Attached files

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EX-99.1 - LETTER FROM MODEL ACTUARIAL PRICING SYSTEMS, DATED JULY 26, 2016 - GWG Holdings, Inc.f10q0616ex99i_gwgholdings.htm
EX-32.1 - CERTIFICATION - GWG Holdings, Inc.f10q0616ex32i_gwgholdings.htm
EX-31.2 - CERTIFICATION - GWG Holdings, Inc.f10q0616ex31ii_gwgholdings.htm
EX-31.1 - CERTIFICATION - GWG Holdings, Inc.f10q0616ex31i_gwgholdings.htm

 

 

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, 2016

 

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 or a smaller reporting company (as defined in Rule 12b-2 of the Exchange Act).

 

  Large accelerated filer ☐ Accelerated filer ☐
  Non-accelerated filer ☐ Smaller reporting company ☒

 

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

 

As of August 12, 2016, GWG Holdings, Inc. had 5,977,240 shares of common stock outstanding.

 

 

 

 
 

 

GWG HOLDINGS, INC.

 

Index to Form 10-Q

for the Quarter Ended June 30, 2016

 

    Page No.
PART I. FINANCIAL INFORMATION  
     
Item 1. Financial Statements 1
  Condensed Consolidated Balance Sheets as of June 30, 2016, and December 31, 2015 1
  Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2016 and 2015 2
  Condensed Consolidated Statements of Cash Flows for the three and six months ended June 30, 2016 and 2015 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 27
Item 4. Controls and Procedures 55
     
PART II. OTHER INFORMATION  
     
Item 6. Exhibits 55
     
SIGNATURES 56

  

 
 

 

PART I—FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

 

  

June 30, 2016

(unaudited)

   December 31, 2015 
A S S E T S
Cash and cash equivalents  $17,379,350   $34,425,105 
Restricted cash   11,160,793    2,341,900 
Investment in life insurance contracts, at fair value   431,820,437    356,649,715 
Secured MCA advances   4,328,317    - 
Life insurance contract benefits receivable   6,829,022    - 
Other assets   3,510,443    2,461,045 
TOTAL ASSETS  $475,028,362   $395,877,765 
           
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          
Revolving Senior Credit Facility  $77,475,992   $63,279,596 
Series I Secured Notes   17,965,653    23,287,704 
L Bonds   327,322,906    276,482,796 
Accounts payable   2,529,206    1,517,440 
Interest payable   13,323,746    12,340,061 
Other accrued expenses   1,355,266    1,060,786 
Deferred taxes, net   4,670,715    1,763,968 
TOTAL LIABILITIES  $444,643,484   $379,732,351 
           
STOCKHOLDERS’ EQUITY          
           
CONVERTIBLE PREFERRED STOCK          
(par value $0.001; shares authorized 40,000,000; shares outstanding 2,737,698 and 2,781,735; liquidation preference of $20,533,000 and $20,863,000 on June 30, 2016 and December 31, 2015, respectively)   20,445,320    20,784,841 
           
REDEEMABLE PREFERRED STOCK          
(par value $0.001; shares authorized 100,000; shares outstanding 12,222 on June 30, 2016)   12,212,767    - 
           
MCA PREFERRED STOCK          
(par value $0.001; shares authorized 2,000,000; shares outstanding 7,155 on June 30, 2016)   71,555    - 
           
COMMON STOCK          
(par value $0.001: shares authorized 210,000,000; shares issued and outstanding 5,974,790 and 5,941,790 on June 30, 2016 and December 31, 2015)   5,975    5,942 
Additional paid-in capital   16,488,390    17,149,391 
Accumulated deficit   (18,839,129)   (21,794,760)
TOTAL STOCKHOLDERS’ EQUITY   30,384,878    16,145,414 
           
TOTAL LIABILITIES & EQUITY  $475,028,362   $395,877,765 

 

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, 2016   June 30, 2015   June 30, 2016   June 30, 2015 
REVENUE                
Gain on life insurance contracts, net  $20,383,347   $8,473,886   $38,097,059   $25,257,295 
MCA income   223,255    -    368,216    - 
Interest and other income   170,880    90,380    216,100    139,676 
TOTAL REVENUE   20,777,482    8,564,266    38,681,375    25,396,971 
                     
EXPENSES                    
Interest expense   10,365,581    7,322,347    20,025,966    14,498,881 
Employee compensation and benefits   3,071,507    2,144,725    5,537,705    3,872,642 
Legal and professional fees   1,304,353    642,931    2,510,481    1,166,184 
Other expenses   2,332,685    1,881,321    4,744,845    3,415,060 
TOTAL EXPENSES   17,074,126    11,991,324    32,818,997    22,952,767 
                     
INCOME (LOSS) BEFORE INCOME TAXES   3,703,356    (3,427,058)   5,862,378    2,444,204 
INCOME TAX EXPENSE (BENEFIT)   1,822,030    (1,176,643)   2,906,747    1,432,728 
                     
NET INCOME (LOSS)  $1,881,326   $(2,250,415)  $2,955,631   $1,011,476 
                     
Loss attributable to preferred shareholders   429,760    344,847    772,722    698,003 
INCOME (LOSS) ATTRIBUTABLE TO COMMON SHAREHOLDERS  $2,311,086   $(1,905,568)  $3,728,353   $1,709,479 
NET INCOME (LOSS) PER SHARE                    
Basic  $0.32   $(0.38)  $0.50   $0.17 
Diluted  $0.29   $(0.38)  $0.46   $0.21 
                     
WEIGHTED AVERAGE SHARES OUTSTANDING                    
Basic   5,967,098    5,876,618    5,954,944    5,873,423 
Diluted   8,081,895    5,876,618    8,036,501    7,987,923 

 

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,
2016
   June 30,
2015
   June 30,
2016
   June 30,
2015
 
CASH FLOWS FROM OPERATING ACTIVITIES                
Net income (loss)  $1,881,326   $(2,250,415)  $2,955,631   $1,011,476 
Adjustments to reconcile net income (loss) to net cash flows from operating activities:                    
Gain on life insurance contracts   (21,241,376)   (14,028,327)   (32,772,929)   (12,134,482)
Amortization of deferred financing and issuance costs   2,527,974    507,026    3,312,162    (42,004)
Deferred income taxes   1,851,018    (930,470)   2,906,747    1,251,781 
Preferred stock dividends payable   166,472    146,420    330,049    335,232 
(Increase) decrease in operating assets:                    
Life insurance contract benefits receivable   9,083,817    17,140,000    (6,829,022)   (750,000)
Other assets   (1,210,892)   (225,376)   (1,037,466)   (356,549)
Increase (decrease) in operating liabilities:                    
Due to related party   (1,814,173)   -    (101,781)   - 
Accounts payable and other accrued expenses   (775,213)   (1,333,241)   1,192,756    1,302,446 
            NET CASH FLOWS USED IN OPERATING ACTIVITIES   (9,531,047)   (974,383)   (30,043,853)   (9,382,100)
                     
CASH FLOWS FROM INVESTING ACTIVITIES                    
Investment in life insurance contracts   (24,373,714)   (7,777,541)   (48,700,036)   (10,224,018)
Carrying value of matured life insurance contracts   1,691,764    132,388    6,302,243    3,742,983 
Investment in Secured MCA advances   (1,293,829)   -    (5,647,414)   - 
Proceeds from Secured MCA advances   907,649    -    1,025,792    - 
             NET CASH FLOWS USED IN INVESTING ACTIVITIES   (23,068130)   (7,645,153)   (47,019,415)   (6,481,035)
                     
CASH FLOWS FROM FINANCING ACTIVITIES                    
Net borrowings on (repayments of) Senior Revolving Credit Facility   (3,000,000)   (7,150,000)   17,000,000    (7,150,000)
Payments for redemption of Series I Secured Notes   (485,350)   (2,344,355)   (5,722,743)   (3,617,544)
Proceeds from issuance of L Bonds   36,757,771    22,538,059    71,126,660    50,498,356 
Payments for issuance and redemption of L Bonds   (11,753,782)   (6,134,935)   (22,663,475)   (13,013,057)
Proceeds from (increase in) restricted cash   8,667,826    3,410,427    (8,818,894)   (3,627,137)
Issuance of common stock   166,125    582,000    212,670    582,000 
Proceeds from issuance of preferred stock   9,472,673    -    10,501,209    - 
Payments for issuance and redemption of preferred stock   (845,361)   (273,998)   (1,617,914)   (273,998)
             NET CASH FLOWS PROVIDED BY FINANCING ACTIVITIES   38,979,902    10,627,198    60,017,513    23,398,620 
                     
             NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS   6,380,725    2,007,662    (17,045,755)   7,535,485 
                     
CASH AND CASH EQUIVALENTS                    
BEGINNING OF PERIOD   10,998,625    36,190,527    34,425,105    30,662,704 
END OF PERIOD  $17,379,350   $38,198,189   $17,379,350   $38,198,189 

 

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, 2016   June 30, 2015   June 30, 2016   June 30, 2015 
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION                
Interest and preferred dividends paid  $10,714,000   $7,041,000   $17,168,000   $13,143,000 
Premiums paid  $8,995,000   $6,141,000   $17,441,000   $12,466,000 
Stock-based compensation  $41,000   $-   $50,000   $32,000 
NON-CASH INVESTING AND FINANCING ACTIVITIES                    
Series I Secured Notes:                    
Conversion of accrued interest and commissions payable to principal  $142,000   $86,000   $187,000   $127,000 
L Bonds:                    
Conversion of accrued interest and commissions payable to principal  $370,000   $219,000   $661,000   $438,000 
Issuance of Series A Preferred Stock in lieu of cash dividends  $171,000   $150,000   $339,000   $334,000 
Investment in life insurance contracts included in accounts payable  $780,000   $61,000   $780,000   $61,000 

