80    58,506,000    166,527,000    64    44,953,000    128,581,000 
Thereafter   368    189,946,000    755,606,000    292    146,868,000    618,953,000 
Totals   793   $577,050,000   $1,525,363,000    690   $511,192,000    1,361,675,000 

  

We recognized life insurance benefits of $10,935,000 and $9,829,000 during the three months ended June 30, 2017 and 2016, respectively, related to policies with a carrying value of $3,014,000 and $1,692,000, respectively, and as a result recorded realized gains of $7,920,000 and $8,137,000, respectively. We recognized life insurance benefits of $29,910,000 and $29,067,000 during the six months ended June 30, 2017 and 2016, respectively, related to policies with a carrying value of $5,384,000 and $6,302,000, respectively, and as a result recorded realized gains of $24,526,000 and $22,765,000, respectively.

 

Reconciliation of gain on life insurance policies:

 

   Three Months Ended June 30,   Six Months Ended June 30, 
   2017   2016   2017   2016 
Change in estimated probabilistic cash flows  $16,446,000   $17,972,000   $32,849,000   $27,425,000 
Unrealized gain on acquisitions   8,044,000    9,822,000    18,646,000    17,841,000 
Premiums and other annual fees   (11,859,000)   (8,995,000)   (22,949,000)   (17,441,000)
Change in discount rates(1)   4,143,000    629,000    4,143,000    838,000 
Change in life expectancy evaluation (2)   (6,662,000)   (1,545,000)   (8,604,000)   (914,000)
Realized gain on maturities   7,920,000    8,137,000    24,526,000    22,765,000 
Fair value of matured policies   (6,736,000)   (5,637,000)   (17,915,000)   (12,417,000)
Gain on life insurance policies, net  $11,296,000   $20,383,000   $30,696,000   $38,097,000 

 

(1) The discount rate applied to estimate the fair value of the portfolio of life insurance policies we own was 10.81% as of June 30, 2017, compared to 10.96% as of December 31, 2016 and 11.05% as of June 30, 2016.  The carrying value of policies acquired during each quarterly reporting period is adjusted to current fair value using the fair value discount rate applied to the entire portfolio as of that reporting date.

(2) The change in fair value due to updating independent life expectancy estimates on certain life insurance policies in our portfolio.

 

 - 8 - 

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

We currently estimate that premium payments and servicing fees required to maintain our current portfolio of life insurance policies in force for the next five years, assuming no mortalities, are as follows:

 

Years Ending December 31,  Premiums   Servicing   Premiums and
Servicing Fees
 
Six months ending December 31, 2017  $24,455,000   $654,000   $25,109,000 
2018   52,611,000    654,000    53,265,000 
2019   58,206,000    654,000    58,860,000 
2020   65,722,000    654,000    66,376,000 
2021   74,105,000    654,000    74,759,000 
2022   83,310,000    654,000    83,964,000 
   $358,409,000   $3,924,000   $362,333,000 

 

Management anticipates funding the premium payments estimated above with proceeds from the receipt of policy benefits from our portfolio of life insurance policies, net proceeds from our offering of L Bonds and RPS 2, and from our senior credit facilities. The proceeds of these capital sources may also be used for the purchase, financing, and maintenance of additional life insurance policies.

 

(4)Fair Value Definition and Hierarchy

 

Accounting Standards Codification 820, Fair Value Measurements and Disclosures (“ASC 820”) establishes a hierarchical disclosure framework that prioritizes and ranks the level of market price observability used in measuring assets and liabilities at fair value. Market price observability is affected by a number of factors, including the type of investment, the characteristics specific to the investment and the state of the marketplace, including the existence and transparency of transactions between market participants. Assets and liabilities with readily available and actively quoted prices, or for which fair value can be measured from actively quoted prices in an orderly market, generally will have a higher degree of market price observability and a lesser degree of judgment used in measuring fair value. ASC 820 maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring the use of observable inputs whenever available. Observable inputs are inputs that market participants would use in pricing the asset or liability developed based on market data obtained from independent sources. Unobservable inputs are inputs that reflect assumptions about how market participants price an asset or liability based on the best available information. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e., the “exit price”) in an orderly transaction between market participants at the measurement date.

 

The hierarchy is broken down into three levels based on the observability of inputs as follows:

 

Level 1 - Valuations based on quoted prices in active markets for identical assets or liabilities that the Company has the ability to access.  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 - Valuations based on one or more quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly.

 

Level 3 - Valuations based on inputs that are unobservable and significant to the overall fair value measurement.

 

The availability of observable inputs can vary by types of assets and liabilities and is affected by a wide variety of factors, including, for example, whether an instrument is established in the marketplace, the liquidity of markets and other characteristics particular to the transaction. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Accordingly, the degree of judgment exercised by management in determining fair value is greatest for assets and liabilities categorized in Level 3.

 

Level 3 Valuation Process

 

The estimated fair value of our portfolio of life insurance policies is determined on a quarterly basis by our portfolio management committee, taking into consideration changes in discount rate assumptions, estimated premium payments and life expectancy estimate assumptions, as well as any changes in economic and other relevant conditions. The discount rate incorporates current information about discount rates applied by other reporting companies owning portfolios of life insurance policies, the discount rates observed in other competitive purchases in the life insurance secondary market, market interest rates, the credit exposure to the insurance company that issued the life insurance policy and management’s estimate of the risk premium a purchaser would require to receive the future cash flows derived from our portfolio as a whole. Management has discretion regarding the combination of these and other factors when determining the discount rate.

 

 - 9 - 

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

These inputs are then used to estimate the discounted cash flows from the portfolio using the Model Actuarial Pricing System probabilistic portfolio price model, which estimates the cash flows using various mortality probabilities and scenarios. The valuation process includes a review by senior management as of each valuation date. We also engage a third-party expert to independently test the accuracy of the valuations using the inputs we provide on a quarterly basis. See Exhibit 99.1 filed herewith.

 

The following table reconciles the beginning and ending fair value of our Level 3 investments in our portfolio of life insurance policies for the periods ended June 30, as follows:

 

   Three months ended June 30,   Six months ended June 30, 
   2017   2016   2017   2016 
Beginning balance  $545,397,000   $387,402,000   $511,192,000   $356,650,000 
Purchases   19,432,000    24,869,000    42,122,000    48,700,000 
Maturities (initial cost basis)   (3,014,000)   (1,692,000)   (5,384,000)   (6,303,000)
Net change in fair value   15,235,000    21,241,000    29,120,000    32,773,000 
Ending balance  $577,050,000   $431,820,000   $577,050,000   $431,820,000 

 

In the past, we periodically updated the independent life expectancy estimates on the insured lives in our portfolio, other than insured lives covered under small face amount policies (i.e., $1 million in face value benefits or less), on a continuous rotating three-year cycle, and through that effort attempted to update life expectancies for approximately one-twelfth of our portfolio each quarter. Currently, however, the terms of our senior credit facility with LNV Corporation require us to attempt to update life expectancies on a rotating two-year cycle.

 

The following table summarizes the inputs utilized in estimating the fair value of our portfolio of life insurance policies:

 

  

As of 

June 30,

2017

  

As of

December 31,
2016

 
Weighted-average age of insured, years *   81.5    81.6 
Weighted-average life expectancy, months *   82.6    83.2 
Average face amount per policy  $1,924,000   $1,973,000 
Discount rate   10.81%   10.96%

 

(*) Weighted average by face amount of policy benefits

 

Life expectancy estimates and market discount rates are, by their nature, inherently uncertain and the effect of changes in estimates may be significant. For example, if the life expectancy estimates were increased or decreased by four and eight months on each outstanding policy, and the discount rates were increased or decreased by 1% and 2%, while all other variables were held constant, the fair value of our investment in life insurance policies would increase or decrease as summarized below:

 

Change in Fair Value of the Investment in Life Insurance Policies

 

   Change in life expectancy estimates 
   minus 8 months   minus 4 months   plus
4 months
   plus
8 months
 
                 
June 30, 2017  $78,665,000   $39,075,000   $(38,334,000)  $(75,932,000)
December 31, 2016  $69,253,000   $34,601,000   $(33,846,000)  $(67,028,000)

 

   Change in discount rate 
   minus 2%   minus 1%   plus 1%   plus 2% 
                 
June 30, 2017  $60,606,488   $29,002,000   $(26,678,000)  $(51,277,000)
December 31, 2016  $53,764,000   $25,728,000   $(23,668,000)  $(45,491,000)

 

 - 10 - 

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Other Fair Value Considerations

 

The carrying value of receivables, prepaid expenses, accounts payable and accrued expenses approximate fair value due to their short-term maturities and low credit risk. Using the income-based valuation approach, the estimated fair value of our Series I Secured Notes and L Bonds, having a combined aggregate face value of $414,666,000 as of June 30, 2017, is approximately $424,793,000 based on a weighted-average market interest rate of 6.60%. The carrying value of the senior credit facilities reflects interest charged at the commercial paper rate or 12-month LIBOR, as applicable, plus an applicable margin. The margin represents our credit risk, and the strength of the portfolio of life insurance policies collateralizing the debt. The overall rate reflects market, and the carrying value of the facility approximates fair value.

 

GWG MCA participates in the merchant cash advance industry by directly advancing sums to merchants and lending money, on a secured basis, to companies that advance sums to merchants. Each quarter, we review the carrying value of these advances and loans, and determine if an impairment reserve is necessary. At June 30, 2017 one of our secured loans was potentially impaired. The secured loan to Nulook Capital LLC had an outstanding balance of $2,060,000 and a loan loss reserve of $1,478,000 at June 30, 2017. We deem fair value to be the estimated collectible value on each loan or advance made from GWG MCA. Where we estimate the collectible amount to be less than the outstanding balance, we record a reserve for the difference. We recorded an impairment charge of $870,000 for the quarter ended June 30, 2017.

 

The following table summarizes outstanding warrants related to our Series A offering (see Note 9) and the Company’s initial public offering as of June 30, 2017:

 

Month issued  Warrants issued   Fair value per share   Risk free
rate
   Volatility   Term
September 2012   2,500   $0.72    0.31%   40.49%  5 years
September 2014   16,000   $1.26    1.85%   17.03%  5 years
    18,500                   

 

(5) Credit Facility – Autobahn Funding Company LLC

 

Through GWG DLP Funding III, LLC (“DLP III”) we are party to a $105 million senior credit facility with Autobahn Funding Company LLC (“Autobahn”), with a maturity date of June 30, 2018. The facility is governed by a Credit and Security Agreement (the “Agreement”), and DZ Bank AG Deutsche Zentral-Genossenschaftsbank (“DZ Bank”) acts as the agent for Autobahn under the Agreement. On September 14, 2016, we paid off this senior credit facility in full with funds received from a new senior credit facility with LNV Corporation as described in Note 6.

 

Advances under the facility bear interest at a commercial paper rate of the lender at the time of the advance, or at the lender’s cost of borrowing plus 4.25%. 

 

The amount outstanding under this facility was $0 at both June 30, 2017 and December 31, 2016, respectively. GWG Holdings is a performance guarantor of the various obligations of GWG Life, as servicer, under the Agreement. Obligations under the facility are secured by our pledge of ownership in our life insurance policies to DZ Bank through an arrangement under which Wells Fargo serves as securities intermediary.

 

The Agreement has certain financial (as described below) and non-financial covenants, and we were in compliance with these covenants at both June 30, 2017 and December 31, 2016.

 

We have agreed to maintain (i) a positive consolidated net income on a non-GAAP basis (as defined and calculated under the Agreement) for each complete fiscal year, (ii) a tangible net worth on a non-GAAP basis (again, as defined and calculated under the Agreement) of not less than $45 million, and (iii) cash and eligible investments of $15 million or above.

 

Consolidated non-GAAP net income and non-GAAP tangible net worth for the four quarters ended and as of June 30, 2017, as calculated under the Agreement, was $29,590,000 and $225,661,000, respectively. 

 

No life insurance policies were pledged and no funds were available for additional borrowings under the facility at June 30, 2017 and December 31, 2016.

 

 - 11 - 

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

(6)Credit Facility – LNV Corporation

 

On September 14, 2016, we entered into a senior credit facility with LNV Corporation as lender through our subsidiary GWG DLP Funding IV, LLC. The Loan Agreement governing the facility makes available a total of up to $172,300,000 in credit with a maturity date of September 14, 2026. Additional quarterly advances are available under the Loan Agreement at the LIBOR rate as defined in the Loan Agreement. Interest will accrue on amounts borrowed under the Loan Agreement at an annual interest rate, determined as of each date of borrowing or quarterly if there is no borrowing, equal to (A) the greater of 12-month LIBOR or the federal funds rate (as defined in the agreement) plus one-half of one percent per annum, plus (B) 5.75% per annum. The effective rate at June 30, 2017 was 7.59%. Interest payments are made on a quarterly basis.

 

The amount outstanding under this facility was $155,625,000 at June 30, 2017 and $162,725,000 at December 31, 2016. Obligations under the facility are secured by a security interest in DLP IV’s assets, for the benefit of the lenders under the Loan Agreement, through an arrangement under which Wells Fargo serves as securities intermediary. The life insurance policies owned by DLP IV do not serve as direct collateral for the obligations of GWG Holdings under its L Bonds or Series I Secured Notes. The difference between the outstanding balance as of June 30, 2017 and the carrying amount relates to unamortized debt issuance costs.

 

The Loan Agreement requires DLP IV to maintain a reserve account in an amount sufficient to pay 12 months of servicing, administrative and third party expenses identified under the Loan Agreement, and 12 months of debt service as calculated under the Loan Agreement. As of June 30, 2017, the amount set aside in this specific reserve account was $27,523,000.

