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, 2018

 

or

 

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

 

For the transition period from _________ to ________

 

Commission File Number: None

 

 

GWG HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

 

 

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

 

220 South Sixth Street, Suite 1200

Minneapolis, MN 55402

(Address of principal executive offices, including zip code)

 

(612) 746-1944

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ☒ Yes  ☐ No

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). ☒ Yes  ☐ No

 

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

 

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

 

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

 

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

 

As of August 14, 2018, GWG Holdings, Inc. had 5,813,555 shares of common stock outstanding.

 

 

 

GWG HOLDINGS, INC.

 

Index to Form 10-Q

for the Quarter Ended June 30, 2018

 

		Page No.
PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements	1
	Condensed Consolidated Balance Sheets as of June 30, 2018, and December 31, 2017	1
	Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2018 and 2017	2
	Condensed Consolidated Statements of Cash Flows for the three and six months ended June 30, 2018 and 2017	3
	Consolidated Statement of Changes in Stockholders’ Equity	5
	Notes to Condensed Consolidated Financial Statements	6
Item 1A.	Risk Factors	29
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	32
Item 4.	Controls and Procedures	48
PART II. OTHER INFORMATION
Item 6.	Exhibits	49
SIGNATURES		50

 

 

 

PART I — FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

 

		June 30, 2018				December 31, 2017
		(unaudited)
A S S E T S
Cash and cash equivalents		$	124,444,804			$	114,421,491
Restricted cash			6,651,309				28,349,685
Investment in life insurance policies, at fair value			726,063,244				650,527,353
Life insurance policy benefits receivable			27,035,000				16,658,761
Other assets			10,841,567				8,898,884
TOTAL ASSETS		$	895,035,924			$	818,856,174
L I A B I L I T I E S & S T O C K H O L D E R S’  E Q U I T Y
LIABILITIES
Senior credit facility with LNV Corporation		$	180,630,553			$	212,238,192
L Bonds			518,788,942				447,393,568
Accounts payable			2,626,283				6,394,439
Interest and dividends payable			16,936,725				15,427,509
Other accrued expenses			4,031,070				3,730,723
TOTAL LIABILITIES			723,013,573				685,184,431
STOCKHOLDERS’ EQUITY
REDEEMABLE PREFERRED STOCK
(par value $0.001; shares authorized 100,000; shares outstanding 98,095 and 98,611; liquidation preference of $98,667,000 and $99,186,000 as of June 30, 2018 and December 31, 2017, respectively)			88,997,278				92,840,243
SERIES 2 REDEEMABLE PREFERRED STOCK
(par value $0.001; shares authorized 150,000; shares outstanding 148,705 and 88,709; liquidation preference of $149,573,000 and $89,208,000 as of June 30, 2018 and December 31, 2017, respectively)			131,704,423				80,275,204
COMMON STOCK
(par value $0.001: shares authorized 210,000,000; shares issued and outstanding 5,813,555 as of both June 30, 2018 and December 31, 2017)			5,813				5,813
Additional paid-in capital			-				-
Accumulated deficit			(48,685,163	)			(39,449,517	)
TOTAL STOCKHOLDERS’ EQUITY			172,022,351				133,671,743
TOTAL LIABILITIES & EQUITY		$	895,035,924			$	818,856,174

 

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

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

 

		Three Months Ended								Six Months Ended
		June 30, 2018				June 30, 2017				June 30, 2018				June 30, 2017
REVENUE
Gain on life insurance policies, net		$	23,339,750			$	11,296,266			$	37,208,495			$	30,696,086
Interest and other income			975,198				371,320				1,648,125				1,059,845
TOTAL REVENUE			24,314,948				11,667,586				38,856,620				31,755,931
EXPENSES
Interest expense			17,147,850				12,246,025				33,211,187				25,490,241
Employee compensation and benefits			3,235,699				3,741,299				6,978,368				6,904,360
Legal and professional fees			1,155,728				1,330,589				2,329,357				2,276,937
Other expenses			2,832,777				3,761,098				5,573,354				6,541,420
TOTAL EXPENSES			24,372,054				21,079,011				48,092,266				41,212,958
INCOME (LOSS) BEFORE INCOME TAXES			(57,106	)			(9,411,425	)			(9,235,646	)			(9,457,027	)
INCOME TAX EXPENSE (BENEFIT)			-				(3,717,174	)			-				(3,717,674	)
NET INCOME (LOSS)			(57,106	)			(5,694,251	)			(9,235,646	)			(5,739,353	)
Preferred stock dividends			4,338,487				2,031,097				8,042,971				3,898,857
NET INCOME (LOSS) ATTRIBUTABLE TO COMMON SHAREHOLDERS		$	(4,395,593	)		$	(7,725,348	)		$	(17,278,617	)		$	(9,638,210	)
NET INCOME (LOSS) PER SHARE
Basic		$	(0.76	)		$	(1.34	)		$	(2.97	)		$	(1.69	)
Diluted		$	(0.76	)		$	(1.34	)		$	(2.97	)		$	(1.69	)
WEIGHTED AVERAGE SHARES OUTSTANDING
Basic			5,813,555				5,777,724				5,813,555				5,710,909
Diluted			5,813,555				5,777,724				5,813,555				5,710,909

 

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

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

 

		Three Months Ended								Six Months Ended
		June 30, 2018				June 30, 2017				June 30, 2018				June 30, 2017
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)		$	(57,106	)		$	(5,694,251	)		$	(9,235,646	)		$	(5,739,353	)
Adjustments to reconcile net income (loss) to net cash flows from operating activities:
Change in fair value of life insurance policies			(14,573,175	)			(15,235,502	)			(31,218,769	)			(29,119,335	)
Amortization of deferred financing and issuance costs			2,402,773				1,497,948				4,665,961				4,164,151
Deferred income taxes			-				(3,717,174	)							(3,717,674	)
(Increase) decrease in operating assets:
Life insurance policy benefits receivable			(14,732,270	)			2,005,000				(10,376,239	)			(1,625,000	)
Other assets			(1,732,765	)			55,656				(1,809,206	)			2,252,361
Increase (decrease) in operating liabilities:
Accounts payable and other accrued expenses			542,090				1,400,844				(1,003,118	)			2,947,050
NET CASH FLOWS USED IN OPERATING ACTIVITIES			(28,150,453	)			(19,687,479	)			(48,977,017	)			(30,837,800	)
CASH FLOWS FROM INVESTING ACTIVITIES
Investment in life insurance policies			(30,248,939	)			(19,432,338	)			(55,548,764	)			(42,121,671	)
Carrying value of matured life insurance policies			6,148,349				3,014,834				11,231,643				5,383,808
NET CASH FLOWS USED IN INVESTING ACTIVITIES			(24,100,590	)			(16,417,504	)			(44,317,121	)			(36,737,863	)
CASH FLOWS FROM FINANCING ACTIVITIES
Net borrowings on (repayments of) senior debt			(29,080,815	)			(3,845,037	)			(32,135,150	)			(7,099,537	)
Payments for issuance of senior debt			-				(1,076,118	)			-				(1,190,412	)
Payments for redemption of Series I Secured Notes			-				(4,348,372	)			-				(9,798,261	)
Proceeds from issuance of L Bonds			60,536,446				31,875,811				97,197,545				56,744,470
Payments for issuance and redemption of L Bonds			(13,710,821	)			(15,025,566	)			(25,956,269	)			(39,197,163	)
Issuance (repurchase) of common stock			-				4				-				(1,603,556	)
Proceeds from issuance of preferred stock			14,372,959				34,301,747				56,238,128				61,480,941
Payments for issuance of preferred stock			(984,599	)			(1,945,618	)			(4,142,294	)			(3,963,105	)
Payments for redemption of preferred stock			(1,212,690	)			(1,372,593	)			(1,539,914	)			(1,759,332	)
Preferred stock dividends			(4,338,487	)			(2,031,097	)			(8,042,971	)			(3,898,857	)
NET CASH FLOWS PROVIDED BY FINANCING ACTIVITIES			25,581,993				36,533,161				81,619,075				49,715,188
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS			(26,669,050	)			428,178				(11,675,063	)			(17,860,475	)
CASH AND CASH EQUIVALENTS AND RESTRICTED CASH
BEGINNING OF PERIOD			157,765,163				98,024,925				142,771,176				116,313,578
END OF PERIOD		$	131,096,113			$	98,453,103			$	131,096,113			$	98,453,103

 

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

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS — CONTINUED

(unaudited)

 

		Three Months Ended								Six Months Ended
		June 30, 2018				June 30, 2017				June 30, 2018				June 30, 2017
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Interest paid		$	13,776,000			$	14,323,000			$	27,251,000			$	26,548,000
Premiums paid, including prepaid		$	12,393,000			$	11,646,000			$	24,226,000			$	22,606,000
Stock-based compensation		$	47,000			$	89,000			$	260,000			$	406,000
Payments for exercised stock options		$	-				100,000				37,000				100,000
NON-CASH INVESTING AND FINANCING ACTIVITIES
Options and stock appreciation rights issued			164,000				239,000				168,000				264,000
L Bonds:
Conversion of accrued interest and commissions payable to principal		$	219,000			$	397,000			$	562,000			$	905,000
Conversion of L Bonds to redeemable preferred stock		$	125,000			$	657,000			$	4,546,000			$	1,788,000
Preferred Stock:
Issuance of Series A Preferred Stock in lieu of cash dividends		$	-			$	166,000			$	-			$	337,000
Conversion of L Bonds to redeemable preferred stock		$	125,000			$	657,000			$	4,546,000			$	1,788,000
Investment in life insurance policies included in accounts payable		$	990,000			$	1,296,000			$	990,000			$	1,296,000

 

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

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

 CONDENSED 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, 2016			2,699,704			$	78,726,297				5,980,190			$	5,980			$	7,383,515			$	(18,817,294	)		$	67,298,498
Net income (loss)			-				-				-				-				-				(20,632,223	)			(20,632,223	)
Issuance of common stock			-				-				33,810				33				320,970				-				321,003
Redemption of common stock			-				-				(200,445	)			(200	)			(1,603,360	)			-				(1,603,560	)
Issuance of Series A preferred stock			71,237				498,659				-				-				-				-				498,659
Redemption of Series A preferred stock			(2,711,916	)			(20,199,792	)			-				-				-				-				(20,199,792	)
Issuance of redeemable preferred stock			129,622				122,933,106				-				-				(2,338,457	)			-				120,594,649
Redemption of redeemable preferred stock			(1,328	)			(1,327,776	)			-				-				-				-				(1,327,776	)
Preferred stock dividends			-				(8,925,807	)			-				-				(3,776,534	)			-				(12,702,341	)
Stock-based compensation			-				1,410,760				-				-				13,866				-				1,424,626
Balance, December 31, 2017			187,319			$	173,115,447				5,813,555			$	5,813			$	-			$	(39,449,517	)		$	133,671,743
Net income (loss)			-				-				-				-				-				(9,235,646	)			(9,235,646	)
Issuance of redeemable preferred stock			61,021				56,878,238				-				-				-				-				56,878,238
Redemption of redeemable preferred stock			(1,540	)			(1,539,914	)			-				-				-				-				(1,539,914	)
Preferred stock dividends			-				(8,042,971	)			-				-								-				(8,042,971	)
Stock-based compensation			-				290,901				-				-				-				-				290,901
Balance, June 30, 2018			246,800			$	220,701,701				5,813,555			$	5,813			$	-			$	(48,685,163	)		$	172,022,351

 

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

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

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

 

Nature of Business — We are a financial services company committed to disrupting and transforming the life insurance and related industries. We built our business by creating opportunities for consumers to obtain significantly more value for their life insurance policies in a secondary market as compared to the traditional options offered by the insurance industry. We are enhancing and extending our activities in the life insurance industry by bringing step change technology through the commercialization of advanced epigenetic technology. At the same time, we are creating opportunities for investors to receive income and capital appreciation from our investment activities related to the life insurance industry.

 

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

 

On August 25, 2016, GWG Holdings formed a wholly owned subsidiary, currently named Life Epigenetics Inc. (“Life Epigenetics”), to commercialize advanced epigenetic technology for the life insurance industry related to its exclusive license for “DNA Methylation Based Predictor of Mortality” technology.

 

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

 

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

 

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

 

In a case where our acquisition of a policy is not complete as of a reporting date, but we have nonetheless advanced direct costs and deposits for the acquisition, those costs and deposits are recorded as other assets on our condensed consolidated balance sheets until the acquisition is complete and we have secured title to the policy. On both June 30, 2018 and December 31, 2017, a total of $0 of our other assets comprised direct costs and deposits that we had advanced for life insurance policy acquisitions.

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

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

 

Other Assets — Life Epigenetics is engaged in the development of intellectual property related to its exclusive license for the “DNA Methylation Based Predictor of Mortality” technology for the life insurance industry. The cost of entering into this license agreement is included in other assets on our condensed consolidated balance sheets.

 

To maintain the Company’s life insurance provider licenses in certain states, we are required to keep cash security deposits with the states’ licensing authorities. Security deposits included in other assets were $575,000 at both June 30, 2018 and December 31, 2017.

 

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

 

The risk-free interest rate is based on the U.S. Treasury rates at the date of grant with maturity dates approximately equal to the expected life at grant date. Volatility is based on the standard deviation of the average continuously compounded rate of return of five selected comparable companies. We have not paid common stock dividends.

 

Deferred Financing and Issuance Costs — Loans advanced to us under our senior credit facility with LNV Corporation, as described in Note 6, are reported net of financing costs, including issuance costs, sales commissions and other direct expenses, which are amortized using the straight-line method over the term of the facility. We had no loans advanced to us under our senior credit facility with Autobahn Funding Company during the year ended December 31, 2017 and this credit facility has since been terminated, as described in Note 5. The L Bonds, as described in Note 8, are reported net of financing costs, which are amortized using the interest method over the term of those borrowings. The Series I Secured Notes, as described in Note 7 have been redeemed, was reported net of financing costs, all of which were fully amortized using the interest method as of December 31, 2017. The Series A Convertible Preferred Stock (“Series A”), as described in Note 9, was reported net of financing costs (including the fair value of warrants issued), all of which were fully amortized using the interest method as of December 31, 2017. All shares of Series A have been redeemed and the obligations thereunder satisfied. Selling and issuance costs of Redeemable Preferred Stock (“RPS”) and Series 2 Redeemable Preferred Stock (“RPS 2”), described in Notes 10 and 11, are netted against additional paid-in-capital, until depleted, and then against the outstanding balance of the preferred stock.

 

Earnings (loss) per Share — Basic earnings (loss) per share attributable to common shareholders are calculated using the weighted-average number of shares outstanding during the reported period. Diluted earnings (loss) per share are calculated based on the potential dilutive impact of our Series A, RPS, RPS 2, warrants and stock options. Due to our net loss attributable to common shareholders for the three and six months ended June 30, 2018, there are no dilutive securities.

 

Reclassification — Certain prior year amounts have been reclassified for consistency with the current year presentation. These reclassifications had no effect on the reported results of operations.

 

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

 

In March 2016, the FASB issued Accounting Standards Update 2016-09 (“ASU 2016-09”) to simplify the accounting for stock compensation related to the following items: income tax accounting, award classification, estimation of forfeitures, and cash flow presentation. The new guidance is effective for fiscal years beginning after December 15, 2016. We adopted ASU 2016-09 effective January 1, 2017. The impact of the adoption was not material to the financial statements.

 

In November 2016, the FASB issued Accounting Standards Update 2016-18 (“ASU 2016-18”), which amends ASC 230 Statement of Cash Flows to add or clarify guidance on the classification and presentation of restricted cash in the statement of cash flows. The guidance, to be applied retrospectively when adopted, requires entities to show the changes in the total of cash, cash equivalents, restricted cash and restricted cash equivalents in the statement of cash flows. The new guidance is effective for fiscal years beginning after December 15, 2017, and interim periods within those years. We adopted ASU 2016-18 as of March 31, 2018. The impact of the adoption was not material to the financial statements.

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

(2) Restrictions on Cash

 

Under the terms of our senior credit facility with LNV Corporation (discussed in Note 6), we are required to maintain collection and payment accounts that are used to collect policy benefits from pledged policies, pay annual policy premiums, interest and other charges under the facility, and distribute funds to pay down the facility. The agents for the lender authorize the disbursements from these accounts. At June 30, 2018 and December 31, 2017, there was a balance of $1,937,000 and $19,967,000, respectively, in these collection and payment accounts.

 

To fund the Company’s acquisition of life insurance policies, we are required to maintain escrow accounts. Distributions from these accounts are made according to life insurance policy purchase contracts. At June 30, 2018 and December 31, 2017, there was a balance of $4,714,000 and $8,383,000, respectively, in the Company’s escrow accounts.

 

(3) Investment in Life Insurance Policies

 

Our investments in life insurance policies are valued based on unobservable inputs that are significant to their overall fair value. Changes in the fair value of these policies, net of premiums paid, are recorded in gain on life insurance policies, net in our condensed consolidated statements of operations. Fair value is determined on a discounted cash flow basis that incorporates life expectancy assumptions generally derived from reports obtained from widely accepted life expectancy providers (other than insured lives covered under small face amount policies – those with $1 million in face value benefits or less), assumptions relating to cost-of-insurance (premium) rates and other assumptions. The discount rate we apply incorporates current information about discount rates applied by other public reporting companies owning portfolios of life insurance policies, the discount rates observed in the life insurance secondary market, market interest rates, the estimated credit exposure to the insurance companies that issued the life insurance policies and management’s estimate of the operational risk premium a purchaser would require to receive the future cash flows derived from our portfolio as a whole. Management has discretion regarding the combination of these and other factors when determining the discount rate. As a result of management’s analysis, a discount rate of 10.45% was applied to our portfolio as of both June 30, 2018 and December 31, 2017.

