NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Nature of Business
Organizational Structure
GWG Holdings, Inc. (“GWG Holdings”)
conducts its life insurance secondary market business through a wholly owned subsidiary, GWG Life, LLC (“GWG Life”),
and GWG Life’s wholly owned subsidiaries, GWG Life Trust and GWG DLP Funding IV, LLC. GWG Holdings’ previously wholly-owned
subsidiary, Life Epigenetics Inc. (“Life Epigenetics”) was formed to engage in various life insurance related businesses
and activities related to its development of epigenetic technology. Through its previously wholly-owned subsidiary, youSurance
General Agency, LLC (“youSurance”), GWG Holdings offered life insurance directly to customers from a variety of life
insurance carriers. On November 11, 2019, GWG contributed the common stock of Life Epigenetics and membership interests in youSurance
to a legal entity, InsurTech Holdings, LLC in exchange for a membership interest in the entity (see Note 9).
GWG Holdings’ indirect interests in loans
collateralized by cash flows from other alternative assets are held by The Beneficient Company Group, L.P. (“Ben LP,”
including all of the subsidiaries it may have from time to time — “Beneficient”) and its general partner, Beneficient
Management, L.L.C. (“Beneficient Management”). Prior to December 31, 2019, GWG Holdings’ investment in Beneficient
was accounted for as an equity method investment. On December 31, 2019, as more fully described below, Beneficient became a consolidated
subsidiary of GWG Holdings.
Ben LP is the general partner to Beneficient
Company Holdings, L.P. (“BCH”) and owns 100% of the Class A Subclass A-1 and A-2 Units of BCH. BCH is the holding company
that directly or indirectly receives all active and passive income of Beneficient and allocates that income among the units issued
by BCH. As of December 31, 2019, BCH has issued general partnership Class A Units (Subclass A-1 and A-2), Class S Ordinary Units,
Class S Preferred Units, FLP Units (Subclass 1 and Subclass 2), Preferred Series A Subclass 1 Unit Accounts, and Preferred Series
A Subclass 2 Units. BCH issued to Ben LP Preferred Series A Subclass 2 Units as part of the transaction with GWG Holdings discussed
below. Preferred Series A Subclass 2 Units hold the same rights and privileges as the Preferred Series A Subclass 1 Unit Accounts.
All of the aforementioned legal entities
are organized in Delaware, other than GWG Life Trust, which is governed by the laws of the state of Utah. Unless the context otherwise
requires or we specifically so indicate, all references in this report to “we,” “us,” “our,”
“our Company,” “GWG,” or the “Company” refer to these entities collectively. Our headquarters
are located in Dallas, Texas.
Nature of Business
GWG Holdings, through its wholly-owned subsidiary
GWG Life, has historically purchased life insurance policies in the secondary market and has built a large, actuarially diverse
portfolio of life insurance policies backed by highly rated life insurance companies. These policy purchases were funded primarily
through sales of L Bonds, as discussed in Note 12. In 2018 and 2019, GWG Holdings made strategic decisions to increase capital
allocated toward providing liquidity products to a broader range of alternative assets, primarily through investments in Beneficient.
Beneficient is a financial services firm
based in Dallas, Texas that provides liquidity solutions for mid-to-high net worth (“MHNW”) individuals and small-to-mid
(“STM”) size institutions, which previously had few options to obtain early liquidity for their alternative assets
holdings. On September 25, 2018, Beneficient’s capital companies applied for trust charters from the Texas Department of
Banking to merge into to-be organized limited trust associations. Beneficient’s capital companies submitted revised charter
applications on March 6, 2020. As of March 25, 2020, the trust charters had not been issued to Beneficient. As such, Beneficient
has closed a limited number of transactions to date, but intends to significantly expand its operations if and when the trust charters
are issued.
Beneficient was formed in 2003 but began
its alternative asset business in September 2017. Beneficient operates primarily through its subsidiaries, which provide Beneficient’s
products and services. These subsidiaries include: (i) Beneficient Capital Company, L.L.C. (“BCC”), through which Beneficient
offers loans and liquidity products; (ii) Beneficient Administrative and Clearing Company, L.L.C. (“BACC”), through
which Beneficient provides services for fund and trust administration and plans to provide custody services; (iii) Pen Indemnity
Insurance Company, LTD (“Pen”), through which Beneficient plans to offer insurance services; and (iv) Ben Markets Management
Holdings, L.P., formerly called ACE Portal, L.L.C. (“ACE”), through which Beneficient plans to provide an online portal
for direct access to Beneficient’s financial services and products.
Beneficient’s primary operations
pertain to its liquidity products whereby Ben LP, through its subsidiaries, extends loans collateralized by cash flows from illiquid
alternative assets and provides services to the trustees who administer the collateral. Beneficient’s core business products
are its Exchange Trust, LiquidTrust and the InterChange Trust (introduced in 2020). Beneficient’s clients select one of these
products and place their alternative assets into the custody trust that is a constituent member of a trust structure called the
“ExAlt PlanTM” (comprised of the Exchange Trusts, LiquidTrusts, Custody Trusts, Collective Trusts, and Funding
Trusts). The ExAlt PlanTM then delivers to Beneficient’s clients the consideration required by the specific product
selected by Beneficient’s clients. At the same time, Beneficient, through a subsidiary, extends a loan to the ExAlt PlanTM.
The proceeds (cash or common units in Ben LP) of that loan to the ExAlt PlanTM are ultimately paid to the client. The
cash flows from the client’s alternative asset support the repayment of the loans plus any related interest and fees.
In 2018 and 2019, GWG Holdings and GWG
Life consummated a series of transactions (as more fully described below) with Beneficient that has resulted in a significant reorientation
of our business and capital allocation strategy in addition to changes in our Board of Directors and executive management team.
Liquidity
As of December 31, 2019, we had cash and
cash equivalents of approximately $79.1 million. We generated net losses from operations for the years ended December 31, 2019
and 2018 totaling $137.5 million and $119.5 million. As of February 29, 2020, we had cash and cash equivalents of $104.5 million, not including cash and cash equivalents of Beneficient.
Besides funding operating expenditures and having sufficient cash to fund anticipated additional investments in Beneficient primarily
for its lending products and working capital needs, we are obligated to pay other items such as interest payments and debt redemptions,
and preferred stock dividends and redemptions. We expect to satisfy these obligations and fund our operations through anticipated
operating cash flows, receipt of proceeds from our insurance policies, sales of additional L-Bonds, and, potentially, additional
borrowings under existing debt facilities or new borrowings with other third-party lenders.
GWG
HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
GWG has a history of selling L-Bonds dating
back to January 2012. GWG may not be able sell additional L-Bonds on terms as favorable to the Company as past transactions or
in quantities sufficient to fund all of the Company’s operating requirements. Additionally, the Company may not be able to
obtain additional borrowing under existing debt facilities or new borrowings with other third-party lenders. To the extent that
GWG or its subsidiaries raise additional capital through the future issuance of debt, the terms of those debt securities may include
terms that adversely affect the rights of our existing debt and/or equity holders or involve negative covenants that restrict GWG's
ability to take specific actions, such as incurring additional debt or making additional investments in growing the operations
of the Company. If GWG is unable to fund its operations and other obligations, or defaults on its debt, then the Company will be
required to either i) sell assets to provide sufficient funding or ii) to raise additional capital through the sale of equity and
the ownership interest of our equity holders may be diluted.
Based on projections of anticipated operating
cash flows, receipt of proceeds from our insurance policies, sales of additional L-Bonds, and, potentially, additional borrowings
under existing debt facilities or new borrowings with other third-party lenders, we believe that we will have sufficient cash
resources to finance our operations, satisfy our other obligations, and to fund anticipated additional investments in Beneficient
through March 31, 2021.
The
Exchange Transaction
On
August 10, 2018 (the “Initial Transfer Date”), we completed the first of two closings (the “Initial Transfer”)
contemplated by a Master Exchange Agreement with Ben LP and certain other parties (the “Seller Trusts”), which governs
the strategic exchange of assets among the parties (the “Exchange Transaction”). On the Initial Transfer Date:
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GWG
issued to the Seller Trusts Seller Trust L Bonds due 2023 (the “Seller Trust L Bonds”) in an aggregate principal
amount of $403.2 million, as more fully described below;
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Beneficient
purchased 5,000,000 shares of GWG’s Series B Convertible Preferred Stock, par value $0.001 per share and having a stated
value of $10 per share (“Series B”), for cash consideration of $50.0 million, which shares were subsequently transferred
to the Seller Trusts;
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in
consideration for GWG and GWG Life entering into the Master Exchange Agreement and consummating the transactions contemplated
thereby, Ben LP, as borrower, entered into a commercial loan agreement (the “Commercial Loan Agreement”) with
GWG Life, as lender, providing for a loan in a principal amount of $200.0 million (the “Commercial Loan”);
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Ben
LP delivered to GWG a promissory note (the “Exchangeable Note”) in the principal amount of $162.9 million; and
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the
Seller Trusts delivered to GWG 4,032,349 common units of Ben LP at an assumed value of $10 per common unit.
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On
December 28, 2018, the final closing of the transaction occurred and the following actions took place (the “Final Closing”
and the date upon which the Final Closing occurred, the “Final Closing Date”):
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in
accordance with the Master Exchange Agreement, and based on the net asset value of alternative asset financings as of the
Final Closing Date, effective as of the Initial Transfer Date, (i) the principal amount of the Commercial Loan was reduced
to $182.0 million, (ii) the principal amount of the Exchangeable Note was reduced to $148.2 million, and (iii) the principal
amount of the Seller Trust L Bonds was reduced to $366.9 million;
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the
Seller Trusts refunded to GWG $0.8 million in interest paid on the Seller Trust L Bonds related to the Seller Trust L Bonds
that were issued as of the Initial Transfer Date but cancelled, effective as of the Initial Transfer Date, on the Final Closing
Date;
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the
accrued interest on the Commercial Loan and the Exchangeable Note was added to the principal amount of the Commercial Loan,
as a result of which the principal amount of the Commercial Loan as of the Final Closing Date was $192.5 million;
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the
Seller Trusts transferred to GWG an aggregate of 21,650,087 common units of Ben LP and GWG received 14,822,843 common units
of Ben LP in exchange for the Exchangeable Note, upon completion of which GWG owned (including the 4,032,349 common units
received by GWG on the Initial Transfer Date) 40,505,279 common units of Ben LP;
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Ben LP issued to GWG an option (the “Option Agreement”)
to acquire the number of common units of Ben LP, interests or other property that would be received by a holder of Preferred Series
A Subclass 1 Unit Accounts of BCH; and
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GWG
issued to the Seller Trusts 27,013,516 shares of GWG common stock (including 5,000,000 shares issued upon conversion of the
Series B).
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GWG
HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Description
of the Assets Exchanged
Seller
Trust L Bonds
On
August 10, 2018, in connection with the Initial Transfer, GWG Holdings, GWG Life and Bank of Utah, as trustee, entered into a
Supplemental Indenture (the “Supplemental Indenture”) to the Amended and Restated Indenture dated as of October 23,
2017 (the “Amended and Restated Indenture”). GWG Holdings entered into the Supplemental Indenture to add and modify
certain provisions of the Amended and Restated Indenture necessary to provide for the issuance of the 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 7.5% per year. Interest
is payable monthly in cash.
After
the second anniversary of the Final Closing Date, the holders of the Seller Trust L Bonds will have the right to cause GWG to
repurchase, in whole but not in part, the Seller Trust L Bonds held by such holder. The repurchase may be paid, at GWG’s
option, in the form of cash, a pro rata portion of (i) the outstanding principal amount and accrued and unpaid interest under
the Commercial Loan, and (ii) Ben LP common units, or a combination of cash and such property.
The
Seller Trust L Bonds (see Note 13) are senior secured obligations of GWG, ranking junior only to all senior debt of GWG (see Note
11), pari passu in right of payment and in respect of collateral with all “L Bonds” of GWG (see Note 12), and senior
in right of payment to all subordinated indebtedness of GWG. Payments under the Seller Trust L Bonds are guaranteed by GWG Life
(see Note 23).
Series
B Convertible Preferred Stock
The
Series B converted into 5,000,000 shares of our common stock at a conversion price of $10 per share upon the Final Closing.
Commercial
Loan
The
$192.5 million principal amount under the Commercial Loan is due on August 9, 2023; however, it is extendable for two
five-year terms. See Note 8 for a full description of the terms of the Commercial Loan. Ben LP’s obligations under the
Commercial Loan are unsecured.
The
principal amount of the Commercial Loan bears interest at 5.0% per year. From and after the Final Closing Date, one-half of the
interest, or 2.5% per year, is due and payable monthly in cash, and one-half of the interest, or 2.5% per year, accrues and compounds
annually on each anniversary date of the Final Closing Date and becomes due and payable in full in cash on the maturity date.
In
accordance with the Supplemental Indenture governing the issuance of the Seller Trust L Bonds, upon a redemption event or at the
maturity date of the Seller Trust L Bonds, the Company, at its option, may use the outstanding principal amount of the Commercial
Loan, and accrued and unpaid interest thereon, as repayment consideration of the Seller Trust L Bonds.
Exchangeable
Note
The
Exchangeable Note accrued interest at a rate of 12.4% per year, compounded annually. Interest was payable in cash on the earlier
to occur of the maturity date or the Final Closing Date; provided that Beneficient had the option to add to the outstanding principal
balance under the Commercial Loan the accrued interest in lieu of payment in cash of such accrued interest thereon at the Final
Closing Date. At the Final Closing date, the principal amount of the Exchangeable Note was exchanged for 14,822,843 common units
of Ben LP, and the accrued interest on the Exchangeable Note was added to the principal balance of the Commercial Loan.
Option
Agreement
In connection with the Final Closing,
GWG Holdings entered into the Option Agreement with Ben LP. The Option Agreement gives GWG Holdings the option to acquire the
number of common units in Ben LP that would be received by the holder of Preferred Series A Subclass 1 Unit Accounts of BCH, if
such holder were converting on that date. There is no exercise price and the Company may exercise the option at any time until
December 27, 2028, at which time the option will automatically settle.
Common Units of Ben LP
In connection with the Initial Transfer
and Final Closing, the Seller Trusts and Beneficient delivered to GWG Holdings 40,505,279 common units of Ben LP. These units represented
an approximate 89.9% interest in the common units of Ben LP as of the Final Closing Date (although, on a fully diluted basis, our
ownership interest in common units of Ben LP would be reduced significantly below a majority of those issued and outstanding).
GWG
HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Purchase
and Contribution Agreement
On April 15, 2019, Jon R. Sabes, GWG’s former Chief Executive
Officer and a former director, and Steven F. Sabes, GWG’s former Executive Vice President and a former director, entered
into a Purchase and Contribution Agreement (the “Purchase and Contribution Agreement”) with, among others, Ben LP.
Under the Purchase and Contribution Agreement, Jon and Steven Sabes agreed to transfer all 3,952,155 of the shares of GWG’s
outstanding common stock held directly or indirectly by them to BCC (a subsidiary of Ben LP) and AltiVerse Capital Markets, L.L.C.
(“AltiVerse”). AltiVerse is a limited liability company owned by an entity related to Beneficient’s founders,
including Brad K. Heppner (GWG’s Chairman and Beneficient’s Chief Executive Officer and Chairman) and an entity related
to Thomas O. Hicks (one of Beneficient’s current directors and a director of GWG). GWG was not a party to the Purchase Agreement;
however, the closing of the transactions contemplated by the Purchase and Contribution Agreement (the “Purchase and Contribution
Transaction”) were subject to certain conditions that were dependent upon GWG taking, or refraining from taking, certain
actions.
