Incorporated in Florida, Emergent Capital owns a portfolio of 632 life insurance policies, also referred to as life settlements, with a fair value of $461.9 million and an aggregate death benefit of approximately $3.0 billion at December 31, 2015. The Company primarily earns income on these policies from changes in their fair value and through death benefits.
Our indirect subsidiary, White Eagle, is the owner of 437 of these life insurance policies with an aggregate death benefit of approximately $2.2 billion and an estimated fair value of approximately $331.3 million at December 31, 2015. White Eagle pledged its policies as collateral to secure borrowings made under the White Eagle Revolving Credit Facility, which is used, among other things, to pay premiums on the life insurance policies owned by White Eagle. Additionally, 156 policies, with an aggregate death benefit of approximately $603.9 million and an estimated fair value of approximately $118.6 million at December 31, 2015 were pledged as collateral under the Red Falcon Revolving Credit Facility entered into by Red Falcon, a Delaware statutory trust formed by a wholly-owned Irish subsidiary of the Company. Borrowings under the Revolving Credit Facilities fund the payment of premiums on the life insurance policies that have been pledged as collateral for the respective facilities. See Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources.
During the year ended December 31, 2015, 43 life settlements were acquired with face amounts of $120.9 million that resulted in a gain of $6.0 million. 17 life insurance policies with face amounts totaling $67.4 million matured. The net gain on these maturities was $47.9 million. The gains related to acquisitions and maturities are included in income from changes in fair value of life settlement in the consolidated statement of operations for the year ended December 31, 2015. Of these maturities, three served as collateral under the Red Falcon Revolving Credit Facility and 13 served as collateral under the White Eagle Revolving Credit Facility. Proceeds from maturities totaling $53.5 million were received during the year ended December 31, 2015. Of this amount, approximately $43.2 million and $4.6 million, were utilized to repay borrowings, interest and expenses under the White Eagle Revolving Credit Facility and the Red Falcon Revolving
Credit facility, respectively, during the year ended December 31, 2015. The gains related to acquisitions and maturities are included in income from changes in the fair value of life settlements in the consolidated statement of operations for the year ended December 31, 2015. The Company sold one policy resulting in a loss of approximately $41,000 on net proceeds received of $2.2 million. The loss is included in loss on life settlements in the consolidated statement of operations for the year ended December 31, 2015. We continue to believe that there are accretive opportunities to grow our existing portfolio of life settlements and intend, subject to our liquidity needs and available cash, to selectively deploy capital in both the secondary and tertiary life settlement markets. As we acquire more policies and available cash, our premium payments will increase. Assuming we recognize no policy maturities, our estimated premiums for 2016 would be $71.5 million. White Eagle and Red Falcon would be eligible to borrow approximately $67.3 million of this amount under the Revolving Credit Facilities to pay premiums on policies secured by the Revolving Credit Facilities with approximately $4.2 million in estimated premiums required to maintain the policies not pledged as collateral under the Revolving Credit Facilities as of December 31, 2015.
As originally executed, the waterfall in the White Eagle Revolving Credit Facility did not provide for White Eagle to receive any distributions from policy proceeds prior to the payment of all outstanding debt under the facility. As amended on November 9, 2015, the waterfall provisions in the White Eagle Revolving Credit Facility now contemplate that a portion of the policy proceeds may be made available to White Eagle prior to the payment of outstanding debt based on the then current loan to value ratio of the facility. Similar provisions are provided for in the Red Falcon Credit Facility and the Company expects that these provisions will allow White Eagle and Red Falcon to make distributions to the Company that will meaningfully improve its cash position in future periods. See Note 8, “White Eagle Revolving Credit Facility” to our consolidated financial statements.
Beginning in 2015 and continuing into 2016, certain insurance companies announced that they were increasing the cost of insurance on certain types of their issued policies, which will result in increases to the premium payments necessary to keep the affected policies in force. At December 31, 2015, 21 policies that we own were subject to these cost of insurance increases. These increases caused the fair value of these 21 policies to decrease during the quarter ending December 31, 2015 by approximately $5.0 million and will require us to incur additional costs to maintain these policies. Further cost of insurance increases may cause our projected premium payments to significantly increase, adversely affect the loan to value ratios under the Revolving Credit Facilities and otherwise could have adverse material adverse effect on our business, results of operations and the value of any affected policies.