 

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, 2014   2,738,966   $20,527,866    5,870,193   $5,870   $16,257,686   $(14,401,486)  $22,389,936 
                                    
Net loss   -    -    -    -    -    (7,393,274)   (7,393,274)
                                    
Issuance of common stock   -    -    60,000    60    581,940    -    582,000 
                                    
Series A Preferred Stock conversion to common stock   (15,463)   (115,973)   11,597    12    115,961    -    - 
                                    
Issuance of preferred stock   58,232    387,948    -    -    -    -    387,948 
                                    
Issuance of stock options   -    -    -    -    193,804    -    193,804 
Balance, December 31, 2015   2,781,735   $20,799,841    5,941,790   $5,942   $17,149,391   $(21,794,760)  $16,160,414 
                                    
Net income   -    -    -    -    -    2,955,631    2,955,631 
                                    
Issuance of common stock   -    -    33,000    33    212,637    -    212,670 
                                    
Redemption of Series A Preferred Stock   (92,527)   (693,955)                  -    (693,955)
                                    
Issuance of Series A Preferred Stock   48,490    339,433    -    -         -    339,433 
                                    
Issuance of redeemable preferred stock   12,222    12,212,767    -    -    (916,618)   -    11,296,149 
                                    
Issuance of MCA preferred stock   7,155    71,556              (7,340)        64,216 
                                    
Issuance of stock options   -    -    -    -    50,320    -    50,320 
Balance, June 30, 2016   2,757,075   $32,729,642    5,974,790   $5,975   $16,488,390   $(18,839,129)  $30,384,878 

 

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 – Through its wholly owned subsidiaries, GWG Holdings, Inc. owns a portfolio of life insurance contracts. As of the date of this report, our portfolio had an aggregate fair value of $431.8 million. We earn income from changes in the fair value of our portfolio and through the benefits we receive upon the mortality of insureds. We are also involved in other lines of business, including a business that collects commissions for facilitating the conversion of term life insurance contracts into universal, or permanent, life insurance, and a business that participates in the merchant cash advance industry by advancing sums to merchants and lending money to businesses that advance sums to merchants. Operating results for the three- and six-month periods included in this report are not necessarily indicative of the results that may be expected for the year ending December 31, 2016.

 

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.

 

Use of Estimates – The preparation of our consolidated financial statements in conformity with GAAP requires management to make 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. The Company regularly evaluates estimates and assumptions, which are based on current facts, historical experience, and various other factors that it believes to be reasonable under the circumstances. The actual results experienced by the Company may differ materially and adversely from the Company’s estimates. The most significant estimates with regard to these consolidated financial statements relates to (1) the determination of the assumptions used in estimating the fair value of our investments in life insurance contracts, 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 Contracts – ASC 325-30, Investments in Insurance Contracts (“ASC 325-30”), permits a reporting entity to account for its investments in life insurance contracts using either the investment method or the fair value method. We elected to use the fair value method to account for our life insurance contracts. Under the fair value method we recognize our initial investment at the purchase price. At each subsequent reporting period, we re-measure the investment at fair value in its entirety and recognize the change in fair value as income in the current period income net of premiums paid. We use the term “life insurance contracts” to have the same meaning as “life insurance policies.” 

 

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

 

In a case where our acquisition of a contract 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 secured title to the contract. On June 30, 2016 and December 31, 2015, a total of $16,000 and $31,000, respectively, of our “other assets” comprised direct costs and deposits that we advanced for contract acquisitions. 

 

Deferred Financing and Issuance Costs – Loans advanced to us under our revolving senior credit facility, as described in Note 5, are reported net of financing costs, 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 6 and 7, are reported net of issuance costs, sales commissions and other direct expenses, which are amortized using the interest method over the term of those borrowings. The Series A Preferred Stock, as described in Note 9, is reported net of issuance costs, sales commissions (including the fair value of warrants issued) and other direct expenses, all of which were fully amortized using the interest method as of December 31, 2015. Selling and issuance costs of Redeemable Preferred Stock and MCA Preferred Stock, described in Notes 10 and 11, are netted against additional paid-in-capital.

 

 6 
 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Earnings (loss) per Share – Basic earnings (loss) per share attributable to non-redeemable interests 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 outstanding Series A Preferred Stock, Redeemable Preferred Stock, warrants and stock options.

 

Recently Adopted 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, and that adoption reduced our assets, together with a corresponding reduction to our liabilities, by approximately $2,288,000 as of December 31, 2015. There was no impact on our statements of operations in 2015. 

 

Reclassification Certain 2015 amounts have been reclassified to conform to ASU 2015-03, as described above. These reclassifications had no effect on our reported consolidated net income or loss for prior periods.

  

(2)       Restrictions on Cash

 

Under the terms of our revolving senior credit facility (discussed in Note 5), we are required to maintain collection and escrow accounts that are used to fund the acquisition of contracts, pay annual contract premiums, pay interest and other charges under the facility, and collect contract benefits. The agent for the lender authorizes the disbursements from these accounts. At June 30, 2016 and December 31, 2015, there was a balance of $11,161,000, and $2,342,000, respectively, in these restricted cash accounts.

 

(3)      Investment in Life Insurance Contracts

 

Life insurance contracts are valued based on unobservable inputs that are significant to their overall fair value. Changes in the fair value of these contracts are recorded as gain or loss on life insurance contracts, net of cash premiums paid on those contracts, in our consolidated statements of operations. Fair value is determined on a discounted cash flow basis that incorporates life expectancy assumptions derived from reports obtained from widely accepted life expectancy providers, and assumptions relating to cost-of-insurance (premium) rates. The discount rate we apply incorporates current information about discount rate applied by other reporting companies owning portfolios of life insurance contracts, the discount rates observed in the life insurance secondary market, market interest rates, the credit exposure to the insurance company that issued the life insurance contract 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. As a result of management’s analysis, discount rates of 11.05% and 11.09% were applied to our portfolio as of June 30, 2016 and December 31, 2015, respectively.

  

 7 
 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

A summary of our contracts, organized according to their estimated life expectancy dates as of the date of this report, is as follows:

 

   As of June 30, 2016   As of December 31, 2015 
Years Ending December 31,  Number of Contracts   Estimated Fair Value   Face Value   Number of Contracts   Estimated Fair Value   Face Value 
2016   2   $4,535,000   $5,000,000    5   $7,503,000   $8,500,000 
2017   13    13,967,000    17,339,000    12    12,875,000    17,418,000 
2018   32    38,125,000    54,499,000    27    37,109,000    58,428,000 
2019   52    55,547,000    95,808,000    51    54,242,000    100,967,000 
2020   79    75,764,000    150,740,000    59    64,750,000    137,868,000 
2021   66    58,619,000    138,718,000    48    45,724,000    116,805,000 
2022   51    40,488,000    118,010,000    44    38,394,000    116,998,000 
Thereafter   252    144,775,000    574,684,000    150    96,053,000    387,860,000 
Totals   547   $431,820,000   $1,154,798,000    396   $356,650,000    944,844,000 

 

We recognized life insurance benefits of $9,829,000 and $750,000 during the three months ended June 30, 2016 and 2015, respectively, related to contracts with a carrying value of $1,692,000 and $132,000, respectively, and as a result recorded realized gains of $8,137,000 and $618,000. We recognized life insurance benefits of $29,067,000 and $29,375,000 during the six months ended June 30, 2016 and 2015, respectively, related to contracts with a carrying value of $6,302,000 and $3,743,000, respectively, and as a result recorded realized gains of $22,765,000 and $25,632,000.

 

Reconciliation of gain on life insurance contracts:

 

   Three Months Ended
June 30,
   Six Months Ended
June 30,
 
   2016   2015   2016   2015 
Change in fair value  $21,241,000   $14,028,000   $32,773,000   $12,134,000 
Premiums and other fees   (8,995,000)   (6,172,000)   (17,441,000)   (12,509,000)
Contract maturities   8,137,000    618,000    22,765,000    25,632,000 
Gain on life insurance contracts, net  $20,383,000   $8,474,000   $38,097,000   $25,257,000 

  

We currently estimate that premium payments and servicing fees required to maintain our current portfolio of life insurance contracts 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, 2016  $18,708,000   $656,000   $19,364,000 
2017   39,266,000    656,000    39,922,000 
2018   43,010,000    656,000    43,666,000 
2019   48,131,000    656,000    48,787,000 
2020   53,558,000    656,000    54,214,000 
2021   59,829,000    656,000    60,485,000 
   $262,502,000   $3,936,000   $266,438,000 

 

Management anticipates funding the premium payments estimated above with proceeds from our revolving senior credit facility, proceeds from additional debt and equity financing, and proceeds from maturities of life insurance contracts. The proceeds of these capital sources may also be used for the purchase, financing, and maintenance of additional life insurance contracts. 

 

 8 
 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

(4)       Fair Value Definition and Hierarchy

 

ASC 820, Fair Value Measurement (“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 developed 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 contracts 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 rate applied by other reporting companies owning portfolios of life insurance contracts, the discount rates observed in the life insurance secondary market, market interest rates, the credit exposure to the insurance company that issued the life insurance contract 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.

 

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 contracts for the periods ended June 30, as follows:

 

   Three month ended
June 30,
   Six months ended
June 30,
 
   2016   2015   2016   2015 
Beginning balance  $387,402,000   $278,395,000   $356,650,000   $282,883,000 
Purchases   24,869,000    9,208,000    48,700,000    10,225,000 
Maturities (cash in excess of carrying value)   (1,692,000)   (132,000)   (6,303,000)   (3,743,000)
Net change in fair value   21,241,000    14,028,000    32,773,000    12,134,000 
Ending balance (June 30)  $431,820,000   $301,499,000   $431,820,000   $301,499,000 

 

 9 
 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

We periodically update the independent life expectancy estimates on the insured lives in our portfolio, other than insured lives covered under small face amount contracts (i.e., under $1 million in face amount), on a continuous rotating three-year cycle.  Accordingly, we update life expectancies for approximately one-twelfth of our portfolio each quarter.