 

The Loan Agreement has certain financial and nonfinancial covenants, and we were in compliance with these covenants at June 30, 2017 and December 31, 2016.

 

No funds were available for additional borrowings under the facility at June 30, 2017.

 

(7)Series I Secured Notes

 

Series I Secured Notes (“Series I”) are legal obligations of GWG Life and were privately offered and sold from August 2009 through June 2011. The Series I are secured by the assets of GWG Life and are subordinate to obligations under our senior credit facilities (see Notes 5 and 6). We are party to a Third Amended and Restated Note Issuance and Security Agreement dated November 1, 2011, as amended, under which GWG Life is obligor, GWG Holdings is guarantor, and Lord Securities Corporation serves as trustee of the GWG Life Trust (“Trust”). This agreement contains certain financial and non-financial covenants, and we were in compliance with these covenants at both June 30, 2017 and December 31, 2016.

 

The Series I were sold with original maturity dates ranging from six months to seven years, and with fixed interest rates varying from 5.65% to 9.55% depending on the term of the note. The Series I have renewal features under which we may elect to permit their renewal, subject to the right of noteholders to elect to receive payment at maturity. Since September 1, 2016, we are no longer renewing the Series I.

 

Interest on the Series I is payable monthly, quarterly, annually or at maturity depending on the election of the investor. At June 30, 2017 and December 31, 2016, the weighted-average interest rate of our Series I was 8.72% and 8.68%, respectively. The principal amount of Series I outstanding was $6,815,000 and $16,614,000 at June 30, 2017 and December 31, 2016, respectively. The difference between the amount outstanding on the Series I and the carrying amount on our balance sheet is due to netting of unamortized deferred issuance costs and including redemptions in process. Overall, interest expense includes amortization of deferred financing and issuance costs of $29,000 and $74,000 for the three and six months ended June 30, 2017 and $82,000 and $193,000 for the three and six months ended June 30, 2016. Future expected amortization of deferred financing costs is $134,000 in total over the next five years.

 

 - 12 - 

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Future contractual maturities of Series I payable, and future amortization of their deferred financing costs, at June 30, 2017 are as follows: 

 

Years Ending December 31,  Contractual Maturities   Amortization of Deferred Financing Costs 
Six months ending December 31 ,2017  $749,000   $3,000 
2018   2,376,000    25,000 
2019   1,024,000    17,000 
2020   1,725,000    41,000 
2021   941,000    48,000 
   $6,815,000   $134,000 

 

(8)L Bonds

 

Our L Bonds are legal obligations of GWG Holdings. Obligations under the L Bonds are secured by the assets of GWG Holdings and by GWG Life, as a guarantor, and are subordinate to the obligations under our senior credit facilities (see Notes 5 and 6). We began publicly offering and selling L Bonds in January 2012 under the name “Renewable Secured Debentures.” These debt securities were re-named “L Bonds” in January 2015. L Bonds are publicly offered and sold on a continuous basis under a registration statement permitting us to sell up to $1.0 billion in principal amount of L Bonds. We are party to an indenture governing the L Bonds dated October 19, 2011, as amended (“Indenture”), under which GWG Holdings is obligor, GWG Life is guarantor, and Bank of Utah serves as indenture trustee. The Indenture contains certain financial and non-financial covenants, and we were in compliance with these covenants at June 30, 2017 and December 31, 2016.

 

Effective September 1, 2016, we ceased selling 6-month and 1-year L Bonds until further notice. In addition, effective September 1, 2016, the L Bond interest rates that we offer changed to 5.50%, 6.25%, 7.50% and 8.50% for the 2-, 3-, 5- and 7-year L Bonds, respectively. The bonds have renewal features under which we may elect to permit their renewal, subject to the right of bondholders to elect to receive payment at maturity. Interest is payable monthly or annually depending on the election of the investor.

 

At June 30, 2017 and December 31, 2016, the weighted-average interest rate of our L Bonds was 7.30% and 7.23%, respectively. The principal amount of L Bonds outstanding was $407,850,000 and $387,067,000 at June 30, 2017 and December 31, 2016, respectively. The difference between the amount of outstanding L Bonds and the carrying amount on our balance sheets is due to netting of unamortized deferred issuance costs, cash receipts for new issuances and payments of redemptions in process. Amortization of deferred issuance costs was $927,000 and $2,856,000 for the three and six months ended June 30, 2017 and $1,721,000 and $3,289,000 for the three and six months ended June 30, 2016. Future expected amortization of deferred financing costs as of June 30, 2017 is $13,539,000 in total over the next seven years.

 

Future contractual maturities of L Bonds, and future amortization of their deferred financing costs, at June 30, 2017 are as follows: 

 

Years Ending December 31,  Contractual Maturities   Amortization of Deferred Financing Costs 
Six months ending December 31, 2017  $47,068,000   $353,000 
2018   108,772,000    2,181,000 
2019   116,767,000    4,128,000 
2020   49,062,000    2,147,000 
2021   28,753,000    1,411,000 
Thereafter   57,428,000    3,319,000 
   $407,850,000   $13,539,000 

 

(9) Series A Convertible Preferred Stock

 

From July 2011 through September 2012, we privately offered shares of Series A of GWG Holdings at $7.50 per share. In the offering, we sold an aggregate of 3,278,000 shares for gross consideration of $24,582,000. Holders of Series A are entitled to cumulative dividends at the rate of 10% per annum, paid quarterly. Dividends on the Series A are accumulating and are recorded as a reduction to additional paid-in capital. Under certain circumstances described in the Certificate of Designation for the Series A, additional Series A shares may be issued in lieu of cash dividends at the rate of $7.00 per share.

 

 - 13 - 

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Holders of Series A are entitled to a liquidation preference equal to the stated value of their preferred shares (i.e., $7.50 per share) plus accrued but unpaid dividends. Holders of Series A may presently convert each share of their Series A into 0.75 shares of our common stock at a price of $10.00 per share.

 

As of June 30, 2017, we issued an aggregate of 521,000 shares of Series A in satisfaction of $3,647,000 in dividends on the Series A, and an aggregate of 696,000 shares of Series A were converted into 522,000 shares of our common stock. As of June 30, 2017, we had 2,672,000 Series A shares outstanding with respect to which we incurred aggregate issuance costs of $2,838,000, all of which is included as a component of additional paid-in capital.

 

Purchasers of Series A in our offering received warrants to purchase an aggregate of 431,954 shares of our common stock at an exercise price of $12.50 per share. The grant date fair value of these warrants was $428,000. As of June 30, 2017, none of these warrants had been exercised and 413,000 warrants have expired. The weighted-average remaining life of these warrants was 1.94 and 0.56 years at June 30, 2017 and December 31, 2016, respectively.

 

In September 2014, we completed, at our discretion, a public offering of our common stock and, as a result, the Series A was reclassified from temporary equity to permanent equity. We may redeem Series A shares at a price equal to 110% of their liquidation preference ($7.50 per share) at any time. As of June 30, 2017, we have redeemed an aggregate of 439,000 shares of Series A.

  

(10)Redeemable Preferred Stock

 

On November 30, 2015, our public offering of up to 100,000 shares of Redeemable Preferred Stock (“RPS”) at $1,000 per share was declared effective. Holders of RPS are entitled to cumulative dividends at the rate of 7% per annum, paid monthly. Dividends on the RPS are recorded as a reduction to additional paid-in capital. Under certain circumstances described in the Certificate of Designation for the RPS, additional shares of RPS may be issued in lieu of cash dividends. 

 

The RPS ranks senior to our common stock and pari passu with our Series A, and entitles its holders to a liquidation preference equal to the stated value per share (i.e., $1,000) plus accrued but unpaid dividends. Holders of RPS may presently convert their RPS into our common stock at a conversion price equal to the volume-weighted average price of our common stock for the 20 trading days immediately prior to the date of conversion, subject to a minimum conversion price of $15.00 and in an aggregate amount limited to 15% of the stated value of RPS originally purchased by such holder from us and still held by such holder.

 

Holders of RPS may request that we redeem their RPS at a price equal to their stated value plus accrued but unpaid dividends, less an applicable redemption fee, if any. Nevertheless, the Certificate of Designation for RPS permits us complete discretion to grant or decline redemption requests. Subject to certain restrictions and conditions, we may also redeem shares of RPS without a redemption fee upon a holder’s death, total disability or bankruptcy. In addition, after one year from the date of original issuance, we may, at our option, call and redeem shares of RPS at a price equal to their liquidation preference.

 

As of June 30, 2017, we had sold 99,127 shares of RPS for aggregate gross consideration of $99,127,000, and incurred approximately $7,019,000 of selling costs related to the sale of those shares. On March 31, 2017, we closed the RPS offering to investors.

 

At the time of its issuance, we determined that the RPS contained two embedded features: (1) optional redemption by the holder and (2) optional conversion by the holder. We determined that each of the embedded features met the definition of a derivative and that the RPS should be considered an equity host for the purposes of assessing the embedded derivatives for potential bifurcation. Based on our assessment under Accounting Standards Codification 470 “Debt” (“ASC 470”) we do not believe bifurcation of either the holder’s redemption or conversion feature is appropriate.

 

 - 14 - 

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

(11)Series 2 Redeemable Preferred Stock

 

On February 14, 2017, our public offering of up to 150,000 shares of Series 2 Redeemable Preferred Stock (“RPS 2”) at $1,000 per share was declared effective. Holders of RPS 2 are entitled to cumulative dividends at the rate of 7% per annum, paid monthly. Dividends on the RPS 2, when payable, will be recorded as a reduction to additional paid-in capital. Under certain circumstances described in the Certificate of Designation for the RPS 2, additional shares of RPS 2 may be issued in lieu of cash dividends.

 

The RPS 2 ranks senior to our common stock and pari passu with our Series A and RPS, and entitles its holders to a liquidation preference equal to the stated value per share (i.e., $1,000) plus accrued but unpaid dividends. Holders of RPS 2 may, less an applicable conversion discount, if any, convert their RPS 2 into our common stock at a conversion price equal to the volume-weighted average price of our common stock for the 20 trading days immediately prior to the date of conversion, subject to a minimum conversion price of $12.75 and in an aggregate amount limited to 10% of the stated value of RPS 2 originally purchased by such holder from us and still held by such holder.

 

Holders of RPS 2 may request that we redeem their RPS 2 shares at a price equal to their liquidation preference, less an applicable redemption fee, if any. Nevertheless, the Certificate of Designation for RPS 2 permits us complete discretion to grant or decline requests for redemption. Subject to certain restrictions and conditions, we may also redeem shares of RPS 2 without a redemption fee upon a holder’s death, total disability or bankruptcy. In addition, we may, at our option, call and redeem shares of RPS 2 at a price equal to their liquidation preference (subject to a minimum redemption price, in the event of redemptions occurring less than one year after issuance, of 107% of the stated value of the shares being redeemed).

 

As of June 30, 2017, we had sold 22,536 shares of RPS 2 for aggregate gross consideration of $22,536,000, and incurred approximately $1,078,000 of selling costs related to the sale of those shares.

 

At the time of its issuance, we determined that the RPS 2 contained two embedded features: (1) optional redemption by the holder and (2) optional conversion by the holder. We determined that each of the embedded features met the definition of a derivative and that the RPS 2 should be considered an equity host for the purposes of assessing the embedded derivatives for potential bifurcation. Based on our assessment under ASC 470 we do not believe bifurcation of either the holder’s redemption or conversion feature is appropriate.

 

(12)Income Taxes

 

We had a current income tax liability of $0 as of both June 30, 2017 and December 31, 2016. The components of deferred income tax expense (benefit) for the three and six months ended June 30, 2017 and 2016, respectfully, consisted of the following:

 

   Three Months Ended   Six Months Ended 
   June 30,   June 30,   June 30,   June 30, 
   2017   2016   2017   2016 
Income tax provision (benefit):                
Current:                
Federal  $(27,000)  $(23,000)  $-   $- 
State  $(7,000)  $(6,000)  $-   $- 
Total current tax expense (benefit)   (34,000)   (29,000)        - 
Deferred:                    
Federal  $(2,798,000)  $1,397,000   $(2,818,000)  $2,203,000 
State  $(885,000)  $454,000   $(900,000)  $704,000 
Total deferred tax expense (benefit)   (3,683,000)   1,851,000    (3,718,000)   2,907,000 
Total income tax expense (benefit)   (3,717,000)   1,822,000    (3,718,000)   2,907,000 

 

We provide for a valuation allowance when it is not considered “more likely than not” that our deferred tax assets will be realized. At both June 30, 2017 and December 31, 2016, based upon all available evidence, we provided a valuation allowance of $2,164,000 against deferred tax assets related to the likelihood of recovering the tax benefit of a capital loss on a note receivable from a related entity and other capital losses.

  

The Company is engaged in acquiring of life insurance policies and holding them to maturity. Due to the nature of holding policies and the aging of the underlying insureds, it will be more likely than not that the Company will recognize taxable income as the policies in our portfolio start maturing at an accelerated rate in the near future. Due to this we believe that sufficient taxable income will be recognized during the net operating loss carryover period to utilize the reported deferred tax asset, and that no additional valuation allowance, other than that already recorded, is required.

 

 - 15 - 

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Accounting Standards Codification 740, Income Taxes (“ASC 740”) requires the reporting of certain tax positions that do not meet a threshold of “more likely than not” to be recorded as uncertain tax benefits. It is management’s responsibility to determine whether it is “more likely than not” that a tax position will be sustained upon examination, including resolution of any related appeals or litigation, based upon the technical merits of the position. Management has reviewed all income tax positions taken or expected to be taken for all open years and determined that the income tax positions are appropriately stated and supported. We do not anticipate that the total unrecognized tax benefits will significantly change prior to June 30, 2017.