During the quarter ended September 30, 2015, the U.S. Society of Actuaries released tables for a new Valuation Basic Table, the 2015 VBT. We have not adopted the 2015 VBT although we may do so in the future and are continuing to monitor the market reaction to the 2015 VBT as well as our portfolio’s mortality experience to determine whether future adoption of the 2015 VBT would be an appropriate change to our valuation technique. However, the 2015 VBT would suggest a reduced probabilistic cash flow stream for us over the next several years. Any actual reduction in cash flows would reduce funds available to us from policy proceeds, including from White Eagle and Red Falcon, and would adversely effect our ability to service our indebtedness. Future changes in life expectancies or actuarial tables could have a material adverse effect on the fair value of our life settlements, which could have a material adverse effect on our business, financial condition and results of operations.
On March 11, 2016, we entered into an indenture with Wilmington Trust, National Association, as indenture trustee, and in connection therewith issued approximately $21.2 million in aggregate principal amount of 15.0% senior secured notes due 2018. The indenture permits us to issue up to $30 million in aggregate principal amount of these notes. Please see Note 19, “Subsequent Events,” of the notes to Consolidated Financial Statements.
We follow ASC 820, Fair Value Measurements and Disclosures, which defines fair value as an exit price representing the amount that would be received if an asset were sold or that would be paid to transfer a liability in an orderly transaction between market participants at the measurement date. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, the guidance establishes a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. Level 1 relates to quoted prices in active markets for identical assets or liabilities. Level 2 relates to observable inputs other than quoted prices included in Level 1. Level 3 relates to unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Our investments in life insurance policies, structured settlements and Revolving Credit Facility debt are considered Level 3 as there is currently no active market where we are able to observe quoted prices for identical assets/liabilities and our valuation model incorporates significant inputs that are not observable. See Note 12, “Fair Value Measurements” of the notes to Consolidated Financial Statements for a discussion of our fair value measurement.
We have elected to account for the debt under the Revolving Credit Facilities, which includes the interest in policy proceeds to the lender, using the fair value method. The fair value of the debt is the estimated amount that would have to be paid to transfer the debt to a market participant in an orderly transaction. We calculated the fair value of the debt using a discounted cash flow model taking into account the stated interest rate of the credit facilities and probabilistic cash flows from the pledged policies. Considerable judgment is required in interpreting market data to develop the estimates of fair value. Accordingly, our estimates are not necessarily indicative of the amounts that we, or holders of the instruments, could realize in a current market exchange. The most significant assumptions are the estimates of life expectancy of the insured and the discount rate. The use of assumptions and/or estimation methodologies could have a material effect on the estimated fair values.
Gains on Life Settlements, Net-The Company recognizes gains from life settlement contracts that the Company owns upon the signed sale agreement and/or filing of ownership forms and funds transferred to escrow.
Deferred debt costs include costs incurred in connection with acquiring and maintaining debt arrangements. These costs are amortized over the life of the related loan using the effective interest method and are classified as interest expense in the accompanying consolidated statement of operations. These deferred costs are related to the Company’s notes. The Company did not recognize any deferred debt costs on its Revolving Credit Facilities given all costs were expensed due to electing the fair value option in valuing the Revolving Credit Facilities.
We account for income taxes in accordance with ASC 740, Income Taxes. Under ASC 740, deferred income taxes are determined based on the estimated future tax effects of differences between the financial statement and tax basis of assets and liabilities given the provisions of enacted tax laws. Deferred income tax provisions and benefits are based on changes to the assets or liabilities from year to year. In providing for deferred taxes, we consider tax regulations of the jurisdictions in which we operate, estimates of future taxable income and available tax planning strategies. If tax regulations, operating results or the ability to implement tax-planning strategies varies, adjustments to the carrying value of the deferred tax assets and liabilities may be required. Valuation allowances are based on the “more likely than not” criteria of ASC 740.
In March of 2014, the Company was notified by the IRS of its intention to examine the Company’s tax returns for the years ended December 31, 2012 and 2013. See also “IRS Investigation” in Note 14, Contingencies and Commitments regarding the IRS Investigation.
The Company recorded a liability for the conversion derivative liability attributed to the issuance of the Convertible Notes, the Company recorded a deferred tax asset of $6.5 million for the conversion derivative liability and a deferred tax liability of $6.5 million for the corresponding debt discount. As the changes in the fair value of the conversion derivative liability were included in earnings, the Company recorded additions to the deferred tax asset. At June 5, 2014, when the
Company received shareholder approval to issue shares of common stock upon conversion of the Convertible Notes, the deferred tax asset attributed to the conversion derivative liability (net of allocated unamortized transaction costs) was $8.8 million. In accordance with ASC 815, the Company reclassified the deferred tax asset attributed to the conversion derivative liability (net of allocated unamortized transaction costs) to shareholders’ equity. See Note 10, 8.50% Senior Unsecured Convertible Notes.