 

Portfolio Information

 

Our portfolio of life insurance policies, owned by our subsidiaries as of June 30, 2018, is summarized below:

 

Life Insurance Portfolio Summary

 

Total portfolio face value of policy benefits		$	1,849,079,000
Average face value per policy		$	1,831,000
Average face value per insured life		$	2,052,000
Average age of insured (yrs.)*			81.9
Average life expectancy estimate (yrs.)*			6.8
Total number of policies			1,010
Number of unique lives			901
Demographics			76% Males; 24% Females
Number of smokers			41
Largest policy as % of total portfolio face value			0.72	%
Average policy as % of total portfolio			0.10	%
Average annual premium as % of face value			3.11	%

 

*	Averages presented in the table are weighted averages.

 

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

 

		As of June 30, 2018												As of December 31, 2017
Years Ending December 31,		Number of Policies				Estimated Fair Value				Face Value				Number of Policies				Estimated Fair Value				Face Value
2018			4			$	3,328,000			$	3,375,000				8			$	4,398,000			$	4,689,000
2019			35				44,532,000				55,472,000				48				63,356,000				83,720,000
2020			80				77,686,000				115,736,000				87				79,342,000				127,373,000
2021			97				104,685,000				176,820,000				98				96,154,000				170,695,000
2022			119				100,279,000				190,208,000				90				85,877,000				181,120,000
2023			102				84,874,000				205,340,000				93				69,467,000				175,458,000
2024			111				83,602,000				232,258,000				100				77,638,000				228,188,000
Thereafter			462				227,077,000				869,870,000				374				174,295,000				704,905,000
Totals			1,010			$	726,063,000			$	1,849,079,000				898			$	650,527,000			$	1,676,148,000

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

We recognized life insurance benefits of $27,623,000 and $10,935,000 during the three months ended June 30, 2018 and 2017, respectively. The forgoing amounts pertained to policies with carrying values of $6,148,000 and $3,015,000, respectively, for which we recorded realized gains of $21,475,000 and $7,920,000, respectively. We recognized life insurance benefits of $42,127,000 and $29,910,000 during the six months ended June 30, 2018 and 2017, respectively. The forgoing amounts pertained to policies with carrying values of $11,232,000 and $5,384,000, for which we recorded realized gains of $30,895,000 and $24,526,000, respectively.

 

Reconciliation of gain on life insurance policies:

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2018				2017				2018				2017
Change in estimated probabilistic cash flows (1)		$	17,409,000			$	13,431,000			$	36,414,000			$	27,465,000
Unrealized gain on acquisitions (2)			5,795,000				8,044,000				12,769,000				18,646,000
Premiums and other annual fees			(12,708,000	)			(11,859,000	)			(24,906,000	)			(22,949,000	)
Change in discount rates (3)			-				4,143,000				-				4,143,000
Change in life expectancy evaluation (4)			(95,000	)			(6,662,000	)			(4,963,000	)			(8,604,000	)
Face value of matured policies			27,623,000				10,935,000				42,127,000				29,910,000
Fair value of matured policies			(14,684,000	)			(6,736,000	)			(24,233,000	)			(17,915,000	)
Gain on life insurance policies, net		$	23,340,000			$	11,296,000			$	37,208,000			$	30,696,000

  

(1)	Change in fair value of expected future cash flows relating to our investment in life insurance policies that are not specifically attributable to changes in life expectancy, discount rate or policy maturity events.

 

(2)	Gain resulting from fair value in excess of transaction price for policies acquired during the reporting period.

  

(3)	The discount rate of 10.45% as of June 30, 2018 remained unchanged from both the prior quarter and year end dates. The discount rate of 10.81% as of June 30, 2017 reflected a decrease from the 10.96% rate used at both the preceding quarter and year end dates.

 

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

  

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

 

Years Ending December 31,		Premiums				Servicing				Premiums and Servicing Fees
Six months ending December 31, 2018		$	27,358,000			$	677,000			$	28,035,000
2019			63,323,000				1,355,000				64,678,000
2020			73,758,000				1,355,000				75,113,000
2021			84,700,000				1,355,000				86,055,000
2022			95,964,000				1,355,000				97,319,000
2023			107,289,000				1,355,000				108,644,000
		$	452,392,000			$	7,452,000			$	459,844,000

 

Management anticipates funding the majority of the premium payments estimated above from cash flows realized from life insurance policy benefits, and to the extent necessary, with additional borrowing capacity, created as the premiums and servicing costs of pledged life insurance policies become due, under the amended and restated senior credit facility with LNV Corporation as described in Note 6, and the net proceeds from our offering of L Bonds as described in Note 8. Management anticipates funding premiums and servicing costs of non-pledged life insurance policies with cash flows realized from life insurance policy benefits from our portfolio of life insurance policies and net proceeds from our offering of L Bonds. The proceeds of these capital sources may also be used for the purchase, policy premiums and servicing costs of additional life insurance policies as well as for other working capital and financing expenditures including paying principal, interest and dividends.

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

(4) Fair Value Definition and Hierarchy

 

Accounting Standards Codification 820, Fair Value Measurements and Disclosures (“ASC 820”) establishes a hierarchical disclosure framework that prioritizes and ranks the level of market price observability used in measuring assets and liabilities at fair value. Market price observability is affected by a number of factors, including the type of investment, the characteristics specific to the investment and the state of the marketplace, including the existence and transparency of transactions between market participants. Assets and liabilities with readily available and actively quoted prices, or for which fair value can be measured from actively quoted prices in an orderly market, generally will have a higher degree of market price observability and a lesser degree of judgment used in measuring fair value.

 

ASC 820 maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring the use of observable inputs whenever available. Observable inputs are inputs that market participants would use in pricing the asset or liability developed based on market data obtained from independent sources. Unobservable inputs are inputs that reflect assumptions about how market participants price an asset or liability based on the best available information. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e., the “exit price”) in an orderly transaction between market participants at the measurement date.

 

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

 

Level 1 —

Valuations based on quoted prices in active markets for identical assets or liabilities that the Company has the ability to access. Because valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these products does not entail a significant degree of judgment.

 

Level 2 —

Valuations based on one or more quoted prices in markets that are not active or for which all significant inputs are observable, either directly or indirectly.

 

Level 3 —

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

 

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

 

Level 3 Valuation Process

 

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

 

These inputs are then used to estimate the discounted cash flows from the portfolio using the Model Actuarial Pricing System (“MAPS”) probabilistic and stochastic portfolio pricing model, which estimates the expected cash flows using various mortality probabilities and scenarios. The valuation process includes a review by senior management as of each quarterly valuation date. We also engage MAPS to independently test the accuracy of the valuations using the inputs we provide on a quarterly basis. A copy of a letter documenting the MAPS calculation is filed as Exhibit 99.1 to this report.

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

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

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2018				2017				2018				2017
Beginning balance		$	687,389,000			$	545,397,000			$	650,527,000			$	511,192,000
Purchases			30,249,000				19,432,000				55,549,000				42,122,000
Maturities (initial cost basis)			(6,148,000	)			(3,015,000	)			(11,232,000	)			(5,384,000	)
Net change in fair value			14,573,000				15,236,000				31,219,000				29,120,000
Ending balance		$	726,063,000			$	577,050,000			$	726,063,000			$	577,050,000

 

For life insurance policies with face amounts greater than $1 million and that are not pledged under any senior credit facility (approximately 18.4% of our portfolio by face amount of policy benefits) we attempt to update the life expectancy estimates on a continuous rotating three year cycle. For life insurance policies that are pledged under the LNV senior credit facility (approximately 73.1% of our portfolio by face amount of policy benefits) we are presently required to update the life expectancy estimates every two years beginning from the date of the amended facility. For the remaining small face insurance policies (i.e., a policy with $1 million in face value benefits or less) we may employ a range of methods and timeframes to update life expectancy estimates.

 

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

 

		As of June 30, 2018				As of December 31, 2017
Weighted-average age of insured, years *			81.9				81.7
Weighted-average life expectancy, months *			82.0				82.4
Average face amount per policy		$	1,831,000			$	1,867,000
Discount rate			10.45	%			10.45	%

 

(*)

Weighted-average by face amount of policy benefits

 

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

 

Change in Fair Value of the Investment in Life Insurance Policies

 

		Change in Life Expectancy Estimates
		minus 8 months				minus 4 months				plus 4 months				plus 8 months
June 30, 2018		$	96,387,000			$	47,837,000			$	(47,457,000	)		$	(94,194,000	)
December 31, 2017		$	86,391,000			$	42,886,000			$	(42,481,000	)		$	(84,238,000	)

 

		Change in Discount Rate
		minus 2%				minus 1%				plus 1%				plus 2%
June 30, 2018		$	75,047,000			$	35,898,000			$	(33,001,000	)		$	(63,412,000	)
December 31, 2017		$	68,117,000			$	32,587,000			$	(29,964,000	)		$	(57,583,000	)

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Other Fair Value Considerations

 

The carrying value of receivables, prepaid expenses, accounts payable and accrued expenses approximate fair value due to their short-term maturities and low credit risk. Using the income-based valuation approach, the estimated fair value of our L Bonds, having an aggregate face value of $534,302,000 as of June 30, 2018, is approximately $541,680,000 based on a weighted-average market interest rate of 6.78%. The carrying value of the senior credit facility with LNV Corporation reflects interest charged at 12-month LIBOR plus an applicable margin. The margin represents our credit risk, and the strength of the portfolio of life insurance policies collateralizing the debt. The overall rate reflects market, and the carrying value of the facility approximates fair value.

 

GWG MCA participates in the merchant cash advance industry by directly advancing sums to merchants and lending money, on a secured basis, to companies that advance sums to merchants. Each quarter, we review the carrying value of these cash advances, and determine if an impairment reserve is necessary. At June 30, 2018 one of our secured cash advances was impaired. Specifically, the secured loan to Nulook Capital LLC had an outstanding balance of $1,914,000 and a loan loss reserve of $1,908,000 at June 30, 2018. We deem fair value to be the estimated collectible value on each loan or advance made from GWG MCA. Secured MCA advances, net of loan loss reserve, of $1,345,000 and $1,662,000 are included within other assets on our condensed consolidated balance sheets as of June 30, 2018 and December 31, 2017, respectively. Where we estimate the collectible amount to be less than the outstanding balance, we record a reserve for the difference. Provision for MCA advances are recorded within other expenses on the statement of operations (see Note 15).

 

The following table summarizes outstanding common stock warrants (discussed in Note 13) as of June 30, 2018:

 

Month issued		Warrants issued				Fair value per share				Risk free rate				Volatility				Term
September 2014			16,000			$	1.26				1.85	%			17.03	%		5 years
			16,000

 

(5) Credit Facility — Autobahn Funding Company LLC

 

On September 12, 2017, we terminated our $105 million senior credit facility with Autobahn Funding Company LLC, the Credit and Security Agreement governing the facility as well as the related pledge agreement, pursuant to which our obligations under the facility were secured. We paid off in full all obligations under the facility on September 14, 2016, and since that date, we have had no amounts outstanding under the facility.

 

The Credit and Security Agreement contained certain financial and non-financial covenants, and we were in compliance with these covenants during the year ended December 31, 2017 until the date of termination.

 

(6) Credit Facility — LNV Corporation

 

On September 27, 2017, we entered into an amended and restated senior credit facility with LNV Corporation as lender through our subsidiary GWG DLP Funding IV, LLC (“DLP IV”). The Amended and Restated Loan Agreement governing the facility makes available a total of up to $300,000,000 in credit with a maturity date of September 27, 2029. Additional advances are available under the Amended and Restated Loan Agreement at the LIBOR rate as defined in the Amended and Restated Loan Agreement. Advances are available as the result of additional borrowing base capacity, created as the premiums and servicing costs of pledged life insurance policies become due. Interest will accrue on amounts borrowed under the Amended and Restated Loan Agreement at an annual interest rate, determined as of each date of borrowing or quarterly if there is no borrowing, equal to (A) the greater of 12-month LIBOR or the federal funds rate (as defined in the agreement) plus one-half of one percent per annum, plus (B) 7.50% per annum. The effective rate at June 30, 2018 was 10.19%. Interest payments are made on a quarterly basis.

 

As of June 30, 2018, approximately 73.1% of the total face value of our portfolio is pledged to LNV Corporation. The amount outstanding under this facility was $190,389,000 and $222,525,000 at June 30, 2018 and December 31, 2017, respectively. Obligations under the facility are secured by a security interest in DLP IV’s assets, for the benefit of the lenders under the Amended and Restated Loan Agreement, through an arrangement under which Wells Fargo serves as securities intermediary. The life insurance policies owned by DLP IV do not serve as direct collateral for the obligations of GWG Holdings under the L Bonds. The difference between the amount outstanding and the carrying amount on our condensed consolidated balance sheets is due to netting of unamortized debt issuance costs.

 

The Amended and Restated Loan Agreement has certain financial and nonfinancial covenants, and we were in compliance with these covenants at June 30, 2018 and December 31, 2017.

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

(7) Series I Secured Notes

 

Series I Secured Notes were legal obligations of GWG Life and were privately offered and sold from August 2009 through June 2011. On September 8, 2017, we redeemed all outstanding Series I Secured Notes for an aggregate of $6,815,000.

 

(8) L Bonds

 

Our L Bonds are legal obligations of GWG Holdings. Obligations under the L Bonds are secured by the assets of GWG Holdings and by GWG Life, as a guarantor, and are subordinate to the obligations under our senior credit facility (see Note 6). We began publicly offering and selling L Bonds in January 2012 under the name “Renewable Secured Debentures”. These debt securities were re-named “L Bonds” in January 2015. L Bonds are publicly offered and sold on a continuous basis under a registration statement permitting us to sell up to $1.0 billion in principal amount of L Bonds through January 2018. On December 1, 2017, an additional public offering was declared effective permitting us to sell up to $1.0 billion in principal amount of L Bonds on a continuous basis. The new offering is a follow-on to the previous L Bond offering and contains the same terms and features. We are party to an indenture governing the L Bonds dated October 19, 2011, as amended (“Indenture”), under which GWG Holdings is obligor, GWG Life is guarantor, and Bank of Utah serves as indenture trustee. On March 27, 2018 GWG L Bond holders approved Amendment No.1 to the Amended and Restated Indenture with Bank of Utah. This amendment expands the definition of Total Coverage to include, without duplication, the value of all of our other assets as reflected on our most recently available balance sheet prepared in accordance with GAAP. The Indenture contains certain financial and non-financial covenants, and we were in compliance with these covenants at June 30, 2018 and December 31, 2017.

 

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, 2018 and December 31, 2017, the weighted-average interest rate of our L Bonds was 7.15% and 7.29%, respectively. The principal amount of L Bonds outstanding was $534,302,000 and $461,427,000 at June 30, 2018 and December 31, 2017, respectively. The difference between the amount of outstanding L Bonds and the carrying amount on our condensed consolidated balance sheets is due to netting of unamortized deferred issuance costs, cash receipts for new issuances and payments of redemptions in process. Amortization of deferred issuance costs was $2,139,000 and $927,000 for the three months ended June 30, 2018 and 2017, respectively, and $4,138,000 and $2,856,000 for the six months ended June 30, 2018 and 2017, respectively. Future expected amortization of deferred financing costs as of June 30, 2018 is $18,060,000 in total over the next seven years.

 

Future contractual maturities of L Bonds, and future amortization of their deferred financing costs, at June 30, 2018 are as follows:

 

Years Ending December 31,		Contractual Maturities				Unamortized Deferred Financing Costs
Six months ending December 31, 2018		$	60,612,000			$	312,000
2019			150,617,000				3,024,000
2020			114,594,000				4,050,000
2021			65,293,000				2,860,000
2022			39,713,000				1,888,000
2023			36,818,000				1,984,000
Thereafter			66,655,000				3,942,000
		$	534,302,000			$	18,060,000

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

(9) Series A Convertible Preferred Stock

 

From July 2011 through September 2012, we privately offered shares of Series A of GWG Holdings at $7.50 per share. In the offering, we sold an aggregate of 3,278,000 shares for gross consideration of $24,582,000. Holders of Series A were entitled to cumulative dividends at the rate of 10% per annum, paid quarterly. The Series A Convertible Preferred Stock were only redeemable at our option.

 

Purchasers of Series A in our offering received warrants to purchase an aggregate of 416,000 shares of our common stock at an exercise price of $12.50 per share. As of June 30, 2018 and December 31, 2017, all of these warrants have expired and none of them had been exercised.

 

On October 9, 2017 all shares of Series A were redeemed with a redemption payment equal to the sum of: (i) $8.25 per Series A share and (ii) all accrued but unpaid dividends.

 

(10) Redeemable Preferred Stock

 

On November 30, 2015, our public offering of up to 100,000 shares of RPS at $1,000 per share was declared effective. Holders of RPS are entitled to cumulative dividends at the rate of 7% per annum, paid monthly. Dividends on the RPS are recorded as a reduction to additional paid-in capital, if any, then to the outstanding balance of the preferred stock if additional paid-in-capital has been exhausted. Under certain circumstances described in the Certificate of Designation for the RPS, additional shares of RPS may be issued in lieu of cash dividends.

