News Column

JGWPT HOLDINGS INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

August 14, 2014

You should read the following discussion and analysis of our financial condition and results of operations together with our unaudited condensed consolidated financial statements and the related notes included elsewhere in this Quarterly Report on Form 10-Q. Some of the information contained in this discussion and analysis or set forth elsewhere in this Quarterly Report on Form 10-Q, including information with respect to our plans and strategy for our business and related financing, includes forward-looking statements that involve risks and uncertainties. You should read the "Risk Factors" and the "Forward-Looking Statements" sections of this Quarterly Report on Form 10-Q for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.

Overview



We are a leading direct response marketer that provides liquidity to our customers by purchasing structured settlement, annuity and lottery payment streams and interests in the proceeds of legal claims in the United States. We securitize or sell those payment streams in transactions that are structured to generate cash proceeds to us that exceed the purchase price we paid for those payment streams. We have developed our market leading position as a purchaser of structured settlement payments through our highly recognizable brands and multi-channel direct response marketing platform.

Structured settlements are financial tools used by insurance companies to settle claims on behalf of their customers. They are contractual arrangements under which an insurance company agrees to make periodic payments to an individual as compensation for a claim typically arising out of a personal injury. The structured settlement payments we purchase have long average lives of more than ten years and cannot be prepaid.

We operate two market leading and highly recognizable brands, JG Wentworth and Peachtree, each of which generates a significant volume of inbound inquiries. Brand awareness is critical to our marketing efforts, as there are no readily available lists of holders of structured settlements, annuities or potential pre-settlement customers. Since 1995, we have invested approximately $655.0 million in marketing to establish our brand names and increase customer awareness through multiple media outlets. Since 1995 we have been building proprietary databases of current and prospective customers, which we continue to grow through our marketing efforts and which we consider a key differentiator from our competitors. As of December 31, 2013, our customer databases included more than 121,960 current and prospective structure settlement customers with approximately $32 billion of unpurchased structured settlement payment streams which includes all potential payment streams that customers disclosed to us at our initial contact with them. Since December 31, 2013, we have continued to add to our customer databases and to purchase structured settlement payment streams from our customers who may also sell payment streams to others and, therefore, the amount of unpurchased structured settlement payment streams in our databases may now be greater or smaller. We also maintain databases of pre-settlement and lotteries customers. The strength of our databases and the resulting predictable pipeline of opportunities are demonstrated by the level of repeat business we experience with our customers. Of the total structured settlement customers we have served since 1995, the average customer has completed through 2013 two separate transactions with us. These additional purchasing opportunities come with low incremental acquisition costs.

We serve the liquidity needs of structured settlement payment holders by providing our customers with cash in exchange for a certain number of fixed scheduled future payments. Customers desire liquidity for a variety of reasons, including debt reduction, housing, automotive, business opportunities, education and healthcare costs. Since 1995, we have purchased over $10.1 billion of undiscounted structured settlement payment streams and have completed 39 asset-backed securitizations totaling over $5.6 billion in issuance. The Company refers to undiscounted total receivable balances as "TRB." TRB purchases for the three months ended June 30, 2014 and 2013 were $287.7 million and $294.8 million, respectively. TRB purchases for the six months ended June 30, 2014 and 2013 were $548.3 million and $565.2 million, respectively.

42



--------------------------------------------------------------------------------

Table of Contents

We act as an intermediary that identifies, underwrites and purchases individual payment streams from our customers, aggregates the payment streams and then finances them in the institutional market at financing rates that are below our cost to purchase the payment streams. We purchase future payment streams from our customers for a single up-front cash payment. Such payment is based upon a discount rate that is negotiated with each of our customers. We fund our purchases of payment streams with short and long-term non-recourse financing. We initially fund our purchase of structured settlement payments and annuities through committed warehouse lines. Our guaranteed structured settlement and annuity warehouse facilities totaled $750.0 million as of June 30, 2014 and December 31, 2013, respectively. We intend to undertake a sale or securitization of these assets approximately three times per year, subject to our discretion, in transactions that generate excess cash proceeds over the purchase price we paid for those assets and the amount of warehouse financing used to fund that purchase price. We finance the purchase of other payment steams using a combination of other committed financing sources and our operating cash.