 

Under our accounting policies, interest and penalties on unrecognized tax benefits, as well as interest received from favorable tax settlements, are recognized as components of income tax expense. At June 30, 2017 and December 31, 2016, we recorded no accrued interest or penalties related to uncertain tax positions.

 

Our income tax returns for tax years ended December 31, 2013, 2014, 2015 and 2016 remain open to examination by the Internal Revenue Service and various state taxing jurisdictions. Our tax return for tax year 2012 has now been examined by the IRS (finalized April of 2015) but is open for examination by various state taxing jurisdictions.

 

(13)Common Stock

 

In September 2014, we consummated an initial public offering of our common stock resulting in the sale of 800,000 shares of common stock at $12.50 per share, and net proceeds of approximately $8.6 million after the payment of underwriting commissions, discounts and expense reimbursements. In connection with this offering, we listed our common stock on the Nasdaq Capital Market under the ticker symbol “GWGH.” 

 

(14)Stock Incentive Plan

 

We adopted our 2013 Stock Incentive Plan in March 2013. The Compensation Committee of our Board of Directors is responsible for the administration of the plan. Participants under the plan may be granted incentive stock options and non-statutory stock options; stock appreciation rights; stock awards; restricted stock; restricted stock units; and performance shares. Eligible participants include officers and employees of GWG Holdings and its subsidiaries, members of our Board of Directors, and consultants. As of June 30, 2017, 3,000,000 common stock options are issuable under the plan.

 

Stock Options

 

Through June 30, 2017, we had issued stock options for 1,532,000 shares of common stock to employees, officers, and directors under the plan. Options for 740,000 shares have vested, and the remaining options are scheduled to vest over three years. The options were issued with an exercise price between $6.35 and $10.38 for those beneficially owning more than 10% of our common stock, and between $4.83 and $10.76 for all others, which is equal to the estimated market price of the shares on the date of grant. The expected annualized volatility used in the Black-Scholes model valuation of options issued during the period was 20.0%. The annual volatility rate is based on the standard deviation of the average continuously compounded rate of return of five selected comparable companies over the previous 52 weeks. A forfeiture rate of 15% is based on historical information and expected future trend. As of June 30, 2017, stock options for 679,000 shares had been forfeited and stock options for 70,000 shares had been exercised.

 

On April 17, 2017, GWG Holdings, Inc. entered into a Separation Agreement with Mr. Jon Gangelhoff. Under this agreement, Mr. Gangelhoff retired and resigned his position as Chief Operating Officer. In addition, all of Mr. Gangelhoff’s unvested outstanding common stock options at the time of his separation were vested under the Separation Agreement.

 

Outstanding stock options:

 

   Vested   Un-vested   Total 
Balance as of December 31, 2015   483,703    569,912    1,053,615 
Granted during the year   22,500    608,350    630,850 
Vested during the year   251,788    (251,788)   - 
Exercised during the year               
Forfeited during the year   (19,926)   (82,140)   (102,066)
Balance as of December 31, 2016   738,065    844,334    1,582,399 
Granted year-to-date   20,100    213,300    233,400 
Vested year-to-date   165,783    (165,783)   - 
Exercised year-to-date   (42,000)   -    (42,000)
Forfeited year-to-date   (142,119)   (99,415)   (241,534)
Balance as of June 30, 2017   739,829    792,436    1,532,265 

 

 - 16 - 

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Compensation expense related to unvested options not yet recognized is $541,000. We expect to recognize this compensation expense over the next three years ($89,000 in 2017, $217,000 in 2018, $167,000 in 2019, and $68,000 in 2020).

 

Stock Appreciation Rights (SARs)

 

As of June 30, 2017, we have issued SARs for 280,472 shares of common stock to employees. The strike price of the SARs was between $7.84 and $10.38, which was equal to the market price of the common stock at the date of issuance. As of June 30, 2017, 114,031 of the SARs were vested. On June 30, 2017 the market price of GWG’s common stock was $10.58.

 

Outstanding Stock Appreciation Rights:

 

   Vested   Un-vested   Total 
Balance as of December 31, 2015   -    -    - 
Granted during the year   106,608    133,127    239,735 
Forfeited during the year   -    -    - 
Balance as of December 31, 2016   106,608    133,127    239,735 
Granted during the year   4,063    36,674    40,737 
Vested during the year   3,360    (3,360)     
Forfeited during the year   -    -    - 
Balance as of June 30, 2017   114,031    166,441    280,472 

 

A liability for the SARs was recorded on June 30, 2017 in the amount of $316,000 and compensation expense was charged for the amount of $312,000.

 

Upon the exercise of SARs, the Company is obligated to make cash payment equal to the positive difference between the fair market value of the Company’s common stock on the date of exercise less the fair market value of the common stock on the date of grant.

 

(15)Net Loss per Common Share

 

We have outstanding Series A, RPS and RPS 2, as described in Notes 9, 10 and 11. The Series A, RPS and RPS 2 are anti-dilutive to our net loss or income attributable to common shareholders calculation at both June 30, 2017 and 2016. We also issued warrants to purchase common stock in conjunction with the sale of Series A (see Note 9). Both those warrants and our vested stock options are anti-dilutive at both June 30, 2017 and 2016 and have not been included in the fully diluted net loss per common share calculation.

 

(16)Commitments

 

We are party to an office lease with U.S. Bank National Association as the landlord. On September 1, 2015, we entered into an amendment to our original lease that expanded the leased space to 17,687 square feet and extended the term through 2025. Under the amended lease we are obligated to pay base rent plus common area maintenance and a share of building operating costs. Rent expenses under this agreement were $110,000 and $223,000 during the three and six months ended June 30, 2017 and $123,000 and $232,000 for the three and six months ended June 30, 2016.

 

Minimum lease payments under the amended lease are as follows:

 

Six months ending December 31, 2017  $90,000 
2018   185,000 
2019   191,000 
2020   198,000 
2021   204,000 
2022   210,000 
2023   217,000 
2024   223,000 
2025   230,000 
   $1,748,000 

 

 - 17 - 

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

(17)Contingencies

 

Litigation – In the normal course of business, we are involved in various legal proceedings. In the opinion of management, any liability resulting from such proceedings would not have a material adverse effect on our financial position, results of operations or cash flows.

 

(18)Guarantee of L Bonds

 

We are publicly offering and selling L Bonds under a registration statement declared effective by the SEC, as described in Note 8. Our obligations under the L Bonds are secured by substantially all the assets of GWG Holdings, a pledge of all our common stock held individually by our largest stockholders, and by a guarantee and corresponding grant of a security interest in substantially all the assets of GWG Life. As a guarantor, GWG Life has fully and unconditionally guaranteed the payment of principal and interest on the L Bonds. Substantially all of our life insurance policies are held by DLP III, DLP IV and the Trust. GWG Life’s equity in DLP III and DLP IV serve as collateral for our L Bond obligations. The policies held by DLP III and DLP IV are not collateral for the L Bond obligations as such policies serve as direct collateral for the senior credit facilities.

 

The consolidating financial statements are presented in lieu of separate financial statements and other related disclosures of the subsidiary guarantor and issuer because management does not believe that separate financial statements and related disclosures would be material to investors. There are currently no significant restrictions on the ability of GWG Holdings or GWG Life, the guarantor subsidiary, to obtain funds from its subsidiaries by dividend or loan, except as described in these notes. A majority of insurance policies we own are subject to a collateral arrangement with LNV Corporation described in Note 6. Under this arrangement, collection and escrow accounts are used to fund premiums for the insurance policies and to pay interest and other charges under the senior credit facility.

 

The following represents consolidating financial information as of June 30, 2017 and December 31, 2016, with respect to the financial position, and for the three and six months ended June 30, 2017 and 2016, with respect to results of operations and cash flows of GWG Holdings and its subsidiaries. The parent column presents the financial information of GWG Holdings, the primary obligor for the L Bonds. The guarantor subsidiary column represents the financial information of GWG Life, the guarantor subsidiary of the L Bonds, presenting its investment in DLP III, DLP IV and the Trust under the equity method. The non-guarantor subsidiaries column presents the financial information of all non-guarantor subsidiaries, including DLP III, DLP IV and the Trust.


 - 18 - 

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Condensed Consolidating Balance Sheets

 

June 30, 2017  Parent   Guarantor Subsidiary   Non-Guarantor Subsidiaries   Eliminations   Consolidated 
                     
A S S E T S
                     
Cash and cash equivalents  $49,632,850   $1,451,260   $1,209,362   $-   $52,293,472 
Restricted cash   -    4,454,226    41,705,405    -    46,159,631 
Investment in life insurance policies, at fair value   -    41,720,141    535,329,411    -    577,049,552 
Secured MCA advances   -    -    3,525,381    -    3,525,381 
Life insurance policy benefits receivable   -    -    6,970,000    -    6,970,000 
Deferred taxes, net   1,620,303    -    -    -    1,620,303 
Other assets   3,030,391    1,435,297    352,461    (942,339)   3,875,810 
Investment in subsidiaries   473,239,085    429,798,593    -    (903,037,678)   - 
                          
TOTAL ASSETS  $527,522,629   $478,859,517   $589,092,020   $(903,980,017)  $691,494,149 
                          
L I A B I L I T I E S  &  S T O C K H O L D E R S’  E Q U I T Y 
                          
LIABILITIES                         
Senior credit facilities  $-   $(1,076,118)  $150,084,944   $-   $149,008,826 
Series I Secured Notes   -    6,680,961    -    -    6,680,961 
L Bonds   400,832,308    -    -    -    400,832,308 
Accounts payable   1,166,827    1,377,121    1,616,149    -    4,160,097 
Interest and dividends payable   10,312,340    1,087,782    2,995,669    (8,747)   14,387,044 
Other accrued expenses   1,321,915    990,255    1,157,096    (933,592)   2,535,674 
TOTAL LIABILITIES   413,633,390    9,060,001    155,853,858    (942,339)   577,604,910 
                          
STOCKHOLDERS’ EQUITY                         
Member’s capital   -    469,799,516    433,238,162    (903,037,678)   - 
Convertible preferred stock   19,732,262    -    -    -    19,732,262 
Redeemable preferred stock and Series 2 redeemable preferred stock   118,707,840    -    -    -    118,707,840 
Common stock   5,784    -    -    -    5,784 
Accumulated deficit   (24,556,647)   -    -    -    (24,556,647)
TOTAL STOCKHOLDERS’ EQUITY   113,889,239    469,799,516    433,238,162    (903,037,678)   113,889,239 
                          
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY  $527,522,629   $478,859,517   $589,092,020   $(903,980,017)  $691,494,149 

 

 - 19 - 

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Condensed Consolidating Balance Sheets (continued)

 

December 31, 2016  Parent   Guarantor Subsidiary   Non-Guarantor Subsidiaries   Eliminations   Consolidated 
                     
A S S E T S
                     
Cash and cash equivalents  $28,481,047   $49,360,952   $644,983   $-   $78,486,982 
Restricted cash   -    2,117,649    35,708,947    -    37,826,596 
Investment in life insurance policies, at fair value   -    41,277,896    469,914,458    -    511,192,354 
Secured MCA advances   -    -    5,703,147    -    5,703,147 
Life insurance policy benefits receivable   -    -    5,345,000    -    5,345,000 
Other assets   3,854,233    2,056,822    810,640    (2,033,592)   4,688,103 
Investment in subsidiaries   429,971,148    352,337,037    -    (782,308,185)   - 
                          
TOTAL ASSETS  $462,306,428   $447,150,356   $518,127,175   $(784,341,777)  $643,242,182 
                          
L I A B I L I T I E S  &  S T O C K H O L D E R S’  E Q U I T Y 
                          
LIABILITIES                         
Senior credit facilities  $-   $-   $156,064,818   $-   $156,064,818 
Series I Secured Notes   -    16,404,836    -    -    16,404,836 
L Bonds   381,312,587    -    -    -    381,312,587 
Accounts payable   853,470    731,697    641,545    -    2,226,712 
Interest and dividends payable   9,882,133    3,743,277    2,535,189    -    16,160,599 
Other accrued expenses   862,369    544,032    2,303,952    (2,033,592)   1,676,761 
Deferred taxes, net   2,097,371    -    -    -    2,097,371 
TOTAL LIABILITIES   395,007,930    21,423,842    161,545,504    (2,033,592)   575,943,684 
                          
STOCKHOLDERS’ EQUITY                         
Member’s capital   -    425,726,514    356,581,671    (782,308,185)   - 
Convertible preferred stock   19,701,133    -    -    -    19,701,133 
Redeemable preferred stock   59,025,164    -    -    -    59,025,164 
Common stock   5,980    -    -    -    5,980 
Additional paid-in capital   7,383,515    -    -    -    7,383,515 
Accumulated deficit   (18,817,294)   -    -    -    (18,817,294)
TOTAL STOCKHOLDERS’ EQUITY   67,298,498    425,726,514    356,581,671    (782,308,185)   67,298,498 
                          
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY  $462,306,428   $447,150,356   $518,127,175   $(784,341,777)  $643,242,182 

 

 - 20 - 

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Condensed Consolidating Statements of Operations

 

For the three months ended June 30, 2017  Parent   Guarantor Subsidiary   Non-Guarantor Subsidiaries   Eliminations   Consolidated 
REVENUE                    
Policy servicing income  $-   $133,250   $-   $(133,250)  $- 
Gain on life insurance policies, net   -    201,685    11,094,581    -    11,296,266 
MCA income   -    -    133,583    -    133,583 
Interest and other income   69,221    30,134    164,558    (26,176)   237,737 
TOTAL REVENUE   69,221    365,069    11,392,722    (159,426)   11,667,586 
                          