 

The RPS ranks senior to our common stock and pari passu with our RPS 2 and entitles its holders to a liquidation preference equal to the stated value per share (i.e., $1,000) plus accrued but unpaid dividends. Holders of RPS may presently convert their RPS into our common stock at a conversion price equal to the volume-weighted average price of our common stock for the 20 trading days immediately prior to the date of conversion, subject to a minimum conversion price of $15.00 and in an aggregate amount limited to 15% of the stated value of RPS originally purchased by such holder from us and still held by such holder.

 

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

 

In March 2017, we closed the RPS offering to additional investors having sold 99,127 shares of RPS for an aggregate gross consideration of $99,127,000 and incurred approximately $7,019,000 of related selling costs.

 

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

 

(11) Series 2 Redeemable Preferred Stock

 

On February 14, 2017, our public offering of up to 150,000 shares of RPS 2 at $1,000 per share was declared effective. Holders of RPS 2 are entitled to cumulative dividends at the rate of 7% per annum, paid monthly. Dividends on the RPS 2 are recorded as a reduction to additional paid-in capital, if any, then to the outstanding balance of the preferred stock if additional paid-in capital has been exhausted. Under certain circumstances described in the Certificate of Designation for the RPS 2, additional shares of RPS 2 may be issued in lieu of cash dividends.

 

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

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

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

 

In April 2018, we closed the RPS 2 offering to additional investors having sold 149,979 shares of RPS 2 for an aggregate gross consideration of $149,979,000 and incurred approximately $10,284,000 of related selling costs.

 

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

 

(12) Income Taxes

 

We had a current income tax liability of $0 as of both June 30, 2018 and December 31, 2017. The components of our income tax expense (benefit) and the reconciliation at the statutory federal tax rate to our actual income tax expense (benefit) for the three and six months ended June 30, 2018 and 2017 consisted of the following:

 

		Three Months Ended								Six Months Ended
		June 30,				June 30,				June 30,				June 30,
		2018				2017				2018				2017
Statutory federal income tax (benefit)		$	(12,000	)		$	(3,200,000	)		$	(1,939,000	)		$	(3,215,000	)
State income taxes (benefit), net of federal benefit			10,000				(607,000	)			(692,000	)			(609,000	)
Change in valuation allowance			(36,000	)			-				2,568,000				-
Other permanent differences			38,000				90,000				63,000				106,000
Total income tax expense (benefit)		$	-			$	(3,717,000	)		$	-			$	(3,718,000	)

  

The tax effects of temporary differences that give rise to deferred income taxes were as follows:

 

		As of June 30, 2018				As of December 31, 2017
Deferred tax assets:
Note receivable from related party		$	1,437,000			$	1,437,000
Net operating loss carryforwards			9,787,000				9,995,000
Other assets			1,487,000				1,724,000
Subtotal			12,711,000				13,156,000
Valuation allowance			(8,954,000	)			(6,386,000	)
Deferred tax assets			3,757,000				6,770,000
Deferred tax liabilities:
Investment in life insurance policies			(3,651,000	)			(6,630,000	)
Other liabilities			(106,000	)			(140,000	)
Net deferred tax asset(liability)		$	-			$	-

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

At June 30, 2018 and December 31, 2017, we had federal net operating loss (“NOL”) carryforwards of $34,052,000 and $34,775,000, respectively. The NOL carryforwards will begin to expire in 2031. Future utilization of NOL carryforwards is subject to limitations under Section 382 of the Internal Revenue Code. This section generally relates to a more than 50 percent change in ownership over a three-year period. We currently do not believe that any prior issuance of common stock has resulted in an ownership change under Section 382 through June 30, 2018.

 

We provide for a valuation allowance when it is not considered “more likely than not” that our deferred tax assets will be realized. As of June 30, 2018, based on all available evidence, we have provided a valuation allowance against our total net deferred tax asset of $8,954,000 due to uncertainty as to the realization of our deferred tax assets during the carryforward periods.

 

On December 22, 2017, the U.S. federal government enacted the Tax Cuts and Jobs Act (“Tax Reform Bill”). The Tax Reform Bill changed existing United States tax law, including a reduction of the U.S. corporate income tax rate. The Company re-measured deferred taxes as of the date of enactment, reflecting those changes within deferred tax assets as of December 31, 2017.

 

ASC 740 requires the reporting of certain tax positions that do not meet a threshold of “more-likely-than-not” to be recorded as uncertain tax benefits. It is management’s responsibility to determine whether it is “more-likely-than-not” that a tax position will be sustained upon examination, including resolution of any related appeals or litigation, based upon the technical merits of the position. Management has reviewed all income tax positions taken or expected to be taken for all open years and has determined that the income tax positions are appropriately stated and supported. We do not anticipate that the total unrecognized tax benefits will significantly change prior to December 31, 2018.

 

Under our accounting policies, interest and penalties on unrecognized tax benefits, as well as interest received from favorable tax settlements are recognized as components of income tax expense. At June 30, 2018 and December 31, 2017, we recorded no accrued interest or penalties related to uncertain tax positions.

 

Our income tax returns for tax years ended December 31, 2014, 2015, 2016 and 2017, when filed, remain open to examination by the Internal Revenue Service and various state taxing jurisdictions. Our income tax return for tax year ended December 31, 2013 also remains open to examination by various state taxing jurisdictions.

 

(13) Common Stock

 

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

 

In conjunction with the initial public offering our Company issued warrants to purchase 16,000 shares of common stock at an exercise price of $15.63 per share. As of June 30, 2018, none of these warrants had been exercised. The remaining life of these warrants at June 30, 2018 was 1.3 years.

 

(14) Stock Incentive Plan

 

We adopted our 2013 Stock Incentive Plan in March 2013, as amended on June 1, 2015 and May 5, 2017. The Compensation Committee of our Board of Directors is responsible for the administration of the plan. Participants under the plan may be granted incentive stock options and non-statutory stock options; stock appreciation rights; stock awards; restricted stock; restricted stock units; and performance shares. Eligible participants include officers and employees of GWG Holdings and its subsidiaries, members of our Board of Directors, and consultants. Awards generally expire 10 years from the date of grant. As of June 30, 2018, 6,000,000 common stock options are authorized under the plan, of which 3,735,564 remain available for issuance.

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Stock Options

 

As of June 30, 2018, we had outstanding stock options for 1,679,000 shares of common stock to employees, officers, and directors under the plan. Options for 1,061,000 shares have vested, and the remaining options are scheduled to vest over three years. The options were issued with an exercise price between $6.35 and $10.38 for those beneficially owning more than 10% of our common stock, and between $4.83 and $11.00 for all others, which is equal to the market price of the shares on the date of grant. The expected annualized volatility used in the Black-Scholes model valuation of options issued during the three months ended June 30, 2018 was 20.7%. The annual volatility rate is based on the standard deviation of the average continuously compounded daily changes of stock price of five selected comparable companies. As of June 30, 2018, stock options for 723,000 shares had been forfeited and stock options for 178,000 shares had been exercised.

 

Outstanding stock options:

 

		Vested				Un-vested				Total
Balance as of December 31, 2016			738,065				844,334				1,582,399
Granted during the year			61,099				367,500				428,599
Vested during the year			327,061				(327,061	)			-
Exercised during the year			(126,498	)			-				(126,498	)
Forfeited during the year			(142,535	)			(105,017	)			(247,552	)
Balance as of December 31, 2017			857,192				779,756				1,636,948
Granted year-to-date			4,850				99,200				104,050
Vested year-to-date			235,424				(235,424	)			-
Exercised year-to-date			(23,834	)			-				(23,834	)
Forfeited year-to-date			(12,582	)			(25,501	)			(38,083	)
Balance as of June 30, 2018			1,061,050				618,031				1,679,081

 

As of June 30, 2018, unrecognized compensation expense related to un-vested options is $933,000. We expect to recognize this compensation expense over the remaining vesting period ($304,000 in 2018, $426,000 in 2019, $183,000 in 2020, and $20,000 in 2021).

 

Stock Appreciation Rights (SARs)

 

As of June 30, 2018, we had outstanding SARs for 407,000 shares of the common stock to employees. The strike price of the SARs was between $7.84 and $10.38, which was equal to the market price of the common stock at the date of issuance. As of June 30, 2018, 215,000 of the SARs were vested. On June 30, 2018, the market price of GWG’s common stock was $7.68.

 

Outstanding SARs:

 

		Vested				Un-vested				Total
Balance as of December 31, 2016			106,608				133,127				239,735
Granted during the year			13,001				91,986				104,987
Vested during the year			69,444				(69,444	)			-
Forfeited during the year			-				(1,750	)			(1,750	)
Balance as of December 31, 2017			189,053				153,919				342,972
Granted year-to-date			-				64,050				64,050
Vested year-to-date			25,699				(25,699	)			-
Forfeited year-to-date			-				-				-
Balance as of June 30, 2018			214,752				192,270				407,022

 

The liability for the SARs as of June 30, 2018 and December 31, 2017 was $483,000 and $551,000, respectively, and was recorded within other accrued expenses on the condensed consolidated balance sheets. Employee compensation and benefits expense for SARs of ($118,000) and $23,000 was recorded for the three months ended June 30, 2018 and 2017, respectively, and ($68,000) and $312,000 was recorded for the six months ended June 30, 2018 and 2017, respectively.

 

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

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

The following summarizes information concerning outstanding options and SARs issued under the 2013 Stock Incentive Plan:

 

		June 30, 2018
		Outstanding				Weighted-Average Exercise Price				Weighted-Average Remaining Life (years)				Fair Value at Grant Date
Vested
Stock Options			1,061,050			$	8.21				5.90			$	1.82
SARs			214,752			$	8.61				5.41			$	1.89
Total Vested			1,275,802			$	8.28				5.81			$	1.83
Unvested
Stock Options			618,031			$	9.22				7.18			$	2.21
SARs			192,270			$	8.93				6.11			$	2.10
Total Unvested			810,301			$	9.16				6.93			$	2.18

 

		December 31, 2017
		Outstanding				Weighted-Average Exercise Price				Weighted-Average Remaining Life (years)				Fair Value at Grant Date
Vested
Stock Options			857,192			$	8.05				6.17			$	1.76
SARs			189,053			$	8.54				5.86			$	1.90
Total Vested			1,046,245			$	8.14				6.11			$	1.78
Unvested
Stock Options			779,756			$	9.21				7.50			$	2.17
SARs			153,919			$	9.16				6.24			$	2.02
Total Unvested			933,675			$	9.21				7.30			$	2.15

 

(15) Other Expenses

 

The components of other expenses in our condensed consolidated statements of operations for the three and six months ended June 30, 2018 and 2017 are as follows:

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2018				2017				2018				2017
Contract Labor		$	305,000			$	87,000			$	605,000			$	181,000
Marketing			509,000				649,000				930,000				1,201,000
Information Technology			366,000				351,000				866,000				682,000
Servicing and Facility Fees			468,000				405,000				862,000				686,000
Travel and Entertainment			230,000				283,000				446,000				518,000
Insurance and Regulatory			352,000				393,000				719,000				718,000
Charitable Contributions			-				89,000				-				420,000
Provision for MCA Advances			94,000				878,000				94,000				878,000
General and Administrative			509,000				626,000				1,051,000				1,257,000
Total Other Expenses		$	2,833,000			$	3,761,000			$	5,573,000			$	6,541,000

  

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

(16) Net Loss Attributable to Common Shareholders

 

We have outstanding RPS and RPS 2, as described in Notes 10 and 11. RPS and RPS 2 are anti-dilutive to our net loss attributable to common shareholders calculation for both the three and six months ended June 30, 2018 and 2017. Our vested and un-vested stock options are anti-dilutive for both the three and six months ended June 30, 2018 and 2017.

 

(17) Commitments

 

We are party to an office lease with U.S. Bank National Association as the landlord. On September 1, 2015, we entered into an amendment to our original lease that expanded the leased space to 17,687 square feet and extended the term through October 2025. Under the amended lease we are obligated to pay base rent plus common area maintenance and a share of building operating costs. Rent expenses under this agreement were $110,000 during both three months ended June 30, 2018 and 2017 and $215,000 and $223,000 during the six months ended June 30, 2018 and 2017, respectively.

 

Minimum lease payments under the amended lease are as follows:

 

Six months ending December 31, 2018		$	133,000
2019			275,000
2020			284,000
2021			293,000
2022			302,000
2023			311,000
Thereafter			593,000
		$	2,191,000

 

(18) 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.

 

(19) Guarantee of L Bonds

 

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

 

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

 

The following represents condensed consolidating financial information as of June 30, 2018 and December 31, 2017, with respect to the financial position, and as of June 30, 2018 and 2017, 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 IV and the Trust under the equity method. The non-guarantor subsidiaries column presents the financial information of all non-guarantor subsidiaries, including DLP IV and the Trust.

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Condensed Consolidating Balance Sheets

 

June 30, 2018		Parent				Guarantor Subsidiary				Non-Guarantor Subsidiaries				Eliminations				Consolidated
A S S E T S
Cash and cash equivalents		$	123,017,408			$	546,177			$	881,219			$	-			$	124,444,804
Restricted cash			-				5,648,925				1,002,384				-				6,651,309
Investment in life insurance policies, at fair value			-				70,892,773				655,170,471				-				726,063,244
Life insurance policy benefits receivable			-				800,000				26,235,000				-				27,035,000
Other assets			4,307,833				1,921,184				4,612,550				-				10,841,567
Investment in subsidiaries			577,018,061				498,224,110				-				(1,075,242,171	)			-
TOTAL ASSETS		$	704,343,302			$	578,033,169			$	687,901,624			$	(1,075,242,171	)		$	895,035,924
L I A B I L I T I E S  &  S T O C K H O L D E R S’  E Q U I T Y
LIABILITIES
Senior credit facility with LNV Corporation		$	-			$	-			$	180,630,553			$	-			$	180,630,553
L Bonds			518,788,942				-				-				-				518,788,942
Accounts payable			580,162				738,894				1,307,227				-				2,626,283
Interest and dividends payable			11,449,184				-				5,487,541				-				16,936,725
Other accrued expenses			1,502,663				1,736,033				792,374				-				4,031,070
TOTAL LIABILITIES			532,320,951				2,474,927				188,217,695				-				723,013,573
STOCKHOLDERS’ EQUITY
Member capital			-				575,558,242				499,683,929				(1,075,242,171	)			-
Redeemable preferred stock and Series 2 redeemable preferred stock			220,701,701				-				-				-				220,701,701
Common stock			5,813				-				-				-				5,813
Accumulated deficit			(48,685,163	)			-				-				-				(48,685,163	)
TOTAL STOCKHOLDERS’ EQUITY			172,022,351				575,558,242				499,683,929				(1,075,242,171	)			172,022,351
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY		$	704,343,302			$	578,033,169			$	687,901,624			$	(1,075,242,171	)		$	895,035,924

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Condensed Consolidating Balance Sheets (continued)

 

December 31, 2017		Parent				Guarantor Subsidiary				Non-Guarantor Subsidiaries				Eliminations				Consolidated
A S S E T S
Cash and cash equivalents		$	111,952,829			$	1,486,623			$	982,039			$	-			$	114,421,491
Restricted cash			-				9,367,410				18,982,275				-				28,349,685
Investment in life insurance policies, at fair value			-				51,093,362				599,433,991				-				650,527,353
Life insurance policy benefits receivable			-				1,500,000				15,158,761				-				16,658,761
Other assets			1,912,203				1,986,312				5,000,369				-				8,898,884
Investment in subsidiaries			480,659,789				415,235,212				-				(895,895,001	)			-
TOTAL ASSETS		$	594,524,821			$	480,668,919			$	639,557,435			$	(895,895,001	)		$	818,856,174
L I A B I L I T I E S  &  S T O C K H O L D E R S’  E Q U I T Y
LIABILITIES
Senior credit facility with LNV Corporation		$	-			$	-			$	212,238,192			$	-			$	212,238,192
L Bonds			447,393,568				-				-				-				447,393,568
Accounts payable			1,434,623				844,899				4,114,917				-				6,394,439
Interest and dividends payable			10,296,584				-				5,130,925				-				15,427,509
Other accrued expenses			1,728,303				1,610,773				391,647				-				3,730,723
TOTAL LIABILITIES			460,853,078				2,455,672				221,875,681				-				685,184,431
STOCKHOLDERS’ EQUITY
Member capital			-				478,213,247				417,681,754				(895,895,001	)			-
Redeemable preferred stock and Series 2 redeemable preferred stock			173,115,447				-				-				-				173,115,447
Common stock			5,813				-				-				-				5,813
Accumulated deficit			(39,449,517	)			-				-				-				(39,449,517	)
TOTAL STOCKHOLDERS’ EQUITY			133,671,743				478,213,247				417,681,754				(895,895,001	)			133,671,743
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY		$	594,524,821			$	480,668,919			$	639,557,435			$	(895,895,001	)		$	818,856,174

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Condensed Consolidating Statements of Operations

 