 

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

 

  

As of 

June 30,

2016

  

As of

December 31,

2015

 
Weighted-average age of insured, years   82.1    82.6 
Weighted-average life expectancy, months   81.3    79.3 
Average face amount per contract  $2,111,000   $2,386,000 
Discount rate   11.05%   11.09%

 

These assumptions 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 contract, 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 contracts would increase or (decrease) as summarized below:

 

Change in Fair Value of the Investment in Life Insurance Contracts

 

   Change in life expectancy estimates 
   minus 8 months   minus 4 months   plus  4 months   plus  8 months 
                 
June 30, 2016  $58,540,000   $29,087,000   $(28,537,000)  $(56,562,000)
December 31, 2015  $48,339,000   $24,076,000   $(23,501,000)  $(46,482,000)

 

   Change in discount rate 
   minus 2%   minus 1%   plus 1%   plus 2% 
                 
June 30, 2016  $45,656,000   $21,871,000   $(20,155,000)  $(38,770,000)
December 31, 2015  $35,024,000   $16,786,000   $(15,485,000)  $(29,803,000)

 

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 payable and L Bonds, having a combined aggregate face value of $352,997,000 as of June 30, 2016, is approximately $354,557,000 based on a weighted-average market interest rate of 7.10%. The carrying value of the revolving senior credit facility reflects interest charged at the commercial paper rate plus an applicable margin. The margin represents our credit risk, and the strength of the portfolio of life insurance contracts collateralizing the debt. The overall rate reflects market, and the carrying value of the facility approximates fair value. 

Our wholly owned subsidiary GWG MCA Capital, Inc. (“GWG MCA”) participates in the merchant cash advance 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, 2016 we determined that one of our secured loans was potentially impaired. The secured loan to Nulook Capital LLC had an outstanding balance of $3,304,000 and a loan loss reserve of $400,000 at June 30, 2016. We deem fair value to be the estimated collectible value on each loan made from GWG MCA. Where we estimate the collectible amount to be less than the outstanding balance, we record a reserve for the difference. 

 10 
 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

The following table summarizes outstanding warrants as of June 30, 2016:

 

Month issued  Warrants issued   Fair value per share   Risk free
rate
   Volatility   Term
December 2011   68,937   $0.22    0.42%   25.25%  5 years
March 2012   38,130   $0.52    0.38%   36.20%  5 years
June 2012   161,840   $1.16    0.41%   47.36%  5 years
July 2012   144,547   $1.16    0.41%   47.36%  5 years
September 2012   2,500   $0.72    0.31%   40.49%  5 years
September 2014   16,000   $1.26    1.85%   17.03%  5 years
    431,954                   

 

(5)       Credit Facility – Autobahn Funding Company LLC

 

Through our subsidiaries GWG DLP Funding II, LLC (“DLP II”) and GWG DLP Funding III, LLC (“DLP III”), we are party to a $105 million revolving senior credit facility with Autobahn Funding Company LLC (“Autobahn”), providing us with a $105 million maximum borrowing amount. 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. The Agreement was amended and restated for the second time on May 11, 2015, primarily to add DLP III as a party, increase the total borrowing limit from $100 million to $105 million, and extend the maturity date for borrowings under the facility to June 30, 2018.

 

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%, which is 1.75% less than interest charged under the facility prior to May 11, 2015 amendment. We make interest payments on a monthly basis. The effective rate of interest was 5.48% at June 30, 2016 and 5.58% at December 31, 2015. The weighted-average effective interest rate, after excluding an unused line fee, was 5.47% and 5.37% for the three months ended June 30, 2016 and 2015, respectively, and 5.57% and 6.00% for the six months ended June 30, 2016 and 2015, respectively.

 

The amount outstanding under this facility was $82,011,000 and $65,011,000 at June 30, 2016 and December 31, 2015, respectively. GWG Holdings is a performance guarantor of the various obligations of GWG Life, LLC (“GWG Life”), as servicer, under the Agreement. Obligations under the facility are secured by our pledge of ownership in our life insurance contracts to DZ Bank through an arrangement under which Wells Fargo serves as a securities intermediary.

 

The Agreement has certain financial (as described below) and nonfinancial covenants, and we were in compliance with these covenants at June 30, 2016 and December 31, 2015.

  

The Company has 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) maintain cash and eligible investments of $15 million or above.

 

Consolidated non-GAAP net income and non-GAAP tangible net worth as of and for the four quarters ended June 30, 2016, as calculated under the Agreement, was $30,628,000 and $128,454,000, respectively.

 

Total funds available for additional borrowings under the facility at June 30, 2016 and December 31, 2015, were $22,989,000 and $39,989,000 respectively.

 

(6)       Series I Secured Notes

 

Series I Secured Notes (“Notes”) are legal obligations of our subsidiary GWG Life and were privately offered and sold from August 2009 through June 2011. The Notes are secured by the assets of GWG Life and are subordinate to obligations under our revolving senior credit facility (see Note 5). 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 June 30, 2016 and December 31, 2015.

 

 11 
 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

The Notes 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 Notes 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. Effective September 1, 2016, we no longer anticipate renewing the Notes. 

 

Interest on the Notes is payable monthly, quarterly, annually or at maturity depending on the election of the investor. At June 30, 2016 and December 31, 2015, the weighted-average interest rate of our Notes was 8.62% and 8.47%, respectively. The principal amount of Notes outstanding was $18,283,000 and $23,578,000 at June 30, 2016 and December 31, 2015, respectively. The difference between the amount outstanding on the Notes and the carrying amount on our balance sheet is due to netting of unamortized deferred issuance costs. Overall, interest expense includes amortization of deferred financing and issuance costs of $82,000 and $193,000 for the three and six months ended June 30, 2016 and $81,000 and $211,000 for the three and six months ended June 30, 2015. Future expected amortization of deferred financing costs is $317,000 in total over the next six years.

 

Future contractual maturities of Notes payable and future amortization of their deferred financing costs at June 30, 2016 are as follows: 

 

Years Ending December 31,  Contractual Maturities   Amortization of Deferred Financing Costs 
Six months ending December 31, 2016  $3,574,000   $14,000 
2017   8,758,000    113,000 
2018   2,401,000    56,000 
2019   869,000    16,000 
2020   1,766,000    59,000 
Thereafter   915,000    59,000 
   $18,283,000   $317,000 

 

(7)       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 revolving senior credit facility (see Note 5). 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 presently being 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 and 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, 2016 and December 31, 2015.

 

L Bonds have maturity dates ranging from six months to seven years, and fixed interest rates varying from 4.25% to 9.50% depending on the term of the bond. 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, 2016 and December 31, 2015, the weighted-average interest rate of our L Bonds was 7.17% and 7.18%, respectively. The principal amount of L Bonds outstanding was $334,714,000 and $282,171,000 at June 30, 2016 and December 31, 2015, 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 and cash receipts for new issuances in process. Amortization of deferred issuance costs was $1,721,000 and $3,289,000 for the three and six months ended June 30, 2016 and $1,366,000 and $2,340,000 for the three and six months ended June 30, 2015. Future expected amortization of deferred financing costs as of June 30, 2016 is $9,960,000 in total over the next eight years.

 

Effective September 1, 2016, we will cease selling 6-month and 1-year L Bonds until further notice. In addition, effective September 1, 2016, the L Bond interest rates will change to 5.50%, 6.25%, 7.50% and 8.50% for the 2-, 3-, 5- and 7-year L Bonds, respectively. 

 

 12 
 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Future contractual maturities of L Bonds, and future amortization of their deferred financing costs, at June 30, 2016 are as follows: 

 

Years Ending December 31,  Contractual Maturities   Amortization of Deferred Financing Costs 
Six months ending December 31, 2016  $58,270,000   $364,000 
2017   85,052,000    1,764,000 
2018   87,168,000    2,986,000 
2019   50,526,000    2,148,000 
2020   19,457,000    845,000 
Thereafter   34,241,000    1,853,000 
   $334,714,000   $9,960,000 

 

(8)     Note Payable to Related Party

 

In February 2016, GWG MCA acquired certain assets relating to our merchant cash advance business. To finance this acquisition, GWG MCA borrowed $1,760,000 from Insurance Strategies Fund, LLC, as evidenced by an unsecured promissory note dated February 16, 2016. GWG MCA paid off the promissory note in its entirety in June 2016.

  

(9)     Convertible Preferred Stock

 

From July 2011 until September 2012, we privately offered shares of Series A Preferred Stock (“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 included as interest expense in the statements of operations. 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.

 

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.

 

As of June 30, 2016, we issued an aggregate of 423,000 shares of Series A in satisfaction of $2,959,000 in dividends on the Series A, and an aggregate of 693,000 shares of Series A were converted into 520,000 shares of our common stock. As of June 30, 2016, we had 2,738,000 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 three-year 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, 2016 and December 31, 2015, none of these warrants were exercised, and the weighted-average remaining life of these warrants was 0.93 and 1.43, respectively.

 

In September 2012, we completed 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, 2016, we have redeemed an aggregate of 277,000 shares of Series A.

 

 (10)       Redeemable Preferred Stock

 

Beginning November 30, 2015, we began publicly offering up to 100,000 shares of Redeemable Preferred Stock (“RPS”) at $1,000 per share. Holders of RPS are entitled to cumulative dividends at the rate of 7% per annum, paid monthly. Dividends on the RPS are included as interest expense in the statements of operations. Under certain circumstances described in the Certificate of Designation for the RPS, additional shares of RPS may be issued in lieu of cash dividends.