EXPENSES                         
Policy servicing fees   -    -    133,250    (133,250)   - 
Interest expense   8,325,874    391,061    3,555,266    (26,176)   12,246,025 
Employee compensation and benefits   2,109,562    1,529,188    102,549    -    3,741,299 
Legal and professional fees   284,756    179,461    866,372    -    1,330,589 
Provision for MCA advances   -    -    878,000    -    878,000 
Other expenses   1,885,146    650,320    347,632    -    2,883,098 
TOTAL EXPENSES   12,605,338    2,750,030    5,883,069    (159,426)   21,079,011 
                          
INCOME (LOSS) BEFORE EQUITY IN INCOME OF SUBSIDIARIES   (12,536,117)   (2,384,961)   5,509,653    -    (9,411,425)
                          
EQUITY IN INCOME OF SUBSIDIARIES   3,124,692    7,241,779    -    (10,366,471)   - 
                          
INCOME (LOSS) BEFORE INCOME TAXES   (9,411,425)   4,856,818    5,509,653    (10,366,471)   (9,411,425)
                          
INCOME TAX BENEFIT   (3,717,174)   -    -    -    (3,717,174)
NET INCOME (LOSS)   (5,694,251)   4,856,818    5,509,653    (10,366,471)   (5,694,251)
Preferred stock dividends   2,031,097    -    -    -    2,031,097 
NET LOSS ATTRIBUTABLE TO COMMON SHAREHOLDERS  $(7,725,348)  $4,856,818   $5,509,653   $(10,366,471)  $(7,725,348)

 

For the three months ended June 30, 2016  Parent   Guarantor Subsidiary   Non-Guarantor Subsidiaries   Eliminations   Consolidated 
REVENUE                    
Policy servicing income  $-   $-   $-   $-   $- 
Gain on life insurance policies, net   -    -    20,383,347    -    20,383,347 
MCA income   -    -    223,255    -    223,255 
Interest and other income   71,222    706    157,927    (58,975)   170,880 
TOTAL REVENUE   71,222    706    20,764,529    (58,975)   20,777,482 
                          
EXPENSES                         
Policy servicing fees   -    -    -    -    - 
Interest expense   7,530,444    644,735    1,648,452    (58,975)   9,764,656 
Employee compensation and benefits   1,638,893    1,283,968    148,646    -    3,071,507 
Legal and professional fees   783,596    476,505    44,252    -    1,304,353 
Other expenses   1,519,349    425,354    387,982    -    2,332,685 
TOTAL EXPENSES   11,472,282    2,830,562    2,229,332    (58,975)   16,473,201 
                          
INCOME (LOSS) BEFORE EQUITY IN INCOME OF SUBSIDIARIES   (11,401,060)   (2,829,856)   18,535,197    -    4,304,281 
                          
EQUITY IN INCOME OF SUBSIDIARIES   15,705,341    18,835,036    -    (34,540,377)   - 
                          
INCOME BEFORE INCOME TAXES   4,304,281    16,005,180    18,535,197    (34,540,377)   4,340,281 
                          
INCOME TAX EXPENSE   1,822,030    -    -    -    1,822,030 
NET INCOME   2,482,250    16,005,180    18,535,197    (34,540,377)   2,482,250 
Preferred stock dividends   600,924    -    -    -    600,924 
NET INCOME ATTRIBUTABLE TO COMMON SHAREHOLDERS  $1,881,326   $16,005,180   $18,535,197   $(34,540,377)  $1,881,326 

 

 - 21 - 

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Condensed Consolidating Statements of Operations (continued)

 

For the six months ended June 30, 2017  Parent   Guarantor Subsidiary   Non-Guarantor Subsidiaries   Eliminations   Consolidated 
REVENUE                    
Policy servicing income  $-   $186,275   $-   $(186,275)  $- 
Gain on life insurance policies, net   -    1,701,012    28,995,074    -    30,696,086 
MCA income   -    -    380,159    -    380,159 
Interest and other income   154,228    49,010    543,643    (67,195)   679,686 
TOTAL REVENUE   154,228    1,936,297    29,918,876    (253,470)   31,755,931 
                          
EXPENSES                         
Policy servicing fees   -    -    186,275    (186,275)   - 
Interest expense   17,587,908    677,415    7,292,113    (67,195)   25,490,241 
Employee compensation and benefits   4,038,357    2,750,770    115,232    -    6,904,359 
Legal and professional fees   777,571    440,549    1,058,817    -    2,276,937 
Provision for MCA advances   -    -    878,000    -    878,000 
Other expenses   3,548,149    1,533,051    582,221    -    5,663,421 
TOTAL EXPENSES   25,951,985    5,401,785    10,112,658    (253,470)   41,212,958 
                          
INCOME (LOSS) BEFORE EQUITY IN INCOME OF SUBSIDIARIES   (25,797,757)   (3,465,488)   19,806,218    -    (9,457,027)
                          
EQUITY IN INCOME OF SUBSIDIARIES   16,340,730    21,305,986    -    (37,646,716)   - 
                          
INCOME (LOSS) BEFORE INCOME TAXES   (9,457,027)   17,840,498    19,806,218    (37,646,716)   (9,457,027)
                          
INCOME TAX BENEFIT   (3,717,674)   -    -    -    (3,717,674)
NET INCOME (LOSS)   (5,739,353)   17,840,498    19,806,218    (37,646,716)   (5,739,353)
Preferred stock dividends   (3,898,857)   -    -    -    (3,898,857)
NET LOSS ATTRIBUTABLE TO COMMON SHAREHOLDERS  $(9,638,210)  $17,840,498   $19,806,218   $(37,646,716)  $(9,638,210)

 

For the six months ended June 30, 2016  Parent   Guarantor Subsidiary   Non-Guarantor Subsidiaries   Eliminations   Consolidated 
REVENUE                    
Policy servicing income  $-   $13,417   $-   $(13,417)  $- 
Gain on life insurance policies, net   -    -    38,097,059    -    38,097,059 
MCA income   -    -    368,216    -    368,216 
Interest and other income   106,019    1,012    198,946    (89,877)   216,100 
TOTAL REVENUE   106,019    14,429    38,664,221    (103,294)   38,681,375 
                          
EXPENSES                         
Policy servicing fees   -    -    13,417    (13,417)   - 
Interest expense   14,618,037    1,301,971    3,083,680    (89,877)   18,913,811 
Employee compensation and benefits   3,175,323    2,113,049    249,333    -    5,537,705 
Legal and professional fees   1,378,335    1,011,155    120,991    -    2,510,481 
Other expenses   2,777,326    1,394,028    573,491    -    4,744,845 
TOTAL EXPENSES   21,949,021    5,820,203    4,040,912    (103,294)   31,706,842 
                          
INCOME (LOSS) BEFORE EQUITY IN INCOME OF SUBSIDIARIES   (21,843,002)   (5,805,774)   34,623,309    -    6,974,533 
                          
EQUITY IN INCOME OF SUBSIDIARIES   28,817,535    35,136,402    -    (63,953,937)   - 
                          
INCOME BEFORE INCOME TAXES   6,974,533    29,330,628    34,623,309    (63,953,937)   6,974,533 
                          
INCOME TAX EXPENSE   2,906,747    -    -    -    2,906,747 
NET INCOME   4,067,786    29,330,628    34,623,309    (63,953,937)   4,067,786 
Preferred stock dividends   (1,112,155)   -    -    -    (1,112,155)
NET INCOME ATTRIBUTABLE TO COMMON SHAREHOLDERS  $2,955,631   $29,330,628   $34,623,309   $(63,953,937)  $2,955,631 

 

 - 22 - 

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Condensed Consolidating Statements of Cash Flows

 

For the three months ended June 30, 2017  Parent   Guarantor Subsidiary   Non-Guarantor Subsidiaries   Eliminations   Consolidated 
CASH FLOWS FROM OPERATING ACTIVITIES                    
Net income (loss)  $(5,694,251)  $4,856,818   $5,509,653   $(10,366,471)  $(5,694,251)
Adjustments to reconcile net income to net cash flows from operating activities:                         
Equity of subsidiaries   (3,124,692)   (7,241,779)   -    10,366,471    - 
Change in fair value of life insurance policies   -    (134,399)   (15,101,103)   -    (15,235,502)
Amortization of deferred financing and issuance costs   926,816    28,964    542,168    -    1,497,948 
Deferred income taxes   (3,717,174)   -    -    -    (3,717,174)
Preferred stock dividends payable   363,959    -    -    -    363,959 
(Increase) decrease in operating assets:                         
Life insurance policy benefits receivable   -    600,000    1,405,000    -    2,005,000 
Other assets   (32,646,205)   (23,493,280)   (297,040)   55,878,537    (557,988)
Increase (decrease) in operating liabilities:                         
Due to related party   398,030    -    (400,000)   -    (1,970)
Accounts payable and accrued expenses   1,213,002    (1,405,114)   1,230,967    -    1,038,855 
NET CASH FLOWS USED IN OPERATING ACTIVITIES   (42,280,515)   (26,788,790)   (7,110,355)   55,878,537    (20,301,123)
                          
CASH FLOWS FROM INVESTING ACTIVITIES                         
Investment in life insurance policies   -    -    (19,432,338)   -    (19,432,338)
Carrying value of matured life insurance policies   -    256,152    2,758,682    -    3,014,834 
Investment in Secured MCA advances   -    -    (39,671)   -    (39,671)
Proceeds from Secured MCA advances   -    -    653,315    -    653,315 
NET CASH FLOWS USED IN INVESTING ACTIVITIES   -    256,152    (16,060,012)   -    (15,803,860)
                          
CASH FLOWS FROM FINANCING ACTIVITIES                         
Net borrowings on senior credit facilities   -    -    (3,845,037)   -    (3,845,037)
Payments for issuance of senior debt   -    (1,076,118)   -    -    (1,076,118)
Payments for redemption of Series I Secured Notes   -    (4,348,372)   -    -    (4,348,372)
Proceeds from issuance of L Bonds   31,875,811    -    -    -    31,875,811 
Payments for issuance and redemption of L Bonds   (15,025,566)   -    -    -    (15,025,566)
Payments to restricted cash   -    (893,893)   2,825,851    -    1,931,958 
Issuance of member capital   -    31,450,843    24,427,694    (55,878,537)   - 
Issuance of common stock   4    -    -    -    4 
Proceeds from issuance of preferred stock   34,301,747    -    -    -    34,301,747 
Payments for issuance and redemption of preferred stock   (3,318,211)   -    -    -    (3,318,211)
Payments of preferred stock dividends   (2,031,097)   -    -    -    (2,031,097)
NET CASH FLOWS PROVIDED BY FINANCING ACTIVITIES   45,802,688    25,132,460    23,408,508    (55,878,537)   38,465,119 
                          
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS   3,522,173    (1,400,178)   238,141         2,360,136 
                          
CASH AND CASH EQUIVALENTS                         
BEGINNING OF THE PERIOD   46,110,677    2,851,438    971,221    -    49,933,336 
                          
END OF THE PERIOD  $49,632,850   $1,451,260   $1,209,362   $-   $52,293,472 

 

 - 23 - 

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Consolidating Statements of Cash Flows (continued)

 

For the three months ended June 30, 2016  Parent   Guarantor Subsidiary   Non-Guarantor Subsidiaries   Eliminations   Consolidated 
CASH FLOWS FROM OPERATING ACTIVITIES                    
Net income  $2,482,250   $16,005,180   $18,535,197   $(34,540,377)  $2,482,250 
Adjustments to reconcile net loss to net cash flows from operating activities:                         
Equity of subsidiaries   (15,705,341)   (18,835,036)   -    34,540,377    - 
Change in fair value of life insurance policies   -    -    (21,241,376)   -    (21,241,376)
Amortization of deferred financing and issuance costs   2,261,032    (282,257)   549,199    -    2,527,974 
Deferred income taxes   1,851,018    -    -    -    1,851,018 
Preferred stock dividends payable   166,472    -    -    -    166,472 
(Increase) decrease in operating assets:                         
Life insurance policy benefits receivable   -    -    9,083,817    -    9,083,817 
Other assets   (21,796,633)   (12,903,506)   -    33,489,247    (1,210,892)
Increase (decrease) in operating liabilities:                         
Due to related party   (71,975)   17,802    (1,760,000)   -    (1,814,173)
Accounts payable and other accrued expenses   1,458,476    130,596    (2,364,285)   -    (775,213)
NET CASH FLOWS USED IN OPERATING ACTIVITIES   (29,354,701)   (15,867,221)   2,802,552    33,489,247    (8,930,123)
                          
CASH FLOWS FROM INVESTING ACTIVITIES                         
Investment in life insurance policies   -    -    (24,373,714)   -    (24,373,714)
Carrying value of matured life insurance policies   -    -    1,691,764    -    1,691,764 
Investment in Secured MCA advances   -    -    (1,293,829)        (1,293,829)
Proceeds from Secured MCA advances   -    -    907,649    -    907,649 
NET CASH FLOWS USED IN INVESTING ACTIVITIES   -    -    (23,068,130)   -    (23,068,130)
                          
