Consolidated Results of Operations Year Ended December 31, 1997 Compared With Year Ended December 31, 1996 Revenues: Total revenues for the year ended December 31, 1997 increased 23.4% to $322.3 million, compared to $261.2 million for the comparable period in 1996. The accompanying table summarizes gross and net premiums written and total revenues for the periods indicated:
Corporate Interest and Amortization. Interest and amortization expenses were $11.9 million for the year ended December 31, 1997 compared to $7.8 million for the same period in 1996. Interest and amortization on the Company's 10.25% Senior Notes due 2004 (the "Senior Notes") was $5.2 million for the year ended December 31, 1997 and $6.0 million for the comparable period in 1996. Also included in interest and amortization expense for the year ended December 31, 1997 is $3.4 million related to a credit facility with First Union National Bank, N. A. ("First Union") established to fund the Acquisition and replace an existing $20 million credit facility.
The Company realized net capital losses of $0.3 million for 1997 compared net capital gains of $1.2 million in 1996. The 1996 net capital gains were realized principally to reposition certain sectors of the portfolio and to modify the portfolio to improve credit quality without sacrificing yield.
Net Income. The Company realized a net profit of $27.8 million for the year ended December 31, 1997 compared with a net profit of $20.5 million for the comparable 1996 period because of the factors discussed above.
Service Operations Revenue from service operations increased to $6.9 million for the year ended December 31, 1996 compared to $1.1 million for the same period in 1995. The improvement reflects increases in advisory fee revenues, equity in the earnings of investee companies acquired in the Merger and development of new fee-based revenue sources during the year.
Corporate Interest and Amortization. Interest and amortization expenses were $7.8 million for the years ended December 31, 1996 and 1995. Interest and amortization on the Senior Notes was $6.0 million for the year ended December 31, 1996 and $8.0 million for the comparable period in 1995. The 1996 amount was reduced due to the redemption of 35% of the principal amount of outstanding Senior Notes on April 8, 1996. Interest expense for the year ended December 31, 1996 also includes $1.4 million of interest and amortization expense on a $20.0 million bank facility established on the date of Merger and $0.5 million of interest and amortization related to the Archer acquisition.
portfolio by sector and to capitalize on some opportunities to improve on credit quality without sacrificing yield. There was no unusual trading activity during 1997. At December 31, 1997, the carrying value of total investments, including cash and cash equivalents, increased 5.3%, to $762.2 million compared to $723.9 million at December 31, 1996. The primary reasons for the increase were positive cash flow from operations of $25.5 million and the increase in the market value of the investment portfolio of $15.8 million. Financing activities have also been a source of liquidity for Chartwell and its subsidiaries. On March 17, 1994, Chartwell Re completed the offering of $75.0 million principal amount of the Senior Notes. The net proceeds to Chartwell Re after transaction expenses were $71.9 million. As of December 31, 1997, $48.8 million in principal amount of the Senior Notes were outstanding. The Senior Notes bear interest at a rate of 10 1/4% per annum and are due on March 1, 2004. In conjunction with the Merger, the Company assumed all of Chartwell Re's obligations with respect to the Senior Notes. (See Note 2 of the Notes to Consolidated Financial Statements contained herein). In the first half of 1996, Chartwell Re completed a public offering of 2,725,000 shares of common stock at $23.00 per share. The net proceeds to Chartwell Re were $58.5 million after deduction of underwriting discount and expenses. Of the net proceeds, $48.5 million was contributed to Chartwell, of which $20.0 million was contributed to the statutory surplus of Chartwell Reinsurance and $28.5 million was used to retire 35% of the Senior Notes plus accrued interest. The remaining funds were retained for general corporate purposes. This redemption reduced Chartwell's annual expense for interest and amortization of debt issuance costs under the Senior Notes by $2.8 million per year. In connection with the Acquisition, stockholders of Archer Holdings could elect to receive Loan Notes in the amount of one Pound Sterling for each Pound Sterling of cash consideration. The aggregate amount of Loan Notes issued in connection with the consummation of the Acquisition was $9.4 million (denominated in Pounds Sterling). The Loan Notes, which are guaranteed by First Union as described below, pay interest semi-annually at the rate per annum calculated as one percent below the Sterling London Interbank Offered Rate ("LIBOR") and will mature in June, 2002 unless redeemed at an earlier date. Also in connection with the Acquisition, Chartwell entered into a new credit facility with First Union, as agent (the "Credit Facility"). The Credit Facility provides for (i) a Tranche A-1 $20.0 million loan, (ii) a Tranche A-2 $10.0 million loan, (iii) a Tranche B $22.0 million loan (denominated in Pounds Sterling) (Tranche A-1, Tranche A-2 and Tranche B collectively, the "First Union Loans"), and (iv) a $25.0 million revolving credit facility (subsequently increased to $60.0 million) (the "First Union Revolver"). The First Union Loans have six-year terms and the First Union Revolver has a five-year term but may be extended for one year with the consent of First Union. Tranche A-1 and A-2 require repayment of principal starting in year 3, $6.0 million; year 4, $7.5 million; year 5, $7.5 million and year 6, $9.0 million. Tranche B requires repayment of principal starting in year 3, $4.2 million; year 4, $5.3 million; year 5, $5.3 million and year 6, $6.4 million. Borrowings under the First Union Revolver are available at any time prior to maturity, subject to minimum funding amounts. Both the First Union Loans and the First Union Revolver will bear interest at a rate selected by Chartwell equal to either (1) the Base Rate (as defined below) or (2) U.S. dollar or Sterling LIBOR plus a margin (the "Margin"), as applicable. The amount of the Margin will depend on the higher of Chartwell's senior debt rating by Standard & Poor's or Moody's and can range from 0.50% to 0.875%. Based on Chartwell's current senior debt ratings, the Margin over LIBOR is currently at 0.75%. The U.S. dollar Base Rate is the higher of (1) First Union's prime commercial lending rate or (2) the federal funds rate plus 0.5%. The Sterling Base Rate is the rate per annum announced by Midland Bank plc plus the Margin. Chartwell will also pay (1) an unused commitment fee equal to 0.25% on the aggregate unused portion of the revolver, (2) utilization fees for the issuance of letters of credit and guarantees of Loan Notes, issued in connection with the Acquisition, at a rate per annum of 0.375% (if secured) or the Margin plus a 0.075% facing fee, currently totaling 0.825% (if unsecured) on the outstanding amount of potential credit exposure, and (3) certain other fees customary in connection with syndicated loans of this nature. All payments of interest and fees with respect to each of the First Union Loans shall be made in the same currency in which the principal of such loan is required. During 1997, Chartwell maintained the full balance on the Tranche A-1 and A-2 loans. The Tranche B loan increased by $2.0 million ((pound)1.2 million) to fund the redemption of certain Loan Notes for the same amount. The First Union Revolver was paid off during 1997. At December 31, 1997, $20.0 million, $10.0 million and $14.0 million were outstanding under the Tranche A-1, Tranche A-2 and Tranche B loans, respectively. In addition, at December 31, 1997, $7.2 million was used under the Tranche B loan to guarantee the Loan Notes and a total of $53.0 million of letters of credit were extended under the First Union Revolver. All amounts denominated in Pounds Sterling were converted to U.S. dollars at the rate of $1.6496 per (pound)1, the rate in effect at December 31, 1997.