The
closing of the Purchase and Contribution Transaction occurred on April 26, 2019. Prior to or in connection with such closing:
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GWG’s
bylaws were amended to increase the maximum number of directors of GWG from nine to 13, and the actual number of directors
comprising the Board of Director was increased from seven to 11. The size of the Board has since been reduced and currently
consists of nine directors.
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All
seven members of GWG’s Board of Directors prior to the closing resigned as directors of GWG, and 11 individuals designated
by Beneficient were appointed as directors of GWG, leaving two board seats vacant after the closing.
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Jon
R. Sabes resigned from all officer positions he held with GWG or any of its subsidiaries prior to the closing, other than
his position as Chief Executive Officer of GWG’s technology-focused then wholly-owned subsidiaries, Life Epigenetics
and youSurance.
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Steven
F. Sabes resigned from all officer positions he held with GWG or any of its subsidiaries prior to the closing, except as Chief
Operating Officer of Life Epigenetics.
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The
resignations of Messrs. Jon and Steven Sabes included a full waiver and forfeit of (i) any severance that may be payable by
GWG or any of its subsidiaries in connection with such resignations or the Purchase and Contribution Transaction, and (ii)
all equity awards of GWG held by either of them.
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Murray
T. Holland was appointed as Chief Executive Officer of GWG.
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GWG
entered into performance share unit agreements with certain employees of GWG pursuant to which such employees will collectively
receive up to $4.5 million in cash compensation under certain terms and conditions, including, among others, that such employees
remain employed by GWG or one of its subsidiaries (or, if no longer employed, such employment was terminated by GWG other
than for cause, as such term is defined in the performance share unit agreement) for a period of 120 days following the closing.
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The
stockholders agreement that was entered into on the Final Closing Date was terminated by mutual consent of the parties thereto.
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BCC
and AltiVerse executed and delivered a Consent and Joinder to the Amended and Restated Pledge and Security Agreement dated
October 23, 2017 by and among the Company, GWG Life, LLC, Messrs. Jon and Steven Sabes and the Bank of Utah, which provides
that the shares of GWG’s common stock acquired by BCC and AltiVerse pursuant to the Purchase and Contribution Agreement
will continue to be pledged as collateral security for GWG’s obligations owing in respect of the L Bonds and Seller
Trust L Bonds.
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Indemnification
Agreements
On
April 26, 2019, GWG entered into Indemnification Agreements (the “Indemnification Agreements”) with each of its executive
officers and the directors appointed to the Board of Directors on such date. On May 13, 2019, GWG entered into Indemnification
Agreement with the three additional directors appointed to the Board of Directors on such date (collectively with the executive
officers and directors appointed on April 26, 2019, the “Indemnitees”). The Indemnification Agreements clarify and
supplement indemnification provisions already contained in GWG’s bylaws and generally provide that GWG shall indemnify the
indemnitees to the fullest extent permitted by applicable law, subject to certain exceptions, against expenses, judgments, fines
and other amounts actually and reasonably incurred in connection with their service as a director or officer and also provide
for rights to advancement of expenses and contribution.
GWG
HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The
Investment and Exchange Agreements
On
December 31, 2019, the Company, Ben LP, BCH, and Beneficient Management entered into a Preferred Series A Unit Account and Common
Unit Investment Agreement (the “Investment Agreement”).
Pursuant
to the Investment Agreement, the Company transferred $79.0 million to Ben LP in return for 666,667 common units of Ben LP and
a Preferred Series A Subclass 1 Unit Account of BCH.
In connection with the Investment Agreement, the Company obtained
the right to appoint a majority of the board of directors of Beneficient Management, the general partner of Ben LP. As a result,
the Company obtained control of Ben LP and began reporting the results of Ben LP and its subsidiaries on a consolidated basis beginning
on the transaction date of December 31, 2019. See Note 5 for more details on the accounting for the consolidation. The Company’s
right to appoint a majority of the board of directors of Beneficient Management will terminate in the event (i) the Company’s
ownership of the fully diluted equity of Ben LP (excluding equity issued upon the conversion or exchange of Preferred Series A
Unit Accounts of BCH held as of December 31, 2019 by parties other than the Company) is less than 25%, (ii) the Continuing Directors
of the Company cease to constitute a majority of the board of directors of the Company, or (iii) certain bankruptcy events occur
with respect to the Company. The term “Continuing Directors” means, as of any date of determination, any member of
the board of directors of the Company who: (1) was a member of the board of directors on December 31, 2019; or (2) was nominated
for election or elected to the board of directors with the approval of a majority of the Continuing Directors who were members
of the board of directors at the time of such nomination or election.
Following the transaction, and as agreed
upon in the Investment Agreement, the Company was issued an initial capital account balance for the Preferred Series A Subclass
1 Unit Account of $319.0 million. The other holders of the Preferred Series A Subclass 1 Unit Accounts are an entity related to
the founders of Ben LP and an entity related to one of GWG’s and Beneficient’s directors (the “Related Account
Holders”), and the aggregate capital accounts of all holders of the Preferred Series A Subclass 1 Unit Accounts after giving
effect to the investment by the Company is $1.6 billion. The Company’s Preferred Series A Subclass 1 Unit Account is the
same class of preferred security as held by the Related Account Holders. If the Related Account Holders exchange their Preferred
Series A Subclass 1 Unit Accounts for securities of the Company, the Company’s Preferred Series A Subclass 1 Unit Account
would be converted into common units of Ben LP (so neither the Company nor the founders would hold Preferred Series A Subclass
1 Unit Accounts).
Also, on December 31, 2019, in a transaction
related to the Investment Agreement, GWG Holdings transferred its interest in the Preferred Series A Subclass 1 Unit Account to
its wholly owned subsidiary, GWG Life.
In addition, on December 31, 2019, the
Company, Ben LP and the holders of common units of Ben LP (the “Common Units”) entered into an Exchange Agreement (the
“Exchange Agreement”) pursuant to which the holders of Common Units from time to time have the right, on a quarterly
basis, to exchange their Common Units for common stock of the Company. The exchange ratio in the Exchange Agreement is based on
the ratio of the capital account associated with the Common Units to be exchanged to the market price of the Company’s common
stock based on the volume weighted average price of the Company’s common stock for the five consecutive trading days prior
to the quarterly exchange date. The Exchange Agreement is intended to facilitate the marketing of Ben LP’s products to holders
of alternative assets.
The Exchange Transaction, the Purchase
and Contribution Transaction, and the Investment and Exchange Agreements are referred to collectively as the “Beneficient
Transactions.”
GWG
HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(2)
Summary of Significant Accounting Policies
Basis of Presentation — The
consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United
States of America (“GAAP”).
Principles of Consolidation —
The consolidated financial statements include the accounts of GWG Holdings, Inc. and its subsidiaries. All material intercompany
balances and transactions have been eliminated upon consolidation. Noncontrolling interests have been recorded for minority ownership
in entities that are not wholly owned and are presented in compliance with the provisions of the Noncontrolling Interest in
Subsidiary subsections of the Accounting Standards Codification (“ASC”).
The
Company has interests in various entities including corporations and limited partnerships. For each such entity, the Company evaluates
its ownership interest to determine whether the entity is a variable interest entity (“VIE”) and, if so, whether it
is the primary beneficiary of the VIE. The Company would consolidate any entity for which it was the primary beneficiary, regardless
of its ownership or voting interests. Upon inception of a variable interest or the occurrence of a reconsideration event, the
Company makes judgments in determining whether entities in which it invests are VIEs. If so, the Company makes judgments to determine
whether it is the primary beneficiary and is thus required to consolidate the entity.
If it is concluded that an entity is not
a VIE, then the Company considers its proportional voting interests in the entity. The Company consolidates majority-owned subsidiaries
in which a controlling financial interest is maintained. A controlling financial interest is determined by majority ownership and
the absence of significant third-party participating rights. Ownership interests in entities for which the Company has significant
influence that are not consolidated under the Company’s consolidation policy are accounted for as equity method investments.
SEC Staff Announcement: Accounting for Limited Partnership Investments (codified in ASC 323-30-S99-1) guidance requires the use
of the equity method unless the investor’s interest “is so minor that the limited partner may have virtually no influence
over partnership operating and financial policies.” The SEC staff’s position is that investments in limited partnerships
of greater than 3% to 5% are considered more than minor and, therefore, should be accounted for using the equity method.
Related
party transactions between the Company and its equity method investees have not been eliminated.
Use of Estimates — The preparation
of our consolidated financial statements in conformity with GAAP requires management to make significant estimates and assumptions
affecting the reported amounts of assets and liabilities at the date of the consolidated financial statements, as well as the
reported amounts of revenue during the reporting period. 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 consolidated financial statements relate to (1) the determination of the assumptions used in estimating the fair
value of our investments in life insurance policies, (2) the assessment of potential impairment of our equity method investments
and our equity security investments and determination of the allowance for credit losses on our financing receivables, and (3)
the value of our deferred tax assets and liabilities. Periodically, we make significant estimates in assessing the fair value
of assets acquired and consideration given in return for those assets, which are used to establish the initial recorded values
of such assets in accordance with ASC 805, Business Combinations. Under ASC 805, the consideration paid in an asset acquisition
is allocated among the assets acquired based on their relative fair values at acquisition date. In relation to the Investment
and Exchange Agreements, relative fair values obtained from a third-party valuation firm were used to calculate the amounts recorded
for the assets acquired and liabilities assumed at their acquisition dates as more fully described in Note 5.
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.
Cash, cash equivalents and restricted cash
on our consolidated statements of cash flows include cash and cash equivalents and restricted cash of $79.1 million and $20.3 million
and $114.6 million and $10.8 million as of December 31, 2019 and 2018, respectively. See Note 4 for a discussion of restrictions
on cash.
GWG
HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Investment in Life Insurance Policies,
at Fair Value — ASC 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 purchase
price, which is the amount paid for the policy, inclusive of all direct external fees and costs associated with the purchase. 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 (loss) on life insurance policies, net in our
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 in our consolidated balance sheets until the acquisition is complete and we have secured
title to the policy. At December 31, 2019 and 2018, none of our other assets comprised direct costs and deposits that we had advanced
for life insurance policy acquisitions.
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 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.
Life Insurance Policy Benefits Receivable,
Net — Our policy benefit receivables represent amounts due from insurance carriers for claims submitted on matured life
insurance policies. Policy benefit receivables are recorded at the policy benefit amounts less reserves for estimated uncollectible
amounts. Uncollectible policy benefits can result from challenges by the insurance carrier to the legal validity of the policy,
typically related to the concept of insurable interest, or from liquidity or solvency problems at the insurance carrier (although
policy benefits are senior to any other obligations of a carrier).
We reserve for policy benefits when it becomes probable that
we will not collect the full amount of the policy benefit. The reserve requirements are based on the best facts available to us
and are re-evaluated and adjusted as additional information becomes available. Uncollectible policy benefits are written off against
the reserves when it is deemed that a policy amount is uncollectible. As of December 31, 2018, the balance of the allowance for
uncollectible receivables was $4.3 million, relating to a single life insurance policy claim where collection was doubtful. In
2019 we received a settlement on that policy recovering the amount of premiums paid during the period it was held by GWG. As of
December 31, 2019, there was no allowance for uncollectible life insurance policy benefits receivable.
Other Assets — Other assets
consist of fixed assets, intangible assets, prepaid expenses, operating lease right-of-use assets, and other receivables. At December
31, 2019, other assets also includes the fair values of Beneficient’s other assets, net of intercompany eliminations.
In December 2018, in connection with the
Final Closing of the Exchange Transaction, GWG Holdings entered into an Option Agreement with Beneficient. The agreement gives
GWG Holdings the option to acquire the number of common units in Ben LP that would be received by the holder of Preferred Series
A Subclass 1 Unit Accounts of BCH. There is no exercise price and the Company may exercise the option at any time until December
27, 2028, at which time the option will automatically exercise and settle. The Option Agreement was eliminated upon consolidation
of Beneficient on December 31, 2019, and the balance of $38.6 million was recorded in other assets at December 31, 2018. The Option
Agreement is considered an equity security investment and earns a preferred return that we accrued to the investment balance and
recorded in interest and other income in the consolidated statement of operations up until December 31, 2019. Any future gains
or losses on this investment will be eliminated in consolidation.
Financing Receivables — ASC
310, Receivables, provides guidance for receivables and notes that arise from credit sales, loans or other transactions.
Financing receivables includes loans and notes receivable. Originated loans we hold for which we have the intent and ability to
hold for the foreseeable future or to maturity (or payoff) are classified as held for investment. Financing receivables held for
investment are reported in our consolidated balance sheets at the outstanding principal balance adjusted for any write-offs, allowance
for loan losses, deferred fees or costs, and any unamortized premiums or discounts. Interest income is accrued on outstanding principal
as earned. Unamortized discounts and premiums are amortized using the effective interest method with the amortization recognized
as part of interest income in the consolidated statements of operations.
GWG
HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Losses
on financing receivables are recognized when they are incurred, which requires us to make our best estimate of probable losses.
Specific allowances are recorded for individually impaired loans to the extent we determine it is probable we will be unable to
collect all amounts due according to original contractual terms of the loan agreement. Certain loans classified as impaired may
not require an allowance for loan loss because we believe we will ultimately collect the unpaid balance (through collection or
collateral repossession). The method for calculating the best estimate of losses depends on the type and risk characteristics
of the related financing receivables. Such an estimate requires consideration of historical loss experience, adjusted for current
conditions, and judgments about the probable effects of relevant observable data, including present economic conditions such as
delinquency rates, financial health of market sectors, and the present and expected future levels of interest rates. The underlying
assumptions, estimates and assessments we use to provide for losses are updated periodically to reflect our view of current conditions.
Changes in such estimates can significantly affect the allowance and provision for losses. It is possible we will experience credit
losses that are different from our current estimates. We have no allowance for losses at December 31, 2019 or December 31, 2018.
Write-offs are deducted from the allowance for losses when we judge the principal to be uncollectible and subsequent recoveries
are added to the allowance at the time cash is received on a written-off account.
Equity Method Investments —
The Company accounts for investments in common stock or in-substance common stock in which we have the ability to exercise significant
influence, but do not own a controlling financial interest, under the equity method of accounting. Investments within the scope
of the equity method of accounting are initially measured at cost, including the cost of the investment itself and direct transaction
costs incurred to acquire the investment. After the initial recognition of the investment at cost, we recognize income and losses
from our investment by adjusting upward or downward the balance of our equity method investment on our consolidated balance sheet
with such adjustments, if any, flowing through earnings (loss) from equity method investment on our consolidated statement of
operations, in all cases adjusted to reflect amortization of basis differences, if any, and the elimination of intercompany gains
and losses, if any. Cash distributions received from equity method investees are recorded as reductions to the investment balance
and classified in the statement of cash flows using the cumulative earnings approach.
Equity method investments are reviewed
for impairment whenever events or changes in circumstances indicate the carrying amount of the investment might not be recoverable.
These circumstances can include, but are not limited to evidence that we do not have the ability to recover the carrying amount,
the inability of the investee to sustain earnings, a current fair value of the investment that is less than the carrying amount,
and other investors ceasing to provide support or reducing their financial commitment to the investee. If the fair value of the
investment is less than the carrying amount, and the investment will not recover in the near term, an other-than-temporary impairment
may exist. We recognize a loss in value of an investment deemed other-than-temporary in the period the conclusion is made.