 

 13 
 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

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 liquidation preference, less an applicable redemption fee, if any. Nevertheless, the Certificate of Designation for RPS permits us to decline requests for redemption in certain circumstances. 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, 2016, we had sold 12,222 shares of RPS for aggregate gross consideration of $12,213,000, and incurred approximately $917,000 of selling costs related to the sale of those shares.

 

(11)    GWG MCA Capital, Inc - 9% Preferred Stock

Beginning March 31, 2016, GWG MCA began privately offering up to 2,000,000 shares of GWG MCA 9% Preferred Stock (“MCA Preferred”) at $10.00 per share. Holders of MCA Preferred are entitled to cumulative dividends at a rate of 9% per annum, paid monthly. Dividends on the MCA Preferred are included as interest expense in the statements of operations. Under certain circumstances described in the Certificate of Designation for the MCA Preferred, additional shares of MCA Preferred may be issued in lieu of cash dividends. The MCA Preferred ranks senior to the common stock of MCA (all of which common stock is held by GWG Holdings) and entitles its holders to a liquidation preference equal to the stated value per share (i.e., $10.00) plus accrued but unpaid dividends.

 

Holders of MCA Preferred may request that GWG MCA redeem their MCA Preferred at a price equal to their liquidation preference, less an applicable redemption fee, if any. Nevertheless, the Certificate of Designation for MCA Preferred permits GWG MCA to decline requests for redemption in certain circumstances. In addition, after one year from the date of original issuance, GWG MCA may, at its option, call and redeem shares of MCA Preferred at a price equal to the stated value per share. As of June 30, 2016, a total of 7,155 shares of MCA Preferred had been sold for aggregate gross consideration of $72,000 and approximately $7,000 of selling costs related to the sale of these shares were incurred.

 

(12)    Income Taxes

 

We had a current income tax liability as of $0 as of both June 30, 2016 and December 31, 2015. The components of current and deferred income tax expense for the three and six months ended June 30, 2016 and 2015, respectfully, consisted of the following:

 

   Three Months Ended   Six Months Ended 
   June 30,   June 30,   June 30,   June 30, 
   2016   2015   2016   2015 
Income tax provision (benefit):                
Current:                
Federal  $(23,000)  $(182,000)  $-   $141,000 
State  $(6,000)  $(64,000)  $-   $40,000 
Total current tax expense (benefit)   (29,000)   (246,000)   -    181,000 
Deferred:                    
Federal  $1,397,000   $(670,000)  $2,203,000   $984,000 
State  $454,000   $(261,000)  $704,000   $268,000 
Total deferred tax expense (benefit)   1,851,000    (931,000)   2,907,000    1,252,000 
Total income tax expense (benefit)   1,822,000    (1,177,000)   2,907,000    1,433,000 

 

The primary differences between the June 30, 2016 effective tax rate and the statutory federal rate are the accrual of non-deductible preferred stock dividend expense of $1,112,000, state taxes, and other non-deductible expenses. 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 contracts and revenue recognition with respect to the mark-to-market of our life insurance portfolio.

 

 14 
 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

(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.”

 

On June 24, 2015 we issued 60,000 restricted common shares at $9.70 per share, determined by the closing market price on the date of grant, to a vendor as payment for services to be rendered over three years. The cost of these shares is amortized over a 12-month period. On March 17, 2016, we issued an additional 6,500 restricted common shares at an average price of $7.16 per share, determined by the closing market price on the date of grant, to this same vendor for additional services provided to us. On April 25, 2016, we issued 25,000 restricted shares of common stock at $6.25 per share, determined by the closing market price on the date of grant, to a vendor as a form of payment for services the vendor is providing to us, which is expensed in the current period.

 

(14)    Stock Incentive Plan

 

We adopted our GWG Holdings 2013 Stock Incentive Plan in March 2013. The Compensation Committee of our Board of Directors administers the plan. Incentives 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. 2,000,000 common shares are presently issuable under the plan.

 

Through June 30, 2016, we issued stock options for 1,110,865 shares of common stock to employees, officers, and directors under the plan. Options for 577,196 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 $10.18 for those beneficially owning more than 10% of our common stock, and between $6.00 and $10.25 for all others, which is equal to the estimated market price of the shares on the date of grant using Black-Scholes binomial option pricing model. The expected annualized volatility used in the Black-Scholes model valuation of options issued during the period was 26.6%. 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, 2016, stock options for 360,685 shares were forfeited and stock options for 28,001 shares were exercised.

 

Outstanding stock options:

 

   Vested   Un-vested   Total 
Balance as of December 31, 2014   314,288    685,813    1,000,101 
Granted during the year   79,500    273,700    353,200 
Vested during the year   238,999    (238,999)   - 
Exercised during the year   (27,667)   -    (27,667)
Forfeited during the year   (121,417)   (150,602)   (272,019)
Balance as of December 31, 2015   483,703    569,912    1,053,615 
Granted during the year   15,000    67,750    82,750 
Vested during the year   84,917    (84,917)   - 
Forfeited during the year   (6,424)   (19,076)   (25,500)
Balance as of June 30, 2016   577,196    533,669    1,110,865 

 

Compensation expense related to un-vested options not yet recognized is $475,000. We expect to recognize this compensation expense over the next three years ($173,000 in 2016, $208,000 in 2017, $72,000 in 2018, and $22,000 in 2019).

 

 15 
 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

(15)    Net Income per Common Share

 

We have outstanding Series A shares, as described in Note 9. The Series A is dilutive to our net income per common share calculation at both June 30, 2016 and 2015. 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 as of both June 30, 2016 and 2015 and have not been included in the fully diluted net loss per common share calculation. We issued Redeemable Preferred Stock (see Note 10) that is non-dilutive, as the minimum conversion price of $15 per common share is above market price.

 

(16)    Commitments

 

We are party to an office lease with U.S. Bank National Association as the landlord. The lease was originally for 11,695 square feet of office space located at 220 South Sixth Street, Minneapolis, Minnesota, began in April 2012 and had an original term expiring August 31, 2015. On September 1, 2015, we entered into an amendment to this lease that expanded the leased space to 17,687 square feet and extended the term through August 31, 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 these lease arrangements were $123,000 and $55,000 for the three months ended June 30, 2016 and 2015, respectively, and $232,000 and $122,000 for the six months ended June 30, 2016 and 2015, respectively.

 

Minimum lease payments under the amended lease are as follows:

 

Six months ending December 31, 2016  $87,000 
2017   178,000 
2018   185,000 
2019   191,000 
2020   198,000 
2021   204,000 
2022   210,000 
2023   217,000 
2024   223,000 
2025   230,000 
2026   38,000 
   $1,961,000 

  

(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 Bond under a registration statement declared effective by the SEC, as described in Note 7. Our obligations under the L Bonds are secured by substantially all the assets of GWG Holdings, a pledge of all the common stock held by our largest individual 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 GWG’s life insurance contracts are held by DLP III and the Trust. The contracts held by DLP III are not collateral for the L Bond obligations as such contracts serve as collateral for the senior credit facility.

 

 16 
 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

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 provided herein. DLP II and DLP III are borrowers under a revolving senior credit facility with Autobahn, under which DZ Bank serves as agent, as described in Note 5. The significant majority of insurance contracts we own are subject to a collateral arrangement with DZ Bank described in Notes 2 and 5. Under this arrangement, collection and escrow accounts are used to fund premiums for the insurance contracts and to pay interest and other charges under the revolving senior credit facility. DZ Bank and Autobahn must authorize all disbursements from these accounts, including any distributions to GWG Life. Distributions are limited to an amount that would result in the borrowers (i.e., DLP II, DLP III, GWG Life and GWG Holdings) realizing an annualized rate of return on mortality benefits for such assets of not more than 18%, as determined by DZ Bank. After such amount is reached, the agreement governing the senior revolving credit facility requires that excess funds be used for repayments of borrowings before any additional distributions may be made.

 

The following represents consolidating financial information as of June 30, 2016 and December 31, 2015, with respect to the financial position, and for the three and six months ended June 30, 2016 and 2015, 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 presents the financial information of GWG Life, the guarantor subsidiary of the L Bonds, presenting its investment in DLP II, DLP III and the Trust under the equity method. The non-guarantor subsidiaries column presents the financial information of all non-guarantor subsidiaries, including DLP II, DLP III and the Trust.