For the three months ended June 30, 2018		Parent				Guarantor Subsidiary				Non-Guarantor Subsidiaries				Eliminations				Consolidated
REVENUE
Gain on life insurance policies, net		$	-			$	6,620,224			$	16,719,526			$	-			$	23,339,750
Interest and other income			661,859				17,798				295,541				-				975,198
TOTAL REVENUE			661,859				6,638,022				17,015,067				-				24,314,948
EXPENSES
Interest expense			11,396,554				-				5,751,296				-				17,147,850
Employee compensation and benefits			1,414,360				1,318,806				502,533				-				3,235,699
Legal and professional fees			399,790				234,740				521,198				-				1,155,728
Other expenses			1,697,222				476,907				658,648				-				2,832,777
TOTAL EXPENSES			14,907,926				2,030,453				7,433,675				-				24,372,054
INCOME (LOSS) BEFORE EQUITY IN INCOME OF SUBSIDIARIES			(14,246,067	)			4,607,569				9,581,392				-				(57,106	)
EQUITY IN INCOME OF SUBSIDIARIES			14,188,961				10,693,650				-				(24,882,611	)			-
NET INCOME (LOSS) BEFORE INCOME TAXES			(57,106	)			15,301,219				9,581,392				(24,882,611	)			(57,106	)
INCOME TAX BENEFIT			-				-				-				-				-
NET INCOME (LOSS)			(57,106	)			15,301,219				9,581,392				(24,882,611	)			(57,106	)
Preferred stock dividends			4,338,487				-				-				-				4,338,487
NET INCOME (LOSS) ATTRIBUTABLE TO COMMON SHAREHOLDERS		$	(4,395,593	)		$	15,301,219			$	9,581,392			$	(24,882,611	)		$	(4,395,593	)

 

For the three months ended June 30, 2017		Parent				Guarantor Subsidiary				Non-Guarantor Subsidiaries				Eliminations				Consolidated
REVENUE
Gain on life insurance policies, net		$	-			$	201,685			$	11,094,581			$	-			$	11,296,266
Interest and other income			69,221				163,384				298,141				(159,426	)			371,320
TOTAL REVENUE			69,221				365,069				11,392,722				(159,426	)			11,667,586
EXPENSES
Interest expense			8,325,874				391,061				3,555,266				(26,176	)			12,246,025
Employee compensation and benefits			2,109,562				1,529,188				102,549				-				3,741,299
Legal and professional fees			284,756				179,461				866,372				-				1,330,589
Other expenses			1,885,146				650,320				1,358,882				(133,250	)			3,761,098
TOTAL EXPENSES			12,605,338				2,750,030				5,883,069				(159,426	)			21,079,011
INCOME (LOSS) BEFORE EQUITY IN INCOME OF SUBSIDIARIES			(12,536,117	)			(2,384,961	)			5,509,653				-				(9,411,425	)
EQUITY IN INCOME OF SUBSIDIARIES			3,124,692				7,241,779				-				(10,366,471	)			-
NET INCOME (LOSS) BEFORE INCOME TAXES			(9,411,425	)			4,856,818				5,509,653				(10,366,471	)			(9,411,425	)
INCOME TAX BENEFIT			(3,717,174	)			-				-				-				(3,717,174	)
NET INCOME (LOSS)			(5,694,251	)			4,856,818				5,509,653				(10,366,471	)			(5,694,251	)
Preferred stock dividends			2,031,097				-				-				-				2,031,097
NET INCOME (LOSS) ATTRIBUTABLE TO COMMON SHAREHOLDERS		$	(7,725,348	)		$	4,856,818			$	5,509,653			$	(10,366,471	)		$	(7,725,348	)

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Condensed Consolidating Statements of Operations (continued)

 

For the six months ended June 30, 2018		Parent				Guarantor Subsidiary				Non-Guarantor Subsidiaries				Eliminations				Consolidated
REVENUE
Gain on life insurance policies, net		$	-			$	8,013,679			$	29,194,816			$	-			$	37,208,495
Interest and other income			1,113,898				26,524				507,703				-				1,648,125
TOTAL REVENUE			1,113,898				8,040,203				29,702,519				-				38,856,620
EXPENSES
Interest expense			22,019,206				-				11,191,981				-				33,211,187
Employee compensation and benefits			3,337,093				2,794,537				846,738				-				6,978,368
Legal and professional fees			807,102				466,390				1,055,865				-				2,329,357
Other expenses			3,491,702				941,514				1,140,138				-				5,573,354
TOTAL EXPENSES			29,655,103				4,202,441				14,234,722				-				48,092,266
INCOME (LOSS) BEFORE EQUITY IN INCOME OF SUBSIDIARIES			(28,541,205	)			3,837,762				15,467,797				-				(9,235,646	)
EQUITY IN INCOME OF SUBSIDIARIES			19,305,559				17,557,850				-				(36,863,409	)			-
NET INCOME (LOSS) BEFORE INCOME TAXES			(9,235,646	)			21,395,612				15,467,797				(36,863,409	)			(9,235,646	)
INCOME TAX BENEFIT											-				-
NET INCOME (LOSS)			(9,235,646	)			21,395,612				15,467,797				(36,863,409	)			(9,235,646	)
Preferred stock dividends			8,042,971				-				-				-				8,042,971
NET INCOME (LOSS) ATTRIBUTABLE TO COMMON SHAREHOLDERS		$	(17,278,617	)		$	21,395,612			$	15,467,797			$	(36,863,409	)		$	(17,278,617	)

 

For the six months ended June 30, 2017		Parent				Guarantor Subsidiary				Non-Guarantor Subsidiaries				Eliminations				Consolidated
REVENUE
Gain on life insurance policies, net		$	-			$	1,701,012			$	28,995,074			$	-			$	30,696,086
Interest and other income			154,228				235,285				923,802				(253,470	)			1,059,845
TOTAL REVENUE			154,228				1,936,297				29,918,876				(253,470	)			31,755,931
EXPENSES
Interest expense			17,587,908				677,415				7,292,113				(67,195	)			25,490,241
Employee compensation and benefits			4,038,357				2,750,770				115,232				-				6,904,360
Legal and professional fees			777,571				440,549				1,058,817				-				2,276,937
Other expenses			3,548,149				1,533,051				1,646,496				(186,275	)			6,541,420
TOTAL EXPENSES			25,951,985				5,401,785				10,112,658				(253,470	)			41,212,958
INCOME (LOSS) BEFORE EQUITY IN INCOME OF SUBSIDIARIES			(25,797,757	)			(3,465,488	)			19,806,218				-				(9,457,027	)
EQUITY IN INCOME OF SUBSIDIARIES			16,340,730				21,305,986				-				(37,646,716	)			-
NET INCOME (LOSS) BEFORE INCOME TAXES			(9,457,027	)			17,840,498				19,806,218				(37,646,716	)			(9,457,027	)
INCOME TAX BENEFIT			(3,717,674	)			-				-				-				(3,717,674	)
NET INCOME (LOSS)			(5,739,353	)			17,840,498				19,806,218				(37,646,716	)			(5,739,353	)
Preferred stock dividends			3,898,857				-				-				-				3,898,857
NET INCOME (LOSS) ATTRIBUTABLE TO COMMON SHAREHOLDERS		$	(9,638,210	)		$	17,840,498			$	19,806,218			$	(37,646,716	)		$	(9,638,210	)

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Condensed Consolidating Statements of Cash Flows

 

For the three months ended June 30, 2018		Parent				Guarantor Subsidiary				Non-Guarantor Subsidiary				Eliminations				Consolidated
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)		$	(57,106	)		$	15,301,219			$	9,581,392			$	(24,882,611	)		$	(57,106	)
Adjustments to reconcile net income (loss) to net cash flows from operating activities:
Equity of subsidiaries			(14,188,961	)			(10,693,650	)			-				24,882,611				-
Changes in fair value of life insurance policies			-				(4,693,656	)			(9,879,519	)			-				(14,573,175	)
Amortization of deferred financing and issuance costs			2,139,018				-				263,755				-				2,402,773
(Increase) decrease in operating assets:
Life insurance policy benefits receivable			-				(600,000	)			(14,132,270	)			-				(14,732,270	)
Other assets			(59,942,967	)			(41,271,719	)			346,531				99,135,390				(1,732,765	)
Increase (decrease) in operating liabilities:
Accounts payable and other accrued expenses			471,218				(68,313	)			139,185				-				542,090
NET CASH FLOWS USED IN OPERATING ACTIVITIES			(71,578,798	)			(42,026,119	)			(13,680,926	)			99,135,390				(28,150,453	)
CASH FLOWS FROM INVESTING ACTIVITIES
Investment in life insurance policies			-				(15,548,000	)			(14,700,939	)			-				(30,248,939	)
Carrying value of matured life insurance policies			-				1,313,885				4,834,464				-				6,148,349
NET CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES			-				(14,234,115	)			(9,866,475	)			-				(24,100,590	)
CASH FLOWS FROM FINANCING ACTIVITIES
Net borrowings on (repayments of) senior debt			-				-				(29,080,815	)			-				(29,080,815	)
Proceeds from issuance of L Bonds			60,536,446				-				-				-				60,536,446
Payments for redemption and issuance of L Bonds			(13,710,821	)			-				-				-				(13,710,821	)
Proceeds from issuance of preferred stock			14,372,959				-				-				-				14,372,959
Payments for issuance of preferred stock			(984,599	)			-				-				-				(984,599	)
Payments for redemption of preferred stock			(1,212,690	)			-				-				-				(1,212,690	)
Preferred stock dividends			(4,338,487	)			-				-				-				(4,338,487	)
Issuance of member capital			-				57,296,366				41,839,024				(99,135,390	)			-
NET CASH FLOWS PROVIDED BY FINANCING ACTIVITIES			54,662,808				57,296,366				12,758,209				(99,135,390	)			25,581,993
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS			(16,915,990	)			1,036,132				(10,789,192	)			-				(26,669,050	)
CASH AND CASH EQUIVALENTS AND RESTRICTED CASH
BEGINNING OF THE PERIOD			139,933,398				5,158,970				12,672,795				-				157,765,163
END OF THE PERIOD		$	123,017,408			$	6,195,102			$	1,883,603			$	-			$	131,096,113

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Condensed Consolidating Statements of Cash Flows (continued)

 

For the three months ended June 30, 2017		Parent				Guarantor Subsidiary				Non-Guarantor Subsidiary				Eliminations				Consolidated
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)		$	(5,694,251	)		$	4,856,818			$	5,509,653			$	(10,366,471	)		$	(5,694,251	)
Adjustments to reconcile net income (loss) to net cash flows from operating activities:
Equity of subsidiaries			(3,124,692	)			(7,241,779	)			-				10,366,471				-
Changes in fair value of life insurance policies			-				(134,399	)			(15,101,103	)			-				(15,235,502	)
Amortization of deferred financing and issuance costs			926,816				28,964				542,168				-				1,497,948
Deferred income taxes			(3,717,174	)			-				-				-				(3,717,174	)
(Increase) decrease in operating assets:
Life insurance policy benefits receivable			-				600,000				1,405,000				-				2,005,000
Other assets			(32,646,205	)			(23,493,280	)			316,604				55,878,537				55,656
Increase (decrease) in operating liabilities:
Accounts payable and other accrued expenses			1,974,991				(1,405,114	)			830,967				-				1,400,844
NET CASH FLOWS USED IN OPERATING ACTIVITIES			(42,280,515	)			(26,788,790	)			(6,496,711	)			55,878,537				(19,687,479	)
CASH FLOWS FROM INVESTING ACTIVITIES
Investment in life insurance policies			-				-				(19,432,338	)			-				(19,432,338	)
Carrying value of matured life insurance policies			-				256,152				2,758,682				-				3,014,834
NET CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES			-				256,152				(16,673,656	)			-				(16,417,504	)
CASH FLOWS FROM FINANCING ACTIVITIES
Net borrowings on (repayments of) senior debt			-				-				(3,845,037	)			-				(3,845,037	)
Payments for issuance of senior debt			-				(1,076,118	)			-				-				(1,076,118	)
Payments for redemption of Series I Secured Notes			-				(4,348,372	)			-				-				(4,348,372	)
Proceeds from issuance of L Bonds			31,875,811				-				-				-				31,875,811
Payments for redemption and issuance of L Bonds			(15,025,566	)			-				-				-				(15,025,566	)
Issuance of common stock			4				-				-				-				4
Proceeds from issuance of preferred stock			34,301,747				-				-				-				34,301,747
Payments for issuance of preferred stock			(1,945,618	)			-				-				-				(1,945,618	)
Payments for redemption of preferred stock			(1,372,593	)			-				-				-				(1,372,593	)
Preferred stock dividends			(2,031,097	)			-				-				-				(2,031,097	)
Issuance of member capital			-				31,450,843				24,427,694				(55,878,537	)			-
NET CASH FLOWS PROVIDED BY FINANCING ACTIVITIES			45,802,688				26,026,353				20,582,657				(55,878,537	)			36,533,161
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS			3,522,173				(506,285	)			(2,587,710	)			-				428,178
CASH AND CASH EQUIVALENTS AND RESTRICTED CASH
BEGINNING OF THE PERIOD			46,110,677				6,411,771				45,502,477				-				98,024,925
END OF THE PERIOD		$	49,632,850			$	5,905,486			$	42,914,767			$	-			$	98,453,103

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Condensed Consolidating Statements of Cash Flows (continued)

 

For the six months ended June 30, 2018		Parent				Guarantor Subsidiary				Non-Guarantor Subsidiary				Eliminations				Consolidated
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)		$	(9,235,646	)		$	21,395,612			$	15,467,797			$	(36,863,409	)		$	(9,235,646	)
Adjustments to reconcile net income (loss) to net cash flows from operating activities:
Equity of subsidiaries			(19,305,559	)			(17,557,850	)			-				36,863,409				-
Changes in fair value of life insurance policies			-				(6,205,841	)			(25,012,928	)			-				(31,218,769	)
Amortization of deferred financing and issuance costs			4,138,451				-				527,510				-				4,665,961
(Increase) decrease in operating assets:
Life insurance policy benefits receivable			-				700,000				(11,076,239	)			-				(10,376,239	)
Other assets			(79,448,344	)			(65,365,920	)			521,297				142,483,761				(1,809,206	)
Increase (decrease) in operating liabilities:
Accounts payable and other accrued expenses			1,161,452				19,255				(2,183,825	)			-				(1,003,118	)
NET CASH FLOWS USED IN OPERATING ACTIVITIES			(102,689,646	)			(67,014,744	)			(21,756,388	)			142,483,761				(48,977,017	)
CASH FLOWS FROM INVESTING ACTIVITIES
Investment in life insurance policies			-				(15,548,000	)			(40,000,764	)			-				(55,548,764	)
Carrying value of matured life insurance policies			-				1,954,430				9,277,213				-				11,231,643
NET CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES			-				(13,593,570	)			(30,723,551	)			-				(44,317,121	)
CASH FLOWS FROM FINANCING ACTIVITIES
Net borrowings on (repayments of) senior debt			-				-				(32,135,150	)							(32,135,150	)
Proceeds from issuance of L Bonds			97,197,545				-				-				-				97,197,545
Payments for redemption and issuance of L Bonds			(25,956,269	)			-				-				-				(25,956,269	)
Proceeds from issuance of preferred stock			56,238,128				-				-								56,238,128
Payments for issuance of preferred stock			(4,142,294	)			-				-								(4,142,294	)
Payments for redemption of preferred stock			(1,539,914	)			-				-								(1,539,914	)
Preferred stock dividends			(8,042,971	)			-				-				-				(8,042,971	)
Issuance of member capital			-				75,949,383				66,534,378				(142,483,761	)			-
NET CASH FLOWS PROVIDED BY FINANCING ACTIVITIES			113,754,225				75,949,383				34,399,228				(142,483,761	)			81,619,075
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS			11,064,579				(4,658,931	)			(18,080,711	)			-				(11,675,063	)
CASH AND CASH EQUIVALENTS AND RESTRICTED CASH
BEGINNING OF THE PERIOD			111,952,829				10,854,033				19,964,314				-				142,771,176
END OF THE PERIOD		$	123,017,408			$	6,195,102			$	1,883,603			$	-			$	131,096,113

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Condensed Consolidating Statements of Cash Flows (continued)

 

For the six months ended June 30, 2017		Parent				Guarantor Subsidiary				Non-Guarantor Subsidiary				Eliminations				Consolidated
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)		$	(5,739,353	)		$	17,840,498			$	19,806,218			$	(37,646,716	)		$	(5,739,353	)
Adjustments to reconcile net income (loss) to net cash flows from operating activities:
Equity of subsidiaries			(16,340,730	)			(21,305,986	)			-				37,646,716				-
Changes in fair value of life insurance policies			-				(1,193,821	)			(27,925,514	)			-				(29,119,335	)
Amortization of deferred financing and issuance costs			2,855,809				74,384				1,233,958				-				4,164,151
Deferred income taxes, net			(3,717,674	)			-				-				-				(3,717,674	)
(Increase) decrease in operating assets:
Life insurance policy benefits receivable			-				-				(1,625,000	)			-				(1,625,000	)
Other assets			(27,138,260	)			(55,534,365	)			1,842,210				83,082,776				2,252,361
Increase (decrease) in operating liabilities:
Accounts payable and other accrued expenses			3,428,613				(1,563,526	)			1,081,963				-				2,947,050
NET CASH FLOWS USED IN OPERATING ACTIVITIES			(46,651,595	)			(61,682,816	)			(5,586,165	)			83,082,776				(30,837,800	)
CASH FLOWS FROM INVESTING ACTIVITIES
Investment in life insurance policies			-				-				(42,121,671	)			-				(42,121,671	)
Carrying value of matured life insurance policies			-				751,576				4,632,232				-				5,383,808
NET CASH FLOWS PROVIDED BY (USED IN) INVESTING ACTIVITIES			-				751,576				(37,489,439	)			-				(36,737,863	)
CASH FLOWS FROM FINANCING ACTIVITIES
Net borrowings on (repayments of) senior debt			-				-				(7,099,537	)			-				(7,099,537	)
Payments for issuance of senior debt			-				(1,076,118	)			(114,294	)			-				(1,190,412	)
Payments for redemption of Series I Secured Notes			-				(9,798,261	)			-				-				(9,798,261	)
Proceeds from issuance of L Bonds			56,744,470				-				-				-				56,744,470
Payments for redemption and issuance of L Bonds			(39,197,163	)			-				-				-				(39,197,163	)
Redemption of common stock			(1,603,556	)			-				-				-				(1,603,556	)
Proceeds from issuance of preferred stock			61,480,941				-				-				-				61,480,941
Payments for issuance of preferred stock			(3,963,105	)			-				-				-				(3,963,105	)
Payments for redemption of preferred stock			(1,759,332	)			-				-				-				(1,759,332	)
Preferred stock dividends			(3,898,857	)			-				-				-				(3,898,857	)
Issuance of member capital			-				26,232,504				56,850,272				(83,082,776	)			-
NET CASH FLOWS PROVIDED BY FINANCING ACTIVITIES			67,803,398				15,358,125				49,636,441				(83,082,776	)			49,715,188
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS			21,151,803				(45,573,115	)			6,560,837				-				(17,860,475	)
CASH AND CASH EQUIVALENTS AND RESTRICTED CASH
BEGINNING OF THE PERIOD			28,481,047				51,478,601				36,353,930				-				116,313,578
END OF THE PERIOD		$	49,632,850			$	5,905,486			$	42,914,767			$	-			$	98,453,103

 

 

GWG HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

(20) Concentration

 

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

 

Life Insurance Company		June 30, 2018				December 31, 2017
John Hancock			14.71	%			15.57	%
AXA Equitable			11.39	%			11.88	%
Lincoln National			11.19	%			10.80	%

 

The following summarizes the states, based on insured state of residence of the insurance policies in our portfolio, exceeding 10% of the total face value held by us:

 

State of Residence		June 30, 2018				December 31, 2017
Florida			19.90	%			20.16	%
California			18.71	%			18.60	%

 

(21) Subsequent Events

 

Subsequent to June 30, 2018, two policies covering two individuals have matured. The combined face value of insurance benefits of these policies were $400,000.