The Company owns certain foreign subsidiaries formed under the laws of Ireland and Bermuda. These foreign subsidiaries utilize the U.S. dollar as their functional currency. The foreign subsidiaries’ financial statements are denominated in U.S. dollars and therefore, there are no translation gains and losses resulting from converting the financial statements at exchange rates other than the functional currency. Any gains and losses resulting from foreign currency transactions (transactions denominated in a currency other than the subsidiaries’ functional currency) are included in income. These gains and losses are immaterial to the Company’s financial statements.
Note 2, “Summary of Significant Accounting Policies,” of the Notes to Consolidated Financial Statements discusses accounting standards adopted in 2015, as well as accounting standards recently issued but not yet required to be adopted and the expected impact of these changes in accounting standards. Any material impact of adoption is discussed in Management’s Discussion and Analysis of Financial Condition and Results of Operations and in the Notes to the Consolidated Financial Statements.
Net loss from continuing operations for the year ended December 31, 2015 was $30.4 million as compared to a loss of $5.2 million for the year ended December 31, 2014, an increase in net loss of $25.2 million. Total income from continuing operations was $46.9 million for the year ended December 31, 2015, an increase of $3.1 million as compared to income from continuing operations of $43.8 million during the same period in 2014. Total expenses from continuing operations were $86.0 million for the year ended December 31, 2015 compared to total expenses from continuing operations of $48.8 million incurred during the same period in 2014, an increase of $37.1 million, primarily as a result of interest expense, the change in fair value of the Revolving Credit Facilities, extinguishment of the Secured Notes and indemnification payment related to the USAO Investigation.
Our net loss for the year ended December 31, 2015 includes approximately $6.5 million in payments relating to the Company's indemnification obligations for the conclusion of the USAO Investigation, $8.8 million related to the extinguishment of our Secured Notes, and an income tax benefit of approximately $8.7 million. See Item 1. “Business”, Note 11, “12.875% Senior Secured Notes” and Note 18, “Income Taxes” to the accompanying consolidated financial statements.
During the year ended December 31, 2015, 17 life insurance policies with face amounts totaling $67.4 million matured compared to seven policies with face amounts of $25.5 million for the same period in 2014. The net gain of these maturities was $47.9 million and $16.4 million for 2015 and 2014, respectively, and is recorded as a change in fair value of life settlements in the consolidated statements of operations for the years ended December 31, 2015 and 2014. Of these maturities, three served as collateral under the Red Falcon Revolving Credit Facility and 13 served as collateral under the White Eagle Revolving Credit Facility. Proceeds from maturities totaling $53.5 million were received during the year ended December 31, 2015. Of this amount, approximately $43.2 million and $4.6 million, were utilized to repay borrowings, interest and credit facility expenses under the White Eagle Revolving Credit Facility and the Red Falcon Revolving Credit facility, respectively, during the year ended December 31, 2015. The Company also recorded a $18.2 million receivable for maturity of life settlements at December 31, 2015 relating to the White Eagle Revolving Credit Facility.
As of December 31, 2015, we owned 632 policies with an estimated fair value of $461.9 million compared to 607 policies with a fair value of $388.9 million at December 31, 2014, an increase of $73.0 million or 19%. Of the 632 policies, 437 policies were pledged to the White Eagle Revolving Credit Facility and 156 policies were pledged to the Red Falcon Revolving Credit Facility. During the year ended December 31, 2015, the Company acquired 43 life insurance policies that resulted in a gain of approximately $6.0 million compared to 16 policies during the same period in 2014 for a gain of $5.9 million. The gain related to acquisitions is included in income from changes in fair value of life settlement in the consolidated statements of operations for the year ended December 31, 2015. As of December 31, 2015, the aggregate death benefit of our life settlements was $3.0 billion.
Of these 632 policies owned as of December 31, 2015, 544 were previously premium financed and are valued using discount rates that range from 16.00% - 24.50%. The remaining 88 policies are valued using discount rates that range from 15.00% - 21.00%. See Note 12, “Fair Value Measurements,” to the accompanying consolidated financial statements.
Loss on life settlements, net. Loss on life settlements, net was approximately $41,000 for the year ended December 31, 2015 compared to a loss of $426,000 for the year ended December 31, 2014, a reduction of $385,000. During the year ended December 31, 2015, one policy was sold resulting in a $41,000 loss on net proceeds received of $2.2 million compared to 14 policies sold and a loss of $426,000 on net proceeds of $4.0 million for the same period in 2014.