 

 17 
 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Condensed Consolidating Balance Sheets 

  

June 30, 2016  Parent   Guarantor Subsidiary   Non-Guarantor Subsidiaries   Eliminations   Consolidated 
                     
A S S E T S
                     
Cash and cash equivalents  $10,051,621   $6,822,484   $505,245   $-   $17,379,350 
Restricted cash   -    4,924,308    6,236,485    -    11,160,793 
Investment in life insurance contracts, at fair value   -    -    431,820,437    -    431,820,437 
Secured MCA advances   -    -    4,328,317    -    4,328,317 
Life insurance contract benefits receivable   -    -    6,829,022    -    6,829,022 
Other assets   4,901,911    1,367,483    30,926    (2,789,877)   3,510,443 
Investment in subsidiaries   358,804,767    363,647,320    -    (722,452,087)   - 
                          
TOTAL ASSETS  $373,758,299   $376,761,595   $449,750,432   $(725,241,964)  $475,028,362 
                          
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  (D E F I C I T)
                          
LIABILITIES                         
Revolving senior credit facility  $-   $(2,639,306)  $80,115,298   $-   $77,475,992 
Series I Secured Notes   -    17,965,653    -    -    17,965,653 
L Bonds   327,322,906    -    -    -    327,322,906 
Notes payable to related parties   -    -    2,700,000    (2,700,000)   - 
Accounts payable   1,270,216    462,220    796,770    -    2,529,206 
Interest payable   9,493,254    3,502,812    417,557    (89,877)   13,323,746 
Other accrued expenses   680,545    589,682    85,039    -    1,355,266 
Deferred taxes, net   4,670,715    -    -    -    4,670,715 
TOTAL LIABILITIES   343,437,636    19,881,061    84,114,664    (2,789,877)   444,643,484 
                          
STOCKHOLDERS’ EQUITY (DEFICIT)                         
Member capital   -    356,880,534    365,571,553    (722,452,087)   - 
Convertible preferred stock   20,445,320    -    -    -    20,445,320 
Redeemable preferred stock   12,212,767    -    -    -    12,212,767 
MCA preferred stock   -    -    71,555    -    71,555 
Common stock   5,975    -    -    -    5,975 
Additional paid-in capital   16,495,730    -    (7,340)   -    16,488,390 
Accumulated deficit   (18,839,129)   -    -    -    (18,839,129)
TOTAL STOCKHOLDERS’ EQUITY (DEFICIT)   30,320,663    356,880,534    365,635,768    (722,452,087)   30,384,878 
                          
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)  $373,758,299   $376,761,595   $449,750,432   $(725,241,964)  $475,028,362 

 

 18 
 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Condensed Consolidating Balance Sheets (continued)

 

December 31, 2015  Parent   Guarantor Subsidiary   Non-Guarantor Subsidiaries   Eliminations   Consolidated 
                     
A S S E T S
                     
Cash and cash equivalents  $32,292,162   $1,982,722   $150,221   $-   $34,425,105 
Restricted cash   -    2,102,257    239,643    -    2,341,900 
Investment in life insurance contracts, at fair value   -    -    356,649,715    -    356,649,715 
Other assets   1,742,074    688,071    30,900    -    2,461,045 
Investment in subsidiaries   269,886,254    291,295,951    -    (561,182,205)   - 
                          
TOTAL ASSETS  $303,920,490   $296,069,001   $357,070,479   $(561,182,205)  $395,877,765 
                          
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  (D E F I C I T)
                          
LIABILITIES                         
Revolving senior credit facility  $-   $(1,000,000)  $64,279,596   $-   $63,279,596 
Series I Secured Notes   -    23,287,704    -    -    23,287,704 
L Bonds   276,482,796    -    -    -    276,482,796 
Accounts payable   280,988    157,217    1,079,235    -    1,517,440 
Interest payable   8,529,959    3,544,626    265,476    -    12,340,061 
Other accrued expenses   717,365    343,421    -    -    1,060,786 
Deferred taxes, net   1,763,968    -    -    -    1,763,968 
TOTAL LIABILITIES   287,775,076    26,332,968    65,624,307    -    379,732,351 
                          
STOCKHOLDERS’ EQUITY (DEFICIT)                         
Member capital   -    269,736,033    291,446,172    (561,182,205)   - 
Convertible preferred stock   20,784,841    -    -    -    20,784,841 
Common stock   5,942    -    -    -    5,942 
Additional paid-in capital   17,149,391    -    -    -    17,149,391 
Accumulated deficit   (21,794,760)   -    -    -    (21,794,760)
TOTAL STOCKHOLDERS’ EQUITY (DEFICIT)   16,145,414    269,736,033    291,446,172    (561,182,205)   16,145,414 
                          
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)  $303,920,490   $296,069,001   $357,070,479   $(561,182,205)  $395,877,765 

 

 

 19 
 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Condensed Consolidating Statements of Operations

 

For the six months ended June 30, 2016  Parent   Guarantor Subsidiary   Non-Guarantor Subsidiaries   Eliminations   Consolidated 
REVENUE                    
       Origination and servicing income  $-   $13,417   $-   $(13,417)  $- 
       Gain on life insurance contracts, 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                         
       Origination and servicing fees   -    -    13,417    (13,417)   - 
       Interest expense   15,730,192    1,301,971    3,083,680    (89,877)   20,025,966 
       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   23,061,176    5,820,203    4,040,912    (103,294)   32,818,997 
                          
INCOME (LOSS) BEFORE EQUITY IN INCOME OF SUBSIDIARIES   (22,955,157)   (5,805,774)   34,623,309    -    5,862,378 
                          
 EQUITY IN INCOME OF SUBSIDIARY   28,817,535    35,136,402    -    (63,953,937)   - 
                          
INCOME BEFORE INCOME TAXES   5,862,378    29,330,628    34,623,309    (63,953,937)   5,862,378 
                          
INCOME TAX EXPENSE   2,906,747    -    -    -    2,906,747 
NET INCOME  $2,955,631   $29,330,628   $34,623,309   $(63,953,937)  $2,955,631 

  

For the six months ended June 30, 2015  Parent   Guarantor Subsidiary   Non-Guarantor Subsidiaries   Eliminations   Consolidated 
REVENUE                    
       Origination and servicing income  $-   $1,018,750   $-   $(1,018,750)  $- 
       Gain on life insurance contracts, net   -    -    25,257,295    -    25,257,295 
       Interest and other income   25,023    6,880    107,773    -    139,676 
 TOTAL REVENUE   25,023    1,025,630    25,365,068    (1,018,750)   25,396,971 
                          
EXPENSES                         
       Origination and servicing fees   -    -    1,018,750    (1,018,750)   - 
       Interest expense   11,031,758    1,458,965    2,008,158    -    14,498,881 
       Employee compensation and benefits   2,911,596    961,046    -    -    3,872,642 
       Legal and professional fees   828,858    337,326    -    -    1,166,184 
       Other expenses   2,056,188    1,302,036    56,836    -    3,415,060 
 TOTAL EXPENSES   16,828,400    4,059,373    3,083,744    (1,018,750)   22,952,767 
                          
INCOME (LOSS) BEFORE EQUITY IN INCOME OF SUBSIDIARIES   (16,803,377)   (3,033,743)   22,281,324    -    2,444,204 
                          
 EQUITY IN INCOME OF SUBSIDIARY   19,247,581    22,281,217    -    (41,528,798)   - 
                          
INCOME BEFORE INCOME TAXES   2,444,204    19,247,474    22,281,324    (41,528,798)   2,444,204 
                          
INCOME TAX EXPENSE   1,432,728    -    -    -    1,432,728 
NET INCOME  $1,011,476   $19,247,474   $22,281,324   $(41,528,798)  $1,011,476 

  

 20 
 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Condensed Consolidating Statements of Operations (continued)

 

For the three months ended June 30, 2016  Parent   Guarantor Subsidiary   Non-Guarantor Subsidiaries   Eliminations   Consolidated 
REVENUE                    
       Gain on life insurance contracts, 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                         
       Interest expense   8,131,369    644,735    1,648,452    (58,975)   10,365,581 
       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   12,073,207    2,830,562    2,229,332    (58,975)   17,074,126 
                          
INCOME (LOSS) BEFORE EQUITY IN INCOME OF SUBSIDIARIES   (12,001,985)   (2,829,856)   18,535,197    -    3,703,356 
                          
 EQUITY IN INCOME OF SUBSIDIARY   15,705,341    18,835,036    -    (34,540,377)   - 
                          
INCOME BEFORE INCOME TAXES   3,703,356    16,005,180    18,535,197    (34,540,377)   3,703,356 
                          
INCOME TAX BENEFIT   1,822,030    -    -    -    1,822,030 
NET INCOME  $1,881,326   $16,005,180   $18,535,197   $(34,540,377)  $1,881,326 

  

For the three months ended June 30, 2015  Parent   Guarantor Subsidiary   Non-Guarantor Subsidiaries   Eliminations   Consolidated 
REVENUE                    
       Origination and servicing income  $-   $661,264   $-   $(661,264)  $- 
       Gain on life insurance contracts, net   -    -    8,473,886    -    8,473,886 
       Interest and other income   17,480    430    72,470    -    90,380 
 TOTAL REVENUE   17,480    661,694    8,546,356    (661,264)   8,564,266 
                          
EXPENSES                         
       Origination and servicing fees   -    -    661,264    (661,264)   - 
       Interest expense   5,781,796    684,879    855,672    -    7,322,347 
       Employee compensation and benefits   1,605,795    538,930    -    -    2,144,725 
       Legal and professional fees   351,507    291,424    -    -    642,931 
       Other expenses   1,104,826    732,243    44,252    -    1,881,321 
 TOTAL EXPENSES   8,843,924    2,247,476    1,561,188    (661,264)   11,991,324 
                          
INCOME (LOSS) BEFORE EQUITY IN INCOME OF SUBSIDIARIES   (8,826,444)   (1,585,782)   6,985,168    -    (3,427,058)
                          
 EQUITY IN INCOME OF SUBSIDIARY   5,399,386    6,985,112    -    (12,384,498)   - 
                          
INCOME BEFORE INCOME TAXES   (3,427,058)   5,399,330    6,985,168    (12,384,498)   (3,427,058)
                          
INCOME TAX BENEFIT   (1,176,643)   -    -    -    (1,176,643)
NET INCOME (LOSS)  $(2,250,415)  $5,399,330   $6,985,168   $(12,384,498)  $(2,250,415)

 

 21 
 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Condensed Consolidating Statements of Cash Flows

 

For the six months ended June 30, 2016  Parent   Guarantor Subsidiary   Non-Guarantor Subsidiaries   Eliminations   Consolidated 
CASH FLOWS FROM OPERATING ACTIVITIES                    
Net income  $2,955,631   $29,330,628   $34,623,309   $(63,953,937)  $2,955,631 
Adjustments to reconcile net income to net cash flows from operating activities:                         
(Equity) of subsidiaries   (28,817,535)   (35,136,402)   -    63,953,937    - 
Gain on life insurance contracts   -    -    (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) in operating assets:                         
Life insurance contract benefits receivable   -    -    (6,829,022)        (6,829,022)
Other assets   (60,457,838)   (37,895,574)   -    97,315,946    (1,037,466)
Increase (decrease) 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   (79,735,476)   (44,429,318)   (3,195,005)   97,315,946    (30,043,853)
                          