CASH FLOWS FROM FINANCING ACTIVITIES                         
Net repayment of senior credit facilities   -    -    (3,000,000)        (3,000,000)
Payments for redemption of Series I Secured Notes   -    (485,350)   -    -    (485,350)
Proceeds from issuance of L Bonds   36,757,771    -    -    -    36,757,771 
Payments for issuance and redemption of L Bonds   (11,753,782)   -    -    -    (11,753,782)
Payments to restricted cash   -    (116,672)   8,784,498    -    8,667,826 
Issuance of member capital   -    18,951,362    14,537,885    (33,489,247)   - 
Issuance of common stock   166,125    -    -    -    166,125 
Proceeds from issuance of preferred stock   9,401,118    -    71,555    -    9,472,673 
Payments for issuance and redemption of preferred stock   (838,021)   -    (7,340)   -    (845,361)
Payments of preferred stock dividends   (600,924)   -    -    -    (600,924)
NET CASH FLOWS PROVIDED BY FINANCING ACTIVITIES   33,132,287    18,349,340    20,386,598    (33,489,247)   38,378,978 
                          
NET INCREASE IN CASH AND CASH EQUIVALENTS   3,777,586    2,482,119    121,020    -    6,380,725 
                          
CASH AND CASH EQUIVALENTS                         
BEGINNING OF THE PERIOD   6,274,035    4,340,365    384,225    -    10,998,625 
                          
END OF THE PERIOD  $10,051,621   $6,822,484   $505,245   $-   $17,379,350 

 

 - 24 - 

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Consolidating Statements of Cash Flows (continued)

 

For the six months ended June 30, 2017  Parent   Guarantor Subsidiary   Non-Guarantor Subsidiaries   Eliminations   Consolidated 
CASH FLOWS FROM OPERATING ACTIVITIES                    
Net income (loss)  $(5,739,353)  $17,840,498   $19,806,218   $(37,646,716)  $(5,739,353)
Adjustments to reconcile net loss to net cash flows from operating activities:                         
Equity of subsidiaries   (16,340,730)   (21,305,986)   -    37,646,716    - 
Change in fair value of life insurance policies   -    (1,193,821)   (27,925,514)   -    (29,119,335)
Amortization of deferred financing and issuance costs   2,855,809    74,384    1,233,958    -    4,164,151 
Deferred income taxes   (3,717,674)   -    -    -    (3,717,674)
Preferred stock dividends payable   700,748    -    -    -    700,748 
(Increase) decrease in operating assets:                         
Life insurance policy benefits receivable   -    -    (1,625,000)   -    (1,625,000)
Other assets   (27,138,260)   (55,534,365)   458,179    83,082,776    868,330 
Increase (decrease) in operating liabilities:                         
Due to related party   1,089,895    320    (1,100,000)   -    (9,785)
Accounts payable and other accrued expenses   1,637,970    (1,563,846)   2,181,963    -    2,256,087 
NET CASH FLOWS USED IN OPERATING ACTIVITIES   (46,651,595)   (61,682,816)   (6,970,196)   83,082,776    (32,221,831)
                          
CASH FLOWS FROM INVESTING ACTIVITIES                         
Investment in life insurance policies   -    -    (42,121,671)   -    (42,121,671)
Carrying value of matured life insurance policies   -    751,576    4,632,232    -    5,383,808 
Investment in Secured MCA advances   -    -    (39,671)   -    (39,671)
Proceeds from Secured MCA advances   -    -    1,423,702    -    1,423,702 
NET CASH FLOWS USED IN INVESTING ACTIVITIES   -    751,576    (36,105,408)   -    (35,353,832)
                          
CASH FLOWS FROM FINANCING ACTIVITIES                         
Net repayment of senior credit facilities   -    -    (7,099,537)   -    (7,099,537)
Payments for issuance of senior debt        (1,076,118)   (114,294)   -    (1,190,412)
Payments for redemption of Series I Secured Notes   -    (9,798,261)   -    -    (9,798,261)
Proceeds from issuance of L Bonds   56,744,470    -    -    -    56,744,470 
Payments for issuance and redemption of L Bonds   (39,197,163)   -    -    -    (39,197,163)
Payments to restricted cash   -    (2,336,577)   (5,996,458)   -    (8,333,035)
Issuance of member capital   -    26,232,504    56,850,272    (83,082,776)   - 
Payments for issuance and redemption of common stock   (1,603,556)   -    -    -    (1,603,556)
Proceeds from issuance of preferred stock   61,480,941    -    -    -    61,480,941 
Payments for issuance and redemption of preferred stock   (5,722,437)   -    -    -    (5,722,437)
Payments of preferred stock dividends   (3,898,857)   -    -    -    (3,898,857)
NET CASH FLOWS PROVIDED BY FINANCING ACTIVITIES   67,803,398    13,021,548    43,639,983    (83,082,776)   41,382,153 
                          
NET INCREASE IN CASH AND CASH EQUIVALENTS   21,151,803    (47,909,692)   564,379    -    (26,193,510)
                          
CASH AND CASH EQUIVALENTS                         
BEGINNING OF THE PERIOD   28,481,047    49,360,952    644,983    -    78,486,982 
                          
END OF THE PERIOD  $49,632,850   $1,451,260   $1,209,362   $-   $52,293,472 

 

 - 25 - 

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Consolidating Statements of Cash Flows (continued)

  

For the six months ended June 30, 2016  Parent   Guarantor Subsidiary   Non-Guarantor Subsidiaries   Eliminations   Consolidated 
CASH FLOWS FROM OPERATING ACTIVITIES                    
Net income  $4,067,786   $29,330,628   $34,623,309   $(63,953,937)  $4,067,786 
Adjustments to reconcile net income to net cash flows from operating activities:                         
Equity of subsidiaries   (28,817,535)   (35,136,402)   -    63,953,937    - 
Change in fair value of life insurance policies   -    -    (32,772,929)   -    (32,772,929)
Amortization of deferred financing and issuance costs   3,909,923    (1,446,463)   848,702    -    3,312,162 
Deferred income taxes   2,906,747    -    -    -    2,906,747 
Preferred stock dividends payable   330,049    -    -    -    330,049 
(Increase) decrease in operating assets:                         
Life insurance policy benefits receivable   -    -    (6,829,022)        (6,829,022)
Other assets   (60,457,838)   (37,895,574)   -    97,315,946    (1,037,466)
Increase in operating liabilities:                         
Due to related party   (2,802,976)   1,195    2,700,000    -    (101,781)
Accounts payable and accrued expenses   2,240,523    717,298    (1,765,065)   -    1,192,756 
NET CASH FLOWS USED IN OPERATING ACTIVITIES   (78,623,321)   (44,429,318)   (3,195,005)   97,315,946    (28,931,698)
                          
CASH FLOWS FROM INVESTING ACTIVITIES                         
Investment in life insurance policies   -    -    (48,700,036)   -    (48,700,036)
Carrying value of matured life insurance policies   -    -    6,302,243    -    6,302,243 
Investment in Secured MCA advances   -    -    (5,647,414)   -    (5,647,414)
Proceeds from Secured MCA advances   -    -    1,025,792    -    1,025,792 
NET CASH FLOWS USED IN INVESTING ACTIVITIES   -    -    (47,019,415)   -    (47,019,415)
                          
CASH FLOWS FROM FINANCING ACTIVITIES                         
Net borrowings on senior credit facilities   -    -    17,000,000    -    17,000,000 
Payments for redemption of Series I Secured Notes   -    (5,722,743)   -    -    (5,722,743)
Proceeds from issuance of L Bonds   71,126,660    -    -    -    71,126,660 
Payments for issuance and redemption of L Bonds   (22,663,475)   -    -    -    (22,663,475)
Payments to restricted cash   -    (2,822,051)   (5,996,843)   -    (8,818,894)
Issuance of common stock   212,670    -    -    -    212,670 
Proceeds from issuance of preferred stock   10,429,654    -    71,555    -    10,501,209 
Payments for issuance and redemption of preferred stock   (1,610,574)   -    (7,340)   -    (1,617,914)
Payments of preferred stock dividends   (1,112,155)   -         -    (1,112,155)
Issuance of member capital   -    57,813,874    39,502,072    (97,315,946)   - 
NET CASH FLOWS PROVIDED BY FINANCING ACTIVITIES   56,382,780    49,269,080    50,569,444    (97,315,946)   58,905,358 
                          
NET INCREASE IN CASH AND CASH EQUIVALENTS   (22,240,541)   4,839,762    355,024    -    (17,045,755)
                          
CASH AND CASH EQUIVALENTS                         
BEGINNING OF THE PERIOD   32,292,162    1,982,722    150,221    -    34,425,105 
                          
END OF THE PERIOD  $10,051,621   $6,822,484   $505,245   $-   $17,379,350 

 

 - 26 - 

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

(19)Concentrations

 

We purchase life insurance policies written by life insurance companies having investment-grade ratings by independent rating agencies. As a result, there may be certain concentrations of policies with life insurance companies. The following summarizes the face value of insurance policies with specific life insurance companies exceeding 10% of the total face value of our portfolio.

 

Life insurance company  June 30,   December 31, 
   2017   2016 
John Hancock   14.13%   14.36%
AXA Equitable   12.69%   13.42%
Lincoln National   10.86%   11.22%
Transamerica   10.31%   * 

 

* percentage does not exceed 10% of the total face value.

 

The following summarizes the number of insurance policies held in specific states exceeding 10% of the total face value of our portfolio:

 

State of Residence  June 30,   December 31, 
   2017   2016 
Florida   20.30%   19.42%
California   19.29%   20.72%

 

(20)Subsequent events

 

Since June 30, 2017, we have issued approximately $15,789,000 of L Bonds.

 

Since June 30, 2017, we have issued approximately $12,762,000 of RPS 2.

 

As of the date of this report, we exercised our contractual rights to call for the redemption of our Series I Secured Notes and our Series A Preferred Stock and all outstanding warrants related to our Series A offering.

 

 - 27 - 

 

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

 

You should read the following discussion in conjunction with the condensed consolidated financial statements and accompanying notes and the information contained in other sections of this report. This discussion and analysis is based on the beliefs of our management, as well as assumptions made by, and information currently available to, our management.

 

Risk Relating to Forward-Looking Statements

 

This report contains forward-looking statements that reflect our current expectations and projections about future events. Actual results could differ materially from those described in these forward-looking statements.

 

The words “believe,” “could,” “possibly,” “probably,” “anticipate,” “estimate,” “project,” “expect,” “may,” “will,” “should,” “seek,” “intend,” “plan,” “expect,” or “consider” and similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements. Forward-looking statements are subject to risks and uncertainties, which could cause actual results to differ materially from such statements.  Many of the forward-looking statements contained in this report can be found in our MD&A discussion and in the updates we provide in Part II, Item 5 “Other Information.” 

 

changes in the secondary market for life insurance;
changes resulting from the evolution of our business model and strategy with respect to the life insurance industry;
our limited operating history;
the valuation of assets reflected on our financial statements;
the reliability of assumptions underlying our actuarial models, including our life expectancy estimates;
our reliance on debt financing;
risks relating to the validity and enforceability of the life insurance policies we purchase;
risks relating to our ability to license and effectively apply technologies to improve and expand the scope of our business;
our reliance on information provided and obtained by third parties;
federal, state and FINRA regulatory matters;
competition in the secondary market of life insurance;
the relative illiquidity of life insurance policies;
our ability to satisfy our debt obligations if we were to sell our entire portfolio of life insurance policies;
life insurance company credit exposure;
cost-of-insurance (premium) increases on our life insurance policies;
general economic outlook, including prevailing interest rates;
performance of our investments in life insurance policies;
financing requirements;
risks associated with the merchant cash advance business;

the various risks associated with our attempts to commercialize our M-Panel technology;

litigation risks;
restrictive covenants contained in borrowing agreements; and
our ability to make cash distributions in satisfaction of dividend obligations and redemption requests.

 

We caution you that the foregoing list of factors is not exhaustive. Forward-looking statements are only estimates and predictions, or statements of current intent. Actual results, outcomes or actions that we ultimately undertake could differ materially from those anticipated in the forward-looking statements due to risks, uncertainties or actual events differing from the assumptions underlying these statements.

 

JOBS Act

 

On April 5, 2012, the Jumpstart Our Business Startups Act of 2012, or JOBS Act, was enacted. Section 107 of the JOBS Act provides that an “emerging growth company” can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act of 1933 for complying with new or revised accounting standards. This means that an “emerging growth company” can make an election to delay the adoption of certain accounting standards until those standards would apply to private companies. We are an emerging growth company and have elected to delay our adoption of new or revised accounting standards and, as a result, we may not comply with new or revised accounting standards at the same time as other public reporting companies that are not “emerging growth companies.” This exemption will apply for a period of five years following our first sale of common equity securities under an effective registration statement (September 2019) or until we no longer qualify as an “emerging growth company” as defined under the JOBS Act, whichever is earlier.

 

 - 28 - 

 

 

Overview

 

We are a financial services company disrupting and transforming the life insurance industry and related industries with innovative products and services. We built our business by creating opportunities for consumers to obtain significantly more value for their life insurance policies as compared to the traditional options offered by the insurance industry by creating a secondary market. We are enhancing and extending these activities through innovation in our products and services, business processes, financing strategies, and advanced epigenetic technologies that we expect will improve insurance predictive underwriting analytics. At the same time, we are creating opportunities for investors to receive income and capital appreciation from our life insurance investment activities and the businesses we create in the life insurance and related industries.  

 

Critical Accounting Policies

 

Critical Accounting Estimates

 

The preparation of our consolidated financial statements in accordance with the Generally Accepted Accounting Principles (GAAP) requires us to make significant 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 revenues and expenses during the reporting period. We base our judgments, estimates, and assumptions on historical experience and on various other factors believed to be reasonable under the circumstances. Actual results could differ materially from these estimates. 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 valuing our investments in life insurance policies have the greatest potential impact on our consolidated financial statements and accordingly believe these to be our critical accounting estimates. Below we discuss the critical accounting policies associated with these estimates as well as certain other critical accounting policies.

