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IFT > SEC Filings for IFT > Form 10-Q/A on 14-Nov-2013All Recent SEC Filings

Show all filings for IMPERIAL HOLDINGS, INC. | Request a Trial to NEW EDGAR Online Pro

Form 10-Q/A for IMPERIAL HOLDINGS, INC.


14-Nov-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion summarizes the significant factors affecting the consolidated operating results, financial condition, liquidity, and cash flows of our Company as of and for the periods presented below and should be read in conjunction with the financial statements and accompanying notes included with this Quarterly Report on Form 10-Q. This discussion contains forward-looking statements that are based on the beliefs of our management, as well as assumptions made by, and information currently available to, our management. Actual results could differ materially from those discussed in or implied by forward-looking statements as a result of various factors. See "Forward-Looking Statements."

Overview

We were founded in December 2006 as a Florida limited liability company and in connection with our initial public offering, in February 2011, Imperial Holdings, Inc. succeeded to the business of Imperial Holdings, LLC and its assets and liabilities.

Imperial Holdings, Inc. (the "Company" or "Imperial") operates in two reportable business segments: life finance (formerly referred to as premium finance) and structured settlements. In the life finance business, the Company earns revenue/income from changes in the fair value of life insurance policies that the Company acquires and receipt of death benefits with respect to matured life insurance policies it owns as well as from interest accruing on outstanding loans and loan origination fees recognized over the life of outstanding loans. In the structured settlement business, the Company purchases structured settlement receivables at a discounted rate and sells these receivables to third parties. Our Annual Report on Form 10-K for the fiscal year ended December 31, 2012 provides additional information about our business, operations and financial condition.

New Revolving Credit Facility, Retirement of Bridge Facility, Portfolio Growth and Change in Accounting Estimate

In anticipation of a liquidity shortfall in the second quarter of 2013, on March 27, 2013, a subsidiary of the Company borrowed $45.0 million in aggregate principal amount under an 18-month senior secured bridge facility (the "Bridge Facility") while the Company continued in its efforts to source longer-term capital.

On April 29, 2013, White Eagle Asset Portfolio, LLC, a subsidiary of the Company entered into a 15-year revolving credit facility providing for up to $300.0 million in borrowings (the "Revolving Credit Facility") to pay premiums on the policies pledged as collateral under the facility, debt service and for the fees and expenses of certain service providers. The initial advance under the Revolving Credit Facility was approximately $83.0 million, with a portion of such borrowings used to retire the debt outstanding under the Bridge Facility. In addition, proceeds of the initial advance were used to pay transaction fees and expenses, a distribution to the Company and to fund a $48.5 million release payment under a termination agreement (the "Termination Agreement") to the Company's lender protection insurance coverage provider (the "LPIC Provider") who released all of its salvage and subrogation rights in 323 policies that the Company has historically treated as contingent assets and described as "Life Settlements with Subrogation rights, net" as well as in 93 policies that were owned by CTL Holdings, LLC ("CTL"). On April 30, 2013, the Company acquired CTL and its 93 policies. At June 30, 2013 the Company's portfolio consists of 627 policies, with an aggregate death benefit of $3.0 billion compared to 220 policies, with an aggregate death benefit of $1.1 billion at March 31, 2013.

459 policies owned by White Eagle, with an aggregate death benefit of $2.3 billion, and an estimated fair value of approximately $218.1 million at June 30, 2013 have been pledged as collateral under the Revolving Credit Facility and the Company can use subsequent draws to pay premiums on these policies. The Company is presently evaluating the 168 policies that have not been pledged as collateral, the majority of which had historically been maintained by the LPIC Provider, and may pledge certain of these policies in the future. It may also determine to sell or lapse certain of these policies as its portfolio strategy and liquidity needs dictate. Should it choose maintain all of the policies that have not been pledged as collateral under the Revolving Credit Facility, the Company estimates that it will need to pay approximately $6.5 million to maintain these 168 policies in force through 2013 and may seek to raise additional capital to maintain some or all of these policies.