Because our purchase and financing of periodic payment streams is undertaken on a positive cash flow basis, we view our ability to purchase payment streams as key to our business model. Another key feature of our business model is our ability to aggregate payment streams from many individuals and from a well-diversified base of payment counterparties. We continuously monitor the efficiency of marketing expenses and the hiring and training of personnel engaged in the purchasing process.

We are subject to federal, state and, in some cases, local regulation in the jurisdictions in which we operate. These regulations govern and/or affect many aspects of our business as set forth more fully under "Part 1, Item 1. Business" in our Annual Report on Form 10-K for the year ended December 31, 2013.

On November 14, 2013, we consummated our IPO whereby 11,212,500 shares of our Class A common stock were sold to the public. The aggregate net proceeds received from our IPO were $141.3 million, after deducting underwriting discounts and offering expenses. We used the aggregate net proceeds to purchase 11,212,500 Common Interests of the newly formed JGWPT Holdings, LLC, representing 37.9% of the then outstanding Common Interests of Holdings LLC. Holdings LLC used a portion of the net proceeds of our IPO to repay a portion of our senior secured term loan, with the remainder used for general corporate purposes.

43



--------------------------------------------------------------------------------

Table of Contents Results of Operations



The following table sets forth our unaudited condensed consolidated statement of operations for the three and six months ended June 30, 2014 and 2013:

Three Months Ended Six Months Ended June 30, June 30, 2014 2013 2014 2013 (In thousands) REVENUES Interest income $ 46,638$ 37,943$ 94,460$ 80,582 Unrealized gains on VIE and other finance receivables, long-term debt and derivatives 70,317 30,245 157,628 163,843 Loss on swap terminations, net - - (574 ) (174 ) Servicing, broker, and other fees 1,030 1,423 2,172 2,536 Realized and unrealized gains (losses) on marketable securities, net 3,467 (1,080 ) 4,356 4,997 Realized gain (loss) on notes receivable, at fair value 2,098 (1,862 ) 2,098 (1,862 ) Other (62 ) (8 ) (62 ) (53 ) Total Revenues $ 123,488$ 66,661$ 260,078$ 249,869 EXPENSES Advertising $ 16,432$ 17,349$ 33,925$ 33,803 Interest expense 50,700 43,346 101,930 85,970 Compensation and benefits 10,483 11,551 19,769 23,396 General and administrative 4,613 6,226 9,083 10,361 Professional and consulting 5,518 4,975 8,962 9,098 Debt issuance 19 44 3,020 3,072 Securitization debt maintenance 1,564 1,544 3,121 2,984 Provision for losses on finance receivables 1,127 1,587 2,218 2,683 Depreciation and amortization 1,121 1,386 2,202 2,763 Installment obligations expense (income), net 4,122 (231 ) 5,614 6,519 Total Expenses $ 95,699$ 87,777$ 189,844$ 180,649 Income (loss) before income taxes 27,789 (21,116 ) 70,234 69,220 Provision for income taxes 6,081 524 13,993 1,155 Net Income (Loss) $ 21,708$ (21,640 )$ 56,241$ 68,065 Less net income attributable to non-controlling interests 15,440 40,951 Net income attributable to JGWPT Holdings Inc. $ 6,268$ 15,290 44



--------------------------------------------------------------------------------

Table of Contents

Comparison of Consolidated Results for the Three Months Ended June 30, 2014 and 2013

Revenues



Total revenues for the three months ended June 30, 2014 were $123.5 million, an increase of $56.8 million, or 85.2%, from $66.7 million for the three months ended June 30, 2013. The increase was primarily attributable to a $40.1 million increase in unrealized gains on VIE and other finance receivables, long-term debt and derivatives, a $8.7 million increase in interest income, a $4.5 million increase in realized and unrealized gains (losses) on marketable securities, net, and a $4.0 million increase in realized gain (loss) on notes receivable, at fair value that resulted from the repayment and maturity of the notes receivables during the respective periods.

Interest income for the three months ended June 30, 2014 was $46.6 million, an increase of $8.7 million, or 22.9%, from $37.9 million for the three months ended June 30, 2013, due to an increase in our finance receivables balance.