 

Ownership of Life Insurance Policies—Fair Value Option

 

We account for the purchase of life insurance policies in accordance with ASC 325-30, which requires us to use either the investment method or the fair value method. We have elected to account for all of our life insurance policies using the fair value method.

 

The fair value of our life insurance policies is determined as the net present value of the life insurance portfolio’s future expected cash flows (policy benefits received and required premium payments) that incorporates current life expectancy estimates and discount rate assumptions.

 

Fair Value Components – Medical Underwriting

 

Unobservable inputs, as discussed below, are a critical component of our estimate for the fair value of our investments in life insurance policies. We currently use a probabilistic method of estimating and valuing the projected cash flows of our portfolio, which we believe to be the preferred and most prevalent valuation method in the industry. In this regard, the most significant assumptions we make are the life expectancy estimates of the insureds and the discount rate applied to the expected future cash flows to be derived from our portfolio.

 

The 2015 Valuation Basic Table (“2015 VBT”) finalized by the Society of Actuaries is based on a much larger dataset of insured lives, face amount of policies and more current information compared to the dataset underlying the 2008 Valuation Basic Table. The new 2015 VBT dataset includes 266 million policies compared to the 2008 VBT dataset of 75 million. The experience data in the 2015 VBT dataset includes 2.55 million claims on policies from 51 insurance carriers. Life expectancies implied by the 2015 VBT are generally longer for male and female nonsmokers between the ages of 65 and 80, while smokers and insureds of both genders over the age of 85 have significantly lower life expectancies. We adopted the 2015 VBT in our valuation process in June 2016.

 

For life insurance policies with face amounts greater than $1 million and that are not pledged under any senior credit facility (approximately 30% of our portfolio by face amount of policy benefits) we attempt to update the independent life expectancy estimates on a continuous rotating three year cycle. For life insurance policies with face amounts greater than $750,000 that are pledged under the LNV senior credit facility (approximately 58% of our portfolio by face amount of policy benefits) we are presently required to update the independent life expectancy estimates every two years.

 

Our prior experience in updating independent life expectancy estimates has generally resulted in shorter life expectancies of the updated insureds within our portfolio, but often not as short as we had projected. This has resulted in reductions to the fair value of our portfolio in the amounts of $6.7 million and $8.6 million for the three and six months ended June 30, 2017, respectively. As our life insurance portfolio continues to grow, we may experience additional and material adjustments to the fair value of our portfolio due to updating independent life expectancy estimates.

 

 - 29 - 

 

 

In July 2017, Lincoln National Life Insurance Company announced pending cost-of-insurance rate (i.e., premium) increases for certain life insurance policies which were effected on August 1, 2017. We identified two affected policies in our portfolio. We have requested updated policy illustrations in order to calculate the change in fair value resulting from the expected increased premiums. In August 2017, Transamerica Life Insurance Company announced pending cost-of-insurance rate increases for certain life insurance policies that will be effected on the policy anniversary dates. We identified three affected policies in our portfolio. We are aware of one additional pending cost-of-insurance increase affecting one other policy in our portfolio.

 

Fair Value Components – Required Premium Payments

 

We must pay the premiums on the life insurance policies within our portfolio in order to collect the policy benefit. The same probabilistic model and methodologies used to generate expected cash inflows from the life insurance policy benefits over the expected life of the insured are used to estimate cash outflows due to required premium payments. Premiums paid are offset against revenue in the applicable reporting period.

 

Fair Value Components – Discount Rate

 

A discount rate is used to calculate the net present value of the expected cash flows. The discount rate used to calculate fair value of our portfolio incorporates the guidance provided by ASC 820.

 

The table below provides the discount rate used to estimate the fair value of our portfolio of life insurance policies for the period ending:

 

  June 30, 2017   December 31, 2016  
  10.81%   10.96%  

 

The change in the discount rate incorporates current information about discount rates applied by other reporting companies owning portfolios of life insurance policies, discount rates observed by us in the life insurance secondary market, market interest rates, credit exposure to the issuing insurance companies, and our estimate of the risk premium a purchaser would require to receive the future cash flows derived from our portfolio of life insurance policies. Management has discretion regarding the combination of these and other factors when determining the discount rate. The discount rate we choose assumes an orderly and arms-length transaction (i.e., a non-distressed transaction in which neither seller nor buyer is compelled to engage in the transaction), which is consistent with related GAAP guidance. The carrying value of policies acquired during each quarterly reporting period are adjusted to their current fair value using the fair value discount rate applied to the entire portfolio as of that reporting date.

 

We engaged Model Actuarial Pricing System, Inc. (“MAPS”) to prepare a calculation of our life insurance portfolio. MAPS owns and maintains the portfolio pricing software we use. MAPS processed policy data, future premium data, life expectancy estimate data, and other actuarial information to calculate a net present value for our portfolio using the specified discount rate of 10.81%. MAPS independently calculated the net present value of our portfolio of 793 policies to be $577.0 million and furnished us with a letter documenting its calculation. A copy of such letter is filed as Exhibit 99.1 to this report.

 

Deferred Income Taxes

 

Under ASC 740, deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. A valuation allowance is established for deferred tax assets that are not considered “more likely than not” to be realized. Realization of deferred tax assets depends upon having sufficient past or future taxable income in periods to which the deductible temporary differences are expected to be recovered or within any applicable carryback or carryforward periods. After assessing the realization of the net deferred tax assets, we believe that it is “more likely than not” that we will be able to realize all of our deferred tax assets other than those which have resulted from capital losses.

  

Deferred Financing and Issuance Costs

 

Financing costs, which include issuance costs, sales commissions and other direct expenses incurred under the senior credit facilities, were capitalized and are amortized using the straight-line method over the term of the senior credit facilities. The Series I Secured Note obligations are reported net of financing costs, which are amortized using the interest method over the term of each respective borrowing. The L Bonds are reported net of financing costs, which are amortized using the interest method over the term of each respective borrowing.

 

 - 30 - 

 

 

Principal Revenue and Expense Items

 

We earn revenues from the following three primary sources.

 

Life Insurance Policy Benefits Realized. We recognize the difference between the face value of the policy benefits and carrying value when an insured event has occurred and we determine that settlement and collection of the policy benefits is realizable and reasonably assured. Revenue from a transaction must meet both criteria in order to be recognized. We generally collect the face value of the life insurance policy from the insurance company within 45 days of our notification of the insured’s mortality.

 

Change in Fair Value of Life Insurance Policies. We value our portfolio investments for each reporting period in accordance with the fair value principles discussed herein, which reflects the expected receipt of policy benefits in future periods as shown in our consolidated financial statements, net premium costs.

 

Sale of a Life Insurance Policy. In the event of a sale of a policy, we recognize gain or loss as the difference between the sale price and the carrying value of the policy on the date of the receipt of payment on such sale.

  

Our main components of expense are summarized below.

 

Selling, General and Administrative Expenses. We recognize and record expenses incurred in our business operations, including operations related to the purchasing and servicing of life insurance policies. These expenses include salaries and benefits, sales, marketing, occupancy and other expenditures.

 

Interest Expense. We recognize and record interest expenses associated with the costs of financing our life insurance portfolio for the current period. These expenses include interest paid to our senior lenders under our senior credit facilities, interest paid on our L Bonds and other outstanding indebtedness such as our Series I Secured Notes. When we issue debt, we amortize the financing costs associated with such indebtedness over the outstanding term of the financing, and classify it as interest expense.

 

Results of Operations — Three and Six Months Ended June 30, 2017 Compared to the Same Periods in 2016 

 

The following is our analysis of the results of operations for the periods indicated below. This analysis should be read in conjunction with our consolidated financial statements and related notes.

 

Revenue

  

   Three Months Ended
June 30,
   Six Months Ended
June 30,
 
   2017   2016   2017   2016 
Revenue recognized from maturities of life insurance contracts   7,920,000    8,137,000    24,526,000    22,765,000 
Revenue recognized from change in fair value of life insurance contracts  $15,235,000   $21,241,000   $29,119,000   $32,773,000 
Premiums and other annual fees   (11,859,000)   (8,995,000)   (22,949,000)   (17,441,000)
Gain on life insurance contracts, net  $11,296,000   $20,383,000   $30,696,000   $38,097,000 
Other income   372,000    394,000    1,060,000    584,000 
Total revenue  $11,668,000   $20,777,000   $31,756,000   $38,681,000 
                     
Number of policies matured   9    6    19    12 
Face value of matured policies  $10,935,000   $19,238,000   $29,910,000   $29,067,000 
The change in fair value related to new policies acquired during the period  $8,044,000   $9,822,000   $18,645,000   $17,841,000 

 

(1) The discount rate applied to estimate the fair value of the portfolio of life insurance policies we own was 10.81% as of June 30, 2017, compared to 10.96% as of December 31, 2016 and 11.05% as of June 30, 2016.  The carrying value of policies acquired during each quarterly reporting period is adjusted to current fair value using the fair value discount rate applied to the entire portfolio as of that reporting date.

 

 - 31 - 

 

 

Expenses.

 

   Three Months Ended June 30,   Six Months Ended June 30, 
   2017   2016   Increase/
Decrease
   2017   2016   Increase/
Decrease
 
Employee compensation and benefits (1)  $3,741,000   $3,071,000   $670,000   $6,904,000   $5,538,000   $1,366,000 
Interest expense (including amortization of deferred financing costs) (2)   12,246,000    9,765,000    2,481,000    25,490,000    18,914,000    6,576,000 
Legal and professional expenses (3)   1,331,000    1,304,000    27,000    2,277,000    2,510,000    (233,000)
Provision for MCA loans (4)   878,000    300,000    578,000    878,000    400,000    478,000 
Other expenses (5)   2,883,000    2,033,000    850,000    5,664,000    4,345,000    1,319,000 
Total expenses  $21,079,000   $16,473,000   $4,606,000   $41,213,000   $31,707,000   $9,506,000 

 

(1) We hired additional members to our sales, marketing and policy acquisition teams.  At June 30, 2017 we employed 76 employees and on June 30, 2016, we employed 66 employees.
(2) Increase in all periods was due to the increase in our average debt outstanding.
(3) Increase for the three months ended June 30, 2017 over the same period of 2016 is due to increased legal fees associated with MCA collections. Decrease for the six months ended June 30, 2017 over the same period of 2016 is due to fewer SEC filings.
(4) Increase is due to further impairment of the Nulook loan due to decreased recovery estimates.
(5) Increase is due to public relations, sales and marketing costs associated with growing and servicing our network of independent financial advisors and appointed agents.

 

Deferred Income Taxes.

 

The Company is engaged in acquiring of life insurance policies and holding them to maturity. Due to the nature of holding policies and the aging of the underlying insureds, it will be more likely than not that the Company will recognize taxable income as the policies in our portfolio start maturing at an accelerated rate in the near future. Due to this, we believe that sufficient taxable income will be recognized during the net operating loss carryover period to utilize the reported deferred tax asset, and that no additional valuation allowance, other than that already recorded, is required.

 

Income Tax Expense. For both the three and six months ended June 30, 2017, we realized income tax benefits of $3.7 million. In the three and six months ended June 30, 2016, we had an income tax expense of $1.8 million and $2.9 million, respectively. The effective tax rate for the three and six months ended June 30, 2017 was 39.5% and 39.3% and for the three and six months ended June 30, 2016, was 42.3% and 41.7%, respectively.

 

The following table provides a reconciliation of our income tax expense at the statutory federal tax rate to our actual income tax expense:

 

  Three Months Ended   Six Months Ended 
   June 30, 2017   June 30, 2016   June 30, 2017   June 30, 2016 
Statutory federal income tax (benefit)  $(3,200,000)   34.0%  $1,463,000    34.0%  $(3,215,000)   34.0%  $2,371,000    34.0%
State income taxes (benefit), net of federal benefit   (607,000)   6.5%   281,000    6.5%   (609,000)   6.4%   456,000    6.5%
Other permanent differences   90,000    (1.0)%   78,000    1.8%   106,000    (1.1)%   80,000    1.2%
Total income tax expense (benefit)  $(3,717,000)   39.5%  $1,822,000    42.3%  $(3,718,000)   39.3%  $2.907,000    41.7%

 

The most significant temporary differences between GAAP net income and taxable net income are the treatment of interest costs with respect to the acquisition of the life insurance policies and revenue recognition with respect to the mark-to-market of the life insurance portfolio.

 

 - 32 - 

 

 

Liquidity and Capital Resources

 

We finance our business through a combination of life insurance policy benefit receipts, origination fees, equity offerings, debt offerings, and our senior credit facilities. We have used our debt offerings and our senior credit facilities primarily for policy acquisition, policy servicing, and portfolio-related financing expenditures including paying principal and interest.

 

Under the terms of our senior credit facilities (discussed in Notes 5 and 6), we are required to maintain collection and escrow accounts that are used to fund the acquisition of policies, pay annual policy premiums, pay interest and other charges under the facility, and collect policy benefits. The agents for the lenders authorize disbursements from these accounts. At June 30, 2017 and December 31, 2016, there was a balance of $46,160,000, and $37,827,000, respectively, in these restricted cash accounts.

 

As of June 30, 2017 and December 31, 2016, we had approximately $105.4 million and $121.7 million, respectively, in combined available cash, cash equivalents, policy benefits receivable, if any, and available borrowing base surplus capacity, if any, under our senior credit facilities for the purpose of purchasing additional life insurance policies, paying premiums on existing policies, paying portfolio servicing expenses, and paying principal and interest on our outstanding financing obligations.