The procurement of the $300.0 million 15-year Revolving Credit Facility and the retirement of the $45.0 million Bridge Facility served to effectively recapitalize the Company and significantly mitigate liquidity risk. While the Revolving Credit Facility provides the lender with a significant interest in the policies pledged as collateral, the initial borrowings under the facility allowed the Company to opportunistically triple the size of its portfolio through the extinguishment of subrogation rights in policies that were historically considered contingent assets and through the acquisition of the CTL policies.

At June 30, 2013, the Company or its subsidiaries owned 402 policies that were either acquired through the acquisition of CTL or that were considered contingent assets prior to the effectiveness of the Termination Agreement, with an aggregate death benefit of $1.9 billion and an estimated fair value of approximately $139.7 million. The Company believes that it was uniquely positioned to transact with both the LPIC Provider and CTL and that the transaction prices were, accordingly, not indicative of what an exit price would be for these 402 policies in a negotiated market transfer. The addition of these policies resulted in a $65.8 million unrealized gain in investments in life settlements during the quarter ended June 30, 2013 and policy acquisitions similar in scale and in transaction price to those made during the quarter should not be anticipated in future periods.

Due to these policy additions, the application of fair value accounting to amounts owing under the Revolving Credit Facility and the elimination of servicing fee income through intercompany consolidation, the results of prior periods may not be comparable to the Company's results at June 30, 2013 or in future periods.


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The Company collected death benefits of $5.0 million and $1.0 million plus interest, respectively, in the second quarter of 2013 in respect of two policies that matured in the first quarter of 2013 and collected an additional $1.0 million from the surrender of two policies that were acquired during the second quarter of 2013.

Settlement of Shareholder Litigation

On December 18, 2012, attorneys for Imperial signed a Term Sheet for Global Settlement Regarding Imperial Holdings, Inc. Matters (the "Term Sheet"). Also signing the Term Sheet were attorneys representing the plaintiffs in the previously disclosed class action lawsuits and derivative actions instituted against the Company as well attorneys for Imperial's director and officer liability insurance carriers ("D&O Carriers"), certain individual defendants named in the class actions and the underwriters in Imperial's initial public offering. The Term Sheet provides the terms upon which each of the parties represented by the signatories would be willing to settle the class action litigation and derivative actions as well as the declaratory relief action filed by Catlin, Imperial's primary D&O Carrier.

On July 29, 2013, the parties to the Term Sheet executed definitive settlement agreements in respect of the class action litigation, derivative action and insurance coverage declaratory relief complaint. The class action litigation and derivative action settlements are subject to court approval and all of the settlements are contingent on effectiveness of the other settlements. On August 6, 2013, the federal court entered an order preliminarily approving the class action settlements and setting a settlement hearing for December 16, 2013. On August 13, 2013, the state court entered an order preliminarily approving the derivative action settlement and setting a final fairness hearing for December 17, 2013. Final court approval of the class action and derivative action settlements could be delayed by appeals or other proceedings

The terms of the class action settlement include a cash payment of $12.0 million, of which $11.0 million is to be contributed by Imperial's primary and excess D&O Carriers, and the issuance of two million warrants for shares of the Company's stock with an estimated fair value of $3.1 million at the date of the signing of the Term Sheet. The value of the warrants were reassessed during the six months ended June 30, 2013 and resulted in an increase in fair value of $3.3 million. The estimated fair value at June 30, 2013 was $6.4 million. The fair value of the warrants will be re-assessed at issuance. The warrants will have a five-year term with an exercise price of $10.75 and will be issued when the settlement proceeds are distributed to the claimants. In addition, the underwriters in Imperial's initial public offering are to waive their rights to indemnity and contribution by Imperial. The Company recorded a reserve at June 30, 2013 related to the proposed settlement of $18.4 million, which is included in other liabilities and a receivable for insurance recoverable from the Company's D&O Carrier of $11.0 million, which is included in prepaid and other assets. $4.1 million net effect of the settlement was included in legal fees in the statement of operations for the year ended December 31, 2012.

The derivative action settlement requires implementation of certain compliance reforms and contemplates payment by Imperial's primary D&O carrier of $1.5 million for legal fees in respect of the derivative actions and the contribution of $500,000 in Imperial stock.

In addition, the settlements contemplate that Imperial will contribute $500,000 to a trust to cover certain claims under its director and officer liability insurance policies.