 

Subsequent to June 30, 2018, we have issued approximately $28,462,000 of L Bonds.

 

On January 12, 2018, GWG Holdings and its wholly owned subsidiary GWG Life entered into a Master Exchange Agreement with The Beneficient Company Group, L.P., a Delaware limited partnership (“Beneficient”), MHT Financial SPV, LLC, a Delaware limited liability company (“MHT SPV”), and various related trusts (the “Seller Trusts”), as amended and restated on January 18, 2018 with effect from January 12, 2018, and as further amended by the First Amendment to Master Exchange Agreement and Second Amendment to Master Exchange Agreement (as amended, the “Master Exchange Agreement”). Under the Master Exchange Agreement, GWG Holdings, on the one hand, and any of Beneficient, MHT SPV or the Seller Trusts, on the other hand, could terminate the Master Exchange Agreement prior to the closing under certain circumstances, including if the conditions to closing of the transaction had not been fulfilled by June 30, 2018 (the “Closing Conditions Date”). On March 30, 2018 and June 29, 2018, GWG Holdings, GWG Life, Beneficient, MHT SPV, and the Seller Trusts entered into First and Second Amendments to Master Exchange Agreement pursuant to which the Closing Conditions Date was extended to July 30, 2018. The material terms and conditions of the Master Exchange Agreement were described in GWG Holdings’ Current Report on Form 8-K filed with the Securities and Exchange Commission on January 18, 2018. The transactions contemplated by the Master Exchange Agreement are referred to as the “Exchange Transaction”. 

 

On August 10, 2018, GWG Holdings, GWG Life, Beneficient, MHT SPV, and the Seller Trusts entered into a Third Amendment to Master Exchange Agreement (the “Third Amendment”). Pursuant to the Third Amendment, the parties agreed to consummate the Exchange Transaction in two closings. The Third Amendment also generally deleted MHT SPV as a party to the Master Exchange Agreement. The material terms and conditions of the Third Amendment, the Exchange Transaction and the first closing thereof were described in GWG Holdings’ Current Report on Form 8-K filed with the Securities and Exchange Commission on August 14, 2018.

 

In connection with the transactions contemplated by the Third Amendment, on August 10, 2018, GWG Holdings, GWG Life and Bank of Utah, as trustee (the “Trustee”), entered into a Supplemental Indenture (the “Supplemental Indenture”) to the Amended and Restated Indenture dated as of October 23, 2017 between GWG Holdings, GWG Life and the Trustee, as amended. GWG Holdings entered into the Supplemental Indenture to add and change certain provisions of the Amended and Restated Indenture necessary to provide for the issuance of a new class of securities titled “Seller Trust L Bonds”. The maturity date of the Seller Trust L Bonds is August 9, 2023. The Seller Trust L Bonds bear interest at 7.50% per year. The material terms and conditions of the Supplemental Indenture and the Seller Trust L Bonds were described in GWG Holdings’ Current Report on Form 8-K filed with the Securities and Exchange Commission on August 14, 2018.

 

On August 14, 2018 the Company’s Board of Directors declared a special dividend of $4.30 per share of common stock (approximately $25 million) payable in cash on September 5, 2018 to shareholders of record on August 27, 2018.

 

 

ITEM 1A.

RISK FACTORS.

 

On August 10, 2018, GWG Holdings, GWG Life, Beneficient, MHT SPV, and the Seller Trusts entered into a Third Amendment to Master Exchange Agreement (the “Third Amendment”). Pursuant to the Third Amendment, the parties agreed to consummate the transactions contemplated by the Master Exchange Agreement in two closings. The first closing occurred on August 10, 2018. The material terms and conditions of the Third Amendment and such first closing were described in GWG Holdings’ Current Report on Form 8-K filed with the Securities and Exchange Commission on August 14, 2018. The risk factors below update the risk factors regarding the Exchange Transaction (as defined below) that were previously included in our Annual Report on Form 10-K for the year ended December 31, 2017 and filed on March 29, 2018.

Risks associated with our Exchange Transaction with The Beneficient Company Group, L.P.:

 

We may not complete the Final Closing of the Exchange Transaction within our anticipated timeframe or at all.

 

We have entered into a Master Exchange Agreement (as amended, the “Master Agreement”) to govern our securities exchange transaction with The Beneficient Company Group, L.P. (“Beneficient”) and certain other parties (the “Exchange Transaction”). The Master Agreement contemplates that the Exchange Transaction will occur in two closings, an initial closing, which was completed on August 10, 2018 (the “Initial Transfer”) and a final closing (the “Final Closing”), which is subject to various conditions. Upon consummation of the Initial Transfer, we issued $403 million of a new series of L Bonds to certain parties referred to as the “Seller Trusts” in the Master Agreement and 5.0 million shares at $10.00 per share of Series B Convertible Preferred Stock to Beneficient who we understand will transfer such shares to the Seller Trusts; in exchange Beneficent owes us $200 million under a commercial loan (the “Commercial Loan”); $162.9 million under an exchangeable note (“Exchangeable Note”) which automatically converts into 16.3 million Beneficient common units upon consummation of the Final Closing; and issued us 4.0 million Beneficient common units at $10.00 per unit. Although we anticipate that the Final Closing will occur in the fourth quarter of 2018, there can be no assurance that it will be completed on this timeframe or at all. Under the Master Agreement, in the Final Closing, (i) the Seller Trusts will transfer to us an additional 24.2 million Beneficient common units at $10.00 per unit, (ii) Beneficient will issue to us approximately 16.3 million Beneficient common units at $10.00 per unit in satisfaction of the Exchangeable Note, and we will deliver to the Seller Trusts 24.2 million shares of our common stock at $10.00 per share and the Convertible Preferred Stock will convert into 5.0 million shares of our common stock at $10.00 per share. If the Final Closing of the Exchange Transaction is not completed for any reason, we will not realize all of the anticipated benefits of the Exchange Transaction described elsewhere in this report. Further, the price of our common stock may decline to the extent that the current market price reflects an assumption that the Final Closing of the Exchange Transaction will be completed.

 

Beneficient may be unable to operate its business successfully, which would negatively impact its ability to generate distributable cash flow and increase the value of its common units.

 

Beneficient plans to provide liquidity products and loans with trust services (collectively, “liquidity products”) to owners of alternative assets and illiquid investment funds. Beneficient intends to market its liquidity products to mid-to-high net worth individuals (i.e., individuals having a net worth of between $5 million and $30 million), along with a variety of other financial services, including custody and clearing of alternative assets, fund and trust administration, retirement funds and insurance services for covering risks attendant to owning or managing alternative assets. Beneficient intends to operate as a master limited partnership. The success of the Exchange Transaction from our perspective will depend, in part, on Beneficient’s ability to operate its business successfully, generate distributable cash flow to limited partners and increase the value of its common units. If Beneficient is unable to do so, such inability will negatively impact the value of our investment in Beneficient and, in turn, would have a corresponding negative impact on the value of our assets and the price of our common stock.

 

Beneficient’s operations will materially impact our financial performance.

 

We expect to account for our acquisition of common units of Beneficient using the equity method of accounting. As a result, we will recognize a share of the profits and losses of Beneficient in the periods when such profits and losses are earned or incurred by Beneficient. Because common units of Beneficient will represent a significant percent of our assets, the impact on our financial statements of Beneficient’s financial performance may be material.

 

Beneficient may be unable to obtain a trust bank charter, or tax status as a master limited partnership, which would hinder Beneficient’s ability to successfully pursue its current business plan and could adversely affect the value of its common units.

 

Beneficient is a privately-held company organized as a Delaware limited partnership that intends to operate as a master limited partnership. In addition, Beneficient intends to seek a trust bank charter from the State of Texas and carry on much of its business through a trust company. There can be no assurance that Beneficient will be successful in obtaining a trust bank charter or the timing of the receipt of such trust bank charter. Because Beneficient’s current business plans are based in part on obtaining regulatory approval to operate as a regulated trust bank and a master limited partnership, a failure to do so may materially and adversely impact its financial performance and prospects, which would likely decrease the value of the Beneficient common units we hold.

 

 

Beneficient may be unable to obtain a listing for its common units which would hinder Beneficient’s ability to successfully pursue its current business plan and could adversely affect the value of its common units.

 

Under the Master Agreement, Beneficient has agreed to use its commercial best efforts to pursue and obtain a listing following the closing of the Exchange Transaction. If Beneficient fails to file a registration statement with the SEC in connection with a listing within 24 months after such closing, or secure a listing on or prior to the 40-month anniversary of such closing, then the Master Agreement provides that we may, at our election, cause Beneficient to adopt a strategy to redeem all of the common units of Beneficient then held by us at a redemption price equal to the greater of $11.00 per unit or the book value per unit as of the redemption date. Under this strategy, Beneficient would be required to use a portion of its distributable cash flow to satisfy our redemption election (together with all other redemption elections that may be made by the holders of other interests in Beneficient or interests convertible into interests of Beneficient). However, there is no assurance that Beneficient’s distributable cash flow will be sufficient to affect a redemption within a particular period of time or at all. If Beneficient is ultimately unable to satisfy its redemption obligations, we may not be able to recoup our investment in Beneficient common units.

 

We will have limited or no ability to influence Beneficient’s management’s decisions regarding its business.

 

Although, upon the Final Closing of the Exchange Transaction, we will own a significant percentage of Beneficient’s outstanding common units (approximately 87%), Beneficient’s general partner is authorized to perform all acts that it determines to be necessary or appropriate to carry out Beneficient’s purposes and to conduct its business. As a result, we will have only limited voting rights relating to certain matters and, as is contemplated by the terms of Beneficient’s limited partnership agreement (which we have become a party to as a result of the completion of the Initial Transfer), any person or group that acquires beneficial ownership of 20% or more of Beneficient’s common limited partnership units (including GWG) will lose voting rights associated with all of its common units and such common units may not be voted on any matter. Further, any person or group (other than Beneficient’s general partner and its affiliates, or a direct or subsequently approved transferee of the general partner or its affiliates or such person or group approved by the board of directors of the general partner of Beneficient) who acquires, in the aggregate, beneficial ownership of 20% or more of Beneficient’s common units (including GWG which, upon the Final Closing will own approximately 87%), will lose voting rights associated with all of its common units and such common units may not be voted on any matter and will not be considered to be outstanding when sending notices of a meeting of limited partners, calculating required votes, determining the presence of a quorum or for other similar purposes. In addition, prior to a listing, if any, of Beneficient’s common units on a national stock exchange or, in lieu thereof, quotation of the common units in an automated quotation system, the executive committee of the board of directors of the general partner of Beneficient will be entitled to cast all of the votes that the limited partners would otherwise be entitled to cast, and no limited partner, in its capacity as such, will be permitted to vote in respect of its common units. As a result, we will have limited or no ability to influence Beneficient’s management’s decisions regarding its business.

 

Beneficient’s partnership agreement eliminates fiduciary duties that might otherwise be owed to us under Delaware law.

 

Beneficient’s business and affairs are managed by Beneficient Management, LLC, its general partner (“Beneficient Management”). Beneficient’s partnership agreement eliminates the fiduciary duties that might otherwise be owed by the Beneficient Management under Delaware law and replaces them with the duties expressly set forth in such agreement. Beneficient’s partnership agreement provides that, when the general partner is permitted or required to make a decision in its “discretion” or pursuant to a provision not subject to an express standard of “good faith,” in making such decision, the general partner has no duty to give any consideration to any interest of or factors affecting Beneficient or any other person. If a decision under Beneficient’s partnership agreement is subject to an express standard of “good faith,” such decision will not constitute a breach of the agreement if the decision is approved by (i) a majority of the members of the conflicts committee of the board of directors of the general partner of Beneficient, (ii) holders of a majority of the voting power of the Beneficient’s common units entitled to vote (excluding voting common units owned by the general partner and its affiliates), or (iii) the general partner acting without a subjective belief that such decision was adverse to the interests of Beneficient. Potential conflicts of interest may arise among the general partner and its affiliates, on the one hand, and Beneficient, on the other hand, and the general partner may be able to favor its own interest to the detriment of Beneficient and the holders of the common units.

 

Beneficient has significant debt obligations outstanding to us and has the ability to incur additional indebtedness.

 

Subject to certain restrictions within the Commercial Loan, Beneficient is permitted to incur additional indebtedness ranking senior to the Commercial Loan and the Exchangeable Note. If Beneficient is unable to execute its business plans, it may materially and adversely impact Beneficient’s ability to repay its indebtedness, including the Commercial Loan and Exchangeable Note in accordance with their respective terms. As a significant holder of Beneficient indebtedness, a payment default under any additional indebtedness Beneficient may incur, or under the Commercial Loan or Exchangeable Note, would likely have a corresponding negative impact on the value of our assets (including the value of our Beneficient common units) and the price of our common stock.

 

Our percentage ownership in Beneficient may be diluted.

 

Upon consummation of the Final Closing of the Exchange Transaction, we will become the owner of approximately 87% of the issued and outstanding common units in Beneficient. Our percentage ownership does not take into account (i) approximately 125,657,883 limited partner interests that may be issued upon the conversion of outstanding securities issued by Beneficient or its affiliates, or (ii) additional limited partner interests that may be issued after the closing of the Exchange Transaction. Importantly, the general partner of Beneficient has discretion to cause Beneficient to issue additional limited partner interests from time to time, and Beneficient’s partnership agreement contains no meaningful restrictions on this authority. Moreover, the Beneficient organizational structure permits the future issuance of additional securities that can, upon certain circumstances or at the discretion of their holders, be converted into additional limited partner interests in Beneficient. As a result, our percentage ownership in Beneficient may be diluted in the future.

 

 

The resale of our common stock issued in the Exchange Transaction could put downward pressure on the market price of our common stock and result in a destabilized trading market for our common stock.

 

Upon the Final Closing, our Series B Convertible Preferred Stock will automatically convert to 5 million shares of our common stock and we will also issue approximately 24.2 million additional shares of our common stock, which in the aggregate will represent approximately 83% of our outstanding common stock. The shares of common stock we issue on the Final Closing will be subject to contractual resale restrictions, governance restrictions, as well as resale restrictions. The Master Agreement and related ancillary agreements require that we register the resale of the shares of common stock issued in the Final Closing to the Seller Trusts to the extent permitted by applicable SEC rules and regulations. Upon the effectiveness of such registration, or the lapse of applicable resale restrictions under applicable securities laws or applicable lock-up restrictions, the shares of our common stock issued in the Exchange Transaction will be available for resale in the public equity markets only through an Orderly Marketing Agreement or in a widely dispersed registered public offering. We cannot predict the effect, if any, that future sales of these shares or the availability of these shares for future sale will have on the market price of our common stock.

 

At the Final Closing, we will enter into an Orderly Marketing Agreement among GWG, the Seller Trusts and Credit Suisse Securities (USA), LLC for the orderly marketing and resale of the common stock to be issued to the Seller Trusts in the Exchange Transaction. The purpose of this Orderly Marketing Agreement is to manage the timing and amount of our common shares that are publicly resold in the market because the number of shares of our common stock to be issued in the Exchange Transaction will substantially increase the total number of our issued and outstanding shares. However, there is no assurance that the Orderly Marketing Agreement will accomplish its purpose of maintaining a stable market for our common stock. Until the sales of our common stock under the Orderly Marketing Agreement, certain governance restrictions will remain in place for the benefit of our current shareholders under a Stockholders Agreement.