When we do not expect financial information
of our equity method partner companies to be consistently available on a timely basis, the Company reports its share of the income
or loss of the equity method investment on a one-quarter lag.
For more information on equity method investments,
see Note 9.
Leases — The Company adopted
ASC 842, Leases, on January 1, 2019. The Company leases certain real estate for its office premises that are classified
as operating leases. We assess whether an arrangement is a lease at inception. Leases with an initial term of twelve months or
less are not recorded in the balance sheet. We have elected the practical expedient to not separate lease and non-lease components
for all assets. Operating lease assets and operating lease liabilities are calculated based on the present value of the future
minimum lease payments over the lease term at the lease start date. As our leases do not provide an implicit rate, we use our incremental
borrowing rate based on the information available at the lease start date in determining the present value of future payments.
The operating lease asset is increased by any lease payments made at or before the lease start date and reduced by lease incentives
and initial direct costs incurred. The lease term includes options to renew or terminate the lease when it is reasonably certain
that we will exercise that option. The exercise of lease renewal options is at our sole discretion. The depreciable life of lease
assets and leasehold improvements are limited by the lease term, unless there is a transfer of title or purchase option reasonably
certain of exercise. Lease expense for operating leases is recognized on a straight-line basis over the lease term.
GWG
HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Stock-Based Compensation —
The Company measures and recognizes 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 fair value of stock options and stock
appreciation rights. For restricted stock grants (including restricted stock units), 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. We account for the effects
of forfeitures as they occur.
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 companies.
Deferred Financing and Issuance Costs
— Loans advanced to us under our second amended and restated senior credit facility with LNV Corporation, as described in
Note 11, 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. The L Bonds, as described in Note 12, are reported net
of financing costs, which are amortized using the effective interest method over the term of those borrowings. Selling and issuance
costs of Redeemable Preferred Stock (“RPS”) and Series 2 Redeemable Preferred Stock (“RPS 2”), described
in Note 15, are netted against additional paid-in capital, until depleted, and then against the outstanding balance of the preferred
stock. The offerings of our RPS and RPS 2 closed in March 2017 and April 2018, respectively. There were no issuance costs associated
with the August 2018 issuance of the Series B Convertible Preferred Stock, described in Note 15.
Business Combinations — The
Company includes the results of operations of the businesses that it acquires from the acquisition date. In allocating the purchase
price of a business combination, in accordance with ASC 805, Business Combinations, the Company records all assets acquired
and liabilities assumed at fair value, and the fair value of any noncontrolling interests, with the excess of the purchase price
over the aggregate fair values recorded as goodwill. ASC Topic 820, Fair Value Measurements, defines fair value as the price
that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at
the measurement date. The purchase price of an acquisition is allocated to the underlying assets acquired and liabilities assumed
based upon their estimated fair values as of the date of acquisition. To the extent the purchase price exceeds the fair value of
the net identifiable tangible and intangible assets acquired and liabilities assumed, such excess is allocated to goodwill. The
Company determines the estimated fair values after review and consideration of relevant information, including discounted cash
flows, quoted market prices and estimates made by management. The fair value assigned to identifiable intangible assets acquired
is based on estimates and assumptions made by management at the time of the acquisition. The Company adjusts the preliminary purchase
price allocation, as necessary, during the measurement period of up to one year after the acquisition closing date as it obtains
more information as to facts and circumstances existing as of the acquisition date. Acquisition-related costs are recognized separately
from the business combination and are expensed as incurred.
Goodwill and Other Intangibles
— Preliminary goodwill of $2.4 billion and intangible assets of $3.4 million were recognized as a result of the business
combination related to the Investment and Exchange Agreements on December 31, 2019 (see Note 5). Intangible assets are included
in other assets in the Company’s consolidated balance sheet. The Company accounts for goodwill and intangible assets in
accordance with ASC Topic 350, Intangibles – Goodwill and Other. The amount of goodwill initially recorded is based
on the fair value of the acquired entity at the time of acquisition. Management performs goodwill and intangible asset impairment
testing annually, during the fourth quarter, or when events occur, or circumstances change that would more likely than not indicate
impairment has occurred. Goodwill impairment exists when the carrying value of goodwill exceeds its implied fair value. Intangible
assets include an insurance license and a non-compete agreement. Finite-lived intangibles are stated at cost less accumulated
amortization. Amortization is recorded using the straight-line method, which approximates the expected pattern of economic benefit,
over the estimated lives of the assets. The insurance license intangible has an indefinite life and is evaluated for impairment
annually. The non-compete agreement is amortized over its estimated useful life of four years and is evaluated for impairment
when indicators of impairment are present as outlined in the subsequent paragraph.
GWG
HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The
Company reviews the carrying value of its finite-lived intangible assets whenever events or changes in circumstances indicate
that the carrying amount of the asset group may not be recoverable. Factors that would require an impairment assessment include,
among other things, a significant change in the extent or manner in which an asset is used, a continual decline in the Company’s
operating performance, or as a result of fundamental changes in a subsidiary’s business condition.
Income Taxes — The Company
is a corporation for tax purposes. Certain of the Company’s subsidiaries operate in the U.S. as partnerships for U.S. federal
income tax purposes. In addition, certain of the wholly-owned subsidiaries of the Company will be subject to federal, state, and
local corporate income taxes at the entity level and the related tax provision attributable to the Company’s share of this
income tax is reflected in the consolidated financial statements. Income taxes are accounted for using the asset and liability
method of accounting. Under this method, deferred tax assets and liabilities are recognized for the expected future tax consequences
of differences between the carrying amounts of assets and liabilities and their respective tax basis, using tax rates in effect
for the year in which the differences are expected to reverse. The effect on deferred assets and liabilities of a change in tax
rates is recognized in income in the period when the change is enacted. Deferred tax assets are reduced by a valuation allowance
when it is more likely than not that some portion or all of the deferred tax assets will not be realized. Current and deferred
tax liabilities, if any, are recorded within accounts payable and accrued expenses and other liabilities in the consolidated balance
sheets. The Company analyzes its tax filing positions in all of the U.S. federal, state, local and foreign tax jurisdictions where
it is required to file income tax returns, as well as for all open tax years in these jurisdictions. The Company records uncertain
tax positions on the basis of a two-step process: (a) determination is made whether it is more likely than not that the tax positions
will be sustained based on the technical merits of the position, and (b) those tax positions that meet the more likely than not
threshold are recognized as the largest amount of tax benefit that is greater than 50 percent likely to be realized upon ultimate
settlement with the related tax authority. The Company recognizes accrued interest and penalties related to uncertain tax positions
in other expenses within the consolidated statements of operations.
Earnings (Loss) per Common 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 RPS, RPS 2, restricted stock units, warrants (if applicable) and stock options.
Net earnings, less any preferred dividends
accumulated for the period (whether or not declared), is allocated to common stock. Basic earnings per common share is computed
by dividing net earnings available to common stockholders by the weighted average number of common shares outstanding during the
period.
Diluted earnings per common share is computed in a similar manner,
except that first the denominator is increased to include the number of additional common shares that would have been outstanding
if potentially dilutive common shares were issued using the treasury stock method in the case of restricted stock units, warrants
and options, or the if-converted method in the case of RPS and RPS 2. During 2019 and 2018, RPS, RPS2, restricted stock units
and stock options were the potentially dilutive non-participating instruments issued by the Company.
Accounting Policies of Recently Consolidated
Subsidiaries — As discussed in Note 5, as a result of the Company acquiring the right to appoint a majority of the board
of directors of Beneficient Management, the general partner of Ben LP, on December 31, 2019, Beneficient became a consolidated
subsidiary of GWG Holdings. The Company reviewed the accounting policies of Beneficient and conformed those of Beneficient with
those of the Company. For those accounting policies utilized by Beneficient that were not applicable to GWG prior to the consolidation
of Beneficient, the Company adopted those accounting policies as of December 31, 2019. Additionally, Beneficient’s balance
sheet was remeasured to fair value on that date in accordance with our business combination accounting policy described above.
A description of each of the most pertinent accounting policies applicable to Beneficient is included below. This list is not exhaustive.
Loan Receivables
Loan receivables are carried at the principal
amount outstanding, plus interest paid-in-kind. The loans do not have scheduled principal or interest payments due prior to their
maturity date, which is generally 12 years from the date of origination. Prepayment of the loans, in whole or in part, is permitted
without premium or penalty. Loans bear contractual interest at the greater of 14% or 1-month LIBOR plus 10% compounded daily.
The primary source of repayment for the loans and related fees is cash flows from the alternative assets collateralizing the loans.
Interest income on loans is accrued on the principal amount outstanding and interest compounds on a daily basis.
GWG
HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Allowances
for Loan Losses
The allowance for loan losses is a valuation
allowance for probable incurred credit losses in the portfolio. Management’s determination of the allowance is based upon
an evaluation of the loan portfolio, impaired loans, economic conditions, volume, growth and composition of the collateral to
the loan portfolio, and other risks inherent in the portfolio. Management applies risk factors to categories of loans and individually
reviews all impaired loans above a de minimis threshold. Management relies heavily on statistical analysis, current net asset
value (“NAV”) and distribution performance of the underlying alternative asset collateral and industry trends related
to alternative asset investments to estimate losses. Management evaluates the adequacy of the allowance by reviewing relevant
internal and external factors that affect credit quality. As the collateral is the sole source of repayment of the loans and related
interest, these loans are considered to be collateral dependent. Any charge-offs are recognized in the period in which they arise
for the collateral dependent loans (i.e., impaired collateral dependent loans are written down to their estimated net realizable
value based on disposition value).
Fees Receivable
Fees receivable represent balances arising
from services provided to clients and are recorded on an accrual basis. Fees receivable are written off when they are determined
to be uncollectible. Any allowance for doubtful accounts is estimated based on our estimate of the ability of the collateral to
satisfy the amounts due. Most of the fees receivable consist of unpaid upfront fees and trust service fees that will be paid from
the cash flows from the client’s alternative asset based on an allocation of those cash flows as prescribed in the associated
trust agreement. Upfront fees and trust service fees are required to be paid first from the cash flows from the client’s
alternative asset and thus, we believe that the amounts are fully collectible. Accordingly, our consolidated financial statements
do not include an allowance for bad debt nor any bad debt expense.
Noncontrolling interests – Redeemable
and Non-redeemable
Noncontrolling interests represent the
portion of certain consolidated subsidiaries’ limited partnership interests that are held by third parties. Amounts are adjusted
by the noncontrolling interest holder’s proportionate share of the subsidiaries’ or VIEs’ earnings or losses
each period and for any distributions that are paid.
Noncontrolling interests are reported as
a component of equity unless the noncontrolling interest is considered redeemable, in which case the noncontrolling interest is
recorded between liabilities and equity (mezzanine or temporary equity) in the Company’s consolidated balance sheets. The
redeemable noncontrolling interest is adjusted at each balance sheet date to its maximum redemption value if the amount is greater
than the carrying value. Changes in the Company’s redeemable noncontrolling interests are presented in the consolidated statements
of changes in stockholders’ equity.
Noncontrolling interests include holders,
which consist of “Related Entities”, an entity affiliated with a related party, and third parties, of Class S Ordinary
Units issued by BCH. “Related Entities” are defined as certain trusts and those entities held by such trusts that are
controlled by Beneficient’s founder and in which Beneficient’s founder and his family members are also among classes
of economic beneficiaries whether or not Beneficient’s founder is entitled to economic distributions from such trusts. Beneficient’s
founder is also chairman of the board of directors of GWG Holdings.
Redeemable noncontrolling interests are
held by holders, which consist of a Related Entity, an entity affiliated with a related party, and a third-party entity, of Preferred
Series A Subclass 1 Unit Accounts issued by BCH.
Upfront Fees
Non-refundable upfront fees are earned
for setting up and providing the client access to the EXAlt PlanTM. These activities do not transfer a separate promised
service and therefore, represent advanced payments for trust administration services. Upfront fees are billed at the origination
of the liquidity transaction and are based on a percentage of NAV plus any unfunded capital commitments. Payment of the fees occurs
in the first step of the waterfall distribution per the LiquidTrust agreement. Upfront fees are deferred upon receipt and recognized
ratably over the period of benefit which is generally consistent with estimated expected life of LiquidTrusts (typically 7 to 10
years). Upfront fees are recorded on the consolidated balance sheets as fees receivable with a corresponding amount recorded to
deferred revenue. Deferred revenue is subsequently recognized as trust services revenues on the consolidated statements of comprehensive
income (loss), ratably over the expected life of the LiquidTrust.
GWG
HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Trust
Administration Revenues
Trust administration fees are earned for
providing administrative services to trustees for existing liquidity solution clients. The performance obligation under these
agreements is satisfied over time as the administration and management services are provided. Fees are recognized monthly based
upon the beginning of quarter (in advance) net asset value plus any remaining unfunded loan commitments and the applicable fee
rate of the account as outlined in the agreement. Payment frequency is defined in the individual contracts, which primarily stipulate
billings on a quarterly basis in advance. Trust administration fee receivables are recorded in the consolidated balance sheets
in the fees receivable line item and in trust services revenues on the consolidated statements of comprehensive income (loss).
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. See Note 3 for an explanation of certain reclassifications we recorded in comparative periods
on the guarantor financial statements.
Newly Adopted Accounting Pronouncements
— On January 1, 2019, we adopted Accounting Standards Update (“ASU”) No. 2016-02, Leases (Topic 842).
ASU 2016-02 requires lessees to recognize right-of-use assets and lease liabilities on the balance sheet for all leases with a
term greater than twelve months. We elected to adopt the standard using the modified retrospective method, without restatement
of prior periods’ financial information. The impact to the balance sheet on January 1, 2019, was the addition of approximately
$0.9 million in right-of-use assets, a reduction to deferred rent of $0.7 million, and a net increase to lease liabilities of $1.6
million for our operating lease. The adoption of the new standard did not materially affect our consolidated statements of operations,
consolidated statements of cash flows or consolidated statements of changes in stockholders’ equity. We have entered into
additional leases and have consolidated Beneficient’s right-of-use assets and lease liabilities since the adoption of ASU
2016-02 as discussed in Note 21.
ASU 2017-04, Goodwill, (Topic 350)
was issued in January 2017. This standard simplifies how an entity is required to test goodwill for impairment by eliminating Step
2 from the goodwill impairment test. Step 2 measures a goodwill impairment loss by comparing the implied fair value of a reporting
unit’s goodwill with the carrying amount of that goodwill. Under the new guidance, goodwill impairment loss will be measured
on the basis of the fair value of the reporting unit relative to the reporting unit’s carrying amount rather than on the
basis of the implied amount of goodwill relative to the goodwill balance of the reporting unit. ASU 2017-04 is effective for annual
periods beginning after December 15, 2019, including interim periods within those periods, for public business entities. Early
adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company
adopted this ASU on January 1, 2020, and it did not have a material impact on its consolidated financial statements and related
disclosures.
Recently Issued Accounting Pronouncements
— In June 2016, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2016-13, Financial Instruments
— Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which changes the impairment model
for most financial assets and certain other instruments, including trade and other receivables, held-to-maturity debt securities
and loans. There have been numerous codification improvements and technical corrections issued through subsequent ASUs snice the
issuance of ASU No. 2016-13. The standard requires entities to use a new, forward-looking “expected loss” model that
is expected to generally result in the earlier recognition of allowances for losses. The guidance is effective for annual periods
beginning after December 15, 2022, including interim periods within those years, for smaller reporting companies, as defined by
the SEC, but early adoption is permitted. The Company is evaluating the potential impact of this guidance on our consolidated financial
statements.