The Company established a reserve related to the proposed derivative settlement and insurance trust of $2.5 million, which is included in other liabilities and a receivable for insurance recoverable from the Company's D&O Carrier of $1.5 million, which is included in prepaid and other assets. The net effect of the settlement of $1.0 million was included in legal fees in the statement of operations for the year ended December 31, 2012.

The settlements also require Imperial to advance legal fees to and indemnify certain individuals covered under the policies. The obligation to advance and indemnify on behalf of these individuals, while currently unquantifiable, may be substantial and could have a material adverse effect on the Company's financial position and results of operations.

Use of Updated Life Expectancies & Recent Announcements by Life Expectancy Providers

To calculate the fair value of its life insurance policies, beginning with the quarter ended September 30, 2012 and consistent with the practice of many participants in the secondary and tertiary markets, the Company utilizes a "blend" of the life expectancy reports furnished by AVS Underwriting LLC ("AVS") and 21st Services, LLC ("21st Services") to establish a composite mortality factor input into its fair value model.

On January 22, 2013, 21st Services announced revisions to its underwriting methodology and on February 4, 2013, announced that it was correcting errors discovered in its previously announced revised methodology. According to the 21st Services, these revisions have generally been understood to lengthen the average reported life expectancy furnished by this life expectancy provider by 19%. At March 31, 2013, the Company had not received any life expectancy reports from 21st Services utilizing its revised methodology and, to account for the impact of the revisions and based off of market responses to the methodology change, the Company lengthened the life expectancies furnished by 21st Services by 13% prior to blending them with the life expectancy reports furnished by AVS.

As of June 30, 2013, the Company received 98 updated life expectancy reports from 21st Services that utilize its revised methodology. These life expectancies reported an average lengthening of life expectancies of 15.8% and, based on this sample, for the six months ended June 30, 2013, the Company increased the life expectancies furnished by 21st Services by 15.8% on the rest of its portfolio of life settlements prior to blending them with the life expectancy reports furnished by AVS. The Company expects to continue to lengthen life expectancies furnished


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by 21st Services that have not been re-underwritten using their updated methodology. Since the Revolving Credit Facility necessitates that the Company procure updated life expectancies on a periodic basis, the amount of policies that are lengthened by the Company in this manner will decrease over time and the fair value calculations in future periods will, accordingly, reflect the actual impact of the revised 21st Services methodology on a policy by policy basis as updated life expectancy reports are procured. At June 30, 2013, had the Company not applied the 15.8% increase to the 21st Services life expectancy reports, the portfolio would have increased from the reported amount of $265.8 million by $5.3 million.

Prior to the quarter ended June 30, 2013, when blending AVS and 21st Services' life expectancy reports to derive a composite mortality factor, the Company would cap the higher mortality factor at an amount that was 150% above the lower mortality factor. This was done so as to reduce variances between life expectancies furnished by these two life expectancy providers. For the period ending June 30, 2013, the Company terminated its use of such a cap. The Company believes that the elimination of this cap is consistent with valuation methodologies employed by other market participants in connection with 21st Services' revised methodology.

One of the Company's life expectancy providers, AVS, filed for federal bankruptcy protection under Chapter 11 on February 12, 2013. The Company cannot, at this time, predict what impact the bankruptcy filing will have on the Company's ability to procure life expectancy reports from AVS in the future, AVS's ability to continue its operations or whether other market participants will continue to use AVS life expectancy reports for valuation purposes going forward. The Company will continue to monitor the market response to these developments and may elect to adjust the application of life expectancy reports in its fair value methodology or source reports from different life expectancy providers in future periods.

Critical Accounting Policies

Critical Accounting Estimates

The preparation of the financial statements requires us to make judgments, estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. We base our judgments, estimates and assumptions on historical experience and on various other factors that are believed to be reasonable under the circumstances. Actual results could differ materially from these estimates under different assumptions and conditions. 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 the accounting for the loan impairment valuation, allowance for doubtful accounts, income taxes, valuation of structured settlements and the valuation of investments in life settlements have the greatest potential impact on our financial statements and accordingly believe these to be our critical accounting estimates. Below we discuss the critical accounting policies associated with the estimates as well as selected other critical accounting policies.