CASH FLOWS FROM INVESTING ACTIVITIES                         
Investment in life insurance contracts   -    -    (48,700,036)   -    (48,700,036)
Carrying value of matured life insurance contracts   -    -    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 Revolving Credit Facility   -    -    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 redemption and issuance of L Bonds   (22,663,475)   -    -    -    (22,663,475)
Proceeds from (increase in) 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)
Issuance of member capital   -    57,813,874    39,502,072    (97,315,946)   - 
NET CASH FLOWS PROVIDED BY FINANCING ACTIVITIES   57,494,935    49,269,080    50,569,444    (97,315,946)   60,017,513 
                          
NET INCREASE (DECREASE) 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 

 

 22 
 

 

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, 2015  Parent   Guarantor Subsidiary   Non-Guarantor Subsidiaries   Eliminations   Consolidated 
CASH FLOWS FROM OPERATING ACTIVITIES                    
Net income  $1,011,476   $19,247,474   $22,281,324   $(41,528,798)  $1,011,476 
Adjustments to reconcile net income to net cash flows from operating activities:                         
(Equity) of subsidiaries   (19,247,582)   (22,281,216)   -    41,528,798    - 
Gain on life insurance contracts   -    -    (12,134,482)   -    (12,134,482)
Amortization of deferred financing and issuance costs   1,729,175    211,116    (1,982,295)   -    (42,004)
Deferred income taxes   1,251,781    -    -    -    1,251,781 
Preferred stock dividends payable   335,232    -    -    -    335,232 
(Increase) in operating assets:                         
Life insurance contract benefits receivable   -    -    (750,000)        (750,000)
Other assets   (17,998,823)   (11,114,039)   -    28,756,313    (356,549)
Increase in operating liabilities:                         
Accounts payable and accrued expenses   2,493,495    228,640    (1,419,689)   -    1,302,446 
NET CASH FLOWS USED IN OPERATING ACTIVITIES   (30,425,246)   (13,708,025)   (5,994,858)   28,756,313    (9,382,100)
                          
CASH FLOWS FROM INVESTING ACTIVITIES                         
Investment in life insurance contracts   -    -    (10,224,018)   -    (10,224,018)
Carrying value of matured life insurance contracts   -    -    3,742,983    -    3,742,983 
NET CASH FLOWS USED IN INVESTING ACTIVITIES   -    -    (6,481,035)   -    (6,481,035)
                          
CASH FLOWS FROM FINANCING ACTIVITIES                         
Repayment of Senior Revolving Credit Facility   -    -    (7,150,000)   -    (7,150,000)
Payments for redemption of Series I Secured Notes   -    (3,617,544)   -    -    (3,617,544)
Proceeds from issuance of L Bonds   50,498,356    -    -    -    50,498,356 
Payments for redemption and issuance of L Bonds   (13,013,057)   -    -    -    (13,013,057)
Proceeds from (increase in) restricted cash   -    (102,500)   (3,524,637)   -    (3,627,137)
Issuance of common stock   582,000    -    -    -    582,000 
Payments for issuance and redemption of preferred stock   (273,998)   -    -    -    (273,998)
Issuance of member capital   -    17,445,391    11,310,922    (28,756,313)   - 
NET CASH FLOWS PROVIDED BY FINANCING ACTIVITIES   37,793,301    13,725,347    636,285    (28,756,313)   23,398,620 
                          
NET INCREASE IN CASH AND CASH EQUIVALENTS   7,368,055    17,322    150,108    -    7,535,485 
                          
CASH AND CASH EQUIVALENTS                         
BEGINNING OF THE PERIOD   30,446,473    216,231    -    -    30,662,704 
                          
END OF THE PERIOD  $37,814,528   $233,553   $150,108   $-   $38,198,189 

 

 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  $1,881,326   $16,005,180   $18,535,197   $(34,540,377)  $1,881,326 
Adjustments to reconcile net loss to net cash flows from operating activities:                         
(Equity) of subsidiaries   (15,705,341)   (18,835,036)   -    34,540,377    - 
Gain on life insurance contracts   -    -    (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) in operating assets:                         
Life insurance contract 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   (29,955,625)   (15,867,221)   2,802,552    33,489,247    (9,531,047)
                          
CASH FLOWS FROM INVESTING ACTIVITIES                         
Investment in life insurance contracts   -    -    (24,373,714)   -    (24,373,714)
Carrying value of matured life insurance contracts   -    -    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 Revolving Credit Facility   -    -    (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 redemption and issuance of L Bonds   (11,753,782)   -    -    -    (11,753,782)
Proceeds from (increase in) 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)
NET CASH FLOWS PROVIDED BY FINANCING ACTIVITIES   33,733,211    18,349,340    20,386,598    (33,489,247)   38,979,902 
                          
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 three months ended June 30, 2015  Parent   Guarantor Subsidiary   Non-Guarantor Subsidiaries   Eliminations   Consolidated 
                     
CASH FLOWS FROM OPERATING ACTIVITIES                    
Net income (loss)  $(2,250,415)  $5,399,330   $6,985,168   $(12,384,498)  $(2,250,415)
Adjustments to reconcile net loss to net cash flows from operating activities:                         
(Equity) of subsidiaries   (5,399,386)   (6,985,112)   -    12,384,498    - 
Gain on life insurance contracts   -    -    (14,028,327)   -    (14,028,327)
Amortization of deferred financing and issuance costs   1,685,700    80,928    (1,259,602)   -    507,026 
Deferred income taxes   (930,470)   -    -    -    (930,470)
Preferred stock dividends payable   146,420    -    -    -    146,420 
(Increase) in operating assets:                         
Life insurance contract benefits receivable   -    -    17,140,000    -    17,140,000 
Other assets   (7,124,387)   (5,236,604)   -    12,135,615    (225,376)
Increase (decrease) in operating liabilities:                         
Accounts payable and other accrued expenses   213,843    (509,444)   (1,037,640)   -    (1,333,241)
NET CASH FLOWS USED IN OPERATING ACTIVITIES   (13,658,695)   (7,250,902)   7,799,599    12,135,615    (974,383)
                          
CASH FLOWS FROM INVESTING ACTIVITIES                         
Investment in life insurance contracts   -    -    (7,777,541)   -    (7,777,541)
Carrying value of matured life insurance contracts   -    -    132,388    -    132,388 
NET CASH FLOWS USED IN INVESTING ACTIVITIES   -    -    (7,645,153)   -    (7,645,153)
                          
CASH FLOWS FROM FINANCING ACTIVITIES                         
Repayment of Senior Revolving Credit Facility   -    -    (7,150,000)        (7,150,000)
Payments for redemption of Series I Secured Notes   -    (2,344,355)   -    -    (2,344,355)
Proceeds from issuance of L Bonds   22,538,059    -    -    -    22,538,059 
Payments for redemption and issuance of L Bonds   (6,134,935)   -    -    -    (6,134,935)
Proceeds from (increase in) restricted cash   -    1,677,500    1,732,927    -    3,410,427 
Issuance of member capital   -    6,872,932    5,262,683    (12,135,615)   - 
Issuance of common stock   582,000    -    -    -    582,000 
Payments for issuance and redemption of preferred stock   (273,998)   -    -    -    (273,998)
NET CASH FLOWS PROVIDED BY FINANCING ACTIVITIES   16,711,126    6,206,077    (154,390)   (12,135,615)   10,627,198 
                          
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS   3,052,431    (1,044,825)   56    -    2,007,662 
                          
CASH AND CASH EQUIVALENTS                         
BEGINNING OF THE PERIOD   34,762,097    1,278,378    150,052    -    36,190,527 
                          
END OF THE PERIOD  $37,814,528   $233,553   $150,108   $-   $38,198,189 

 

 25 
 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

(19)    Concentrations

 

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

 

Life insurance company  June 30,   December 31, 
   2016   2015 
AXA Equitable   15.1%   14.0%
Transamerica   10.8%   * 
John Hancock   10.0%   12.7%

 

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

 

The following summarizes the number of insurance contracts insuring the lives of persons living in specific states exceeding 10% of the total face value held by us:

 

State of Residence  June 30,   December 31, 
   2016   2015 
California   21.8%   25.2%
Florida   19.6%   19.2%

 

(20)    Subsequent events

 

Subsequent to June 30, 2016, one policy covering one individual matured. The life insurance contract benefit of this policy was $700,000 and we recorded realized gains of $452,000 on this policy.

 

Subsequent to June 30, 2016, we have issued approximately $19,009,000 in additional principal amount of L Bonds, and 7,336 shares of RPS for gross consideration of approximately $7,336,000.

 

Subsequent to June 30, 2016 , the Company has issued 500 shares of common stock to a vendor as a form of payment for services the vendor provided to the Company. Also, one of our Series A Preferred Stock holders converted 2,600 shares of preferred stock into 1,950 shares of common stock.

 

Effective September 1, 2016, we will cease selling 6-month and 1-year L Bonds until further notice. In addition, effective September 1, 2016, the L Bond interest rates will change to 5.50%, 6.25%, 7.50% and 8.50% for the 2-, 3-, 5- and 7-year L Bonds, respectively.

 

Effective September 1, 2016, we no longer anticipate renewing Series I Secured Notes.

 

 26 
 

 

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

 

You should read the following discussion in conjunction with the 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” 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.