In August 2018, the FASB issued ASU No.
2018-13, Fair Value Measurement (Topic 820): Disclosure Framework — Changes to the Disclosure Requirements for Fair
Value Measurement, which eliminates, adds and modifies certain disclosure requirements for fair value measurements. The guidance
is effective for fiscal years and interim periods beginning after December 15, 2019. Certain of the amendments require prospective
application, while the remainder require retrospective application. Early adoption is allowed either for the entire standard or
only the provisions that eliminate or modify the requirements. The Company believes that we are currently compliant with this pronouncement
but continues to evaluate potential impact of this guidance on our consolidated financial statements.
GWG
HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(3)
Correction of an Immaterial Error
In
the consolidated statement of cash flows for the year ended December 31, 2018, we have separated the gross borrowings
and repayments on our senior credit facility with LNV Corporation that were previously erroneously reported on a net basis in
cash flows from financing activities.
For the year ended December 31, 2018, we previously reported
net repayments of senior debt of $64.3 million. We revised the comparative information for the year ended December 31, 2018, to
report gross borrowings on senior debt of $12.9 million, and gross repayments of senior debt of $77.2 million, in the consolidated
statements of cash flows. This revision had no effect on the total cash flows from financing activities.
(4)
Restrictions on Cash
Under
the terms of our second amended and restated senior credit facility with LNV Corporation (discussed in Note 11), 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, distribute funds to pay down the facility, and distribute excess funds
to the borrower (GWG DLP Funding IV, LLC).
The agents for the lender authorize the disbursements from these
accounts. At December 31, 2019 and 2018, there was a balance of $20.3 million and $4.2 million, 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 December 31, 2019 and 2018, there was a balance
of $0 and $6.6 million, respectively, in the Company’s escrow accounts.
(5)
Business Combination
Prior to December 31, 2019, the Company owned 41,505,279 common
units of Ben LP, for a total limited partnership interest in the common units of Ben LP of approximately 90.2%. This investment
was historically accounted for using the equity method (see Note 9). On December 31, 2019, the Company entered into the Investment
Agreement and Exchange Agreements described in Note 1.
Pursuant
to the Investment Agreement, the Company transferred $79.0 million to Ben LP in return for 666,667 additional common units of
Ben LP and a Preferred Series A Subclass 1 Unit Account of BCH, which increased the Company’s ownership in Ben LP common
units to approximately 95.5%. Also on December 31, 2019, in a transaction related to the Investment Agreement, GWG Holdings transferred
its interest in the Preferred Series A Subclass 1 Unit Account to its wholly owned subsidiary, GWG Life. In connection with the
Investment Agreement, the Company obtained the right to appoint a majority of the board of directors of Beneficient Management,
the general partner of Ben LP. As a result, the Company obtained control of Ben LP and consolidated Ben LP as of December 31,
2019, under the guidance in ASC 805, Business Combinations.
As a result of the change-of-control, the Company was required
to remeasure its existing equity investment at fair value prior to consolidation. At December 31, 2019, the Company’s equity
investment in the common units of Ben LP had a carrying value of $368.6 million, prior to the additional investment noted above.
The Company estimated the fair value of its investment in Ben LP to be approximately $622.5 million, resulting in the recognition
of a gain of $253.9 million during the fourth quarter of 2019. This gain is included in gain on consolidation of equity method
investment in the Company’s consolidated statement of operations for the year ended December 31, 2019. This gain was partially
offset by the remeasurement to fair value of the Commercial Loan Agreement between GWG Life and Ben and the Option Agreement between
GWG Holdings and Ben which resulted in a net loss of $4.2 million. The net gain on consolidation of equity method investment after
remeasurement of these preexisting balances was $249.7 million. The Company’s proportionate share of the earnings or losses
from Ben LP was recognized in earnings (loss) from equity method investment in our consolidated statement of operations from August
10, 2018 until December 31, 2019 (see Note 9 for further information) and was previously recorded on a one-quarter lag basis. In
connection with the consolidation of Beneficient, the Company was required to discontinue the one-quarter lag.
GWG
HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes the fair value measurement of
the assets acquired and liabilities assumed as of December 31, 2019 (in thousands):
ASSETS
|
|
|
|
Loans receivable
|
|
$
|
232,344
|
|
Fees receivable
|
|
|
29,168
|
|
Investment in public equity securities
|
|
|
24,550
|
|
Other assets
|
|
|
14,053
|
|
Intangible assets
|
|
|
3,449
|
|
Total identifiable assets acquired
|
|
|
303,564
|
|
|
|
|
|
|
LIABILITIES
|
|
|
|
|
Other borrowings
|
|
|
153,086
|
|
Commercial loan agreement from parent
|
|
|
168,420
|
|
Other liabilities and deferred revenue
|
|
|
105,866
|
|
Accounts payable and accrued expenses
|
|
|
13,713
|
|
Total liabilities assumed
|
|
|
441,085
|
|
Net liabilities assumed
|
|
|
(137,521
|
)
|
|
|
|
|
|
NONCONTROLLING INTERESTS
|
|
|
|
|
Common Units not owned by GWG Holdings(1)
|
|
|
181,383
|
|
Class S Ordinary Units
|
|
|
85,448
|
|
Class S Preferred Units
|
|
|
17
|
|
Preferred Series A Subclass 1 Unit Accounts
|
|
|
1,269,654
|
|
Total noncontrolling interests
|
|
|
1,536,502
|
|
|
|
|
|
|
ACQUISITION CONSIDERATION
|
|
|
|
|
Cash, less cash acquired
|
|
|
61,479
|
|
Fair value of preexisting investment in Common Units(2)
|
|
|
622,503
|
|
Fair value of noncontrolling interest
|
|
|
1,536,502
|
|
Total estimated consideration
|
|
|
2,220,484
|
|
Less: Net liabilities assumed
|
|
|
(137,521
|
)
|
Resulting preliminary goodwill
|
|
|
2,358,005
|
|
(1)
|
Calculated as 1,974,677 Common Units not owned by GWG Holdings at December 31, 2019, multiplied by the $15.00 per unit derived from the enterprise valuation of Beneficient. Also includes $151.8 million of share-based payment awards that were granted by Beneficient prior to the change in control but were not replaced by awards of GWG Holdings upon the change in control. These awards were treated as noncontrolling interests in accordance with ASC 805, Business Combinations.
|
(2)
|
Calculated as 41,505,279 Common Units owned by GWG Holdings prior to the change in control multiplied by the $15.00 per unit derived from the enterprise valuation of Beneficient, with a nominal rounding adjustment.
|
Methods
Used to Determine Equity Value and to Fair Value Assets and Liabilities
The
following is a description of the valuation methodologies used to estimate the fair value of equity and the fair values of major
categories of assets acquired and liabilities assumed. In many cases, determining the fair value of equity and the acquired assets
and assumed liabilities required management to estimate cash flows expected from those assets and liabilities and to discount
those cash flows at appropriate rates of interest. This required the utilization of significant estimates and management judgment
in accounting for the 2019 change-of-control event.
Loan receivables — The loan portfolio
was valued based on current guidance that defines fair value as the price that would be received to sell an asset or transfer a
liability in an orderly transaction between market participants at the measurement date. Level 3 inputs were utilized to value
the loan portfolio and included the use of present value techniques employing cash flow estimates and incorporated assumptions
that marketplace participants would use in estimating fair values, specifically market interest rate and general credit fair value
assumptions. In instances where reliable market information was not available, management used assumptions in an effort to determine
reasonable fair value. There was no carryover related allowance for loan losses.
GWG
HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Cash
and cash equivalents and fees receivable — Cash and cash equivalents and fees receivable were valued using their current
carrying amounts which approximate fair value.
Investment
in public equity securities — The fair value of the investments in public equity securities was determined using quoted
market prices. As these were investments by Beneficient in the common stock of GWG, these amounts were eliminated in consolidation
and treated as treasury stock as of December 31, 2019.
Other
assets — Other assets include miscellaneous receivables that were valued using the current carrying amount as that amount
approximates fair value due to the relatively short time between their origination date and the fair value date. Miscellaneous
intercompany receivables were eliminated in consolidation.
Intangible
assets — Intangible assets include an insurance license and a non-compete agreement. Both assets were valued using their
current carrying amount which approximates fair value. The insurance license was valued at $3.1 million and the non-compete agreement
was valued at $0.3 million.
Other
borrowings and commercial loan agreement from parent — The measurement of the fair value of other borrowings and commercial
loan agreement from parent was based on market prices that generally are observable for similar liabilities at commonly quoted
intervals and is considered a Level 2 fair value measurement. The Commercial Loan Agreement between Beneficient and GWG Life was
eliminated in consolidation as of December 31, 2019.
Other
liabilities and deferred revenue — The carrying amounts of other liabilities and deferred revenue
approximate their fair value. The Option Agreement between Beneficient and GWG was eliminated in consolidation as of December 31,
2019.
Accounts
payable and accrued expenses — Due to their short-term nature, the carrying amounts of accounts
payable and accrued expenses approximate the fair value. Miscellaneous intercompany payables were eliminated in consolidation as
of December 31, 2019.
Noncontrolling interests —
The values for each noncontrolling interest component were calculated after determination of an overall enterprise value for the
Company. The enterprise value of the Company was determined using the Option Pricing Model (“OPM”) Backsolve approach
under the market method. The OPM Backsolve approach uses a Black-Scholes option pricing model to calculate the implied equity
value of the firm. Once an overall equity value was determined, amounts were allocated to the various classes of equity based
on the security class preferences. The inputs to the OPM Backsolve approach are the equity value for one component of the capital
structure, expected time to exit, the risk-free interest rate and an assumed volatility based on the volatility of similar publicly
traded companies. The OPM Backsolve inputs include Level 3 inputs.
The
value of the noncontrolling interest includes an amount related to outstanding share-based payment awards that remain outstanding
after the change-of-control. For these awards, the portion of the acquisition-date fair value of the share-based payment awards
attributable to pre-combination service is recognized in noncontrolling interest as of December 31, 2019.
Goodwill
— The resulting excess of the overall enterprise value after deducting the fair values of assets acquired and liabilities
assumed is recognized as goodwill. The goodwill recognized is the result of the inherent value associated with the assembled business
after all separately identifiable assets acquired and liabilities assumed are deducted from the enterprise value. None of the
goodwill is expected to be deductible for income tax purposes. The goodwill is allocated to our Investment in Beneficient reporting
unit.
As of December 31, 2019, the accounting for
the estimates of equity values, which includes noncontrolling interests, the fair value of loan receivables, and any separately
identifiable intangibles was based on the facts and circumstances that existed as of the acquisition date. Should management obtain
new information about facts and circumstances that existed at the acquisition date, adjustments to the fair values assigned to
these items could occur during the measurement period of one year from the acquisition date. Any such adjustment will result in
corresponding adjustments to goodwill.
GWG
HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The
following unaudited pro forma financial information presents the combined results of operations of GWG Holdings as if the acquisition
of Ben LP had occurred as of January 1, 2018:
(in thousands, except shares and per share data)
|
|
Years ended December 31,
|
|
|
|
2019
|
|
|
2018
|
|
Total Revenue
|
|
|
|
|
|
|
Pro forma
|
|
$
|
104,989
|
|
|
$
|
89,949
|
|
As reported
|
|
$
|
92,276
|
|
|
$
|
(390
|
)
|
|
|
|
|
|
|
|
|
|
Net Income (Loss) Attributable to Common Shareholders
|
|
|
|
|
|
|
|
|
Pro forma
|
|
$
|
(218,572
|
)
|
|
$
|
(87,808
|
)
|
As reported
|
|
$
|
91,166
|
|
|
$
|
(136,114
|
)
|
|
|
|
|
|
|
|
|
|
Net Earnings (Loss) per Diluted Common Share
|
|
|
|
|
|
|
|
|
Pro forma
|
|
$
|
(6.15
|
)
|
|
$
|
(2.67
|
)
|
As reported
|
|
$
|
2.65
|
|
|
$
|
(22.32
|
)
|
The
unaudited pro forma financial information is presented for informational purposes only. It is not necessarily indicative of what
our consolidated results of operations actually would have been had the acquisition occurred at the beginning of each year, nor
does it attempt to project the future results of operations of the combined company.
The
unaudited pro forma financial information above gives effect to the following:
|
·
|
Deconsolidation
of certain Beneficient trusts included in the EXAlt PlanTM
|
|
·
|
Exclusion of the $249.7 million nonrecurring
gain on consolidation of equity method investment
|
|
·
|
Reduction of Beneficient interest expense
related to acquisition-date debt principal payments
|
|
·
|
Elimination of intercompany transactions,
including the Commercial Loan Agreement and Option Agreement
|
|
·
|
Exclusion of nonrecurring acquisition-related
transaction costs
|
(6)
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 (loss) on life insurance policies, net in our 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 — which utilize either a single fully underwritten, or simplified report based on self-reported
medical interview), assumptions relating to cost-of-insurance (premium) rates and other assumptions. The discount rate we apply
incorporates current information about the discount rates observed in the life insurance secondary market through competitive bidding
observations (which have recently declined for us as a result of our decreased purchase activity) and other means, fixed income
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 yield premium a purchaser would require to receive the future cash flows derived from our portfolio
as a whole. Management has significant 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 8.25% was applied to our portfolio as of both December 31,
2019 and 2018.
Portfolio
Information
Our
portfolio of life insurance policies, owned by our subsidiaries as of December 31, 2019 is summarized below:
Life
Insurance Portfolio Summary
Total life insurance portfolio face value of policy benefits (in thousands)
|
|
$
|
2,020,973
|
|
Average face value per policy (in thousands)
|
|
$
|
1,756
|
|
Average face value per insured life (in thousands)
|
|
$
|
1,883
|
|
Average age of insured (years)*
|
|
|
82.4
|
|
Average life expectancy estimate (years)*
|
|
|
7.2
|
|
Total number of policies
|
|
|
1,151
|
|
Number of unique lives
|
|
|
1,073
|
|
Demographics
|
|
|
74%
Male; 26% Female
|
|
Number of smokers
|
|
|
48
|
|
Largest policy as % of total portfolio face value
|
|
|
0.7
|
%
|
Average policy as % of total portfolio face value
|
|
|
0.1
|
%
|
Average annual premium as % of face value
|
|
|
3.3
|
%
|
(*)
|
Averages
presented in the table are weighted averages by face amount of policy benefits.
|
GWG
HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A
summary of our policies organized according to their estimated life expectancy dates, grouped by year, as of the reporting date,
is as follows:
|
|
|
As of December 31, 2019
|
|
|
As of December 31, 2018
|
|
Years Ending December 31,
|
|
|
Number of
Policies
|
|
|
Estimated
Fair Value
(in
thousands)
|
|
|
Face
Value
(in
thousands)
|
|
|
Number of
Policies
|
|
|
Estimated
Fair Value
(in
thousands)
|
|
|
Face
Value
(in
thousands)
|
|
2019
|
|
|
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
|
9
|
|
|
$
|
6,380
|
|
|
$
|
7,305
|
|
2020
|
|
|
|
8
|
|
|
|
5,869
|
|
|
|
6,342
|
|
|
|
41
|
|
|
|
46,338
|
|
|
|
59,939
|
|
2021
|
|
|
|
55
|
|
|
|
62,061
|
|
|
|
79,879
|
|
|
|
81
|
|
|
|
68,836
|
|
|
|
108,191
|
|
2022
|
|
|
|
90
|
|
|
|
89,074
|
|
|
|
138,723
|
|
|
|
104
|
|
|
|
97,231
|
|
|
|
177,980
|
|
2023
|
|
|
|
128
|
|
|
|
123,352
|
|
|
|
222,369
|
|
|
|
109
|
|
|
|
93,196
|
|
|
|
185,575
|
|
2024
|
|
|
|
109
|
|
|
|
103,111
|
|
|
|
217,053
|
|
|
|
107
|
|
|
|
84,150
|
|
|
|
211,241
|
|
2025
|
|
|
|
113
|
|
|
|
74,223
|
|
|
|
171,961
|
|
|
|
124
|
|
|
|
77,718
|
|
|
|
210,781
|
|
Thereafter
|
|
|
|
648
|
|
|
|
338,349
|
|
|
|
1,184,646
|
|
|
|
579
|
|
|
|
274,074
|
|
|
|
1,086,980
|
|
Totals
|
|
|
|
1,151
|
|
|
$
|
796,039
|
|
|
$
|
2,020,973
|
|
|
|
1,154
|
|
|
$
|
747,923
|
|
|
$
|
2,047,992
|
|
We recognized life insurance benefits of $125.1 million and
$71.1 million during the years ended December 31, 2019 and 2018, respectively, related to policies with a carrying value of $33.2
million and $20.8 million, respectively, and as a result recorded realized gains of $91.9 million and $50.3 million.