 

Upon consummation of the Exchange Transaction, the Seller Trusts, collectively, will own a substantial majority of our outstanding common stock.

 

At the Final Closing of the Exchange Transaction, our 5 million shares of Series B Convertible Preferred Stock will convert into 5 million shares of our common stock and we will issue 24.2 million shares of our common stock to the Seller Trusts. Upon conversion of our Series B Convertible Preferred Stock and the issuance of our common stock, such shares will represent approximately 83% of our outstanding common stock. At the Final Closing, we will enter into a Stockholders Agreement with the Seller Trusts which provides that for so long as the Seller Trusts own voting securities of GWG Holdings representing 10% or more of the total voting power of all shares of GWG Holdings voting securities, all voting securities of GWG Holdings over which the Seller Trusts (and their respective transferees) have voting control will be voted solely in proportion with the votes cast by all other holders of voting securities of GWG on any matter put before them. In the Stockholders Agreement, the Seller Trusts have agreed to only sell shares of our Common Stock under the Orderly Marketing Agreement or in a registered public offering to or through one or more underwriters or placement agents and to instruct the underwriters or placement agents to use their reasonable best efforts to (x) effect as wide a distribution of the shares of our common stock as is reasonably practicable without adversely affecting the pricing thereof and (y) not sell any shares of our common stock to any person or group who, after consummation of the sale, would have beneficial ownership of our voting securities representing in the aggregate 5.0% or more of the total voting power of all shares of GWG Holdings voting securities or, in the case of certain institutional investors, 10% or more of the total voting power of all shares of GWG Holdings voting securities). In addition, until the earlier of (i) one year from the closing of the Exchange Transaction and (ii) the termination of the Orderly Marketing Agreement, the Seller Trusts (including their assignees and transferees, and their respective affiliates) will be subject to certain standstill restrictions that will prohibit the Seller Trusts from, among other things, acquiring any of our voting securities, seeking or proposing to influence or control our management, Board of Directors, or policies, and submitting a proposal for any merger, recapitalization, reorganization, business combination, or other extraordinary transaction involving our Company. Following expiration of the standstill period, however, the Seller Trusts, to the extent they continue to hold shares of our common stock, may engage in such activities. Notwithstanding these contractual restrictions, we cannot assure you that the Seller Trusts will not have some influence over our business.

 

An inability to obtain accurate and timely financial information from Beneficient may prevent us from complying with reporting obligations under federal securities law and compromise our ability to finance our operations through the public equity or debt markets.

 

On August 14, 2018, we filed a current report on Form 8-K disclosing the initial closing of the transactions contemplated by the Master Agreement. We are required under applicable SEC reporting rules to amend that current report to include certain historical and pro forma financial information, including audited historical financial statements of Beneficient, within the timeline required. Although we expect to obtain such audited historical financial statements, to date we have not done so.

 

Going forward, we expect to recognize a share of the profits and losses of Beneficient in the periods when such profits and losses are earned or incurred by Beneficient. Therefore, we will continue to be heavily reliant on Beneficient to provide us with accurate and timely financial reporting that will allow us to timely prepare and file our own financial statements in accordance with U. S. generally accepted accounting principles and in compliance with SEC regulations.

 

If we are unable to obtain accurate and timely financial information from Beneficient and are unable to timely prepare and file our financial statements as a result, we may fail to comply with reporting obligations under federal securities law, become subject to delisting from the Nasdaq Stock Market, and may be unable to utilize the public debt or equity markets to finance our operations. Because we have been heavily reliant on the public offer and sale of L Bonds, discontinuing our L Bond offers would have a material adverse impact on our ability to expand our life insurance portfolio and otherwise fund our operations. In addition, our failure to deliver financial information and comply with disclosure requirements under applicable SEC regulations may result in covenant violations under our amended and restated senior credit facility with LNV Corporation.

 

 

 

ITEM 2.

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

 

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

 

Risk Relating to Forward-Looking Statements

 

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

 

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

 

Such risks and uncertainties include, but are not limited to:

 

changes in the secondary market for life insurance;

 

changes resulting from the evolution of our business model and strategy with respect to the life insurance industry;

 

the valuation of assets reflected on our financial statements;

 

the reliability of assumptions underlying our actuarial models, including our life expectancy estimates;

 

our reliance on debt financing and continued access to the capital markets;

 

our history of operating losses;

 

risks relating to the validity and enforceability of the life insurance policies we purchase;

 

risks relating to our ability to license and effectively apply epigenetic technology to improve and expand the scope of our business;

 

our reliance on information provided and obtained by third parties, including underwriting tables;

 

federal, state and FINRA regulatory matters;

 

competition in the secondary market of life insurance and epigenetic technology;

 

the relative illiquidity of life insurance policies;

 

our ability to satisfy our debt obligations if we were to sell our entire portfolio of life insurance policies;

 

life insurance company credit exposure;

 

cost-of-insurance (premium) increases on our life insurance policies;

 

general economic outlook, including prevailing interest rates;

 

performance of our investments in life insurance policies;

 

financing requirements;

 

risks associated with the merchant cash advance business;

 

the various risks associated with our attempts to commercialize our epigenetic technology;

 

 

risks associated with our ability to protect our intellectual property rights;

 

litigation risks;

 

restrictive covenants contained in borrowing agreements;

 

our ability to make cash distributions in satisfaction of dividend obligations and redemption requests; and

  

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 historically qualified as an emerging growth company and have elected to delay our adoption of new or revised accounting standards and, as a result, we may not have complied with new or revised accounting standards at the same time as other public reporting companies that are not “emerging growth companies.” Effective upon the initial closing of the transactions contemplated by the Master Exchange Agreement (discussed below), we no longer qualify as an emerging growth company as a result of the aggregate amount of non-convertible debt that we have issued during the prior three year period.

 

Overview

 

We are a financial services company committed to disrupting and transforming the life insurance and related industries. We built our business by creating opportunities for consumers to obtain significantly more value for their life insurance policies in a secondary market as compared to the traditional options offered by the insurance industry.

 

We are enhancing and extending our activities in the life insurance industry by bringing step change technology through the commercialization of advanced epigenetic technology. At the same time, we are creating opportunities for investors to receive income and capital appreciation from our investment activities related to the life insurance industry.

 

 

Critical Accounting Policies

 

Critical Accounting Estimates

 

The preparation of our consolidated financial statements in accordance with the Generally Accepted Accounting Principles in the United States of America (GAAP) requires us to make significant judgments, estimates, and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. We base our judgments, estimates, and assumptions on historical experience and on various other factors believed to be reasonable under the circumstances. Actual results could differ materially from these estimates. We evaluate our judgments, estimates, and assumptions on a regular basis and make changes accordingly. We believe that the judgments, estimates, and assumptions involved in valuing our investments in life insurance policies and evaluating deferred taxes have the greatest potential impact on our consolidated financial statements and accordingly believe these to be our critical accounting estimates. Below we discuss the critical accounting policies associated with these estimates as well as certain other critical accounting policies.

 

Ownership of Life Insurance Policies — Fair Value Option

 

We account for the purchase of life insurance policies in accordance with Accounting Standards Codification 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 policies using the fair value method.

 

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

 

We initially record our purchase of life insurance policies at the transaction price, which is the amount paid for the policy, inclusive of all external fees and costs associated with the acquisition. At each subsequent reporting period, we re-measure the investment at fair value in its entirety and recognize the change in fair value as unrealized gain (revenue) in the current period, net of premiums paid. Changes in the fair value of our portfolio are based on periodic evaluations and are recorded in our consolidated statements of operations as changes in fair value of life insurance policies.

 

Fair Value Components — Life Expectancies

 

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

 

The 2015 Valuation Basic Table (“2015 VBT”) finalized by the Society of Actuaries is based on a much larger dataset of insured lives, face amount of policies and more current information compared to the dataset underlying the 2008 Valuation Basic Table. The 2015 VBT dataset includes 266 million policies compared to the 2008 VBT dataset of 75 million. The experience data in the 2015 VBT dataset includes 2.6 million claims on policies from 51 insurance carriers. Life expectancies implied by the 2015 VBT are generally slightly longer for both males and females nonsmokers between the ages of 65 and 80. However, insureds of both genders over the age of 80 have significantly longer life expectancies, approximately 8% to 42% longer, as compared to the 2008 VBT. We adopted the 2015 VBT in our valuation process in 2016.

 

For life insurance policies with face amounts greater than $1 million and that are not pledged under any senior credit facility (approximately 18.4% of our portfolio by face amount of policy benefits) we attempt to update the life expectancy estimates on a continuous rotating three year cycle. For life insurance policies that are pledged under the LNV senior credit facility (approximately 73.1% of our portfolio by face amount of policy benefits) we are presently required to update the life expectancy estimates every two years beginning from the date of the amended facility. For the remaining small face insurance policies (i.e., a policy with $1 million in face value benefits or less) we may employ a range of methods and timeframes to update life expectancy estimates.

 

We conduct medical underwriting on the life insurance policies we own with life expectancy reports produced by independent third-party medical-actuarial underwriting firms. Each life expectancy report summarizes the underlying insured person’s medical history based on the underwriter’s review of recent and historical medical records. We obtain two such life expectancy reports for almost all policies, except for small face value insurance policies (i.e., a policy with $1 million in face value benefits or less) for which we have obtained at least one fully underwritten or simplified third-party report. A simplified third-party underwriting report is based on a medical interview, which may be supplemented with additional information obtained from a pharmacy benefit manager database. For valuation purposes, we use the life expectancy estimate, using the average, in the case of multiple reports, expressed as the number of months at which the individual will have a 50% probability of mortality.

 

 

Our prior experience in updating life expectancy estimates has generally resulted in shorter life expectancies of the updated insureds within our portfolio, but often not as short as we had projected. This has resulted in reductions to the fair value of our portfolio in the amounts of $0.1 million and $6.7 million for the three months ended June 30, 2018 and 2017, respectively and $5.0 million and $8.6 million for the six months ended June 30, 2018 and 2017, respectively. As our life insurance portfolio continues to grow, we may experience additional and material adjustments to the fair value of our portfolio due to updating life expectancy estimates.

 

Fair Value Components — Required Premium Payments

 

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

 

Fair Value Components — Discount Rate

 

A discount rate is used to calculate the net present value of the expected cash flows. The discount rate used to calculate fair value of our portfolio incorporates the guidance provided by Accounting Standards Codification 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 policies for the period ending:

 

June 30, 2018				December 31, 2017
	10.45%				10.45%

 

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

 

We engaged Model Actuarial Pricing System, LP. (“MAPS”), owner of the actuarial portfolio pricing software we use, to prepare a calculation of our life insurance portfolio. MAPS processed policy data, future premium data, life expectancy estimate data, and other actuarial information to calculate a net present value for our portfolio using the specified discount rate of 10.45%. MAPS independently calculated the net present value of our portfolio of 1,010 policies to be $726.1 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 Accounting Standards Codification 740, Income Taxes (“ASC 740”), deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. A valuation allowance is established for deferred tax assets that are not considered “more likely than not” to be realized. Realization of deferred tax assets depends upon having sufficient past or future taxable income in periods to which the deductible temporary differences are expected to be recovered or within any applicable carryback or carryforward periods or sufficient tax planning strategies. After assessing the realization of the net deferred tax assets, we believe that there is substantial uncertainty that our net deferred tax asset will be realized during the applicable carryforward period. As such, a valuation allowance has been established against the total net deferred tax asset as of June 30, 2018 and December 31, 2017, respectively.

 

Principal Revenue and Expense Items

 

We earn revenues from the following three primary sources.

 

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

 

 

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

 

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

 

Our main components of expense are summarized below.

 

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

 

Interest Expense. We recognize, and record interest expenses associated with the costs of financing our life insurance portfolio for the current period. These expenses include interest paid to our senior lenders under our senior credit facility with LNV Corporation, interest paid on our L Bonds and other outstanding indebtedness. When we issue debt, we amortize the financing costs (commissions and other fees) 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, 2018 Compared to the Same Periods in 2017

 

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

 

Revenue

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2018				2017				2018				2017
Revenue realized from maturities of life insurance policies		$	21,475,000			$	7,920,000			$	30,895,000			$	24,526,000
Revenue recognized from change in fair value of life insurance policies			14,573,000				15,235,000				31,219,000				29,119,000
Premiums and other annual fees			(12,708,000	)			(11,859,000	)			(24,906,000	)			(22,949,000	)
Gain on life insurance policies, net			23,340,000				11,296,000				37,208,000				30,696,000
Interest and other income			975,000				372,000				1,649,000				1,060,000
Total revenue		$	24,315,000			$	11,668,000			$	38,857,000			$	31,756,000
Attribution of gain on life insurance policies, net:
Change in estimated probabilistic cash flows, net of premium and other annual fees paid		$	4,701,000			$	1,572,000			$	11,508,000			$	4,516,000
Net revenue recognized at matured policy event			12,939,000				4,199,000				17,894,000				11,995,000
Unrealized gain on acquisitions			5,795,000				8,044,000				12,769,000				18,646,000
Change in discount rates			-				4,143,000				-				4,143,000
Change in life expectancy evaluation			(95,000	)			(6,662,000	)			(4,963,000	)			(8,604,000	)
Gain on life insurance policies, net		$	23,340,000			$	11,296,000			$	37,208,000			$	30,696,000
Number of policies acquired			85				49				144				122
Face value of purchases		$	118,308,000			$	88,740,000			$	212,660,000			$	193,495,000
Purchases (initial cost basis)		$	30,249,000			$	19,432,000			$	55,549,000			$	42,122,000
Unrealized gain on acquisition (% of face value)			4.9	%			9.1	%			6.0	%			9.6	%
Number of policies matured			17				9				32				19
Face value of matured policies		$	27,623,000			$	10,935,000			$	42,127,000			$	29,910,000
Net revenue recognized at maturity event (% of face value matured)			46.8	%			38.4	%			42.5	%			40.1	%

  

Revenue from changes in estimated probabilistic cash flows, net of premiums paid was $4.7 million and $1.6 million for the three months ended and $11.5 million and $4.5 million for the six months ended June 30, 2018 and 2017, respectively. Increases of $3.1 million and $7.0 million for the three and six months ended June 30, 2018 over the comparable prior year periods resulted from premium optimization actions coordinated with our external servicer, leveraging certain guarantee features and shadow accounts on certain life insurance policies in our portfolio, and growth of face value in our portfolio, partially offset by COI premium increases recognized of $4.3 million and $5.5 million for the three and six months ended June 30, 2018 compared to $0 for the three and six months ended June 30, 2017.

 

 

The face value of policies purchased were $118.3 million and $88.7 million for the three months ended and $212.7 million and $193.5 million for the six months ended June 30, 2018 and 2017, respectively, reflecting increases of face value purchased of $29.6 million and $19.2 million for the three and six months ended June 30, 2018 over the comparable prior year periods. The resulting unrealized gain on acquisition was $5.8 million and $8.0 million for the three months ended and $12.8 million and $18.6 million for the six months ended June 30, 2018 and 2017, respectively, reflecting decreases of $2.2 million and $5.8 million for the three and six months ended June 30, 2018 over the comparable prior year periods. Decreased unrealized gain on acquisition in the current periods is the result of increased purchase competition driving down yields in the broker market.

 

The face value of matured policies was $27.6 million and $10.9 million for the three months ended and $42.1 million and $29.9 million for the six months ended June 30, 2018 and 2017, respectively, reflecting increases of face value of matured policies of $16.7 million and $12.2 million for the three and six months ended June 30, 2018 over the comparable prior year periods. The resulting revenue recognized at matured policy event was $12.9 million and $4.2 million for the three months ended and $17.9 million and $12.0 million for the six months ended June 30, 2018 and 2017, respectively. Revenue increases from maturity events of $8.7 million and $5.9 million for the three and six months ended June 30, 2018 over the comparable prior year periods primarily resulted from the increased face value of policies matured during those same periods.

 

Revenue recognized from changes in discount rate were $0 and $4.1 million for both the three and six months ended June 30, 2018 and 2017, respectively. The discount rate of 10.45% as of June 30, 2018 remained unchanged from both the prior quarter and year end dates. The discount rate of 10.81% as of June 30, 2017 reflected a decrease from the 10.96% rate used at both the preceding quarter and year end dates.

 

Net revenue charges from change in life expectancy evaluation of $0.1 million and $6.7 million for the three months ended and $5.0 million and $8.6 million for the six months ended June 30, 2018 and 2017, respectively. The resulting net revenue increases of $6.6 million and $3.6 million for the three and six months ended June 30, 2018 over the comparable prior year periods primarily resulted from lower number of life expectancy updates received during the three and six months ended June 30, 2018 over the comparable prior year periods. The decreased number of life expectancy updates is primarily the result of our cycle update timing and concentrated efforts of our external servicer in the prior year to resolve a backlog of third party evaluations.

 

Interest and other income is comprised of bank interest and other miscellaneous items. Increased revenue of $0.6 million for the three and six months ended June 30, 2018 were primarily driven by higher bank account balances and the implementation of a sweep process to move balances to higher interest earning bank accounts.

