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 13, “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 Facility, which includes its 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 facility and probabilistic cash flows from the pledged policies. Considerable judgment is required in interpreting market data to develop the estimates of fair value. Accordingly, 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 different values.
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, 2011 and 2012. See also “IRS Investigation” in Note 14, Contingencies and Commitments regarding the IRS Criminal Investigation Division’s investigation related to the Company’s former structured settlement business.
At the time 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 11, 8.50% Senior Unsecured Convertible Notes.
We have adopted ASC 718, Compensation-Stock Compensation. ASC 718 addresses accounting for share-based awards, including stock options, restricted stock, performance shares and warrants, with compensation expense measured using fair value and recorded over the requisite service or performance period of the award. The fair value of equity instruments will be determined based on a valuation using an option pricing model that takes into account various assumptions that are subjective. Key assumptions used in the valuation will include the expected term of the equity award taking into account both the contractual term of the award, the effects of expected exercise and post-vesting termination behavior, expected volatility, expected dividends and the risk-free interest rate for the expected term of the award.
Note 2, “Summary of Significant Accounting Policies,” of the Notes to Consolidated Financial Statements discusses accounting standards adopted in 2014, 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.
Change in Fair Value of Life Settlements. Change in fair value of life settlements was a gain of approximately $44.1 million for the year ended December 31, 2014 compared to a gain of $88.7 million for the year ended December 31, 2013, a reduction of $44.6 million. The gain for 2013 was primarily driven by the fair value associated with the acquisition of 432 life insurance policies during the year ended December 31, 2013. The gain for 2014 was primarily a result of increased life settlement values.
During the year ended December 31, 2014, seven life insurance policies with face amounts totaling $25.5 million matured compared to four policies with face amount of $14.1 million for the same period in 2013. The net gain on these maturities was $16.4 million and $9.2 million for 2014 and 2013, 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, 2014 and 2013. Proceeds from maturities totaling $23.6 million were received during the year ended December 31, 2014 which includes $21.5 million associated with maturities occurring in 2014 and $2.1 million that was accounted for as a receivable as of December 31, 2013. All seven maturities for 2014 occurred on policies that served as collateral under the Revolving Credit Facility and amounts totaling $23.6 million were utilized to repay borrowings under the facility. The Company also recorded a $4.0 million receivable for maturity of life settlements at December 31, 2014.
As of December 31, 2014, the Company owned 607 policies with an estimated fair value of $388.9 million compared to 612 policies with a fair value of $303.0 million at December 31, 2013, an increase of $85.9 million or 28%. Of the 607 policies, 450 policies were pledged to the Revolving Credit Facility. During the year ended December 31, 2013, the Company acquired 432 life insurance policies, 16 of which were a result of certain of the
Company’s borrowers defaulting on premium finance loans and relinquishing the underlying policies to the Company. Of the remaining 416 policies, 323 policies were previously considered contingent assets held off balance sheet and known as life settlements with subrogation rights, net with the remaining 93 acquired through the Company’s acquisition of CTL Holdings, LLC. As of December 31, 2014, the aggregate death benefit of the Company’s investment in life settlements was $2.9 billion.
Gain/(Loss) on life settlements, net. Loss on life settlements, net was approximately $426,000 for the year ended December 31, 2014 compared to a loss of $2.0 million as of December 31, 2013 a reduction of $1.6 million. During the year ended December 31, 2014, 14 policies were sold resulting in a loss of approximately $426,000 on net proceeds received of $4.0 million. During the year ended December 31, 2013, the Company sold eight policies that resulted in a loss of approximately $922,000 and received proceeds of $5.8 million.
Also during the year ended December 31, 2013, the Company surrendered two policies resulting in a gain of approximately $255,000 and received cash surrender value proceeds of $1.0 million, and lapsed 20 policies resulting in a loss of $1.3 million. The net effect of these surrenders and lapses was a loss of $1.1 million. There were no policies surrendered or lapsed for the year ended December 31, 2014.
Interest expense. Interest expense increased to $16.2 million during the year ended December 31, 2014, compared to $13.7 during the same period in 2013, an increase of $2.6 million, as the principal on the Company’s outstanding debt increased by $123.2 to $256.4 million as of December 31, 2014. Outstanding debt includes $160.7 million of outstanding principal on the Revolving Credit Facility, $70.7 million of Convertible Notes and $25.0 million of Secured Notes.