A reconciliation of gain (loss) on life insurance policies is
as follows (in thousands):
|
|
Years Ended
December
31,
|
|
|
|
2019
|
|
|
2018
|
|
Change
in estimated probabilistic cash flows(1)
|
|
$
|
67,186
|
|
|
$
|
75,444
|
|
Unrealized gain
on acquisitions(2)
|
|
|
6,921
|
|
|
|
28,017
|
|
Premiums and other annual fees
|
|
|
(65,577
|
)
|
|
|
(54,087
|
)
|
Change in discount
rates(3)
|
|
|
—
|
|
|
|
—
|
|
Change in life expectancy
evaluation(4)
|
|
|
(2,332
|
)
|
|
|
(4,890
|
)
|
Change in life expectancy
evaluation methodology(5)
|
|
|
—
|
|
|
|
(87,100
|
)
|
Face value of matured policies
|
|
|
125,148
|
|
|
|
71,090
|
|
Fair value of matured policies
|
|
|
(56,026
|
)
|
|
|
(42,579
|
)
|
Gain (loss) on life insurance policies, net
|
|
$
|
75,320
|
|
|
$
|
(14,105
|
)
|
(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 changes or policy maturity events.
|
(2)
|
Gain
resulting from fair value in excess of the purchase price for life insurance policies acquired during the reporting period.
|
(3)
|
The
discount rate applied to estimate the fair value of the portfolio of life insurance policies we own was 8.25% at December
31, 2019 and 2018.
|
(4)
|
The
change in fair value due to updating life expectancy estimates on certain life insurance policies in our portfolio.
|
(5)
|
The
change in fair value due to the adoption of the Longest Life Expectancy methodology on life policies in our portfolio, partially
offset by the impact of a decrease in the discount rate associated thereto.
|
GWG
HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Estimated
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 (in thousands), are as follows:
Years Ending December 31,
|
|
Premiums
|
|
|
Servicing
|
|
|
Total
|
|
2020
|
|
$
|
67,455
|
|
|
$
|
1,674
|
|
|
$
|
69,129
|
|
2021
|
|
|
84,712
|
|
|
|
1,674
|
|
|
|
86,386
|
|
2022
|
|
|
97,757
|
|
|
|
1,674
|
|
|
|
99,431
|
|
2023
|
|
|
110,156
|
|
|
|
1,674
|
|
|
|
111,830
|
|
2024
|
|
|
120,077
|
|
|
|
1,674
|
|
|
|
121,751
|
|
|
|
$
|
480,157
|
|
|
$
|
8,370
|
|
|
$
|
488,527
|
|
Management anticipates funding the majority of the premium payments
and servicing fees 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 second amended and restated senior credit facility with LNV Corporation as described in Note 11. 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; additional investments in Beneficient; the purchase, policy premiums and servicing costs of additional life
insurance policies; working capital; and financing expenditures including paying principal, interest and dividends.
(7)
Fair Value Definition and Hierarchy
ASC
820, Fair Value Measurements and Disclosures, 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 third-party 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 (a non-distressed
transaction in which neither seller nor buyer is compelled to engage in the transaction). A sale of the portfolio or a portion
of the portfolio in an other than orderly transaction would likely occur at less than the fair value of the respective life insurance
policies.
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. Valuations
are based on quoted prices that are readily and regularly available in an active market.
|
|
|
|
|
|
|
|
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.
|
GWG
HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 observed in the life insurance secondary market through competitive bidding observations (which
have declined recently as a result of our decreased purchase activity) and other means, fixed income 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 yield premium a purchaser would require to receive the future cash flows derived from our portfolio as a whole.
Management has significant 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 ClariNet LS probabilistic and stochastic
portfolio pricing model from ClearLife Limited, 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
ClearLife Limited to prepare a net present value calculation of our life insurance portfolio using the inputs we provide on a
quarterly basis.
The following table reconciles the beginning and ending fair
value of our Level 3 investments in our portfolio of life insurance policies (in thousands):
|
|
Years Ended
December
31,
|
|
|
|
2019
|
|
|
2018
|
|
Beginning balance
|
|
$
|
747,922
|
|
|
$
|
650,527
|
|
Purchases
|
|
|
32,367
|
|
|
|
128,502
|
|
Maturities (initial cost basis)
|
|
|
(33,265
|
)
|
|
|
(20,763
|
)
|
Net change in fair value
|
|
|
49,015
|
|
|
|
(10,344
|
)
|
Ending balance
|
|
$
|
796,039
|
|
|
$
|
747,922
|
|
Historically, for life insurance policies with face amounts
greater than $1 million and that are not pledged as collateral under our second amended and restated senior credit facility with
LNV Corporation (approximately 14.6% of our portfolio by face amount of policy benefits), we attempted to obtain updated life expectancy
reports on a continuous rotating three year cycle. For life insurance policies that are pledged under our second amended and restated
senior credit facility with LNV Corporation (approximately 77.3% of our portfolio by face amount of policy benefits as of December
31, 2019), prior to entering into the second amended and restated senior credit facility with LNV Corporation on November 1, 2019,
we were required to update the life expectancy estimates every two years beginning from the closing date of the second amended
and restated senior credit facility with LNV Corporation. Under the second amended and restated senior credit facility with LNV
Corporation, we are required to update the life expectancy estimates for all life insurance policies that are pledged no later
than December 18, 2020, and obtain updated life expectancy updates no less frequently than once every five years. For the remaining
small face insurance policies (i.e., a policy with $1 million in face value benefits or less), we employ other methods and timeframes
to update life expectancy estimates.
GWG
HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In the fourth quarter of 2018, we adopted
the Longest Life Expectancy portfolio valuation methodology. Under our Longest Life Expectancy methodology, we: i) utilize life
expectancy reports from third-party life expectancy providers for the pricing of all life insurance policies; ii) apply a stable
valuation methodology driven by the experience of our life insurance portfolio, which is re-evaluated if experience deviates by
a specified margin; and iii) use relevant market observations that can be validated and mapped to the discount rate used to value
the life insurance portfolio.
With the adoption of the Longest Life Expectancy method, we
discontinued the practice of obtaining updated life expectancy reports (or updating specific life expectancies in any manner) except
as required by lenders to comply with existing and future covenants within credit facilities. This change was accounted for as
a change in accounting estimate and affected the year ended December 31, 2019 and will affect all periods thereafter. To the extent
such updated life expectancy reports are available, we do not expect to incorporate these life expectancy reports into our revised
valuation methodology; however, we will monitor this data to determine over time if there exists any additive predictive value
in relation to the basis of its mortality projections.
The
following table summarizes the inputs utilized in estimating the fair value of our portfolio of life insurance policies:
|
|
As of
December 31,
2019
|
|
|
As of
December 31,
2018
|
|
Weighted-average age of insured, years*
|
|
|
82.4
|
|
|
|
82.1
|
|
Age of insured range, years
|
|
|
62-101
|
|
|
|
61-100
|
|
Weighted-average life expectancy, months*
|
|
|
86.2
|
|
|
|
93.2
|
|
Life expectancy range, months
|
|
|
0-240
|
|
|
|
1-251
|
|
Average face amount per policy (in thousands)
|
|
$
|
1,756
|
|
|
$
|
1,775
|
|
Discount rate
|
|
|
8.25
|
%
|
|
|
8.25
|
%
|
|
(*)
|
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 (in thousands)
|
|
Change
in Life Expectancy Estimates
|
|
|
|
minus
8 months
|
|
|
minus
4 months
|
|
|
plus
4 months
|
|
|
plus
8 months
|
|
December 31, 2019
|
|
$
|
113,812
|
|
|
$
|
57,753
|
|
|
$
|
(55,905
|
)
|
|
$
|
(111,340
|
)
|
December 31, 2018
|
|
$
|
113,410
|
|
|
$
|
57,611
|
|
|
$
|
(55,470
|
)
|
|
$
|
(110,473
|
)
|
|
|
Change
in Discount Rate
|
|
|
|
minus 2%
|
|
|
minus 1%
|
|
|
plus 1%
|
|
|
plus 2%
|
|
December 31, 2019
|
|
$
|
91,890
|
|
|
$
|
43,713
|
|
|
$
|
(39,790
|
)
|
|
$
|
(76,118
|
)
|
December 31, 2018
|
|
$
|
95,747
|
|
|
$
|
45,440
|
|
|
$
|
(41,179
|
)
|
|
$
|
(78,615
|
)
|
Other
Fair Value Considerations
The carrying value of policy benefit 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 and Seller Trust L Bonds, largely containing
the same terms, was approximately $1.4 billion and $1.0 billion as of December 31, 2019 and 2018, respectively, based on a weighted-average
market interest rate of 6.34% and 7.11%, respectively.
The Commercial Loan receivable from Ben
LP has a below-market interest rate of 5.0% per year; provided that the accrued interest from the date of the Initial Transfer
to the Final Closing Date of the Exchange Transaction was added to the principal balance of the Commercial Loan. From and after
the Final Closing Date, one-half of the interest, or 2.5% per year, is due and payable monthly in cash, and (ii) one-half of the
interest, or 2.5% per year, accrues and compounds annually on each anniversary date of the Final Closing Date and becomes due and
payable in full in cash on the maturity date. Utilizing an implied yield of 6.75%, we estimated the fair value of the Commercial
Loan to be approximately $183.1 million as of December 31, 2018 based on a market yield analysis for similar instruments with similar
credit profiles. As previously discussed, the Commercial Loan was eliminated in consolidation on December 31, 2019.
The Promissory Note receivable from the
LiquidTrusts (see Note 8) earns interest at 7.0% per year, payable upon maturity in 2023. Utilizing an implied yield of 10.0%,
we estimate the fair value of the Promissory Note to be approximately $59.6 million as of December 31, 2019 based on a market
yield analysis for similar instruments with similar credit profiles. The Promissory Note had a carrying value of $67.2 million
as of December 31, 2019.
Beneficient
also has assets and liabilities measured at fair value on a non-recurring basis including loan receivables, fees receivable and
other borrowings. As of December 31, 2019, all of the Beneficient’s assets and liabilities were recorded at fair value in the
consolidated balance sheet due to the application of pushdown accounting as described in Note 5.
GWG
HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The
carrying value of the second amended and restated 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 the current interest rate market, and the carrying value of the facility approximates
fair value.
GWG MCA Capital, Inc. (“GWG MCA”) participated 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, determine if an impairment exists
and establish or adjust an allowance for loan loss as necessary. At December 31, 2019, one of our secured cash advances was impaired.
Specifically, the secured loan to Nulook Capital LLC had an outstanding balance of $1.9 million and an allowance for loan loss
of $1.9 million at December 31, 2019. We deem fair value to be the estimated collectible value on each loan or advance made from
GWG MCA. Secured merchant cash advances, net of allowance for loan loss, of $0.3 and $0.5 million are included within other assets
in our consolidated balance sheets as of December 31, 2019 and December 31, 2018, respectively. Where we estimate the collectible
amount to be less than the outstanding balance, we record an allowance for the difference. Provision for merchant cash advances
are recorded within other expenses on our consolidated statements of operations (see Note 17). GWG MCA no longer participates in
the merchant cash advance industry.
Certain
assets are subject to periodic impairment testing by comparing the respective carrying value of the asset to its estimated fair
value. In the event we determine these assets to be impaired, we would recognize an impairment loss equal to the amount by which
the carrying value of the impaired asset exceeds its estimated fair value. These periodic impairment tests utilize company-specific
assumptions involving significant unobservable inputs, or Level 3, in the fair value hierarchy.
GWG
Holdings previously had outstanding common stock warrants; however, the warrants expired in the quarter ended September 30, 2019.
(8)
Financing Receivables from Affiliates
Commercial
Loan-Ben LP
On August 10, 2018, in connection with the Initial Transfer
of the Exchange Transaction, GWG Life, as lender, and Ben LP, as borrower, entered into the Commercial Loan Agreement. On December
28, 2018, the Final Closing Date of the Exchange Transaction, the agreement was amended to adjust the principal to $192.5 million.
The principal amount under the Commercial Loan is due on August 9, 2023, but is extendable for two five-year terms under certain
circumstances. Repayment of the Commercial Loan is subordinated in right of payment to other Beneficient obligations. Ben LP’s
obligations under the Commercial Loan Agreement are unsecured.
In
accordance with the Supplemental Indenture governing the issuance of the Seller Trust L Bonds, upon a redemption event or at the
maturity date of the Seller Trust L Bonds, the Company, at its option, may use the outstanding principal amount of the Commercial
Loan, and accrued and unpaid interest thereon, as repayment consideration of the Seller Trust L Bonds (see Note 13).
On December 31, 2019, the Commercial Loan
was eliminated as an intercompany balance as a result of the consolidation of Beneficient.
GWG
HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Promissory
Note-LiquidTrusts
On May 31, 2019, GWG Life entered into a Promissory Note (the
“Promissory Note”), made by Jeffrey S. Hinkle and Dr. John A. Stahl, not in their individual capacity but solely as
trustees of The LT-1 LiquidTrust, The LT-2 LiquidTrust, The LT-5 LiquidTrust, The LT-7 LiquidTrust, The LT-8 LiquidTrust and The
LT-9 LiquidTrust (collectively, the “LiquidTrust Borrowers”) in the principal amount of $65.0 million. Pursuant to
the terms of the Promissory Note, GWG Life funded a term loan to the LiquidTrust Borrowers in an aggregate principal amount of
$65.0 million (the “Loan”), which Loan was funded in two installments as described below. The Loan was made pursuant
to GWG’s strategy to further diversify into alternative assets (beyond life insurance) and ancillary businesses and was intended
to better position Beneficient’s balance sheet, working capital and liquidity profile to satisfy anticipated Texas Department
of Banking regulatory requirements.