Interest expense. Interest expense increased to $27.3 million during the year ended December 31, 2015, compared to $16.2 million during the same period in 2014, an increase of $11.1 million, as the Company's outstanding debt increased to $298.2 million. Outstanding debt included $172.0 million of outstanding principal on the White Eagle Revolving Credit Facility, $55.4 million on the Red Falcon Revolving Credit Facility and $70.7 million of Convertible Notes. During the year ended December 31, 2015, the Company redeemed all outstanding Secured Notes.
Extinguishment of Secured Notes. During the year ended December 31, 2015, the Company redeemed all of the outstanding Secured Notes and discharged the related Secured Note indenture. The Secured Notes were redeemed at 106% of their principal amount plus interest up to but excluding November 10, 2015. Approximately $8.8 million was expensed as extinguishment related to the early repayment of the Secured Notes for the year ended December 31, 2015. This includes $5.2 million, $171,000, $1.7 million and $1.7 million related to interest and prepayment penalties, unused fees, write off of debt discount and write off of issuance cost.
Change in fair value of the Revolving Credit Facilities. Change in fair value of the Revolving Credit Facilities was a loss of $12.2 million for the year ended December 31, 2015 compared to a gain of $5.5 million for the year ended December 31, 2014.
Approximately $11.9 million of this loss is attributable to the White Eagle Revolving Credit Facility, which is due to a reduction in the discount rate after amending the facility along with projected earlier repayments due to maturities. These were offset by increased borrowings, lengthening of life expectancies of certain insureds underlying polices pledged as collateral in the facilities and projected cost of insurance increase. The $5.5 million gain for 2014 resulted from increased borrowings and an increase in the discount rate used to value the facility. These were offset by projected early repayment of the White Eagle Revolving Credit Facility given earlier than projected maturities. The White Eagle Revolving Credit Facility is valued at December 31, 2015 using a discount rate of 20.55% compared to 23.89% at December 31, 2014.
Change in fair value of Revolving Credit Facilities also includes a loss of $270,000 attributable to the Red Falcon Revolving Credit Facility for the year ended December 31, 2015. This change is associated with the election of the fair value option in accounting for the facility and a reduction in the discount rate since inception. These were offset by increased borrowings and projected cost of insurance increase. The Red Falcon Revolving Credit Facility is valued at December 31, 2015 using a discount rate of 11.65%.
Legal expenses for the year ended December 31, 2015 were $20.7 million compared to $13.6 million for the year ended December 31, 2014. Of the legal expense, approximately $17.0 million is associated with the USAO Investigation, IRS Investigation and related matters for the year ended December 31, 2015, compared to $5.0 million for the year ended December 31, 2014. These expenses were significantly impacted by a $6.5 million payment relating to the Company's indemnification obligations for the conclusion of the USAO Investigation at December 31, 2015.
Net loss from continuing operations for the year ended December 31, 2014 was $5.2 million as compared to net income of $51.8 million for the year ended December 31, 2013, a reduction of $57.0 million. Total income from continuing operations was $43.8 million for the year ended December 31, 2014, a reduction of $45.3 million over total income from continuing operations of $89.1 million during the same period in 2013, which was primarily driven by the acquisition in 2013 of 432 policies that impacted the change in fair value of investment in life settlements in 2013. Total expenses from continuing operations were $48.8 million for the year ended December 31, 2014 compared to total expenses from continuing operations of $37.2 million incurred during the same period in 2013, an increase of $11.6 million, or 31%.
Our net loss for the year ended December 31, 2014 included income tax expense of approximately $3.7 million, which resulted from the adoption of ASU No. 2013-11. See Note 18 “Income Taxes,” to the accompanying consolidated financial statements.
Of these 607 policies owned as of December 31, 2014, 553 were premium financed and are valued using discount rates that range from 16.05% - 25.80%. The remaining 54 policies are valued using discount rates that range from 14.80% - 20.80%. See Note 12, “Fair Value Measurements,” to the accompanying consolidated financial statements.
Other Income. Other income was $85,000 for the year ended December 31, 2014 compared to $2.0 million in 2013, a decrease of $1.9 million. The amount for 2013 is attributable to a write off of liabilities that were payable to a third party.
Loss on extinguishment of Bridge Facility. Loss on extinguishment of a bridge facility was approximately $4.0 million for the year ended December 31, 2013. This amount is related to a bridge facility issued during the year ended March 31, 2013 that was fully repaid during the year ended December 31, 2013. The bridge facility had a face value of $45.0 million, with a funding discount of $3.6 million and deferred financing cost of approximately $400,000. All amounts were expensed during the year ended December 31, 2013 as a result of repayment of the facility.