 

Such factors include, but are not limited to: 

 

changes in the secondary market for life insurance;
our limited operating history;
the valuation of assets reflected on our financial statements;
the reliability of assumptions underlying our actuarial models;
our reliance on debt financing;
risks relating to the validity and enforceability of the life insurance contracts we purchase;
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 contracts;
our ability to satisfy our debt obligations if we were to sell our entire portfolio of life insurance contracts;
life insurance company credit exposure;
cost-of-insurance (premium) increases on our life insurance contracts;
general economic outlook, including prevailing interest rates;
performance of our investments in life insurance contracts;
financing requirements;
risks associated with our recent entry into the merchant cash advance business;
litigation risks; and
restrictive covenants contained in borrowing agreements.

 

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 have elected to delay such 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 or until we no longer qualify as an “emerging growth company” as defined under the JOBS Act, whichever is earlier.

 

 27 
 

 

Overview

 

GWG Holdings, Inc. is a specialty finance company and a leading financial purchaser of life insurance assets in the secondary market. We create opportunities for consumers owning life insurance to obtain significant value for their contracts as compared to the traditional options offered by insurance companies. We also create opportunities for investors to participate in alternative asset classes, such as life insurance, not correlated to traditional financial markets. In so doing, we enable investors to take advantage of financial opportunities dominated by banks prior to the 2008 credit crisis.

 

We seek to build a profitable and large portfolio of life insurance assets that are well diversified in terms of insurance companies and insureds. We believe that diversification is a key risk mitigation strategy to provide consistent cash flows and reliable investment returns from our portfolio of life insurance assets. To grow our portfolio and achieve the diversification we seek, we offer investors the opportunity to participate in the yield potentially generated by our portfolio of life insurance assets through a variety of financings and securities offerings. We chose to finance our business in this manner after the 2008 credit crisis, during which banks largely ceased financing alternative asset classes as a result of the regulatory response to the financial crisis. We believe we are well positioned to continue providing investors with yield participation opportunities from alternative asset classes once dominated by the banking sector. 

 

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 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 contracts 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 contracts associated with these estimates as well as certain other critical accounting contracts.

 

Ownership of Life Insurance Contracts—Fair Value Option

 

We account for the purchase of life insurance contracts in accordance with ASC 325-30, Investments in Insurance Contracts, 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 contracts using the fair value method.

 

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

 

We initially record our purchase of life insurance contracts at the transaction price, which is the amount paid for the contract, inclusive of all external fees and costs associated with the acquisition. The fair value of our investment in our portfolio of insurance contracts is evaluated at the end of each subsequent reporting period. Changes in the fair value of our portfolio are based on periodic evaluations and are recorded in our consolidated and combined statement of operations as changes in fair value of life insurance contracts.

 

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 contracts. 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 Society of Actuaries recently finalized the 2015 Valuation Basic Table (“2015 VBT”). The 2015 VBT is based on a much larger dataset of insured lives, face amount of contracts and more current information compared to the dataset underlying the 2008 Valuation Basic Table. The new 2015 VBT dataset includes 266 million contracts compared to the 2008 VBT dataset of 75 million. The experience data in the 2015 VBT dataset includes 2.55 million claims on contracts 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, which increased our fair value from $425 million to $432 million as of June 30, 2016 (see Note 4 for more information about our valuation process). The contracts receiving the largest increase in value were the contracts on the oldest insured lives in our portfolio.

 

In September 2015, Equitable Life Insurance Company (“AXA”) announced pending cost-of-insurance rate increases for certain universal life contracts which were effected on March 1, 2016.  We identified 14 affected contracts in our portfolio. In April 2016, we received updated contract illustrations from AXA and calculated the change in the fair value of our portfolio resulting from the increased premiums to be a reduction of $2,395,000. This reduction was reflected in our balance sheet as of March 31, 2016. Our review of AXA’s cost-of-insurance rate increases is complete as of June 30, 2016. We are aware of pending cost of insurance increases affecting approximately 3.8% of our portfolio by face amount of benefits. We will adjust our premium schedules and resultant valuation when we have received the required information from the related carriers.

 

 28 
 

 

Fair Value Components – Required Premium Payments

 

We must pay the premiums on the life insurance contracts within our portfolio in order to collect the contract benefit. The same probabilistic model and methodologies used to generate expected cash inflows from the life insurance contract 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 represents the internal rate of return we expect to earn on investments in a contract or in the portfolio as a whole at the stated fair value. The discount rate used to calculate fair value of our portfolio incorporates the guidance provided by ASC 820, Fair Value Measurements and Disclosures.

 

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

 

  June 30, 2016   December 31, 2015  
  11.05%   11.09%  

 

The change in the discount rate incorporates current information about discount rates applied by other reporting companies owning portfolios of life insurance contracts, 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 contracts. Because we use the discount rate to arrive at the fair value of our portfolio, the rate we choose necessarily 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). The carrying value of contracts 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 Systems (“MAPS”), to prepare a calculation of our life insurance portfolio. MAPS owns and maintains the portfolio pricing software we use. MAPS processed contract 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 11.05%. MAPS independently calculated the net present value of our portfolio of 547 contracts to be $431.8 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, Income Taxes, 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.

 

We provided a valuation allowance against the deferred tax asset related to a note receivable, which was charged-off for financial reporting purposes, because we believe that, when realized for tax purposes, it will result in a capital loss that will not be utilized because we have no expectation of generating a capital gain within the applicable carryforward period. Therefore, we do not believe that it is “more likely than not” that the deferred tax asset will be realized.

 

We also provided a valuation allowance against the deferred tax asset related to a tax basis capital loss generated with respect to our settlement and subsequent disposal of an earlier investment in Athena Structured Funds PLC. As we have no expectation of generating capital gains with the applicable carryforward period, we do not believe that it is “more likely than not” that the deferred asset will be realized.

  

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 are expected to result in a capital loss.

 

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Deferred Financing and Issuance Costs

 

Financing costs incurred under the revolving senior credit facility were capitalized and are amortized using the straight-line method over the term of the revolving senior credit facility. The Series I Secured Note obligations are reported net of issuance costs, sales commissions, and other direct expenses, which are amortized using the interest method over the term of each respective borrowing. The L Bonds are reported net of issuance costs, sales commissions, and other direct expenses, which are amortized using the interest method over the term of each respective borrowing. The Series A Preferred Stock, as described in Note 9, was reported net of issuance costs, sales commissions, including the fair value of warrants issued, and other direct expenses, which were amortized using the interest method as interest expense over a three-year redemption period. As of December 31, 2015, these costs have been fully amortized.  Selling and issuance costs of Redeemable Preferred Stock and MCA Preferred Stock, described in Notes 10 and 11, are netted against additional paid-in-capital.

 

Principal Revenue and Expense Items

 

We earn revenues from the following three primary sources.

 

Life Insurance Contract Benefits Realized. We recognize the difference between the face value of the contract benefits and carrying values when an insured’s mortality event occurs and determine that settlement and collection of the contract 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 contract benefit from the insurance company within 45 days of recognizing the revenue.

 

Change in Fair Value of Life Insurance Contracts. We value our portfolio investments for each reporting period in accordance with the fair value principles discussed herein, which includes the expected payment of premiums for future periods.

 

Sale of a Life Insurance Contract. In the event of a sale of a contract, we recognize gain or loss as the difference between the sale price and the carrying value of the contract 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 contracts. These expenses include salaries and benefits, sales, marketing, occupancy and other expenditures.

 

Interest and Dividends. 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 lender under our revolving senior credit facility, interest paid on our L Bonds and other outstanding indebtedness such as our Series I Secured Notes, and dividends on our Series A Preferred Stock and our Redeemable Preferred Stock. When we issue debt, we amortize the issuance 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, 2016 Compared to the Same Periods in 2015 

 

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,
 
   2016   2015   2016   2015 
Revenue recognized from the receipt of contract benefits  $8,137,000   $618,000   $22,765,000   $25,632,000 
Revenue (expense) recognized from the change in fair value of life insurance contracts, net of premiums and carrying costs (1)   12,246,000    7,856,000    15,332,000    (375,000)
Gain on life insurance contracts, net  $20,383,000   $8,474,000   $38,097,000   $25,257,000 
Number of contracts matured   6    1    12    7 
The change in fair value related to new contracts acquired  $9,822,000   $4,511,000   $17,841,000   $5,123,000 

 

(1) The discount rate applied to estimate the fair value of the portfolio of life insurance contracts we own was 11.05% as of June 30, 2016, compared to 11.19% as of June 30, 2015.  The carrying value of contracts 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 (see Note 4 to our consolidated financial statements).

 

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Expenses.

 

   Three Months Ended
June 30,
   Six Months Ended
June 30,
 
   2016   2015   Increase   2016   2015   Increase 
Employee compensation and benefits (1)  $3,071,000   $2,145,000   $926,000   $5,538,000   $3,873,000   $1,665,000 
Interest expense (including amortization of deferred financing costs and preferred stock dividends) (2)   10,366,000    7,322,000    3,044,000    20,026,000    14,499,000    5,527,000 
Legal and professional expenses (3)   1,304,000    643,000    661,000    2,510,000    1,166,000    1,344,000 
Other expenses (4)   2,333,000    1,881,000    452,000    4,745,000    3,415,000    1,330,000 
Total expenses  $17,074,000   $11,991,000   $5,083,000   $32,819,000   $22,953,000   $9,866,000 

 

(1) We hired additional members to our sales, marketing, legal and information technology teams.  At the end of 2015 we employed approximately 50 employees, and at June 30, 2016 we employed approximately 68 employees.
(2) The increase in the current period was due to the increase in our average debt outstanding.
(3) Increase is due to SEC filings and other costs related to securities offerings and on-going compliance.
(4) Increase is due to increased public relations, sales and marketing costs associated with growing and servicing our network of independent financial advisors.

 

Income Tax Expense.