Change in fair value of Revolving Credit Facility. Change in fair value of the debt under the Revolving Credit Facility was a gain of approximately $5.5 million for the year ended December 31, 2014 compared to a
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 quarter 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 11, 8.50% Senior Unsecured Convertible Notes to the accompanying consolidated financial statements.
Interest Income. Interest income was $28,000 for the year ended December 31, 2013 compared to $1.7 million in 2012, a decrease of $1.7 million. During the years ended December 31, 2013 and 2012, the Company originated no loans. Interest income declined as the balance of net loans receivable decreased from $3.0 million as of December 31, 2012 to zero as of December 31, 2013 due to loan maturities. Loans outstanding declined from 22 to zero at December 31, 2013. As a result of the voluntary termination of our premium finance business and maturity of all outstanding loans, we have ceased earning interest income from premium loan financing.
Other Income. Other income was $2.0 million for the year ended December 31, 2013 compared to $748,000 in 2012, an increase of $1.3 million. The amount for 2013 is attributable to a write off of liabilities that were payable to a third party. The amount for 2012 was primarily related to insurance recovery from the Company’s insurance carrier associated with the USAO Investigation.
Interest expense. Interest expense increased to $13.7 million during the year ended December 31, 2013, compared to $1.3 million during the same period in 2012, an increase of $12.4 million, as the principal on the Revolving Credit Facility debt increased to $133.2 million as of December 31, 2013. During the year ended December 31, 2012, we repaid all outstanding notes associated with our Cedar Lane financing facility. The estimated fair value of $123.8 million Revolving Credit Facility debt at December 31, 2013 relates to the Revolving Credit Facility entered into on April 29, 2013 that is collateralized by the life insurance policies owned by White Eagle. Of the interest expense of $13.7 million, approximately $10.3 million represents loan origination costs incurred under the Revolving Credit Facility that were not capitalized as a result of electing the fair value option for valuing this debt and interest paid of $2.8 million. Interest expense also includes $4,000, $35,000 and $510,000 representing loan closing costs, amortization of note discount and interest paid, respectively, on the Bridge Facility entered into during the quarter ended March 31, 2013. We expect interest expense on the Revolving Credit Facility to increase in 2014 as we continue to borrow funds under this facility.
Loss on extinguishment of Bridge Facility. Loss on extinguishment of Bridge Facility was approximately $4.0 million for the year ended December 31, 2013, compared to zero during the same period in 2012. This amount is related to the Bridge Facility issued during the quarter ended March 31, 2013 and was fully repaid during the quarter ended June 30, 2013. The Bridge Facility had a face of $45.0 million, with a funding discount of $3.6 million and deferred financing cost of approximately $426,000; all amounts were expensed during the year ended December 31, 2013 as a result of repayment of the facility.
Approximately $749,000 was included in legal expenses for the year ended December 31, 2012, which represented a reserve established for the Insurance Coverage Declaratory Relief Complaint. Based on a settlement, this amount was reversed during the year ended December 31, 2013 and was offset against legal fees, see Note 15, “Commitments and Contingencies,” to the accompanying consolidated financial statements.
Total expenses from our discontinued structured settlement operations were $9.1 million for the year ended December 31, 2013 compared to $16.6 million incurred during the same period in 2012, a decrease of $7.5 million, or 45%. This reduction is mainly attributable to $2.5 million decrease in personnel cost, $3.1 million decrease in advertising, $1.2 million decrease in legal fees, $588,000 decrease in professional fees and $194,000 decrease in other SG&A expenses.
Our consolidated financial statements have been prepared assuming the realization of assets and the satisfaction of liabilities in the normal course, as well as continued compliance with the covenants contained in the Revolving Credit Facility, the indentures governing the Notes and other financing arrangements.
At December 31, 2014 we had approximately $54.9 million of cash and cash equivalents. We expect to meet our liquidity needs for the next year primarily through the receipt of death benefits from life insurance policy maturities, additional issuances of Secured Notes or other strategic capital market raises and cash on hand. See Note 20, “Subsequent Events” of the notes to Consolidated Financial Statements. We may also sell policies from time to time, subject to the asset sale restrictions on our debt arrangements.