Upon consummation of the Merger, Chartwell Re became the successor to Piedmont under the CI Notes. The CI Notes do not require interest payments until maturity or earlier redemption or repurchase. Under certain circumstances the CI Notes may be settled by delivery of shares of Chartwell Re's common stock. The CI Notes mature on June 30, 2006. Chartwell and its subsidiaries may incur additional indebtedness in the future, subject to the limitations contained in the Senior Notes indenture and the agreements governing the Credit Facility. Chartwell is largely dependent upon receipt of dividends and other statutorily permissible payments from its subsidiaries to meet its obligations, including the obligation to pay interest and principal on the Senior Notes and under the Credit Facility. Further, dividend payments by Chartwell Reinsurance and INSCORP are subject to limits under the laws of the States of Minnesota and New York, respectively. Under the applicable provisions of the insurance holding company laws of the State of Minnesota, Chartwell Reinsurance may, upon five days notice to the Commissioner of Insurance of the State of Minnesota ("the Commissioner") following the declaration of dividends to stockholders, and upon at least ten days notice to the Commissioner prior to dividend payments, pay dividends without the approval of the Commissioner, unless such dividends, together with other dividends paid within the preceding twelve months, exceed the greater of (i) 10% of Chartwell Reinsurance's policyholders' surplus as of the end of the prior calendar year or (ii) Chartwell Reinsurance's statutory net income, excluding realized capital gains, for the prior calendar year. Any dividend in excess of the amount determined pursuant to the foregoing formula would be characterized as an "extraordinary dividend" requiring the prior approval of the Commissioner. In any case, the maximum amount of dividends Chartwell Reinsurance may pay is limited to its earned surplus, also known as unassigned funds. As of December 31, 1997, Chartwell Reinsurance reported unassigned funds, as defined, in the amount of $68.8 million. Up to $26.3 million is available under the foregoing formula for the payment of dividends by Chartwell Reinsurance without regulatory approval in 1998. On November 25, 1997, Chartwell Reinsurance paid a $3.0 million dividend to Chartwell. Chartwell Reinsurance paid no dividends in 1996 or 1995. Under New York law, which is applicable to INSCORP, the maximum ordinary dividend payable in any twelve month period without the approval of the Superintendent may not exceed the lesser of (a) 10% of policyholders surplus as shown on the company's last annual statement or any more recent quarterly statement or (b) the company's adjusted net investment income. Adjusted net investment income is defined as net investment income for the twelve months preceding the declaration of the dividend plus the excess, if any, of net investment income over dividends declared or distributed during the period commencing thirty-six months prior to the declaration or distribution of the current dividend and ending twelve months prior thereto. In any case, New York law permits the payment of an ordinary dividend by an insurer or reinsurer only out of earned surplus. Moreover, notwithstanding the receipt of any dividend from INSCORP, Chartwell Reinsurance may make dividend payments to Chartwell only to the extent permitted under the Minnesota provisions described above. In addition to the foregoing limitation, the New York Insurance Department, as is its practice in any change of control situation, required Chartwell to commit to preclude the acquired New York-domiciled insurer, INSCORP, from paying any dividends for two years after the Merger without prior regulatory approval. The foregoing restriction expired on December 13, 1997. The maximum dividend permitted by law is not indicative of an insurer's actual ability to pay dividends, which may be constrained by business and regulatory considerations, such as the impact of dividends on surplus, which could affect an insurer's ratings or competitive position, the amount of premiums that can be written and the ability to pay future dividends. Furthermore, beyond the limits described in the preceding paragraph, the Commissioner and Superintendent have discretion to limit the payment of dividends by insurance companies domiciled in Minnesota and New York, respectively. Management believes that current levels of cash flow from operations and assets held at the holding company level provide the Company with sufficient liquidity to meet its operating needs in the short term (over the next 12 months). Management expects Chartwell to be able to continue to meet its operating needs after the next 12 months from internally generated funds. Since the ability of Chartwell to meet its obligations in the long term (beyond such 12-month period) is dependent upon such factors as market changes, insurance regulatory changes and economic conditions, no assurance can be given that the available net cash flow will be sufficient to meet its operating needs. The Company expects that, in order to repay the principal amount of the Senior Notes on maturity or otherwise, it will be required to seek additional financing or engage in asset sales or similar transactions. There can be no assurance that sufficient funds for any of the foregoing purposes would be available to the Company at such time.
Accounting Standards Disclosures About Segments of an Enterprise and Related Information Footnotes - SFAS No. 131 In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information Footnotes," which became effective for the Company beginning January 1, 1998. SFAS No. 131 establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports issued to shareholders. It also establishes standards for related disclosures about products and services, geographic areas and major customers. Management believes that the presentation of financial information under the new Statement will not be materially different than the current presentation.
Long-Lived Assets - SFAS No. 121 In March 1995, the FASB issued SFAS No. 121, "Accounting For the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of," which is effective for the financial statements of Chartwell for the year ended December 31, 1996. SFAS No. 121 requires impairment of property, plant and equipment, identifiable intangibles and goodwill to be considered whenever evidence suggests a lack of recoverability. The implementation of SFAS No. 121 did not have a material effect on the financial condition or results of operations of Chartwell.
Financial Statements and Supplementary Data. See the Consolidated Financial Statements and Notes thereto and the Schedules on pages through and S-1 through S-7 included in Part IV, Item 14.