 

Financings Summary

 

We had the following outstanding debt balances as of June 30, 2017 and December 31, 2016:

 

   As of June 30, 2017   As of December 31, 2016 
Issuer/Borrower 

Principal Amount

Outstanding

  

Weighted Average

Interest Rate

  

Principal Amount

Outstanding

  

Weighted Average

Interest Rate

 
GWG Holdings, Inc. – L Bonds  $407,850,000    7.30%  $387,067,000    7.23%
GWG Life, LLC – Series I Secured Notes   6,815,000    8.72%   16,614,000    8.68%
GWG DLP Funding IV, LLC – Senior credit facilities   155,625,000    7.59%   162,725,000    7.34%
Total  $570,290,000    7.40%  $566,406,000    7.30%

 

In November 2009, our wholly owned subsidiary GWG Life began a private placement of Series I Secured Notes to accredited investors only. This offering was closed in November 2011. As of June 30, 2017 and December 31, 2016, we had approximately $6.8 million and $16.6 million, respectively, in principal amount of Series I Secured Notes outstanding. Effective as of the date of this report, we exercised our contractual right to call for the redemption of the Series I Secured Notes. We expect that our redemption of outstanding Series I Secured Notes will occur on or about September 8, 2017 and require us to pay an aggregate of approximately $6.6 million.

 

In June 2011, we concluded a private placement offering of Series A for new investors, having received an aggregate $24.6 million in subscriptions for our Series A. These subscriptions consisted of $14.0 million in conversions of outstanding Series I Secured Notes and $10.6 million of new investments.

 

As of both June 30, 2017 and December 31, 2016, we had approximately $19.7 million of Series A stated value outstanding. As of the date of this report, we exercised our contractual right to call for the redemption of the Series A Preferred Stock and all related outstanding warrants. We expect that our redemption of outstanding Series A Preferred Stock and related warrants will occur on or about October 9, 2017 and require us to pay an aggregate of approximately $22.2 million.

 

In January 2012, we began publicly offering up to $250.0 million in debt securities (initially named “Renewable Secured Debentures” and subsequently renamed “L Bonds”) that was completed in January 2015.

 

On September 24, 2014, we consummated an initial public offering of our common stock resulting in the sale of 800,000 shares of common stock at $12.50 per share and net proceeds of approximately $8.6 million after the deduction of underwriting commissions, discounts and expense reimbursements.

 

In January 2015, we began publicly offering up to $1.0 billion of L Bonds as a follow-on to our earlier $250.0 million public debt offering. Through June 30, 2017, the total amount of these L Bonds sold, including renewals, was $749.8 million. As of June 30, 2017 and December 31, 2016, respectively, we had approximately $407.9 million and $387.1 million in principal amount of L Bonds outstanding.

 

In October 2015, we began publicly offering up to 100,000 shares of our RPS at a per-share price of $1,000. As of June 30, 2017, we had issued approximately $99.1 million stated value of RPS. As of June 30, 2017, we no longer offer RPS.

 

 - 33 - 

 

 

On February 14, 2017, we began publicly offering up to 150,000 shares of RPS 2 at a per-share price of $1,000. As of June 30, 2017, we have issued approximately $22.5 million stated value of RPS 2.

 

The weighted-average interest rate of our outstanding Series I Secured Notes as of June 30, 2017 and December 31, 2016 was 8.72% and 8.68%, respectively, and the weighted-average maturity at those dates was 1.96 and 1.14 years, respectively. Effective September 1, 2016, we no longer renew the Series I Secured Notes.

 

The weighted-average interest rate of our outstanding L Bonds as of June 30, 2017 and December 31, 2016 was 7.30% and 7.23%, respectively, and the weighted-average maturity at those dates was 2.27 and 2.13 years, respectively. Our L Bonds have renewal features. Since we first issued our L Bonds, we have experienced $341.9 million in maturities, of which $207.8 million has renewed through June 30, 2017 for an additional term. This has provided us with an aggregate renewal rate of approximately 61% for investments in these securities. Effective September 1, 2016, we discontinued the sales and renewals of 6-month and 1-year L Bonds.

 

Future contractual maturities of Series I Secured Notes and L Bonds at June 30, 2017 are:

 

Years Ending December 31,  Series I Secured Notes   L Bonds   Total 
Six months ending December 31, 2017  $749,000   $47,068,000   $47,817,000 
2018   2,376,000    108,772,000    111,148,000 
2019   1,024,000    116,767,000    117,791,000 
2010   1,725,000    49,062,000    50,787,000 
2021   941,000    28,753,000    29,694,000 
2022   -    24,773,000    24,773,000 
Thereafter   -    32,655,000    32,655,000 
   $6,815,000   $407,850,000   $414,665,000 

 

The L Bonds and Series I Secured Notes are secured by all of our assets, and are subordinate to our senior credit facilities. The L Bonds and Series I Secured Notes are pari passu with respect to a security interest in our assets pursuant to an intercreditor agreement (see Notes 7 and 8).

 

We maintain a $105 million senior credit facility with Autobahn/DZ Bank through DLP III. The senior credit facility is used to pay the premium expenses related to our portfolio of life insurance policies. As of both June 30, 2017 and December 31, 2016, we had no amounts outstanding under that senior credit facility, no life insurance policies were pledged, and we maintained an available borrowing base of $0 million. On September 14, 2016, we paid off the Autobahn/DZ Bank senior credit facility in full with funds received under a new senior credit facility with LNV Corporation as described in Note 6.

 

On September 14, 2016, we entered into a $172 million senior credit facility with LNV Corporation in which DLP IV is the borrower. We intend to use the proceeds from this facility to grow and maintain our portfolio of life insurance policies, for liquidity and for general corporate purposes. As of June 30, 2017 we had approximately $155.6 million outstanding under the LNV senior credit facility.

 

We expect to meet our ongoing operational capital needs through a combination of the receipt of policy benefits from our portfolio of life insurance policies and net proceeds from our L Bonds and RPS 2 offerings. We expect to meet our policy acquisition, servicing, and financing capital needs principally from the receipt of policy benefits from our portfolio of life insurance policies, net proceeds from our offering of L Bonds and RPS 2, and from our senior credit facilities. We estimate that our liquidity and capital resources are sufficient for our current and projected financial needs for at least the next twelve months given current assumptions. However, if we are unable to continue our offerings for any reason (or if we become unsuccessful in selling our securities), and we are unable to obtain capital from other sources, our business will be materially and adversely affected. In addition, our business will be materially and adversely affected if we do not receive the policy benefits we forecast and if holders of our L Bonds or Series I Secured Notes fail to renew with the frequency we have historically experienced. In such a case, we could be forced to sell our investments in life insurance policies to service or satisfy our debt-related and other obligations.

 

Capital expenditures have historically not been material and we do not anticipate making material capital expenditures in 2017 or beyond.

 

 - 34 - 

 

 

Debt Financing Summary

 

The table below reconciles the face amount of our outstanding debt to the carrying value shown on our balance sheet:

 

   As of
June 30,
2017
   As of
December 31,
2016
 
Total senior facilities and other indebtedness        
Face amount outstanding  $155,626,000   $162,725,000 
Unamortized selling costs   (6,617,000)   (6,660,000)
Carrying amount  $149,009,000   $156,065,000 
           
Series I Secured Notes:          
Face amount outstanding  $6,815,000   $16,614,000 
Unamortized selling costs   (134,000)   (209,000)
Carrying amount  $6,681,000   $16,405,000 
           
L Bonds:          
Face amount outstanding  $407,850,000   $387,067,000 
Subscriptions in process   6,521,000    5,882,000 
Unamortized selling costs  $(13,539,000)  $(11,636,000)
Carrying amount  $400,832,000   $381,313,000 

 

Portfolio Assets and Secured Indebtedness 

 

At June 30, 2017, the fair value of our investments in life insurance policies of $577.0 million plus our cash balance of $52.3 million and our restricted cash balance of $46.2 million, plus matured policy benefits receivable of $7.0 million, totaled $682.5 million representing an excess of portfolio assets over secured indebtedness of $105.4 million. At December 31, 2016, the fair value of our investments in life insurance policies of $511.2 million plus our cash balance of $78.5 million and our restricted cash balance of $37.8 million, plus matured policy benefits receivable of $5.3 million, totaled $632.9 million, representing an excess of portfolio assets over secured indebtedness of $66.4 million.

 

The following forward-looking table seeks to illustrate the impact that a hypothetical sale of our portfolio of life insurance assets at various discount rates would have on our ability to satisfy our debt obligations as of June 30, 2017. In all cases, the sale of the life insurance assets owned by DLP III and DLP IV will be used first to satisfy all amounts owing, if any, under the respective senior credit facilities. The net sale proceeds remaining after satisfying all obligations under the senior credit facilities would be applied to L Bonds and Series I Secured Notes on a pari passu basis.

 

Portfolio Discount Rate  10%  11%  12%  13%  14%  15%  16%
Value of portfolio  $599,960,000   $571,539,000   $545,377,000   $521,240,000   $498,920,000   $478,238,000   $459,034,000 
Cash, cash equivalents and policy benefits receivable   105,423,000    105,423,000    105,423,000    105,423,000    105,423,000    105,423,000    105,423,000 
Total assets   705,383,000    676,962,000    650,800,000    626,663,000    604,343,000    583,661,000    564,457,000 
Senior credit facilities   155,625,000    155,625,000    155,625,000    155,625,000    155,625,000    155,625,000    155,625,000 
Net after senior credit facilities   549,758,000    521,337,000    495,175,000    471,038,000    448,718,000    428,036,000    408,832,000 
Series I Secured Notes and L Bonds   414,665,000    414,665,000    414,665,000    414,665,000    414,665,000    414,665,000    414,665,000 
Net after Series I Secured Notes and L Bonds   135,093,000    106,672,000    80,510,000    56,373,000    34,053,000    13,371,000    (5,833,000)
Impairment to Series I Secured Notes and L Bonds   

No

impairment

    

No

impairment

    

No

impairment

    

No

impairment

    

No

impairment

    

No

impairment

    

 

Impairment

 

 

 - 35 - 

 

 

The table illustrates that our ability to fully satisfy amounts owing under the L Bonds and Series I Secured Notes would likely be impaired upon the sale of all our life insurance assets at a price equivalent to a discount rate of approximately 15.69% or higher. At December 31, 2016, the likely impairment occurred at a discount rate of approximately 13.94% or higher. The discount rate used to calculate the fair value of our portfolio was 10.81% and 10.96% at June 30, 2017 and December 31, 2016, respectively.

 

The table does not include any allowance for transactional fees and expenses associated with a portfolio sale (which expenses and fees could be substantial), and is provided to demonstrate how various discount rates used to value our portfolio could affect our ability to satisfy amounts owing under our debt obligations in light of our senior secured lender’s right to priority payments. This table also does not include the yield maintenance fee, which could be substantial, we are required to pay in certain circumstances under our senior credit facility with LNV Corporation. You should read the above table in conjunction with the information contained in other sections of this report, including our discussion of discount rates included under the “Critical Accounting Policies — Fair Value Components – Discount Rate” caption above. This discussion and analysis is based on the beliefs of our management, as well as assumptions made by, and information currently available to, our management.

 

Cash Flows

 

The payment of premiums and servicing costs to maintain life insurance policies represents our most significant requirement for cash disbursement. When a policy is purchased, we are able to calculate the minimum premium payments required to maintain the policy in-force. Over time as the insured ages, premium payments will increase. Nevertheless, the probability we will actually be required to pay the premiums decreases as mortality becomes more likely. These scheduled premiums and associated probabilities are factored into our expected internal rate of return and cash-flow modeling. Beyond premiums, we incur policy servicing costs, including annual trustee, tracking costs, and debt servicing costs, including principal and interest payments all of which are excluded from our internal rate of return (“IRR”) calculations. Until we receive a sufficient amount of proceeds from the policy benefits, we intend to pay these costs from our senior credit facilities, when permitted, and through the issuance of debt securities, including the L Bonds, and equity securities including our preferred stock offerings. 

 

The amount of payments for anticipated premiums and servicing costs that we will be required to make over the next five years to maintain our current portfolio, assuming no mortalities, is set forth in the table below.

 

Years Ending December 31,  Premiums   Servicing   Premiums and Servicing Fees 
Six months ending December 31, 2017  $24,455,000   $654,000   $25,109,000 
2018   52,611,000    654,000    53,265,000 
2019   58,206,000    654,000    58,860,000 
2020   65,722,000    654,000    66,376,000 
2021   74,105,000    654,000    74,759,000 
2022   83,310,000    654,000    83,964,000 
   $358,409,000   $3,924,000   $362,333,000 

 

 - 36 - 

 

 

Our anticipated premium expenses are subject to the risk of increased cost-of-insurance charges (i.e., premium charges) for the universal life insurance policies we own. In July 2017, Lincoln National Life Insurance Company announced pending cost-of-insurance rate increases for certain life insurance policies which were effected on August 1, 2017. We identified two affected policies in our portfolio. We have requested updated policy illustrations and in order to calculate the change in fair value resulting from the expected increased premiums. In August 2017, Transamerica Life Insurance Company announced pending cost-of-insurance rate increases for certain life insurance policies that will be effected on the policy anniversary dates. We identified three affected policies in our portfolio. We are aware of one additional pending cost-of-insurance increase affecting one other policy in our portfolio. As a result, we expect that our premium expense will increase and the fair value of the policy and our portfolio will be negatively impacted once the insurer has specified and implemented the proposed increases. Except as noted above, we are not aware of cost-of-insurance increases by other insurers, but we are aware that cost-of-insurance increases have become more prevalent in the industry. Thus, we may see additional insurers implementing cost-of-insurance increases in the future.