Life Finance Loans Receivable

We report loans receivable acquired or originated by us at cost, adjusted for any deferred fees or costs in accordance with ASC 310-20, Receivables - Nonrefundable Fees and Other Costs, discounts, and loan impairment valuation. All loans are collateralized by life insurance policies. Interest income is accrued on the unpaid principal balance on a monthly basis based on the applicable rate of interest on the loans.

In accordance with ASC 310, Receivables, we specifically evaluate all loans for impairment based on the fair value of the underlying policies as collectability is primarily collateral dependent. The loans are considered to be collateral dependent as the repayment of the loans is expected to be provided by the underlying insurance policies. In the event of default, the borrower typically relinquishes ownership of the policy to us in exchange for our release of the debt (or we enforce our security interests in the beneficial interests in the trust that owns the policy). For loans that had lender protection insurance, we made a claim against the lender protection insurance policy and, subject to terms and conditions of the lender protection insurance policy, our lender protection insurer had the right to direct control or take beneficial ownership of the policy upon payment of our claim. For loans without lender protection insurance, we have the option of selling the policy or maintaining it on our balance sheet for investment.

We evaluate the loan impairment valuation on a monthly basis based on our periodic review of the estimated value of the underlying collateral. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. The loan impairment valuation is established as losses on loans are estimated and the provision is charged to earnings. Once established, the loan impairment valuation cannot be reversed to earnings.

In order to originate premium finance transactions our lenders required that we procure lender protection insurance. This lender protection insurance mitigates our exposure to losses, which may be caused by declines in the fair value of the underlying policies. At the end of each reporting period, for loans that had lender protection insurance, a loan impairment valuation was established if the carrying value of the loan receivable exceeded the amount of coverage. The lender protection insurance program was terminated as of December 31, 2010, and all loans originated after December 31, 2010, do not carry lender protection insurance coverage. Thus, for all loans originated in 2011 and beyond, a loan impairment valuation is established if the carrying value of a loan receivable exceeds the fair value of the underlying collateral. The Company ceased originating loans in the fourth quarter of 2011. The Termination Agreement entered into on April 30, 2013 between the Company and its lender protection insurer eliminated lender protection insurance coverage for all loans that previously had such coverage.


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Fair Value Option

As of July 1, 2010, we elected to adopt the fair value option, in accordance with ASC 825, Financial Instruments, to record newly-acquired structured settlements at fair value. We have the option to measure eligible financial assets, financial liabilities, and commitments at fair value on an instrument-by-instrument basis. This option is available when we first recognize a financial asset or financial liability or enter into a firm commitment. Subsequent changes in the fair value of assets, liabilities, and commitments where we have elected the fair value option are recorded in our consolidated statement of operations. We have made this election for our structured settlement assets because it is our intention to sell these assets within the next twelve months, and we believe it significantly reduces the disparity that exists between the GAAP carrying value of these structured settlements and our estimate of their economic value.

We have elected to account for the note payable under the Revolving Credit Facility with LNV Corporation, which includes the 50% interest in policy proceeds to the lender, using the fair value method. The fair value of the debt is the amount the Company would have to pay to transfer the debt to a market participant in an orderly transaction. We calculated the fair value of the debt using a discounted cash flow model taking into account the stated interest rate of the credit facility and probabilistic cash flows from the pledged policies. Considerable judgment is required in interpreting market data to develop the estimates of fair value. Accordingly, our estimates are not necessarily indicative of the amounts that we, or holders of the instruments, could realize in a current market exchange. The most significant assumptions are the estimates of life expectancy of the insured and the discount rate. The use of different assumptions and/or estimation methodologies could have a material effect on the estimated fair values.