For the year ended December 31, 2014, we paid $55.5 million in premiums to maintain our policies in force. Of this amount $47.2 million of this amount was paid by White Eagle through its Revolving Credit Facility borrowings. While the liquidity risk associated with the policies that have been pledged as collateral under the Revolving Credit Facility has been mitigated, any available proceeds under the facility’s waterfall provisions will generally be directed to pay outstanding interest and principal on the loan unless the lenders determine otherwise. Accordingly, there can be no assurance as to when the proceeds from maturities of the policies pledged as collateral under the Revolving Credit Facility will be distributed to the Company. As we continue to acquire additional life settlement assets in 2015 that will not be pledged as collateral under the Revolving Credit Facility, we expect our premium obligations to increase. Assuming no policy maturities, we expect to pay $10.1 million in premiums in 2015 on the 157 policies that have not been pledged by White Eagle under the Revolving Credit Facility. Additionally, in 2014, the Company issued $70.7 million and $25.0 million in aggregate principal amount Convertible Notes and Secured Notes, which accrue interest at 8.50% and 12.875%, respectively. Interest on the Convertible Notes is due semi-annually and interest on the Secured Notes is due monthly. See Item 1A - Risk Factors - Risks Related to Our Indebtedness & Organizational Structure.
Effective April 29, 2013, White Eagle, as borrower, entered into a $300.0 million, 15-year Revolving Credit Facility, which was amended and restated on May 16, 2014 in connection with the conversion of White Eagle from a Delaware limited liability company to a Delaware limited partnership, with Imperial Finance and Trading,
At December 31, 2014, the fair value of the debt was $145.8 million. As of December 31, 2014, the borrowing base was approximately $162.5 million including $160.7 million in outstanding principal. There are no scheduled repayments of principal. Payments are due upon receipt of death benefits and distributed pursuant to the waterfall as described above.
In November 2014, we issued $25.0 million in aggregate principal amount of 12.875% senior secured notes due 2017. On January 21, 2015, the Company issued an additional $25 million in aggregate principal amount of Secured Notes. The indenture governing these notes requires us to maintain at least $20 million in cash in certain pledged accounts. For a description of the Secured Notes, see Note 12, “12.875% Senior Secured Notes” and Note 20, “Subsequent Events,” of the notes to Consolidated Financial Statements.
During the year ended December 31, 2014, operating activities used cash of $33.0 million. Our net loss of $5.5 million was adjusted for Revolving Credit Facility financing costs and fees of $6.7 million, which represent interest expense and other fees associated with the Revolving Credit Facility, the amount was withheld by the lender and added to the outstanding loan balance; change in fair value of life settlement gains of $44.1 million that is mainly attributable to the maturities of seven policies; change in fair value of Revolving Credit Facility gain of $5.5 million that resulted from increased borrowings and lengthening of life expectancy estimates for the policies in the facility that was partially offset by decreasing discount rates; change in fair value of conversion derivative liability loss of $6.8 million resulted from an increase in the fair value of the embedded derivative included in the Convertible Notes issued during the year and, a net positive change in the components of
operating assets and liabilities of $5.0 million. This $5.0 million change in operating assets and liabilities is partially attributable to a $14.2 million decrease in other liabilities and a $13.5 million decrease in restricted cash, both associated with the settlement of class action and derivative litigation. These reductions were offset by a $2.5 million increase in interest payable and $3.2 million increase in accounts payable and accrued expenses.
Net cash used in investing activities for the year ended December 31, 2014 was $46.0 million and includes $4.0 million of proceeds from sale of investments in life settlements that were associated with the sale of 14 policies during the year and proceeds of $23.6 million from maturity of seven life settlements. This was offset by $55.5 million for premiums paid on investments in life settlements, $1.6 million for deposits on purchase of investment in life settlements, and $16.3 million for purchases of investments in life settlements.
Net cash provided by financing activities for the year ended December 31, 2014 was $111.1 million and includes $67.9 million in net proceeds from Convertible Notes, $22.5 million of net proceeds from Secured Notes, and $50.5 million of borrowings from the Revolving Credit Facility. These were offset by $29.8 million in repayment of borrowings under the Revolving Credit Facility.