Change in fair value of conversion derivative liability. Change in fair value of conversion derivative liability embedded in the Convertible Notes was a loss of approximately $6.8 million for the year ended December 31, 2014 compared to zero for the year ended December 31, 2013. ASC 815, Derivatives and Hedging, required the Company to bifurcate the embedded conversion option that was valued on February 21, 2014 and June 5, 2014, which resulted in a fair value loss of approximately $6.8 million for the year ended December 31, 2014. During the year ended December 31, 2014, the conversion derivative liability was reclassified to additional-paid-in-capital, accordingly there will be no further adjustment to the fair value of this derivative liability reflected in the Company’s financial statements. See Note 10, “8.50% Senior Unsecured Convertible Notes,” to the accompanying consolidated financial statements.
Selling, General and Administrative Expenses. SG&A expenses were $31.3 million for the year ended December 31, 2014 compared to $29.0 million in 2013, an increase of approximately $2.3 million. This increase was primarily a result of a $1.9 million increase in legal fees, a $586,000 increase in personnel costs, and a $119,000 increase in other SG&A expenses. These increases were offset by a reduction in insurance costs of $286,000 and a $27,000 reduction in professional fees.
Legal expenses for the year ended December 31, 2014 were $13.6 million compared to $11.7 million for 2013. Of the legal expense, approximately $5.0 million is mainly associated with the USAO Investigation for 2015, compared to $4.5 million for the year ended December 31, 2013. Legal expense also includes approximately $2.3 million associated with the warrants for the class action litigation for the year ended December 31, 2013. See Note 14, “Commitments and Contingencies,” to the accompanying consolidated financial statements.
Total expenses from our discontinued structured settlement operations were $725,700 for the year ended December 31, 2015 compared to $793,000 incurred during the same period in 2014. This decrease was attributable to a $42,000 decrease in legal fees.
As of December 31, 2015, the Company’s cumulative legal and related fees in respect of the USAO Investigation (including indemnification obligations), the SEC Investigation, the IRS Investigation and related matters were $57.7 million, including $17.3 million and $5.7 million incurred during the years ended December 31, 2015 and 2014, respectively. Of the $57.7 million, approximately $56.6 million was related to expenses incurred in connection with the USAO Investigation. We do not expect to incur material expense related to the USAO matter in the future. However, we may continue to incur significant expense on the SEC Investigation and IRS Investigation in future periods, in addition to expenses for general litigation and judicial proceedings over the next year, and possibly beyond. These amounts, while currently unquantifiable, may be substantial and could have a material adverse effect on the Company’s financial position and results of operations.
Accordingly, the Company must pro-actively manage its cash in order to effectively run its businesses, service its debt and opportunistically grow its assets. To do so, the Company may in the future determine, subject to the covenants and restrictions in its debt arrangements, to sell or, under certain circumstances, lapse certain of its policies as its portfolio management strategy and liquidity needs dictate. The lapsing of policies, if any, could result in events of default under the Revolving Credit Facilities and would create losses as such assets would be written down to zero.
At December 31, 2015, there was $70.7 million in aggregate principal amount of the Company’s 8.50% senior unsecured convertible notes due 2019 outstanding. For a description of the Convertible Notes see Note 10, “8.50% Senior Unsecured Convertible Notes,” of the notes to Consolidated Financial Statements.
The following table summarizes our cash flows, which includes both continuing and discontinued operations, from operating, investing and financing activities for the years ended December 31, 2015, 2014 and 2013 (in thousands):
Net cash used in investing activities for the year ended December 31, 2014 was $46.0 million and includes $4.0 million from sale of life settlements that were associated with the sale of 14 policies during the period and proceeds of $23.6 million from maturity of seven life settlements. This was offset by $55.5 million for premiums paid on life settlements and $16.3 million for purchase of life settlements.
Net cash provided by financing activities for the year ended December 31, 2015 was $60.7 million and includes $38.3 million of net proceeds from the rights offering completed in the second quarter of 2015, $23.8 million of net proceeds from the Secured Notes, $47.1 million of borrowings from the White Eagle Revolving Credit Facility and $5.7 million of borrowings from the Red Falcon Revolving Credit Facility. These were offset by $43.2 million in repayment of borrowings under the White Eagle Revolving Credit Facility, $4.4 million in repayment of borrowings under the Red Falcon Revolving Credit Facility, $3.6 million for the extinguishment of the Secured Notes and $2.5 million for purchase of treasury stock.
Please see Note 8, “White Eagle Revolving Credit Facility,” to our consolidated financial statements.
At December 31, 2015, there were no off-balance sheet arrangements between us and any other entity that have, or are reasonably likely to have, a current or future effect on our financial condition, changes in financial condition, revenue or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to shareholders.