The LiquidTrust Borrowers are common law trusts established
as part of alternative asset financings extended by a subsidiary of Ben LP, of which the Company owns approximately 95% of the
issued and outstanding common units of Ben LP (although, on a fully diluted basis, our ownership interest in common units of Ben
LP would be reduced significantly below a majority of those issued and outstanding). Although each Borrower is allocated a portion
of the Loan equal to approximately 16.7% of the aggregate outstanding principal of the Loan, the Loan constitutes the joint and
several obligations of the LiquidTrust Borrowers.
An
initial advance in the principal amount of $50.0 million was funded on June 3, 2019 and, subsequent to satisfaction of certain
customary conditions, the second advance in the principal amount of $15.0 million was funded on November 22, 2019. The Loan bears
interest at 7.0% per annum, with interest payable at maturity, and matures on June 30, 2023. Subject to the Intercreditor Agreements
(as defined below), the Loan can be prepaid at the LiquidTrust Borrowers’ election without premium or penalty.
The Loan is unsecured and is subject to certain covenants (including
a restriction on the incurrence of any indebtedness senior to the Loan other than existing senior loan obligations to each of HCLP
Nominees, L.L.C. (“HCLP”) and Beneficient Holdings, Inc. (“BHI”, and together with HCLP, the “Senior
Lenders”), as lenders) and events of default. At the time Beneficient was consolidated, all existing senior loan obligations
were held by HCLP. The Senior Lenders are directly or indirectly associated with one of Beneficient’s founders, who is also
Chairman of the Company’s Board of Directors. HCLP is not considered a related party of GWG Holdings or Beneficient.
Intercreditor
Agreements
In connection with the Promissory Note,
the Company also entered into two intercreditor and subordination agreements: (1) an Intercreditor Agreement between GWG Life
and HCLP and (2) an Intercreditor Agreement between GWG Life and BHI (the “Intercreditor Agreements”). Under the Intercreditor
Agreements, GWG Life agrees to subordinate the Loan to the secured obligations of Beneficient and its affiliates outstanding to
the Senior Lenders (the “Senior Loan Obligations”), agrees to not take any liens to secure the Loan (and to subordinate
such liens, if any, to the liens of the Senior Lenders), and agrees not to take enforcement actions under the Promissory Note
until such Senior Loan Obligations are paid in full. The Intercreditor Agreements establish various other inter-lender and subordination
terms, including, without limitation, with respect to permitted actions by each party, permitted payments, waivers, voting arrangements
in bankruptcy, application of certain proceeds and limitations on amendments of the respective loan obligations of the parties.
The Senior Lenders have agreed not to extend the maturity of their respective loan obligations beyond June 30, 2023 or increase
the outstanding principal of the loans made by the Senior Lenders without the written consent of GWG Life. GWG Life has agreed
not to transfer, assign, pledge, grant a security interest in or otherwise dispose of (including, without limitation, pursuant
to a foreclosure) the Promissory Note except with the written consent of the Senior Lenders (such consent not to be unreasonably
withheld) or to the Company or direct or indirect wholly owned subsidiaries thereof.
GWG
HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The
following table summarizes outstanding principal, discount and accrued interest balances of the financing receivables from affiliates
(in thousands):
|
|
December 31,
|
|
|
|
2019
|
|
|
2018
|
|
Commercial Loan
|
|
|
|
|
|
|
Commercial Loan receivable – principal
|
|
$
|
—
|
|
|
$
|
192,508
|
|
Discount on Commercial Loan receivable
|
|
|
—
|
|
|
|
(7,846
|
)
|
Accrued interest receivable on Commercial Loan
|
|
|
—
|
|
|
|
107
|
|
Balance
outstanding on Commercial Loan (1)
|
|
|
—
|
|
|
|
184,769
|
|
|
|
|
|
|
|
|
|
|
Promissory Note
|
|
|
|
|
|
|
|
|
Promissory Note receivable – principal
|
|
|
65,000
|
|
|
|
—
|
|
Accrued interest receivable on Promissory Note
|
|
|
2,153
|
|
|
|
—
|
|
Balance outstanding on Promissory Note
|
|
$
|
67,153
|
|
|
$
|
—
|
|
(1)
|
The
Commercial Loan was eliminated upon consolidation of Beneficient
at December 31, 2019. The outstanding principal and accrued interest at December 31,
2019 was $197.4 million.
|
(9)
Equity Method Investments
The
balances of our equity method investments are as follows (in thousands):
|
|
December 31,
|
|
|
|
2019
|
|
|
2018
|
|
Beneficient
Company Group, L.P. (1)
|
|
$
|
—
|
|
|
$
|
360,842
|
|
InsurTech
Holdings, LLC (2)
|
|
|
1,761
|
|
|
|
—
|
|
Total
|
|
$
|
1,761
|
|
|
$
|
360,842
|
|
(1)
|
The preexisting equity method investment in Ben was remeasured
to fair value, and Ben and its subsidiaries were consolidated on December 31, 2019 (see Note 5).
|
(2)
|
On November 11, 2019, GWG Holdings contributed the common stock and membership interests of its previously-wholly owned subsidiaries Life Epigenetics and youSurance to InsurTech Holdings in exchange for a membership interest in InsurTech Holdings. Although GWG Holdings currently owns 100% of the equity of InsurTech Holdings, it does not have a controlling financial interest in InsurTech Holdings because the managing member has substantive participating rights. Therefore, GWG Holdings accounts for its ownership interest in InsurTech Holdings as an equity method investment.
|
Beneficient
Company Group, L.P.
During 2018, we acquired 40.5 million common
units of Ben LP for a total limited partnership interest in the common units of Ben LP of approximately 89.9% as of December 31,
2018. On June 12, 2019, we acquired an additional 1,000,000 common units of Ben LP from a third party for a cash investment of
$10.0 million. On December 31, 2019, we acquired an additional 666,667 newly-issued common units of Ben LP for a cash investment
of $10.0 million. The common units of Ben LP are not publicly traded on a stock exchange.
Prior to December 31, 2019, our investment
in the common units of Ben LP was presented in equity method investment on our consolidated balance sheets. Our proportionate
share of earnings or losses from our investee was recognized in earnings (loss) from equity method investments in our consolidated
statements of operations. We recorded our share of the income or loss of Beneficient through September 30, 2019 on a one-quarter
lag.
GWG
HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
On December 31, 2019, we obtained control
of Beneficient and consolidated Beneficient as of that date under the guidance in ASC 805, Business Combinations. See Note
5 for further information on the business combination. In connection with the consolidation, we discontinued the one-quarter reporting
lag.
Financial
information pertaining to Beneficient is summarized in the table below (in thousands):
|
|
Twelve months
ended
September 30,
2019
(unaudited)
|
|
|
August 10 to
September 30,
2018
(unaudited)
|
|
Total revenues
|
|
$
|
93,921
|
|
|
$
|
18,409
|
|
Net income (loss)
|
|
|
(32,133
|
)
|
|
|
8,291
|
|
Net earnings (loss) attributable to Ben LP common unitholders
|
|
|
(13,754
|
)
|
|
|
129
|
|
GWG portion of net
earnings (loss) (1)
|
|
|
(2,460
|
)
|
|
|
18
|
|
|
(1)
|
Our
portion of Beneficient’s net earnings (loss) for the periods noted.
|
We
eliminated the effects of any intercompany transactions in the summarized information presented above. Our historical ownership
percentage of our investment in Ben LP common units is as follows:
Date
|
|
Percentage of outstanding common units
|
|
|
Reason
|
|
|
|
|
|
August
10, 2018
|
|
|
13.9%
|
|
|
Purchase
of units
|
December
28, 2018
|
|
|
89.9%
|
|
|
Purchase
of units
|
March
31, 2019
|
|
|
88.1%
|
|
|
Change
in investee outstanding units
|
June
12, 2019
|
|
|
90.2%
|
|
|
Purchase
of units
|
December
31, 2019
|
|
|
95.5%
|
|
|
Purchase
of units
|
Insurtech
Holdings, LLC
On
November 11, 2019, GWG contributed the common stock and membership interests of its wholly owned Life Epigenetics and youSurance
subsidiaries (“Insurtech Subsidiaries”) to a legal entity, InsurTech Holdings, LLC (“InsurTech Holdings”)
in exchange for a membership interest in InsurTech Holdings. Although we currently own 100% of InsurTech Holdings’ equity,
we do not have a controlling financial interest in InsurTech Holdings because the managing member has substantive participating
rights. Therefore, we account for our ownership interest in InsurTech Holdings as an equity method investment.
The
transaction resulted in a loss of control of the Insurtech Subsidiaries and, as a result, we deconsolidated the subsidiaries and
recorded an equity method investment balance during the fourth quarter of 2019. The loss of control required us to measure the
equity investment at fair value. We determined the fair value of our investment in InsurTech approximated the carrying value of
$3.4 million which was primarily comprised of cash and fixed assets contributed to the entity during the fourth quarter of 2019.
We recognized a loss on equity method investment of $1.6 million during the fourth quarter of 2019, resulting in an ending balance
of $1.8 million as of December 31, 2019.
In accordance with the operating agreement of InsurTech Holdings,
GWG contributed $2.1 million in cash to InsurTech Holdings during the fourth quarter of 2019 and is committed to contribute an
additional $17.9 million to the entity over the next two years.
Our investment in the membership interest of InsurTech Holdings
is presented in equity method investment in our consolidated balance sheets. Our proportionate share of earnings or losses from
our investee is recognized in earnings (loss) from equity method investments in our consolidated statements of operations.
GWG
HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(10)
Variable Interest Entities
In accordance with ASC 810, Consolidation,
the Company assesses whether it has a variable interest in legal entities in which it has a financial relationship and, if so,
whether or not those entities are variable interest entities (“VIEs”). For those entities that qualify as VIEs, ASC
810 requires the Company to determine if the Company is the primary beneficiary of the VIE, and if so, to consolidate the VIE.
Prior to December 31, 2019, we determined
that Beneficient is a VIE, but that we were not the primary beneficiary of the investment. GWG did not have the power to direct
any activities of Beneficient, or any of its related parties, that most significantly impacted Beneficient’s economic performance.
GWG had no board representation at Ben LP or at its general partner. The general partner is exclusively assigned all management
powers over the business and affairs of Beneficient, and the limited partners did not have the ability to remove the general partner.
Therefore, we did not consolidate the results of Beneficient in our consolidated financial statements through September 30, 2019.
The Company’s exposure to risk of loss in Beneficient was generally limited to its investment in the common units of Ben
LP, its financing receivable from Beneficient and its equity security investment in the Option Agreement to purchase additional
common units of Ben LP. Effective December 31, 2019, GWG acquired the ability to appoint a majority of the board of directors of
the general partner of Ben LP. As a result, we became the primary beneficiary of Ben LP on December 31, 2019 and consolidated the
balance sheet of Beneficient on that date.
We determined that the LiquidTrust Borrowers are VIEs, but that
we are not the primary beneficiary of the variable interests. We do not have the power to direct any activities of the LiquidTrust
Borrowers that most significantly impact the Borrower’s economic performance. The Company’s exposure to risk of loss
in the LiquidTrust Borrowers is limited to its financing receivable from the LiquidTrust Borrowers.
We determined that Insurtech is a
VIE, but that we are not the primary beneficiary of the variable interests. We do not have the power to direct any activities of
Insurtech that most significantly impact its economic performance. The Company’s exposure to risk of loss in Insurtech is
limited to its equity method investment in the limited partnership units of Insurtech Holdings, LLC and its remaining unfunded
capital commitments.
The Company also determined that certain trusts included within
the EXAltTM Plans used in connection with Beneficient’s operations are VIEs but that neither GWG nor Beneficient
are the primary beneficiary of the trusts. The Company does not have both the power to direct the trust’s most significant
activities and the obligation to absorb losses or right to receive benefits that could potentially be significant to the trusts.
The Company’s investments in the trusts are carried in loans receivable in the consolidated balance sheet. The Company’s
exposure to risk of loss was determined as the amortized cost of the loans to the trusts, any earned but unpaid fees or expenses
plus any remaining potential contributions for unfunded capital commitments and cash reserve commitments.
The following table shows the classification, carrying value
and maximum exposure to loss with respect to the Company’s unconsolidated VIEs (in thousands):
|
|
December 31, 2019
|
|
|
December 31, 2018
|
|
|
|
Carrying
Value
|
|
|
Maximum
Exposure to
Loss
|
|
|
Carrying
Value
|
|
|
Maximum
Exposure
to Loss
|
|
Loan receivables
|
|
$
|
232,344
|
|
|
$
|
335,255
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Financing receivables from affiliates
|
|
|
67,153
|
|
|
|
67,153
|
|
|
|
184,769
|
|
|
|
184,769
|
|
Equity method investments
|
|
|
1,761
|
|
|
|
19,661
|
|
|
|
360,842
|
|
|
|
360,842
|
|
Other asset
|
|
|
—
|
|
|
|
—
|
|
|
|
38,562
|
|
|
|
38,562
|
|
Accounts payable and accrued expenses
|
|
|
(2,515
|
)
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
Total
|
|
$
|
298,743
|
|
|
$
|
422,069
|
|
|
$
|
584,173
|
|
|
$
|
584,173
|
|
(11)
Senior Credit Facility with 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 senior credit facility makes available a total
of up to $300.0 million in credit with a maturity date of September 27, 2029. Additional advances are available under the second
amended and restated senior credit facility at the LIBOR rate as herein defined. 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 second amended and restated senior credit facility at an annual interest rate, determined
as of each date of borrowing or quarterly if there is no borrowing, equal to (a) 12-month LIBOR plus (b) 7.50% per annum.
GWG
HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
On
November 1, 2019, DLP IV entered into a second amended and restated senior credit facility with LNV Corporation, as lender, and
CLMG Corp., as the administrative agent on behalf of the lenders under the agreement (the “Second Amended and Restated Agreement”),
which replaced the amended and restated senior credit facility dated September 27, 2017 that previously governed the DLP IV’s
senior credit facility. The second amended and restated senior credit facility with LV Corporation makes available a total of
up to $300.0 million in credit to DLP IV with a maturity date of September 27, 2029. Subject to available borrowing base capacity,
additional advances are available under the second amended and restated senior credit facility at the LIBOR rate described below.
Such advances are available to pay the premiums and servicing costs of pledged life insurance policies as such amounts become
due. Interest will accrue on amounts borrowed under the second amended and restated senior credit facility at an annual interest
rate, determined as of each date of borrowing or quarterly if there is no borrowing, equal to (a) 12-month LIBOR, plus (b) 7.50%
per annum. The effective rate at December 31, 2019 was 9.54%. Interest payments are made on a quarterly basis.
Under
the second amended and restated senior credit facility, 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.
In conjunction with entering into the second amended and restated
senior credit facility, DLP IV pledged life insurance policies having an aggregate face value of approximately $298.3 million as
additional collateral and received an advance of approximately $37.1 million (inclusive of certain fees and expenses incurred in
connection with the negotiation and entry into the second amended and restated senior credit facility). The second amended and
restated senior credit facility has certain financial and nonfinancial covenants, and we were in compliance with these covenants
at December 31, 2019 and as of the date of this filing.
As
of December 31, 2019, approximately 77.3% of the total face value of our life insurance policies portfolio is pledged to LNV Corporation.
The amount outstanding under this facility was $184.6 million and $158.2 million at December 31, 2019 and 2018, respectively.
Obligations under the second amended and restated senior credit facility are secured by a security interest in DLP IV’s
assets, for the benefit of the lenders, through an arrangement under which Wells Fargo Bank, N.A. 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 and Seller Trust L Bonds. The difference between the amount outstanding and the carrying amount on our consolidated balance
sheets is due to netting of unamortized debt issuance costs.