 

For the quarter-end dates set forth below, the following table illustrates the total amount of face value of policy benefits owned, and the trailing 12 months of life insurance policy benefits collected and premiums paid on our portfolio. The trailing 12-month benefits/premium coverage ratio indicates the ratio of policy benefits received to premiums paid over the trailing 12-month period from our portfolio of life insurance policies.

 

Quarter End Date 

Portfolio

Face Amount

  

12-Month

Trailing

Benefits Collected

  

12-Month

Trailing Premiums Paid

  

12-Month

Trailing

Benefits/
Premium

Coverage Ratio

 
December 31, 2014   779,099,000    18,050,000    23,265,000    77.6%
March 31, 2015   754,942,000    46,675,000    23,786,000    196.2%
June 30, 2015   806,274,000    47,125,000    24,348,000    193.5%
September 30, 2015   878,882,000    44,482,000    25,313,000    175.7%
December 31, 2015   944,844,000    31,232,000    26,650,000    117.2%
March 31, 2016   1,027,821,000    21,845,000    28,771,000    75.9%
June 30, 2016   1,154,798,000    30,924,000    31,891,000    97.0%
September 30, 2016   1,272,078,000    35,867,000    37,055,000    96.8%
December 31, 2016   1,361,675,000    48,452,000    40,240,000    120.4%
March 31, 2017   1,447,558,000    48,189,000    42,753,000    112.7%
June 30, 2017   1,525,363,000    49,295,000    45,414,000    108.5%

 

We believe that the portfolio cash flow results set forth above are consistent with our general investment thesis: that the life insurance policy benefits we receive will continue to increase over time in relation to the premiums we are required to pay on the remaining polices in the portfolio. Nevertheless, we expect that our portfolio cash flow on a period-to-period basis will remain inconsistent until such time as we achieve our goal of acquiring a larger, more diversified portfolio of life insurance policies. As our receipt of life insurance policy benefits increases, we expect to use these cash flows to begin paying down our outstanding indebtedness and purchase additional life insurance policies. 

 

Inflation

 

Changes in inflation do not necessarily correlate with changes in interest rates. We presently do not foresee any material impact of inflation on our results of operations in the periods presented in our consolidated financial statements.

 

Off-Balance Sheet Arrangements

 

We are party to an office lease with U.S. Bank National Association as the landlord. On September 1, 2015, we entered into an amendment that expanded the leased space to 17,687 square feet and extended the term through August 31, 2026 (see Note 16).

 

Credit Risk

 

We review the credit risk associated with our portfolio of life insurance policies when estimating its fair value. In evaluating the policies’ credit risk, we consider insurance company solvency, credit risk indicators, economic conditions, ongoing credit evaluations, and company positions. We attempt to manage our credit risk related to life insurance policies typically by purchasing policies issued only from companies with an investment-grade credit rating by either Standard & Poor’s, Moody’s, or A.M. Best Company. As of June 30, 2017, 96.3% of our life insurance policies, by face value benefits, were issued by companies that maintained an investment-grade rating (BBB or better) by Standard & Poor’s. 

 

 - 37 - 

 

 

Interest Rate Risk

 

Our senior credit facilities are floating-rate financing. In addition, our ability to offer interest and dividend rates that attract capital (including in our continuous offering of L Bonds and RPS 2) is generally impacted by prevailing interest rates. Furthermore, while our L Bond and RPS 2 offerings provide us with fixed-rate debt and equity financing, our debt coverage ratio is calculated in relation to the interest rate of our debt financing. Therefore, fluctuations in interest rates impact our business by increasing our borrowing costs, and reducing availability under our debt financing arrangements. We calculate our portfolio earnings based upon the spread generated between the return on our life insurance portfolio and the total cost of our financing. As a result, increases in interest rates will reduce the earnings we expect to achieve from our investments in life insurance policies.

 

Non-GAAP Financial Measures

 

Non-GAAP financial measures disclosed by our management are provided as additional information to investors in order to provide an alternative method for assessing our financial condition and operating results. These non-GAAP financial measures are not in accordance with GAAP and may be different from non-GAAP measures used by other companies, including other companies within our industry. This presentation of non-GAAP financial information is not meant to be considered in isolation or as a substitute for comparable amounts prepared in accordance with GAAP. See our consolidated financial statements and our financial statements contained herein.

 

We use non-GAAP financial measures for maintaining compliance with covenants contained in our borrowing agreement with Autobahn/DZ Bank and for management’s assessment of our financial condition and operating results without regard to GAAP fair value standards. The application of current GAAP fair value standards, especially during a period of significant growth of our portfolio and our company may result in current period GAAP financial results that may not be reflective of our long-term earnings potential or overall financial condition. Management believes that our non-GAAP financial measures permit investors to understand long-term earnings performance without regard to the volatility in GAAP financial results that can and does occur during this stage of our portfolio and company growth.

 

Therefore, in contrast to a GAAP fair valuation (mark-to-market), we seek to measure the accrual of the actuarial gain occurring within the portfolio of life insurance policies at our expected internal rate of return based on statistical mortality probabilities for the insureds (using primarily the insured’s age, sex, health and smoking status). The expected internal rate of return tracks actuarial gain occurring within the policies according to a mortality table as the insureds’ age increases. By comparing the actuarial gain accruing within our portfolio of life insurance policies against our adjusted operating costs during the same period, we can estimate, manage and evaluate the overall financial performance of our business without regard to mark-to-market (fair value) volatility. We use this information to balance our life insurance policy purchasing and manage our capital structure, including the issuance of debt and utilization of our other sources of capital, and to monitor our compliance with borrowing covenants. We believe that these non-GAAP financial measures provide information that is useful for investors to understand period-over-period operating results separate and apart from fair value items that can have a disproportionately positive or negative impact on GAAP results in any particular reporting period.

 

Our senior credit facility with Autobahn/DZ Bank requires us to maintain a “positive net income” and “tangible net worth,” each of which are calculated on an adjusted non-GAAP basis using the method described below, without regard to GAAP-based fair value measures. In addition, our senior credit facility with Autobahn/DZ Bank requires us to maintain an “excess spread,” which is the difference between (i) the weighted average of our expected internal rate of return of our portfolio of life insurance policies; and (ii) the weighted average of the Autobahn/DZ Bank senior credit facility’s interest rate. These non-GAAP measures (i.e., positive net income, tangible net worth, and an excess spread) are common non-GAAP measures of financial performance and condition in the industry.

 

In addition, the Indenture governing our L Bonds and the note issuance and security agreement governing our Series I Secured Notes require us to maintain a “debt coverage ratio” designed to ensure that the expected cash flows from our portfolio of life insurance policies is reasonably expected to be able to adequately service our total outstanding indebtedness. This ratio is calculated using non-GAAP measures in the method described below, again without regard to GAAP-based fair value measures.

Non-GAAP Investment Cost Basis 

As of

June 30,
2017

  

As of

December 31,
2016

 
GAAP fair value  $577,050,000   $511,192,000 
Unrealized fair value gain (A)   (293,745,000)   (264,625,000)
Adjusted cost basis increase (B)   281,924,000    248,377,000 
Non-GAAP investment cost basis (C)  $565,229,000   $494,944,000 

 

(A) This represents the reversal of cumulative unrealized GAAP fair value gain of life insurance policies.
(B) Adjusted cost basis is increased to include interest, premiums and servicing fees that are expensed under GAAP.
(C) This is the non-GAAP cost basis in life insurance policies from which our expected internal rate of return is calculated.

 

 - 38 - 

 

 

Excess Spread. Management uses the “total excess spread” to gauge expected profitability of our investments. The expected IRR of our portfolio is based upon future cash flow forecasts derived from a probabilistic analysis of our policy benefits received and policy premiums paid in relation to our non-GAAP investment cost basis (“Expected IRR”). 

 

  

As of

June 30,
2017

  

As of

December 31,
2016

 
Expected IRR   11.05%   11.34%
Total weighted-average interest rate on indebtedness for borrowed money (1)   7.40%   7.30%
Total excess spread (2)   3.65%   4.04%

 

(1) Represents the weighted-average interest rate paid on all interest-bearing indebtedness as of the measurement date, determined as follows:

 

Indebtedness 

As of

June 30,
2017

  

As of

December 31,
2016

 
Senior credit facilities  $155,626,000   $162,725,000 
Series I Secured Notes   6,815,000    16,614,000 
L Bonds   407,850,000    387,067,000 
Total  $570,291,000   $566,406,000 

 

Interest Rates on Indebtedness          
Senior credit facilities   7.59%   7.34%
Series I Secured Notes   8.72%   8.68%
L Bonds   7.30%   7.23%
Weighted-average interest rates paid on indebtedness   7.40%   7.30%

 

(2) Calculated as the Expected IRR minus the weighted-average interest rate on interest-bearing indebtedness (1).

 

Adjusted Non-GAAP Net Income. We calculate our adjusted non-GAAP net income by recognizing the actuarial gain accruing within our life insurance portfolio at the Expected IRR against our adjusted cost basis without regard to fair value. We net this actuarial gain against our adjusted operating costs during the same period to calculate our net income on a non-GAAP basis. Our senior credit facility with Autobahn/DZ Bank requires us to maintain a positive net income calculated on an adjusted non-GAAP basis.  

 

  

Three Months Ended

June 30,

   Six Months Ended
June 30,
 
   2017   2016   2017   2016 
GAAP net income (loss) attributable to common shareholders  $(7,725,000)  $1,881,000   $(9,638,000)  $2,956,000 
Unrealized fair value gain (1)   (15,235,000)   (21,241,000)   (29,119,000)   (32,773,000)
Adjusted cost basis increase (2)   22,739,000    16,373,000    44,461,000    31,740,000 
Accrual of unrealized actuarial gain (3)   7,505,000    7,460,000    12,415,000    13,527,000 
Total adjusted non-GAAP net income (loss) (4)  $7,284,000   $4,473,000   $18,119,000   $15,450,000 

 

(1) Reversal of unrealized GAAP fair value gain of life insurance policies for current period.
(2) Adjusted cost basis is increased to include interest, premiums and servicing fees that are expensed under GAAP.
(3) Accrual of actuarial gain at the Expected IRR.
(4) We must maintain an annual positive consolidated net income, calculated on a non-GAAP basis, to maintain compliance with our senior credit facility with Autobahn/DZ Bank.

 

 - 39 - 

 

 

Adjusted Non-GAAP Tangible Net Worth. We calculate our adjusted non-GAAP tangible net worth by recognizing the actuarial gain accruing within our life insurance policies at the Expected IRR of the policies we own without regard to fair value. We net this actuarial gain against our costs during the same period to calculate our adjusted tangible net worth on a non-GAAP basis. Our senior credit facility with Autobahn/DZ Bank requires us to maintain a tangible net worth in excess of $45 million calculated on an adjusted non-GAAP basis. 

 

  

As of

June 30,
2017

  

As of

December 31,
2016

 
GAAP net worth  $113,889,000   $67,298,000 
Less intangible assets (1)   (21,630,000)   (19,442,000)
GAAP tangible net worth   92,259,000    47,856,000 
Unrealized fair value gain (2)   (293,745,000)   (264,625,000)
Adjusted cost basis increase (3)   281,924,000    248,377,000 
Accrual of unrealized actuarial gain (4)   145,223,000    132,808,000 
Total adjusted non-GAAP tangible net worth  $225,661,000   $164,416,000 

 

(1) Unamortized portion of deferred financing costs and pre-paid insurance.
(2)

Reversal of cumulative unrealized GAAP fair value gain on life insurance policies.

(3)

Adjusted cost basis is increased to include interest, premiums and servicing fees that are expensed under GAAP.

(4) Accrual of cumulative actuarial gain at the Expected IRR.

 

Debt Coverage Ratio. Our L Bond and Series I Secured Notes borrowing covenants require us to maintain a debt coverage ratio of less than 90%. The debt coverage ratio is calculated by dividing the sum of our total interest-bearing indebtedness by the sum of our cash, cash equivalents, policy benefits receivable, if any, and the net present value of the life insurance portfolio.

 

  

As of

June 30,
2017

  

As of

December 31,
2016

 

Life insurance portfolio policy benefits (5)

  $1,525,363,000   $1,361,675,000 
Discount rate of future cash flows   7.40%   7.30%
Net present value of life insurance portfolio policy benefits  $686,490,000   $614,908,000 
Cash and cash equivalents   98,453,000    121,659,000 
Life insurance policy benefits receivable   6,970,000    - 
Total Coverage   791,913,000    736,567,000 
           
Senior credit facilities   155,626,000    162,725,000 
Series I Secured Notes   6,815,000    16,614,000 
L Bonds   407,850,000    387,067,000 
Total Indebtedness  $570,291,000   $566,406,000 
           
Debt Coverage Ratio   72.01%   76.90%

 

(5) Weighted-average interest rate paid on indebtedness.

  

 - 40 - 

 

 

As of June 30, 2017, we were in compliance with the debt coverage ratio.

 

Expected Portfolio Internal Rate of Return at Purchase. Expected portfolio IRR at purchase is calculated as the weighted average (by face amount of policy benefits) derived from a probabilistic analysis of policy benefits received and policy premiums paid relative to our purchase price for all life insurance policies in the portfolio. This non-GAAP measure isolates our IRR expectation at purchase utilizing our underwriting life expectancy assumptions at that time. This measure does not change with the passage of time as compared to our non-GAAP investment cost basis that increases with the payment of premiums, financing costs, and the effective life expectancy which changes over time, both of which are used to calculate our Expected IRR.

 

   As of
June 30,
   As of
December 31,
 
   2017