Fair Value Measurement Guidance

We follow ASC 820, Fair Value Measurements and Disclosures, which defines fair value as an exit price representing the amount that would be received if an asset were sold or that would be paid to transfer a liability in an orderly transaction between market participants at the measurement date. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions the guidance establishes a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. Level 1 relates to quoted prices in active markets for identical assets or liabilities. Level 2 relates to observable inputs other than quoted prices included in Level 1. Level 3 relates to unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Our investments in life insurance policies, structured settlements and note payable are considered Level 3 assets as there is currently no active market where we are able to observe quoted prices for identical assets and our valuation model incorporates significant inputs that are not observable. Our impaired loans are measured at fair value on a non-recurring basis, as the carrying value is based on the fair value of the underlying collateral. The method used to estimate the fair value of impaired collateral-dependent loans depends on the nature of the collateral. For collateral that has lender protection insurance coverage, the fair value measurement is considered to be Level 3 as the insured value is an observable input to the Company, but not observable to market participants. For collateral that does not have lender protection insurance coverage, the fair value measurement is considered to be Level 3 as the estimated fair value is based on a model whose significant inputs are the life expectancy of the insured and the discount rate, which are not observable.

Ownership of Life Insurance Policies

In the ordinary course of business, a large portion of our borrowers default by not paying off the loan and relinquish ownership of the life insurance policy to us in exchange for our release of the obligation to pay amounts due. We also buy life insurance policies in the secondary and tertiary markets. We account for life insurance policies that we own as investments in life settlements (life insurance policies) in accordance with ASC 325-30, Investments in Insurance Contracts, which requires us to use either the investment method or the fair value method. The election is made on an instrument-by-instrument basis and is irrevocable. We have elected to account for these life insurance policies as investments using the fair value method.

We initially record investments in life settlements at the transaction price. For policies acquired upon relinquishment by our borrowers, we determine the transaction price based on fair value of the acquired policies at the date of relinquishment. The difference between the net carrying value of the loan and the transaction price is recorded as a gain (loss) on loan payoffs and settlement. For policies acquired for cash, the transaction price is the amount paid.

Valuation of Insurance Policies

Our valuation of insurance policies is a critical component of our estimate for the loan impairment valuation and the fair value of our investments in life settlements (life insurance policies). We currently use a probabilistic method of valuing life insurance policies, which we believe to be the preferred valuation method in the industry. The most significant assumptions are the Company's estimate of the life expectancy of the insured and the discount rate.

In determining the life expectancy estimate, we analyze medical reviews from independent secondary market life expectancy providers (each a "LE provider"). An LE provider reviews the medical records and identifies all medical conditions it feels are relevant to the life expectancy of the insured. Debits and credits are then assigned by each LE provider to the individual's health based on these medical conditions. The debit or credit that an LE provider assigns to a medical condition is derived from the experience of mortality attributed to this condition in the portfolio of lives that it monitors. The health of the insured is summarized by the LE provider into a life assessment of the individual's life expectancy expressed both in terms of months and in mortality factor.

The resulting mortality factor represents an indication as to the degree to which the given life can be considered more or less impaired than a standard life having similar characteristics (e.g. gender, age, smoking, etc.). For example, a standard insured (the average life for the


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given mortality table) would carry a mortality rating of 100%. A similar but impaired life bearing a mortality rating of 200% would be considered to have twice the chance of dying earlier than the standard life. Historically, the Company has procured the majority of its life expectancy reports from two life expectancy report providers and only used AVS life expectancy reports for valuation purposes. Beginning in the quarter ended September 30, 2012, the Company began utilizing life expectancy reports from 21st Services for valuation purposes and began averaging or "blending," the results of the two life expectancy reports to establish a composite mortality factor.

The probability of mortality for an insured is then calculated by applying the blended life expectancy estimate to a mortality table. The mortality table is created based on the rates of death among groups categorized by gender, age, and smoking status. By measuring how many deaths occur before the start of each year, the table allows for a calculation of the probability of death in a given year for each category of insured people. The probability of mortality for an insured is found by applying the mortality rating from the life expectancy assessment to the probability found in the actuarial table for the insured's age, sex and smoking status. The Company has historically applied an actuarial table developed by a third party. However, beginning in the quarter ended September 30, 2012, the Company transitioned to a table developed by the U.S. Society of Actuaries known as the 2008 Valuation Basic Table, or the 2008 VBT. However, because the 2008 VBT table does not account for anticipated improvements in mortality in the insured population, the table was modified in conjunction with outside consultants to reflect these expected mortality . . .

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