(12)
L Bonds
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 were 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 until December 2020. This 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.
Effective December 31, 2019, we entered
into Amendment No. 2 to the indenture to define the debt coverage ratio as the ratio, expressed as percentage, of (A) the aggregate
sum of all indebtedness (other than Excluded Indebtedness as described below) of GWG Holdings and its direct and indirect subsidiaries
(including the securities issued under the indenture, but excluding any indebtedness of Ben LP and its direct and indirect subsidiaries)
as reflected on GWG Holdings’ most recent consolidated balance sheet prepared in accordance with GAAP over (B) the sum of
(i) net present asset value of life insurance policies owned by GWG Holdings and its direct or indirect subsidiaries or affiliates,
but excluding life insurance policies held by Ben LP and its direct and indirect subsidiaries and controlled affiliates, plus
(ii) all cash (and cash equivalents) held by GWG Holdings and its direct or indirect Subsidiaries or subsidiaries or affiliates,
but excluding the cash (and cash equivalents) held by Ben LP and its direct and indirect subsidiaries, plus (iii) the original
cost basis in GWG Holdings’ investment in common units or other securities of Ben LP, plus (iv) the outstanding principal
amount of any outstanding loans made under a commercial loan agreement with GWG Life, as lender, plus (v) the cost basis of assets
contributed to GWG Holdings or any direct or indirect subsidiary of GWG Holdings in connection with a Repurchase Transaction,
plus (vi) without duplication, the value of all other assets of GWG Holdings and its direct and indirect subsidiaries or affiliates
(but excluding the value of assets of Ben LP and its direct and indirect subsidiaries) as reflected on its most recent consolidated
balance sheet prepared in accordance with GAAP. For this purpose, “Excluded Indebtedness” is indebtedness that is
payable at GWG Holdings’ option in capital stock of GWG Holdings or securities mandatorily convertible into or exchangeable
for such capital stock of the Company, or any indebtedness that is reasonably expected to be converted or exchanged, directly
or indirectly, into such capital stock, provided that under the terms of such indebtedness in the event any such conversion or
exchange does not occur in accordance with the terms of such transaction, such indebtedness would be cancelled and any assets
received in exchange for such indebtedness would be returned.
We were in compliance with all material
covenants of the indenture at December 31, 2019 and as of the date of this filing, and no Events of Default (as defined in the
Amended and Restated Indenture) existed as of such dates.
GWG
HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
We
publicly offer and sell L Bonds under a registration statement declared effective by the SEC and have issued Seller Trust L Bonds
under a Supplemental Indenture, as described in Note 13. We temporarily suspended the offering of our L Bonds on May 1, 2019 as
a result of our delay in filing certain periodic reports with the SEC. We recommenced our L Bond offering on August 8, 2019.
The
collateral and guarantee provisions of the L Bonds and Seller Trust L Bonds are described in Note 23.
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 December 31, 2019 and 2018, the weighted-average interest
rate of our L Bonds was 7.15% and 7.10%, respectively. The principal amount of L Bonds outstanding was $948.1 million and $662.2
million at December 31, 2019 and 2018, respectively. The difference between the amount of outstanding L Bonds and the carrying
amount on our 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 $12.7 million and $9.0 million for the years
ended December 31, 2019 and 2018, respectively. Future expected amortization of deferred financing costs as of December 31, 2019
is $37.2 million in total over the next seven years.
Future contractual maturities of L Bonds (other
than Seller Trust L Bonds), and future amortization of their deferred financing costs, at December 31, 2019 (in thousands) are
as follows:
Years Ending December 31,
|
|
Contractual
Maturities
|
|
|
Unamortized
Deferred
Financing Costs
|
|
2020
|
|
$
|
152,118
|
|
|
$
|
1,632
|
|
2021
|
|
|
201,419
|
|
|
|
5,774
|
|
2022
|
|
|
163,741
|
|
|
|
6,812
|
|
2023
|
|
|
76,969
|
|
|
|
3,342
|
|
2024
|
|
|
118,848
|
|
|
|
6,328
|
|
Thereafter
|
|
|
235,033
|
|
|
|
13,312
|
|
|
|
$
|
948,128
|
|
|
$
|
37,200
|
|
(13)
Seller Trust L Bonds
On
August 10, 2018, in connection with the Initial Transfer of the Exchange Transaction, GWG Holdings, GWG Life and Bank of Utah,
as trustee, entered into a Supplemental Indenture (the “Supplemental Indenture”) to the Amended and Restated Indenture.
GWG Holdings entered into the Supplemental Indenture to add and modify 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”. GWG issued
Seller Trust L Bonds in the amount of $366.9 million to the various related trusts (the “Seller Trusts”) in connection
with the Exchange Transaction on August 10, 2018.
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. Interest is payable monthly
in cash.
After the second anniversary of the Final Closing,
the holders of the Seller Trust L Bonds will have the right to cause GWG to repurchase, in whole but not in part, the Seller Trust
L Bonds held by such holder. The repurchase may be paid, at GWG’s option, in the form of cash, and/or a pro rata portion
of (i) the outstanding principal amount and accrued and unpaid interest under the Commercial Loan Agreement and (ii) Ben LP common
units, or a combination of cash and such property.
Our
L Bonds are offered and sold under a registration statement declared effective by the SEC, as described in Note 12, and we have
issued Seller Trust L Bonds under a Supplemental Indenture. We temporarily suspended the offering of our L Bonds on May 1, 2019
as a result of our delay in filing certain periodic reports with the SEC. We recommenced our L Bond offering on August 8, 2019.
The
collateral and guarantee provisions of the L Bonds and Seller Trust L Bonds are described in Note 23.
The
principal amount of Seller Trust L Bonds outstanding was $366.9 million at both December 31, 2019 and 2018.
GWG
HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(14)
Other Borrowings
Beneficient had borrowings with an aggregate fair value of $153.1
million upon consolidation as of December 31, 2019. This aggregate balance includes a senior credit agreement and a second lien
credit agreement with respective balances, including accrued interest, of $77.5 million and $72.2 million at December 31, 2019.
Both the senior credit agreement and the second lien credit agreement were held by HCLP as of December 31, 2019. Both loans accrue
interest at a rate of 1-month LIBOR plus 3.95%, compounded daily, with interest due by the 15th of each month. Ben LP
intends to repay with cash or refinance with other third-party lenders the senior credit agreement and the second lien credit agreement
prior to their maturities, both of which are on June 30, 2020. Ben LP may not be able to refinance or obtain additional financing
on favorable terms, or at all. If Ben LP is unable to refinance the senior credit agreement or the second lien credit agreement,
or defaults on either loan, then Ben LP will be required to either (i) sell assets to repay these loans or (ii) to raise additional
capital through the sale of equity and the ownership interest of Ben LP’s equity holders may be diluted. These loans are
not guaranteed by GWG.
The loans contain customary covenants and
events of default and termination, including cross-default provisions. As of December 31, 2019, Beneficient was in compliance with
all covenants except for certain covenants related to providing financial statements and information related to the eligible underlying
investments by a specified date. Subsequent to December 31, 2019, but before these consolidated financial statements were issued,
the covenants were amended whereby the Company is in compliance with all such covenants.
Beneficient has additional borrowings maturing
in 2023 and 2024 with an aggregate principal balance outstanding, including accrued interest, of $2.5 million.
Future contractual maturities of Beneficient’s
borrowings are as follows (in thousands):
Years Ending December 31,
|
|
|
|
2020
|
|
$
|
149,661
|
|
2021
|
|
|
—
|
|
2022
|
|
|
—
|
|
2023
|
|
|
750
|
|
2024
|
|
|
1,579
|
|
Thereafter
|
|
|
—
|
|
|
|
$
|
151,990
|
|
(15)
Stockholders’ Equity
Common
Stock
In September 2014, GWG Holdings consummated an initial public
offering of its 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,
the common stock of GWG Holdings was listed on the Nasdaq Capital Market under the ticker symbol “GWGH.”
In conjunction with the initial public offering, GWG Holdings
issued warrants to purchase 16,000 shares of common stock at an exercise price of $15.63 per share. As of December 31, 2019, all
of these warrants have expired and none of them had been exercised.
On
August 10, 2018, the Company declared a special dividend of $4.30 per share of common stock payable to shareholders of record
on August 27, 2018.
On December 28, 2018, the Series B converted into 5,000,000
shares of GWG Holdings common stock at a conversion price of $10.00 per share immediately following the Final Closing of the Exchange
Transaction.
On December 28, 2018, in connection with the Exchange Transaction,
GWG Holdings issued 22,013,516 shares of common stock to the Seller Trusts at a market value of approximately $203.4 million in
exchange for Ben LP common units. The shares were offered and sold in reliance upon the exemption from registration provided by
Section 4(a)(2) under the Securities Act of 1933, as amended.
The common shares issued to the Seller Trusts were initially
subject to a Stockholders Agreement between GWG and the Seller Trusts, under which the Seller Trusts, as long as they own at least
10% of the voting shares of GWG, agree to vote their shares in proportion to the votes cast by all other voting securities of GWG.
In addition, the Seller Trusts agree, for the period of one year after the Final Closing, not to seek or propose to influence or
control the management, Board of Directors or policies of GWG. The Stockholders Agreement was terminated in connection with the
closing of the Purchase and Contribution Transaction on April 26, 2019.
GWG
HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In
addition, GWG and the Seller Trusts entered into a registration rights agreement and an orderly marketing agreement. Under these
agreements, GWG and the Seller Trusts agreed to take steps to allow for the orderly marketing and resale of the common shares
issued to Seller Trusts as part of the Exchange Transaction, and Seller Trusts agreed to sell their common shares of GWG only
as permitted under these agreements.
On November 15, 2018, the Board of Directors of GWG Holdings
approved a stock repurchase program pursuant to which the Company was permitted, from time to time, to purchase shares of its common
stock for an aggregate purchase price not to exceed $1.5 million. Stock repurchases were able to be executed through various means,
including, without limitation, open market transactions, privately negotiated transactions or otherwise. The stock repurchase program
did not obligate the Company to purchase any shares, and expired on April 30, 2019.
The
following table includes information about the stock repurchase program for the years ended December 31, 2019 and 2018:
2018
Monthly Period
|
|
Number of
Shares
Purchased
|
|
|
Average
Price
Paid per Share
|
|
|
Total
Number
of Shares
Purchased as
Part of the
Program
|
|
|
Maximum
Dollar Value of Shares
that May
Yet Be
Purchased
Under the
Program
|
|
December
2018
|
|
|
10,035
|
|
|
$
|
6.82
|
|
|
|
10,035
|
|
|
$
|
1,432
|
|
2019
Monthly Period(1)
|
|
|
|
|
|
|
|
|
|
|
|
|
January
2019
|
|
|
42,488
|
|
|
$
|
8.47
|
|
|
|
52,523
|
|
|
$
|
1,072
|
|
February
2019
|
|
|
202
|
|
|
|
8.88
|
|
|
|
52,725
|
|
|
|
1,070
|
|
|
(1)
|
No
stock was repurchased after February 2019, and the stock repurchase program expired on April 30, 2019.
|
The
Exchange Agreement, discussed in Note 1, executed on December 31, 2019, allows holders of Ben LP common units to exchange their
common units for common stock of the Company. The exchange ratio in the Exchange Agreement is based on the ratio of the capital
account associated with the common units to be exchanged to the market price of the Company’s common stock based on the
volume weighted average price of the Company’s common stock for the five consecutive trading days prior to the quarterly
exchange date. No Ben LP common units have been exchanged for the Company’s common stock through December 31, 2019.
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 from us and still held by such purchaser.
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, as specified in the Certificate of Designation. 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.
GWG
HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In
March 2017, we closed the RPS offering to additional investors having sold 99,127 shares
of RPS for an aggregate gross consideration of $99.1 million and incurred approximately
$7.0 million 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; however,
based on our assessment under ASC 470, Debt, (“ASC 470”) and ASC 815, Derivatives and Hedging, (“ASC
815”), we do not believe bifurcation of either the holder’s redemption or conversion feature is appropriate.
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 from us and still held by such
purchaser.
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, as specified in the Certificate of Designation. 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 $150.0 million and incurred approximately $10.3 million 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;
however, based on our assessment under ASC 470 and ASC 815, we do not believe bifurcation of either the holder’s redemption
or conversion feature is appropriate.
Series
B Convertible Preferred Stock
On August 10, 2018, GWG Holdings issued 5,000,000 shares of
Series B, par value $0.001 per share and having a stated value of $10.00 per share, to Ben LP for cash consideration of $50.0 million
as part of the Initial Transfer.
On
December 28, 2018, the Series B converted into 5,000,000 shares of our common stock at a conversion price of $10.00 per share
immediately following the Final Closing of the Exchange Transaction.
GWG
HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Preferred
Series A Subclass 1 (Redeemable noncontrolling interest)
BCH, a consolidated subsidiary of Ben LP, had non-unitized equity
outstanding as of December 31, 2019. The Preferred Series A Subclass 1 Unit accounts are non-participating and convertible on a
dollar basis. As of December 31, 2019, the 4th Amended and Restated Limited Partnership Agreement (“LPA”) of BCH governs
the terms of BCH’s equity securities. Account holders are entitled to a compounded quarterly preferred return. The preferred
return to be paid to Preferred Series A Unitholders is limited by a quarterly preferred return rate cap that is based on the annualized
revenues of BCH. Annualized revenues are defined as four times the sum of total quarterly interest, fee and dividend income plus
total noninterest revenues. This quarterly rate cap is defined as follows:
|
●
|
0.25%
if annualized revenues are $80 million or less
|
|
●
|
0.50%
if annualized revenues are greater than $80 million but equal to or less than $105 million
|
|
●
|
0.75%
if annualized revenues are greater than $105 million but equal to or less than $125 million
|
|
●
|
1.00%
if annualized revenues are greater than $125 million but equal to or less than $135 million
|
|
●
|
1.25%
if annualized revenues are greater than $135 million but equal to or less than $140 million
|
|
●
|
If over $140 million, the preferred return calculation is based
on a fraction (i) the numerator of which is (A) the positive percentage rate change, if any, to the seasonally adjusted CPI-U covering
the period from the date of the last allocation of profits to such holders, plus (B) (x) 2% prior to an Initial Public Offering
(as defined in the BCH LPA) by Ben and (y) 3% thereafter, and (ii) the denominator of which is one minus the highest effective
marginal combined U.S. federal, state and local income tax rate in effect as of the beginning of the fiscal quarter for which such
determination is being made for an individual resident in New York City, New York, assuming (1) that the aggregate gross income
allocable with respect to the quarterly preferred return for such fiscal year will consist of the same relative proportion of each
type or character (e.g., long term or short term capital gain or ordinary or exempt income) of gross income item included in the
aggregate gross income actually allocated in respect of the quarterly preferred return for the fiscal year reflected in the BCH’s
most recently filed Internal Revenue Service Form 1065 and (2) any state and local income taxes are not deductible against U.S.
federal income tax.
|
The definition of Initial Public Offering
includes an event, transaction or agreement pursuant to which Ben’s Common Units are convertible or exchangeable into equity
securities listed on a national securities exchange or quotation in an automated quotation system.