 

The following table reconciles our income tax expense at the statutory federal tax rate to our actual income tax expense:

 

   Three Months Ended   Six Months Ended 
   June 30, 2016   June 30, 2015   June 30, 2016   June 30, 2015 
Statutory federal income tax (benefit)  $1,316,000    34.0%  $(1,167,000)   34.0%  $2,050,000    34.0%  $831,000    34.0%
State income taxes (benefit), net of federal benefit   291,000    7.5%   (187,000)   5.5%   466,000    7.7%   229,000    9.4%
Series A preferred stock dividends   204,000    5.3%   168,000    (4.9)%   378,000    6.3%   351,000    14.4%
Other permanent differences   11,000    0.3%   10,000    (0.3)%   13,000    0.2%   22,000    0.8%
Total income tax expense (benefit)  $1,822,000    47.1%  $(1,176,000)   34.3%  $2,907,000    48.2%  $1,433,000    58.6%

 

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 contracts and revenue recognition with respect to the fair value of life insurance portfolio.

 

The primary permanent difference between our effective tax rate and the statutory federal rate are the accrual of preferred stock dividend expense, state income taxes, and other non-deductible expenses. The dividends charged to interest expense were $0.6 million and $0.5 million during the three months ended June 30, 2016 and 2015, respectively, and $1.1 million and $1.0 million during the six months ended June 30, 2016 and 2015, respectively.

 

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Liquidity and Capital Resources

 

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

 

As of June 30, 2016 and December 31, 2015, we had approximately $47.2 million and $74.4 million, respectively, in combined available cash and available borrowing base surplus capacity under our revolving credit facility for the purpose of purchasing additional life insurance contracts, paying premiums on existing contracts, paying portfolio servicing expenses, and paying principal and interest on our outstanding financing obligations.

 

Debt Financings Summary

 

We had the following outstanding debt balances as of June 30, 2016:

 

Issuer/Borrower 

Principal Amount

Outstanding

  

Weighted Average

Interest Rate

 
GWG Holdings, Inc. – L Bonds  $334,714,000    7.17%
GWG Life, LLC – Series I Secured Notes   18,283,000    8.62%
GWG DLP Funding II, LLC – Revolving credit facility   82,011,000    5.48%
Total  $435,008,000    6.91%

 

Our total revolving senior credit facility and other indebtedness balance as of June 30, 2016 and December 31, 2015 was $435.0 million and $370.8 million, respectively. At June 30, 2016, the total outstanding face amount under our Series I Secured Notes outstanding was $18.3 million, less unamortized selling costs of $0.3 million, resulting in a carrying amount of $18.0 million. At December 31, 2015, the total outstanding face amount under our Series I Secured Notes outstanding was $23.6 million, less unamortized selling costs of $0.3 million, resulting in a carrying amount of $23.3 million. At June 30, 2016, the total outstanding face amount of L Bonds was $334.7 million plus $2.6 million of subscriptions in process, less unamortized selling costs of $10.0 million resulting in a carrying amount of $327.3 million. At December 31, 2015, the total outstanding face amount of L Bonds was $282.2 million plus $3.0 million of subscriptions in process, less unamortized selling costs of $8.2 million resulting in a carrying amount of $277.0 million.

 

The weighted-average interest rate of our outstanding Series I Secured Notes as of June 30, 2016 and December 31, 2015 was 8.62% and 8.47%, respectively, and the weighted-average maturity at those dates was 1.45 and 1.06 years, respectively. The Series I Secured Notes have renewal features. Since we first issued our Series I Secured Notes, we experienced $162.6 million in maturities, of which $123.0 million renewed for an additional term as of June 30, 2016. This provided us with an aggregate renewal rate of approximately 76% for investments in these securities.

 

The weighted-average interest rate of our outstanding L Bonds as of June 30, 2016 and December 31, 2015 was 7.17% and 7.18%, respectively, and the weighted-average maturity at those dates was 2.01 and 2.02 years, respectively. Our L Bonds have renewal features. As of June 30, 2016, $217.1 million L Bonds matured, of which $143.3 million renewed for an additional term. The aggregate renewal rate is approximately 66% for investments in these securities. 

 

Future contractual maturities of Series I Secured Notes and L Bonds at December 31, 2016 are:

 

Years Ending December 31,  Series I Secured Notes   L Bonds   Total 
2016  $3,574,000   $58,270,000   $61,844,000 
2017   8,758,000    85,052,000    93,810,000 
2018   2,401,000    87,168,000    89,569,000 
2019   869,000    50,526,000    51,395,000 
2020   1,766,000    19,457,000    21,223,000 
Thereafter   915,000    34,241,000    35,156,000 
   $18,283,000   $334,714,000   $352,997,000 

 

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The L Bonds and Series I Secured Notes are secured by all of our assets, and are subordinate to our revolving senior credit facility with Autobahn/DZ Bank. 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 6 and 7 to our consolidated financial statements). 

 

We maintain a $105 million revolving senior credit facility with Autobahn/DZ Bank through GWG Life’s wholly owned subsidiaries DLP II and DLP III. The revolving senior credit facility is used to pay the premium expenses related to our portfolio of life insurance contracts. As of June 30, 2016 and December 31, 2015, we had approximately $82.0 million and $65.0 million, respectively, outstanding under the revolving senior credit facility, and maintained an available borrowing base surplus of $23.0 million and $40.0 million, respectively. Effective May 11, 2015, we amended and restated our senior credit facility to reduce the interest cost and extend the term of the facility to June 2018 (see Note 5 to our consolidated financial statements). 

  

Capital expenditures have historically not been material and we do not anticipate making material capital expenditures in 2016 or beyond.

 

Corporate Financing History

 

In November 2009, our wholly owned subsidiary GWG Life offered Series I Secured Notes in a private placement to accredited investors only. This offering was closed in November 2011. As of June 30, 2016 and December 31, 2015, we had approximately $18.3 million and $23.6 million, respectively, in principal amount of Series I Secured Notes outstanding.

 

In September 2011, we concluded a private placement offering of Series A Preferred Stock, having received an aggregate $24.6 million in subscriptions for our Series A Preferred Stock. These subscriptions consisted of $14.0 million in conversions of outstanding Series I Secured Notes and $10.6 million of new investments. As of June 30, 2016 and December 31, 2015, respectively, we had approximately $20.4 million and $20.8 million of Series A Preferred Stock outstanding.

 

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 January 2015.

 

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 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 offering to our earlier $250.0 million public debt offering. Through June 30, 2016, the total amount of these L Bonds sold, including renewals, was $551.9 million. As of June 30, 2016 and December 31, 2015, respectively, we had approximately $334.7 million and $282.2 million, respectively, in principal amount of L Bonds outstanding.

 

In October 2015, we began publicly offering up to 100,000 shares of our Redeemable Preferred Stock at a per-share price of $1,000. As of June 30, 2016 we had issued approximately $12.2 million of Redeemable Preferred Stock.

 

Effective February 4, 2016, GWG MCA began to offer for sale up to of 2,000,000 shares of 9% Preferred Stock at an offering price of $10 per share in a private placement. As of June 30, 2016, GWG MCA had issued approximately $72,000 of MCA Preferred Stock.

 

Portfolio Assets and Secured Indebtedness 

 

At June 30, 2016, the fair value of our investments in life insurance contracts of $431.8 million plus our cash balance of $17.4 million, our restricted cash balance of $11.2 million and our life insurance contract benefits receivable of $6.8 million, totaled $467.2 million, representing an excess of portfolio assets over secured indebtedness of $32.2 million. At December 31, 2015, the fair value of our investments in life insurance contracts of $356.6 million plus our cash balance of $34.4 million and our restricted cash balance of $2.3 million, totaled $393.3 million, representing an excess of portfolio assets over secured indebtedness of $22.5 million. The L Bonds and Series I Secured Notes are secured by all of our assets and are subordinate to our revolving senior credit facility with Autobahn/DZ Bank. The L Bonds and Series I Secured Notes are pari passu with respect to a security interest in our asset pursuant to an intercreditor agreement.

 

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The following forward-looking table seeks to illustrate the impact of the sale of our portfolio of life insurance assets at various discount rates in order to satisfy our debt obligations as of June 30, 2016. In all cases, the sale of the life insurance assets owned by DLP III will be used first to satisfy all amounts owing under the revolving senior credit facility with Autobahn/DZ Bank. The net sale proceeds remaining after satisfying all obligations under the revolving senior credit facility would be applied to L Bonds and Series I Secured Notes on a pari passu basis.

 

Portfolio Discount Rate   10%   11%   12%   13%   14%  
Value of portfolio   $ 454,883,000   $ 432,872,000   $ 412,635,000   $ 393,947,000   $ 376,654,000  
Cash, cash equivalents and life insurance contract benefits receivable     35,369,000     35,369,000     35,369,000     35,369,000     35,369,000  
Total assets     490,202,000     468,241,000     448,004,000     429,316,000     412,023,000  
Revolving senior credit facility Autobahn/DZ Bank     82,011,000     82,011,000     82,011,000     82,011,000     82,011,000  
Net after revolving senior credit facility     408,191,000     386,230,000     365,993,000     347,305,000     330,012,000  
Series I Secured Notes and L Bonds     352,997,000     352,997,000     352,997,000     352,997,000     352,997,000  
Net after Series I Secured Notes and L Bonds     55,194,000     33,233,000     12,996,000     (5,692,000 )   (22,985,000 )
Impairment to Series I Secured Notes and L Bonds     No impairment     No impairment     No impairment     Impairment       Impairment   

 

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 of our life insurance assets at a price equivalent to a discount rate of approximately 12.69% or higher. At December 31, 2015, the impairment occurred at a discount rate of approximately 12.58% or higher. The discount rates used to calculate the fair value of our portfolio were 11.05% and 11.09% as of June 30, 2016 and December 31, 2015, 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. You should read the above table in conjuncti