 

Expenses

 

		Three Months Ended June 30,												Six Months Ended June 30,
		2018				2017				Increase/ Decrease				2018				2017				Increase/ Decrease
Interest expense (including amortization of deferred financing costs) (1)		$	17,148,000			$	12,246,000			$	4,902,000			$	33,211,000			$	25,490,000			$	7,721,000
Employee compensation and benefits (2)			3,236,000				3,741,000				(505,000	)			6,978,000				6,904,000				74,000
Legal and professional expenses (3)			1,155,000				1,331,000				(176,000	)			2,330,000				2,278,000				52,000
Other expenses (4)			2,833,000				3,761,000				(928,000	)			5,573,000				6,541,000				(968,000	)
Total expenses		$	24,372,000			$	21,079,000			$	3,293,000			$	48,092,000			$	41,213,000			$	6,879,000

 

(1)

The average debt outstanding increased from approximately $566.0 million during the three months ended June 30, 2017 to approximately $723.4 million during the same period of 2018, and from approximately $563.0 million during the six months ended June 30, 2017 to approximately $706.9 million during the same period of 2018. The average interest rate of the senior credit facility with LNV Corporation increased from 7.56% to 10.17% for the three months ended June 30, 2017 and 2018, respectively, and from 7.50% to 9.89% for the six months ended June 30, 2017 and 2018, respectively.

(2)	Quarterly decrease is due to reduced employee headcount. At June 30, 2018 we employed 63 employees and on June 30, 2017 we employed 76 employees.

(3)	Decrease is due to decreased legal fees associated with MCA collections.

(4)	Increased contract labor costs, servicing and facility fees were offset by a reduction in charitable contributions and marketing costs, and lower provision for MCA advances. See Note 15 for detailed breakdown.

 

Deferred Income Taxes

 

Under ASC 740, Income Taxes (“ASC 740”), deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. A valuation allowance is established for deferred tax assets that are not considered “more likely than not” to be realized. Realization of deferred tax assets depends upon having sufficient past or future taxable income in periods to which the deductible temporary differences are expected to be recovered or within any applicable carryback or carryforward periods. After assessing the realization of the net deferred tax assets, we believe that there is substantial uncertainty that our net deferred tax asset will be realized during the applicable carryforward period. As such, a valuation allowance has been established against the total net deferred tax asset as of June 30, 2018 and December 31, 2017.

 

 

Income Tax Expense

 

We realized income tax benefit of $0 and $3.7 million for the three and six months ended June 30, 2018 and 2017, respectively. The effective rate for the three months ended June 30, 2018 and 2017 were 0% and 39.5%, respectively, and 0% and 39.3% for the six month ended June 30, 2018 and 2017, respectively, compared to expected statutory rate of 21.0% and 34.0%, respectively.

 

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

 

		Three Months Ended																Six Months Ended
		June 30, 2018								June 30, 2017								June 30, 2018								June 30, 2017
Statutory federal income tax (benefit)		$	(12,000	)			21.0	%		$	(3,200,000	)			34.0	%		$	(1,939,000	)			21.0	%		$	(3,215,000	)			34.0	%
State income taxes (benefit), net of federal benefit			10,000				(17.1	)%			(607,000	)			6.5	%			(692,000	)			7.5	%			(609,000	)			6.4	%
Valuation allowance			(36,000	)			63.4	%			-				-				2,568,000				(27.8	)%			-				-
Other permanent differences			38,000				(67.3	)%			90,000				(1.0	)%			63,000				(0.7	)%			106,000				(1.1	)%
Total income tax expense (benefit)		$	-				0.0	%		$	(3,717,000	)			39.5	%		$	-				0.0	%		$	(3,718,000	)			39.3	%

 

The Tax Reform Bill enacted by U.S. Federal government in December 2017 changed existing tax law including a reduction of the U.S. Corporate tax rate. The Company re-measured deferred taxes as of the date of enactment, reflecting these changes within deferred tax assets as of December 31, 2017.

 

The most significant temporary differences between GAAP net income (loss) and taxable net income (loss) are the treatment of interest costs, policy premiums and servicing costs with respect to the acquisition and maintenance of the life insurance policies and revenue recognition with respect to the fair value of the life insurance portfolio.

 

Liquidity and Capital Resources

 

We finance our businesses through a combination of life insurance policy benefit receipts, equity offerings, debt offerings, and our senior credit facility. We have used our debt offerings and our senior credit facility for policy acquisition, policy premiums and servicing costs, working capital and financing expenditures including paying principal, interest and dividends.

 

As of June 30, 2018 and December 31, 2017, we had approximately $158.1 million and $159.4 million, respectively, in combined available cash, cash equivalents, restricted cash and policy benefits receivable for the purpose of purchasing additional life insurance policies, paying premiums on existing policies, paying portfolio servicing expenses, and paying principal, interest and dividends on our outstanding debt and equity securities. Additional future borrowing base capacity for premiums and servicing costs, created as the premiums and servicing costs of pledged life insurance policies become due and by additional policy pledges to the facility, if any, exists under the amended and restated senior credit facility with LNV Corporation.

 

Financings Summary

 

We had the following outstanding debt balances as of June 30, 2018 and December 31, 2017:

 

		As of June 30, 2018								As of December 31, 2017
Issuer/Borrower		Principal Amount Outstanding				Weighted Average Interest Rate				Principal Amount Outstanding				Weighted Average Interest Rate
GWG Holdings, Inc. – L Bonds (see Note 8)		$	534,302,000				7.15	%		$	461,427,000				7.29	%
GWG DLP Funding IV, LLC – LNV senior credit facility (see Note 6)			190,389,000				10.19	%			222,525,000				9.31	%
Total		$	724,691,000				7.95	%		$	683,952,000				7.95	%

 

In November 2011, we began offering Series I Secured Notes, which were governed by an Intercreditor Agreement, a Third Amended and Restated Note Issuance and Security Agreement dated November 1, 2011, as amended, and a related Pledge Agreement. In September 2017, all of the Series I Secured Notes were paid in full and all obligations thereunder were terminated.

 

In June 2011, we concluded a private placement offering of Series A Preferred Stock for new investors, 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 into Series A Preferred Stock and $10.6 million of new investments. In October 2017, we exercised our contractual right to call for the redemption of the Series A Preferred Stock and all related outstanding warrants and paid an aggregate of approximately $22.2 million.

 

 

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

 

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

 

In January 2015, we began publicly offering up to $1.0 billion of L Bonds as a follow-on to our earlier $250.0 million public debt offering. In January 2018, we began publicly offering up to $1.0 billion L Bonds as a follow-on to our earlier L Bond offering. Through June 30, 2018, the total amount of these L Bonds sold, including renewals, was $972.8 million. As of June 30, 2018 and December 31, 2017, respectively, we had approximately $534.3 million and $461.4 million in principal amount of L Bonds outstanding.

 

In October 2015, we began publicly offering up to 100,000 shares of our Redeemable Preferred Stock (“RPS”) at a per-share price of $1,000. As of December 31, 2017, we had issued approximately $99.1 million stated value of RPS and terminated that offering.

 

In February 2017, we began publicly offering up to 150,000 shares of Series 2 Redeemable Preferred Stock (RPS 2) at a per-share price of $1,000. As of June 30, 2018, we have issued approximately $150 million stated value of RPS 2 and terminated that offering.

 

The weighted-average interest rate of our outstanding L Bonds as of June 30, 2018 and December 31, 2017 was 7.15% and 7.29%, respectively, and the weighted-average maturity at those dates was 2.50 and 2.38 years, respectively. Our L Bonds have renewal features. Since we first issued our L Bonds, we have experienced $438.5 million in maturities, of which $259.3 million has renewed through June 30, 2018 for an additional term. This has provided us with an aggregate renewal rate of approximately 59.1% for investments in these securities.

 

Future contractual maturities of L Bonds at June 30, 2018 are:

 

Years Ending December 31,		L Bonds
Six months ending December 31, 2018		$	60,612,000
2019			150,617,000
2020			114,594,000
2021			65,293,000
2022			39,713,000
2023			36,818,000
Thereafter			66,655,000
		$	534,302,000

 

The L Bonds are secured by all of our assets and are subordinate to our senior credit facility with LNV Corporation.

 

On September 27, 2017, we entered into a $300 million amended and restated senior credit facility with LNV Corporation in which DLP IV is the borrower. We intend to use the proceeds from this facility to grow and maintain our portfolio of life insurance policies, for liquidity and for general corporate purposes. As of June 30, 2018 we had approximately $190.4 million outstanding under the senior credit facility with LNV Corporation.

 

We expect to meet our ongoing operational capital needs for policy acquisition, policy premiums and servicing costs, working capital and financing expenditures including paying principal, interest and dividends through a combination of the receipt of policy benefits from our portfolio of life insurance policies, net proceeds from our L Bond offering, and funding available from our senior credit facility with LNV Corporation. We estimate that our liquidity and capital resources are sufficient for our current and projected financial needs for at least the next twelve months given current assumptions. However, if we are unable to continue our L Bonds offering for any reason, and we are unable to obtain capital from other sources, our business will be materially and adversely affected. In addition, our business will be materially and adversely affected if we do not receive the policy benefits we forecast and if holders of our L Bonds fail to renew with the frequency we have historically experienced. In such a case, we could be forced to sell our investments in life insurance policies to service or satisfy our debt-related and other obligations. A sale under such circumstances may result in significant impairment of the recognized value of our portfolio.

 

Capital expenditures have historically not been material and we do not anticipate making material capital expenditures in 2018 or beyond.

 

 

Debt Financings Summary

 

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

 

		As of June 30, 2018				As of December 31, 2017
Total senior facility with LNV Corporation and other indebtedness
Face amount outstanding		$	190,389,000			$	222,525,000
Unamortized selling costs			(9,758,000	)			(10,287,000	)
Carrying amount		$	180,631,000			$	212,238,000
L Bonds:
Face amount outstanding		$	534,302,000			$	461,427,000
Subscriptions in process			2,547,000				1,560,000
Unamortized selling costs			(18,060,000	)			(15,593,000	)
Carrying amount		$	518,789,000			$	447,394,000

 

Portfolio Assets and Secured Indebtedness

 

At June 30, 2018, the fair value of our investments in life insurance policies of $726.1 million plus our cash balance of $124.4 million and our restricted cash balance of $6.7 million, plus matured policy benefits receivable of $27.0 million, totaled $884.2 million, representing an excess of portfolio assets over secured indebtedness of $159.5 million. At December 31, 2017, the fair value of our investments in life insurance policies of $650.5 million plus our cash balance of $114.4 million and our restricted cash balance of $28.3 million, plus matured policy benefits receivable of $16.7 million, totaled $809.9 million, representing an excess of portfolio assets over secured indebtedness of $126.0 million.

 

The following forward-looking table seeks to illustrate the impact that a hypothetical sale of our portfolio of life insurance assets at various discount rates would have on our ability to satisfy our debt obligations as of June 30, 2018. In all cases, the sale of the life insurance assets owned by DLP IV will be used first to satisfy all amounts owing under the respective senior credit facility with LNV Corporation. The net sale proceeds remaining after satisfying all obligations under the senior credit facility with LNV Corporation would be applied to L Bonds on a pari passu basis.

 

Portfolio Discount Rate		10%				12%				14%				16%				17%
Value of portfolio		$	741,839,000			$	676,034,000			$	620,015,000			$	571,903,000			$	550,346,000
Cash, cash equivalents and policy benefits receivable			158,131,000				158,131,000				158,131,000				158,131,000				158,131,000
Total assets			899,970,000				834,165,000				778,146,000				730,034,000				708,477,000
Senior credit facility			190,389,000				190,389,000				190,389,000				190,389,000				190,389,000
Net after senior credit facility			709,581,000				643,776,000				587,757,000				539,645,000				518,088,000
L Bonds			534,302,000				534,302,000				534,302,000				534,302,000				534,302,000
Net after L Bonds		$	175,279,000			$	109,474,000			$	53,455,000			$	5,343,000			$	(16,214,000	)
Impairment to L Bonds			No impairment				No impairment				No impairment				No Impairment				Impairment

 

The table illustrates that our ability to fully satisfy amounts owing under the L Bonds would likely be impaired upon the sale of all our life insurance assets at a price equivalent to a discount rate of approximately 16.24% or higher. At December 31, 2017, the likely impairment occurred at a discount rate of approximately 15.04% or higher. The discount rates used to calculate the fair value of our portfolio were 10.45% as of both June 30, 2018 and December 31, 2017.

 

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

 

 

Amendment of Credit Facility

 

Effective September 27, 2017, DLP IV entered into an Amended and Restated Loan and Security Agreement with LNV Corporation, as lender, and CLMG Corp., as the administrative agent on behalf of the lenders under the agreement. The Loan and Security Agreement makes available a total of up to $300,000,000 in credit to DLP IV with a maturity date of September 27, 2029. Additional advances are available under the Amended and Restated Loan Agreement at the LIBOR rate as defined in the Amended and Restated Loan Agreement. Advances are available as the result of additional borrowing base capacity, created as the premiums and servicing costs of pledged life insurance policies become due and by additional policy pledges to the facility, if any. Interest will accrue on amounts borrowed under the Amended and Restated Loan Agreement at an annual interest rate, determined as of each date of borrowing or quarterly if there is no borrowing, equal to (A) the greater of 12-month LIBOR or the federal funds rate (as defined in the agreement) plus one-half of one percent per annum, plus (B) 7.50% per annum. The effective rate at June 30, 2018 was 10.19%. Interest payments are made on a quarterly basis.

 

Under the Amended and Restated Loan and Security Agreement, DLP IV has granted the administrative agent, for the benefit of the lenders under the agreement, a security interest in all of DLP IV’s assets. As with prior collateral arrangements relating to the senior secured debt of GWG Holdings and its subsidiaries (on a consolidated basis), GWG Holdings’ equity ownership in DLP IV continues to serve as collateral for the obligations of GWG Holdings under the L Bonds (although the life insurance assets owned by DLP IV will not themselves serve directly as collateral for those obligations).

 

Cash Flows

 

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

 

The amount of payments for anticipated premiums, including the requirement by our senior credit facility with LNV Corporation to maintain a two month cost-of-insurance threshold within each policy cash value account, and servicing costs that we will be required to make over the next five years to maintain our current portfolio, assuming no mortalities, is set forth in the table below.

 

Years Ending December 31,		Premiums				Servicing				Premiums and Servicing Fees
Six months ending December 31, 2018		$	27,358,000			$	677,000			$	28,035,000
2019			63,323,000				1,355,000				64,678,000
2020			73,758,000				1,355,000				75,113,000
2021			84,700,000				1,355,000				86,055,000
2022			95,964,000				1,355,000				97,319,000
2023			107,289,000				1,355,000				108,644,000
		$	452,392,000			$	7,452,000			$	459,844,000

 

Our anticipated premium expenses are subject to the risk of increased cost-of-insurance charges (i.e., “COI” or premium charges) for the life insurance policies we own. On May 9, 2018 we learned that John Hancock Life Insurance Company (“John Hancock”) had begun notifying policy owners of COI increases on Performance UL policies issued between 2003 and 2010. We identified and received notice on 20 such policies in our portfolio, representing $59.6 million in total face value, and have completed our analysis and incorporation of increased cost of insurance charges into our portfolio as of June 30, 2018 reducing the fair value by approximately $2.9 million. In addition, we received notice and recognized COI increases on four policies issued by the Transamerica Life Insurance Company (“Transamerica”) as of June 30, 2018 with a total face value of $9.2 million and a reduction in fair value of $1.4 million.

 

 

We have no known pending cost-of-insurance increases on any policies in our portfolio, but we are aware that cost-of-insurance increases have become more prevalent in the industry. Thus, we may see additional insurers implementing cost-of-insurance increases in the future.

 

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

 

Quarter End Date		Portfolio Face Amount ($)				12-Month Trailing Benefits Realized ($)				12-Month Trailing Premiums Paid ($)				12-Month Trailing Benefits/Premium Coverage Ratio
March 31, 2015		754,942,000				46,675,000				23,786,000				196.2		%
June 30, 2015			806,274,000				47,125,000				24,348,000				193.5	%
September 30, 2015			878,882,000				44,482,000				25,313,000				175.7	%
December 31, 2015			944,844,000				31,232,000				26,650,000				117.2	%
March 31, 2016			1,027,821,000				21,845,000				28,771,000				75.9	%
June 30, 2016			1,154,798,000				30,924,000				31,891,000				97.0	%
September 30, 2016			1,272,078,000				35,867,000				37,055,000				96.8	%
December 31, 2016			1,361,675,000				48,452,000				40,239,000				120.4	%
March 31, 2017			1,447,558,000				48,189,000				42,753,000				112.7	%
June 30, 2017			1,525,363,000				49,295,000				45,414,000				108.5	%
September 30, 2017			1,622,627,000				53,742,000				46,559,000				115.4	%
December 31, 2017			1,676,148,000				64,719,000				52,263,000				123.8	%
March 31, 2018			1,758,066,000				60,248,000				53,169,000				113.3	%
June 30, 2018			1,849,079,000				76,936,000				53,886,000				142.8	%

 

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

 

Inflation

 

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

 

Off-Balance Sheet Arrangements

 

We are party to an office lease with U.S. Bank National Association as the landlord. On September 1, 2015, we entered into an amendment that expanded the leased space to 17,687 square feet and extended the term through October 2025 (see Note 17 to the condensed consolidated financial statements).

 

 

Credit Risk

 

We review the credit risk associated with our portfolio of life insurance policies when estimating its fair value. In evaluating the policies’ credit risk, we consider insurance company solvency, credit risk indicators, economic conditions, ongoing credit evaluations, and company positions. We attempt to manage our credit risk related to life insurance policies typically by purchasing policies issued only from companies with an investment-grade credit rating by either Standard & Poor’s, Moody’s, or A.M. Best Company. As of June 30, 2018, 95.3% of our life insurance policies, by face value benefits, were issued by companies that maintained an investment-grade rating (BBB or better) by Standard & Poor’s.