No amounts have been paid to the Preferred Series A Subclass
1 Unit Account holders related to the preferred return from issuance on September 1, 2017 through December 31, 2019. In connection
with the issuance of Preferred Series A Subclass 2 Units as part of the Option Agreement, the preferred return of Preferred Series
A Subclass 1 Unit Account holders is reduced by the preferred return allocated to the Preferred Series A Subclass 2 Units during
the period the Option Agreement remains outstanding.
Upon election by a holder, the Preferred
Series A Unit Accounts (other than Preferred Series A Subclass 2 Unit Accounts) are, at any time on or after January 1, 2021,
convertible in an amount of Preferred Series A Unit Accounts (other than Preferred Series A Subclass 2 Unit Accounts), equal to
20% of their Sub-Capital Accounts into Class S Ordinary Units (with the right to convert any unconverted amount from previous
years in any subsequent years). Upon an election, a holder of Preferred Series A Subclass 1 Unit Accounts will be issued Class
S Ordinary Units necessary to provide the holder with a number of Class S Ordinary Units that, in the aggregate, equal (a) the
balance of the holder’s capital account associated with the Preferred Series A Subclass 1 Unit Accounts being converted
divided by (b) either (x) prior to an initial public offering, the appraised per Class A Unit fair market value as determined
by Beneficient or (y) following an initial public offering, the average price of a Common Unit for the thirty (30) day period
ended immediately prior to the applicable conversion date. The holder of such newly issued Class S Ordinary Units may immediately
convert them into Common Units. Additionally, effective December 31, 2030, if the Preferred Series A Subclass 1 Unit Accounts
have not been converted, they will redeem for cash in an amount equal to the then outstanding capital account balance of the accounts.
If available redeeming cash (as defined in the LPA) is insufficient to satisfy any such redemption requirements, BCH, on a quarterly
basis, will redeem additional Preferred Series A Units until all such Preferred Series A Units have been redeemed. The Preferred
Series A Subclass 1 Unit Accounts are subject to certain other conversion and redemption provisions.
GWG
HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The current LPA of BCH also includes certain
limitations of BCH, without the consent of a majority-in-interest of the Preferred Series A Unit Account holders, to (i) issue
any new equity securities and (ii) except as otherwise provided, incur indebtedness that is senior to or pari passu with any right
of distribution, redemption, repayment, repurchase or other payments relating to the Preferred Series A Unit accounts. Further,
BCH cannot, prior to the conversion of all the Preferred Series A Unit accounts, incur any additional long-term debt unless (i)
after giving effect to the incurrence of the new long-term debt on a pro forma basis, the sum of certain preferred stock, existing
debt and any new long-term indebtedness would not exceed 55% of the BCH’s NAV plus cash on hand, and (ii) at the time of
incurrence of any new long-term indebtedness, the aggregate balance of the BCH’s (including controlled subsidiaries) debt
plus such new long-term debt does not exceed 40% of the sum of the NAV of the collateral underlying the loan portfolio of BCH and
its subsidiaries plus cash on hand at Ben LP, BCH and its subsidiaries.
The Preferred Series A Subclass 1 Unit
Accounts are recorded in the consolidated balance sheet in the redeemable noncontrolling interest line item.
Class
S Ordinary Units
As of December 31, 2019, BCH,
a subsidiary of Ben LP, had issued and outstanding 5.8 million Class S Ordinary Units, which were all outstanding on each of the
respective dates. The Class S Ordinary Units participate on an as-converted basis pro-rata in the share of the profits or losses
of BCH and subsidiaries following all other allocations made by BCH and its subsidiaries. As limited partner interests, these
units have limited voting rights and do not entitle participation in the management of the Company’s business and affairs.
The Class S Ordinary Units are exchangeable for Common Units of Ben LP on a one-for-one basis, subject to customary conversion
rate adjustments for splits, distributions and reclassifications, as well as compliance with any applicable vesting and transfer
restrictions. Each conversion also results in the issuance to Ben LP of a Class A Unit of BCH for each Common Unit issued.
The Class S Ordinary Units are recorded
in the consolidated balance sheet in the noncontrolling interests line item.
Class
S Preferred Units
The limited partnership agreement of BCH
allows it to issue Class S Preferred Units. The Class S Preferred Units are entitled to a quarterly preferred return that is limited
by the quarterly preferred return rate cap described above for Preferred Series A Subclass 1 except for when annualized revenues
exceed $140 million, the Class S Preferred return is based on a fraction (i) the numerator of which is (A) the positive percentage
rate change, if any, to the seasonally adjusted CPI-U covering the period from the date of the last allocation of profits to such
holders, plus (B) 0.75 percent, and (ii) the denominator of which is one minus the highest effective marginal combined U.S. federal,
state and local income tax rate in effect as of the beginning of the fiscal quarter for which such determination is being made
for an individual resident in New York City, New York, assuming (1) that the aggregate gross income allocable with respect to
the quarterly preferred return for such fiscal year will consist of the same relative proportion of each type or character (e.g.,
long term or short term capital gain or ordinary or exempt income) of gross income item included in the aggregate gross income
actually allocated in respect of the quarterly preferred return for the fiscal year reflected in the Ben Group Partnership’s
most recently filed IRS Form 1065 and (2) any state and local income taxes are not deductible against U.S. federal income tax.
The Class S Preferred Units also participate on an as-converted basis pro-rata in the share of the profits or losses of BCH and
subsidiaries following all other allocations made by BCH and its subsidiaries. As limited partner interests, these units are generally
non-voting and do not entitle participation in the management of the Company’s business and affairs. Generally, the Class
S Preferred Units are exchangeable for Common Units in Ben LP on a 1.2-for-1 basis, subject to customary conversion rate adjustments
for splits, distributions and reclassifications, as well as compliance with any applicable vesting and transfer restrictions.
Each conversion also results in the issuance to Ben LP of a Class A Unit for each Common Unit issued. Holders of Class S Preferred
Units may elect to convert into Class S Ordinary Units in connection with a sale or dissolution of BCH.
GWG
HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
No amounts have been paid to the
Class S Preferred Unit holders related to the preferred return from issuance through December 31, 2019. The Class S Preferred
Units are recorded on the consolidated balance sheet in the noncontrolling interests line item.
(16)
Stock Incentive Plan
We adopted our 2013 Stock Incentive Plan
in March 2013, as amended on June 1, 2015, May 5, 2017 and May 8, 2018. The Stock Option Sub-Committee of our 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. Option awards generally expire 10 years from the date of grant. As of December 31, 2019,
6,000,000 of our common stock options are authorized under the plan, of which 2,594,000 shares were reserved for issuance under
outstanding incentive awards and 3,406,000 shares remain available for future grants.
Stock
Options
As of December 31, 2019, we had outstanding
stock options for 905,381 shares of common stock to employees, officers, and directors under the plan. Options for 673,341 shares
have vested and the remaining options are scheduled to vest over three years. The options were issued with an exercise price between
$4.83 and $11.56, which is equal to the market price of the shares on the date of grant. As of December 31, 2019, stock options
for 1,195,705 shares had been forfeited and stock options for 777,364 shares had been exercised. The total intrinsic value of
stock options exercised during 2019 was $0.3 million. The aggregate intrinsic value of stock options outstanding and exercisable
at December 31, 2019 was $1.0 million and $0.8 million, respectively.
Outstanding
stock options:
|
|
Vested
|
|
|
Unvested
|
|
|
Total
|
|
Balance as of December 31, 2017
|
|
|
857,192
|
|
|
|
779,756
|
|
|
|
1,636,948
|
|
Granted during the year
|
|
|
63,950
|
|
|
|
314,000
|
|
|
|
377,950
|
|
Vested during the year
|
|
|
503,503
|
|
|
|
(503,503
|
)
|
|
|
—
|
|
Exercised during the year
|
|
|
(569,864
|
)
|
|
|
—
|
|
|
|
(569,864
|
)
|
Forfeited during the year
|
|
|
(21,582
|
)
|
|
|
(25,501
|
)
|
|
|
(47,083
|
)
|
Balance as of December 31, 2018
|
|
|
833,199
|
|
|
|
564,752
|
|
|
|
1,397,951
|
|
Granted during the year
|
|
|
—
|
|
|
|
24,250
|
|
|
|
24,250
|
|
Vested during the year
|
|
|
197,859
|
|
|
|
(197,859
|
)
|
|
|
—
|
|
Exercised during the year
|
|
|
(53,001
|
)
|
|
|
—
|
|
|
|
(53,001
|
)
|
Forfeited during the year
|
|
|
(304,716
|
)
|
|
|
(159,103
|
)
|
|
|
(463,819
|
)
|
Balance as of December 31, 2019
|
|
|
673,341
|
|
|
|
232,040
|
|
|
|
905,381
|
|
GWG
HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
We recognized $0.4 million and $1.3
million in expense related to stock options during 2019 and 2018, respectively. As of December 31, 2019, unrecognized compensation
expense related to unvested options is $0.4 million. We expect to recognize this compensation expense over the next three years:
$0.3 million in 2020, $0.1 million in 2021, and the remainder in 2022.
Stock
Appreciation Rights (SARs)
As of December 31, 2019, we had outstanding
SARs for 375,625 shares of common stock to employees. The strike price of the SARs was between $6.75 and $11.55, which was equal
to the market price of the common stock at the date of issuance. SARs vest over varying terms of up to three years. As of December
31, 2019, 200,745 of the SARs were vested and 169,070 have been exercised. On December 31, 2019, the market price of GWG’s
common stock was $9.82.
Outstanding
SARs:
|
|
Vested
|
|
|
Unvested
|
|
|
Total
|
|
Balance as of December 31, 2017
|
|
|
189,053
|
|
|
|
153,919
|
|
|
|
342,972
|
|
Granted during the year
|
|
|
2,625
|
|
|
|
111,025
|
|
|
|
113,650
|
|
Vested during the year
|
|
|
71,785
|
|
|
|
(71,785
|
)
|
|
|
—
|
|
Exercised during the year
|
|
|
(145,622
|
)
|
|
|
—
|
|
|
|
(145,622
|
)
|
Forfeited during the year
|
|
|
—
|
|
|
|
(39,235
|
)
|
|
|
(39,235
|
)
|
Balance as of December 31, 2018
|
|
|
117,841
|
|
|
|
153,924
|
|
|
|
271,765
|
|
Granted during the period
|
|
|
4,250
|
|
|
|
130,650
|
|
|
|
134,900
|
|
Vested during the period
|
|
|
102,102
|
|
|
|
(102,102
|
)
|
|
|
—
|
|
Exercised during the period
|
|
|
(23,448
|
)
|
|
|
—
|
|
|
|
(23,448
|
)
|
Forfeited during the period
|
|
|
—
|
|
|
|
(7,592
|
)
|
|
|
(7,592
|
)
|
Balance as of December 31, 2019
|
|
|
200,745
|
|
|
|
174,880
|
|
|
|
375,625
|
|
The liability for the SARs as of December
31, 2019 and 2018 was $0.6 million and $0.3 million, respectively, and was recorded within other accrued expenses in the consolidated
balance sheets. Remaining compensation expense is expected to be recognized over the next three years. Employee compensation and
benefits expense for SARs of $0.3 million was recorded for both years ended December 31, 2019 and 2018.
GWG
HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Upon
the exercise of SARs, the Company is obligated to make cash payment equal to the positive difference between the market value
of the Company’s common stock on the date of exercise less the market value of the common stock on the date of grant.
The
following summarizes information concerning outstanding options and SARs issued under the 2013 Stock Incentive Plan:
In the third quarter of 2019, a total
of 375,000 RSUs held by employees vested entitling the holders thereof, collectively, to cash payments totaling $4.5 million,
all of which were paid in the third and fourth quarters of 2019 and recognized in employee compensation and benefits in the consolidated
statement of operations for the year ended December 31, 2019. Additionally during 2019, 53,403 RSUs vested and 26,701 shares of
common stock were issued to employees, net of shares forfeited to satisfy tax withholding obligations.
Beneficient has various equity incentive
plans. In 2019 and early 2020, Beneficient granted units to certain of its employees and directors under these plans. The Company
expects the expense recognized related to these plans to be material. The holders of certain of these units, upon vesting, have
the right to convert the units to shares GWG common stock per the Exchange Agreement discussed in Note 1. As such, units issued
and vested under Beneficient’s equity plans could result in dilution of GWG’s common stock.
The components of other expenses in our
consolidated statements of operations are as follows (in thousands):
The components of our income tax expense (benefit)
and the reconciliation at the statutory federal tax rate to our actual income tax expense (benefit) consisted of the following
(in thousands):
The current and deferred components of
tax expense were as follows (in thousands):
The Company’s effective tax rate was 34.8% and 0.0% during 2019 and 2018, respectively. The 2019
effective tax rate was higher than the statutory rate primarily due to the deferred tax liability resulting from the gain on consolidation
of equity method investment. The effective tax rate during 2018 was 0.0% as we did not generate taxable income.
At December 31, 2019 and 2018, we had federal
and aggregate state net operating loss (“NOL”) carryforwards of $28.6 million and $36.5 million, respectively. The
NOL carryforwards will begin to expire in 2033. 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. As a result of the Exchange Transaction, a change in ownership for income tax purposes occurred as of December 28, 2018.
As such, the annual utilization of our net operating losses generated prior to the ownership change was limited. However, net unrealized
built-in gains on our life insurance policies result in an increase in the Section 382 limit over the five-year recognition period,
which resulted a nominal amount of current tax liability in 2019. Included in the deferred tax liability noted in the table above
are our investments in Ben LP and InsurTech Holdings, which are partnerships for federal income tax purposes.
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 December
31, 2019, based on all available evidence, we have provided a valuation allowance of $50.1 million against our deferred tax
assets due to the uncertainty as to the realization of our deferred tax assets during the carryforward periods. In 2019,
valuation allowances were recorded against the total amount of non-permanent deferred tax assets. Permanent deferred tax
assets of $10.8 million in 2019 were comprised of interest expense limitations under Section 163(j) and the tax-effected net
operation loss (“NOL”) created subsequent to 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 December 31, 2019 and 2018, we recorded no accrued interest or penalties related to uncertain tax positions.
Our income tax returns for tax years ended
December 31, 2016 through 2018, and 2019, 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, 2015 also remains open to examination by various state
taxing jurisdictions.
The computations of basic and diluted income (loss) attributable
to common shareholders per share for 2019 and 2018 are as follows (in thousands, except share data and per share data):
RPS and RPS 2 (as described in Note 15) and restricted stock
units and stock options (as described in Note 16) were included in the calculation of diluted earnings per share for the year ended
December 31, 2019. Options to purchase 437,266 shares of common stock were outstanding during 2019 but were excluded from the calculation
of diluted earnings per share because their effects were anti-dilutive. RPS, RPS 2, restricted stock units and stock options were
not included in the calculation of diluted earnings per share for the year ended December 31, 2018 because we recorded a net loss
during that period and the effects were anti-dilutive.
The total assets of the Investment in Beneficient
segment at December 31, 2019, includes goodwill of $2.4 billion which represents all of the goodwill on our consolidated balance
sheet at December 31, 2019.
Total lease costs recognized for the years
ended December 31, 2019 and 2018 were $0.5 million and $0.4 million, respectively. These amounts included operating lease costs
of $0.2 million, variable lease costs of $0.2 million, and short term lease costs of $0.1 million for the year ended December 31,
2019. The weighted average remaining lease term at December 31, 2019 was 4.2 years and the weighted average discount rate was 6.6%.
For the year ended December 31, 2019 and 2018, cash paid for amounts included in the measurement of operating lease liabilities
and included in operating cash flows totaled $0.3 million.