 

Interest Rate Risk

 

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

 

Non-GAAP Financial Measures

 

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

 

We use non-GAAP financial measures for management’s assessment of our financial condition and operating results without regard to GAAP fair value standards. The application of current GAAP fair value standards, especially during a period of significant growth of our portfolio and our Company may result in current period GAAP financial results that may not be reflective of our long-term earnings potential. Management believes our non-GAAP financial measures provide investors an alternative view of the long-term earnings potential without regard to the volatility in GAAP financial results that can, and does, occur during this stage of our portfolio and company growth.

 

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

 

 

In addition, the Indenture governing our L Bonds requires us to maintain a “Debt Coverage Ratio” designed to provide reasonable assurance that the buy and hold value of our life insurance portfolio plus the value of all our other assets exceed our total outstanding indebtedness. This ratio is calculated using non-GAAP measures in the method described below, again without regard to GAAP-based fair value measures.

 

Non-GAAP Investment Cost Basis		As of June 30, 2018				As of December 31, 2017
GAAP fair value		$	726,063,000			$	650,527,000
Unrealized fair value gain (1)			(362,605,000	)			(331,386,000	)
Adjusted cost basis increase (2)			365,886,000				325,100,000
Non-GAAP investment cost basis (3)		$	729,344,000			$	644,241,000

 

(1)

This represents the reversal of cumulative unrealized GAAP fair value gain of life insurance policies.

(2)

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

(3)

This is the non-GAAP investment cost basis in life insurance policies from which our expected internal rate of return is calculated.

 

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

 

		As of June 30, 2018				As of December 31, 2017
Expected IRR (1)			10.19	%			10.48	%
Total weighted-average interest rate on indebtedness for borrowed money (2)			7.95	%			7.95	%
Total excess spread (3)			2.24	%			2.53	%

 

(1)

Excludes IRR realized on matured life insurance policies — which are substantial.

(2)

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

 

Indebtedness		As of June 30, 2018				As of December 31, 2017
Senior credit facility with LNV Corporation		$	190,389,000			$	222,525,000
L Bonds			534,302,000				461,427,000
Total		$	724,691,000			$	683,952,000
Interest Rates on Indebtedness
Senior credit facility with LNV Corporation			10.19	%			9.31	%
L Bonds			7.15	%			7.29	%
Weighted-average interest rates paid on indebtedness			7.95	%			7.95	%

 

(3)

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

 

Adjusted Non-GAAP Net Income. We calculate our adjusted non-GAAP net income by recognizing the actuarial gain accruing within our life insurance portfolio at the Expected IRR against our adjusted cost basis without regard to fair value. We net this actuarial gain against its adjusted costs during the same period to calculate our net income on an adjusted non-GAAP basis.

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2018				2017				2018				2017
GAAP net income (loss) attributable to common shareholders		$	(4,396,000	)		$	(7,725,000	)		$	(17,279,000	)		$	(9,638,000	)
Unrealized fair value gain (1)			(14,573,000	)			(15,235,000	)			(31,219,000	)			(29,119,000	)
Adjusted cost basis increase (2)			27,453,000				22,739,000				53,450,000				44,461,000
Accrual of unrealized actuarial gain (3)			4,973,000				7,505,000				11,575,000				12,415,000
Total adjusted non-GAAP net income (loss)		$	13,457,000			$	7,284,000			$	16,527,000			$	18,119,000

 

(1)

Reversal of unrealized GAAP fair value gain on life insurance policies for current period.

(2)

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

(3)

Accrual of actuarial gain at Expected IRR.

 

 

Adjusted Non-GAAP Tangible Net Worth. We calculate our adjusted non-GAAP tangible net worth by recognizing the actuarial gain accruing within our life insurance policies at the Expected IRR of the policies we own without regard to fair value. We net this actuarial gain against our costs during the same period to calculate our adjusted tangible net worth on a non-GAAP basis.

 

		As of June 30, 2018				As of December 31, 2017
GAAP net worth		$	172,022,000			$	133,672,000
Less intangible assets (1)			(33,133,000	)			(30,354,000	)
GAAP tangible net worth			138,889,000				103,318,000
Unrealized fair value gain (2)			(362,605,000	)			(331,386,000	)
Adjusted cost basis increase (3)			365,886,000				325,100,000
Accrual of unrealized actuarial gain (4)			169,816,000				158,241,000
Total adjusted non-GAAP tangible net worth		$	311,986,000			$	255,273,000

 

(1)

Unamortized portion of deferred financing costs and pre-paid insurance.

(2)

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

(3)

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

(4)

Accrual of cumulative actuarial gain at Expected IRR.

 

Debt Coverage Ratio. Our L Bonds borrowing covenants require us to maintain a Debt Coverage Ratio of less than 90%. The Debt Coverage Ratio is calculated by dividing the sum of our total interest-bearing indebtedness by the sum of our cash, cash equivalents, and policy benefits receivable by the net present value of the life insurance portfolio, and, without duplication, the value of all of our other assets as reflected on our most recently available balance sheet prepared in accordance with GAAP.

 

		As of June 30, 2018				As of December 31, 2017
Life insurance portfolio policy benefits		$	1,849,079,000			$	1,676,148,000
Discount rate of future cash flows (1)			7.95	%(1)			7.95	%(1)
Net present value of life insurance portfolio policy benefits		$	822,029,000			$	737,625,000
Cash and cash equivalents			131,096,000				142,771,000
Life insurance policy benefits receivable			27,035,000				16,659,000
Other assets (2)			10,841,000				-
Total Coverage		$	991,001,000			$	897,055,000
Senior credit facility		$	190,389,000			$	222,525,000
L Bonds			534,302,000				461,427,000
Total Indebtedness		$	724,691,000			$	683,952,000
Debt Coverage Ratio			73.13	%			76.24	%

  

(1)	Weighted-average interest rate paid on indebtedness.
(2)	The Total Coverage amount as of June 30, 2018 includes “Other assets” as defined in the Amendment No.1 to Amended and Restated Indenture with Bank of Utah, dated March 27, 2018.

 

As of June 30, 2018 and December 31, 2017, we were in compliance with the Debt Coverage Ratio.

 

We have in the past reported non-GAAP expected portfolio internal rate of return at purchase among our other non-GAAP financial measures. We have determined, however, to cease reporting this measure primarily because we do not believe that it is sufficiently additive to our existing non-GAAP measures in aiding users of our financial statements and disclosures to measure and evaluate our financial condition or operating results.

 

 

Portfolio Information

 

Our portfolio of life insurance policies, owned by our subsidiaries as of June 30, 2018, is summarized below:

 

Life Insurance Portfolio Summary

 

Total portfolio face value of policy benefits		$	1,849,079,000
Average face value per policy		$	1,831,000
Average face value per insured life		$	2,052,000
Average age of insured (yrs.)*			81.9
Average life expectancy estimate (yrs.)*			6.8
Total number of policies			1,010
Number of unique lives			901
Demographics			76% Males; 24% Females
Number of smokers			41
Largest policy as % of total portfolio face value			0.72	%
Average policy as % of total portfolio			0.10	%
Average annual premium as % of face value			3.11	%

 

*

Averages presented in the table are weighted averages.

 

Our portfolio of life insurance policies, owned by our wholly owned subsidiaries as of June 30, 2018, organized by the insured’s current age and the associated number of policies and policy benefits, is summarized below:

 

Distribution of Policies and Policy Benefits by Current Age of Insured

 

																Percentage of Total
Min Age				Max Age				Number of Policies				Policy Benefits				Number of Policies				Policy Benefits				Wtd. Avg. LE (yrs.)
	95				100				12			$	16,954,000				1.2	%			0.9	%			1.4
	90				94				111				209,514,000				11.0	%			11.3	%			2.8
	85				89				213				446,986,000				21.1	%			24.2	%			4.7
	80				84				213				453,283,000				21.1	%			24.5	%			6.5
	75				79				205				368,928,000				20.3	%			20.0	%			8.9
	70				74				180				263,198,000				17.8	%			14.2	%			10.6
	60				69				76				90,216,000				7.5	%			4.9	%			10.1
	Total								1,010			$	1,849,079,000				100.0	%			100.0	%			6.8

 

Our portfolio of life insurance policies, owned by our subsidiaries as of June 30, 2018, organized by the insured’s estimated life expectancy and associated policy benefits, is summarized below:

 

Distribution of Policies by Current Life Expectancies (LE) of Insured

 

																Percentage of Total
Min LE (Months)				Max LE (Months)				Number of Policies				Policy Benefits				Number of Policies				Policy Benefits
	1				47				268			$	442,256,000				26.5	%			23.9	%
	48				71				198				361,295,000				19.6	%			19.5	%
	72				95				207				391,580,000				20.5	%			21.2	%
	96				119				166				329,115,000				16.4	%			17.8	%
	120				143				97				150,815,000				9.6	%			8.2	%
	144				179				60				130,376,000				6.0	%			7.0	%
	180				228				14				43,642,000				1.4	%			2.4	%
	Total								1,010			$	1,849,079,000				100.0	%		$	100.0	%

 

 

We track concentrations of pre-existing medical conditions among insured individuals within our portfolio based on information contained in life expectancy reports including the underwriter’s designation of primary impairment. We track these medical conditions within the following ten primary categories: (1) cancer, (2) cardiovascular, (3) cerebrovascular, (4) dementia, (5) diabetes, (6) multiple conditions, (7) neurological disorders, (8) respiratory disease, (9) other, and (10) no diseases. Currently, the primary disease categories within our portfolio that represent a concentration of over 10% are multiple conditions, cardiovascular, and other which constitute 26.7%, 21.5%, and 12.7%, respectively, of the face amount of insured benefits of our portfolio as of June 30, 2018.

 

The yield to maturity on bonds issued by life insurance carriers reflects, among other things, the credit risk (risk of default) of such insurance carrier. We follow the yields on certain publicly traded life insurance company bonds because this information is part of the data we consider when valuing our portfolio of life insurance policies for our financial statements.

 

The average yield to maturity of publicly traded life insurance company bonds data we consider when valuing our portfolio of life insurance policies was 4.11% as of June 30, 2018. We believe that this reflects, in part, the financial market’s judgment that credit risk is low with regard to these carriers’ financial obligations. It should be noted that the obligations of life insurance carriers to pay life insurance policy benefits ranks senior to all of their other financial obligations, such as the aforementioned senior bonds they issue.

 

As of June 30, 2018, approximately 95.3% of the face value of policy benefits in our life insurance portfolio were issued by insurance companies with investment-grade credit ratings from Standard & Poor’s. Our ten largest life insurance company credit exposures and the Standard & Poor’s credit rating of their respective financial strength and claims-paying ability is set forth below:

 

Distribution of Policy Benefits by Top 10 Insurance Companies

 

Rank			Policy Benefits				Percentage of Policy Benefit Amount				Insurance Company		Ins. Co. S&P Rating
1			$	271,936,000				14.7	%		John Hancock Life Insurance Company (U.S.A.)		AA-
2				210,626,000				11.4	%		AXA Equitable Life Insurance Company		A+
3				206,917,000				11.2	%		Lincoln National Life Insurance Company		AA-
4				171,627,000				9.3	%		Transamerica Life Insurance Company		AA-
5				120,081,000				6.5	%		Metropolitan Life Insurance Company		AA-
6				90,168,000				4.9	%		American General Life Insurance Company		A+
7				61,737,000				3.3	%		Pacific Life Insurance Company		AA-
8				60,893,000				3.3	%		Massachusetts Mutual Life Insurance Company		AA+
9				54,632,000				2.9	%		Reliastar Life Insurance Company		A
10				53,202,000				2.9	%		Security Life of Denver Insurance Company		A
			$	1,301,819,000				70.4	%

 

Secondary Life Insurance — Portfolio Return Modeling

 

The goal of our portfolio of life insurance assets is to earn superior risk-adjusted returns. At any time, we calculate our returns from our life insurance assets based upon (i) our historical results; and (ii) the future cash flows we expect to realize from our statistical forecasts. To forecast our expected future cash flows and returns, we use the probabilistic method of analysis. The expected internal rate of return of our portfolio is based upon future cash flow forecasts derived from a probabilistic analysis of policy benefits received and policy premiums paid in relation to our non-GAAP investment cost basis. As of June 30, 2018, the expected internal rate of return on our portfolio of life insurance assets was 10.19% based on our portfolio benefits of $1.85 billion and our non-GAAP investment cost basis of $729 million (including purchase price, premiums paid, and financing costs incurred to date). This calculation excludes returns realized from our matured policy benefits which are substantial.

 

 

We seek to further enhance our understanding of our expected future cash flow and returns by using a stochastic analysis, sometimes referred to as a “Monte Carlo simulation,” to provide us with a greater understanding of the variability of our projections. The stochastic analysis we perform provides internal rates of return calculations for different statistical confidence intervals. The results of our stochastic analysis, in which we run 10,000 random mortality scenarios, demonstrates that the scenario ranking at the 50^th percentile of all 10,000 results generates an internal rate of return (“IRR”) of 10.14%, which is very near to our expected IRR (“Expected IRR”) of our portfolio of 10.19%. Our Expected IRR is based upon future cash flow forecasts derived from a probabilistic analysis of our policy benefits received and policy premiums paid in relation to our non-GAAP investment cost basis. The stochastic analysis results also indicate that our portfolio is expected under this hypothetical analysis to generate an internal rate of return of 9.69% or better in 75% of all generated scenarios; and an internal rate of return of 9.30% or better in 90% of all generated scenarios. As the portfolio continues to grow in size and diversity, all else equal, the hypothetical scenario results cluster closer to each other around our median, or 50^th percentile, internal rate of return expectation, thereby lowering future cash flow volatility and potentially justifying our use of lower discount rates to value our portfolio as size and diversification continue to increase over time.

 

The complete detail of our portfolio of life insurance policies, owned by our wholly owned subsidiaries as of June 30, 2018, organized by the current age of the insured and the associated policy benefits, sex, estimated life expectancy, issuing insurance carrier, and the credit rating of the issuing insurance carrier, is set in Exhibit 99.2 to this report.

 

ITEM 4.

CONTROLS AND PROCEDURES.

 

Evaluation of Disclosure Controls and Procedures

 

We maintain disclosure controls and procedures designed to provide reasonable assurance that information required to be disclosed in our reports filed pursuant to the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance the objectives of the control system are met.

 

As of June 30, 2018, our Chief Executive Officer and Chief Financial Officer carried out an evaluation of the effectiveness of our disclosure controls and procedures as such term is defined in Rule 13a-15(e) under the Securities and Exchange Act of 1934, as of the end of the period covered by this report. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded our disclosure controls and procedures were effective.

 

Changes in Internal Control over Financial Reporting

 

There were no changes in our internal control over financial reporting identified in connection with management’s evaluation pursuant to Rules 13a-15(d) or 15d-15(d) of the Securities Exchange Act of 1934 during the period covered by this report that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

Management’s Report on Internal Control over Financial Reporting

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of the financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures are being made only with proper authorizations; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of our assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

Our management, under the supervision of and with the participation of the Chief Executive Officer and Chief Financial Officer, assessed the effectiveness of our internal control over financial reporting as of June 30, 2018 based on criteria for effective control over financial reporting set forth by the Committee of Sponsoring Organizations of the Treadway Commission, 2013 framework in “Internal Control — Integrated Framework.” Based on this assessment, our management concluded that, as of the evaluation date, we maintained effective internal control over financial reporting.

 

 

PART II — OTHER INFORMATION

 

ITEM 6.

EXHIBITS

 

Exhibit
10.1	Second Amendment to Master Exchange Agreement, dated June 29, 2018 (filed herewith).
31.1	Section 302 Certification of the Chief Executive Officer (filed herewith).
31.2	Section 302 Certification of the Chief Financial Officer (filed herewith).
32.1	Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. §1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith).
99.1	Letter from Model Actuarial Pricing Systems, dated July 23, 2018 (filed herewith).
99.2	Portfolio of Life Insurance Policies as of June 30, 2018 (filed herewith).
101.INS	XBRL Instance Document
101.SCH	XBRL Taxonomy Extension Schema Document
101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF	XBRL Taxonomy Extension Definition Linkbase Document
101.LAB	XBRL Taxonomy Extension Label Linkbase Document
101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document

 

 

SIGNATURES

 

Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

	GWG HOLDINGS, INC.
Date: August 14, 2018	By:	/s/ Jon R. Sabes
		Chief Executive Officer
Date: August 14, 2018	By:	/s/ William B. Acheson
		Chief Financial Officer

 

 

EXHIBIT INDEX

 

Exhibit
10.1	Second Amendment to Master Exchange Agreement, dated June 29, 2018 (filed herewith).
31.1	Section 302 Certification of the Chief Executive Officer
31.2	Section 302 Certification of the Chief Financial Officer
32.1	Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. §1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
99.1	Letter from Model Actuarial Pricing Systems, dated April 23, 2018
99.2	Portfolio of Life Insurance Policies as of June 30, 2018
101.INS	XBRL Instance Document
101.SCH	XBRL Taxonomy Extension Schema Document
101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF	XBRL Taxonomy Extension Definition Linkbase Document
101.LAB	XBRL Taxonomy Extension Label Linkbase Document
101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document

 

 

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