Unrealized gains on VIE and other finance receivables, long-term debt and derivatives was $70.3 million for the three months ended June 30, 2014, an increase of $40.1 million from $30.2 million for the three months ended June 30, 2013, primarily due to the impact of decreasing interest rates during the three months ended June 30, 2014 compared to increasing interest rates during the three months ended June 30, 2013. This was partially offset by a 2.4% decrease in total receivables purchased in the second quarter of 2014.

Realized and unrealized gains (losses) on marketable securities, net, was $3.5 million for the three months ended June 30, 2014, an increase of $4.5 million from a ($1.1) million loss for the three months ended June 30, 2013, due to higher investment returns on marketable securities. The increase is primarily offset by a corresponding increase in installment obligations expense (income), net. These amounts relate to the marketable securities and installment obligations payable on our unaudited condensed consolidated balance sheet. The marketable securities are owned by us, but are held to fully offset our installment obligations liability. Therefore, increases or decreases in gain on marketable securities do not impact our net income.

Operating Expenses



Total expenses for the three months ended June 30, 2014 were $95.7 million, an increase of $7.9 million, or 9.0%, from $87.8 million for the three months ended June 30, 2013.

Advertising expense, which consists of our marketing costs including direct mail, television, internet, and other related expenses, decreased by 5.3% to $16.4 million for the three months ended June 30, 2014, from $17.3 million for the three months ended June 30, 2013, primarily due to the timing of our new internet and television initiatives in 2014.

Interest expense, which includes interest on our securitization debt, warehouse facilities and the term loan, increased 17.0% to $50.7 million for the three months ended June 30, 2014, from $43.3 million for the three months ended June 30, 2013. This increase is primarily driven by an increase in debt from securitizations offset by the net decrease in the principal amount of our term loan which occurred in December 2013.

Compensation and benefits expense decreased 9.2% to $10.5 million for the three months ended June 30, 2014, compared to $11.6 million for the three months ended June 30, 2013, primarily driven by cost savings associated with the downsizing of the Boynton Beach office.

General and administrative costs decreased 25.9% to $4.6 million for the three months ended June 30, 2014, from $6.2 million for the three months ended June 30, 2013, primarily due to a decrease in expenses related to information technology, rent and utilities primarily due to cost savings associated with the closing of our Boynton Beach office that was partially offset by an increase in insurance costs.

45



--------------------------------------------------------------------------------

Table of Contents

Professional and consulting costs increased by 10.9% to $5.5 million for the three months ended June 30, 2014, from $5.0 million for the three months ended June 30, 2013, primarily due to an increase in outside legal fees associated with litigation and regulatory inquiries and an increase in audit fees that was partially offset by a decrease in consulting fees.

Provision for losses on finance receivables decreased 29.0% to $1.1 million for the three months ended June 30, 2014 from $1.6 million for the three months ended June 30, 2013, primarily due to a reduction in specific reserves recognized that was offset by an increase in reserves for pre-settlements and structured settlements.

Restructuring Expense



In April 2013, we announced our intention to restructure our Boynton Beach office. In connection with this announcement, we recorded a restructuring charge of $3.2 million which was recorded in the following statement of operations line items: $2.8 million in compensation and benefits and $0.4 million in general and administrative. The associated workforce reductions were substantially completed as of December 31, 2013.

Income (Loss) Before Taxes



For the three months ended June 30, 2014, we earned income before taxes of $27.8 million, an increase of $48.9 million from a loss before taxes of ($21.1) million for the three months ended June 30, 2013. This was primarily due to the increase in unrealized gains on VIE and other finance receivables, long-term debt and derivatives, an increase in interest income primarily due to the increase in our finance receivable balances, a decrease in compensation and benefits expenses, as well as general and administrative expenses primarily due to cost savings associated with the closing of our Boynton Beach office.

Income Taxes



Until the time of our IPO in November 2013, we and the majority of our subsidiaries operated in the U.S. as non-income tax paying entities, and were treated as pass-through entities for U.S. federal and state income tax purposes and generally as corporate entities in non-U.S. jurisdictions. In addition, certain of our wholly owned subsidiaries are operating as corporations within the U.S. and subject to U.S. federal and state income tax. As non-income tax paying entities, the majority of our net income or loss is attributable to the members of Common Interests in Holdings LLC. In connection with our IPO, JGWPT Holdings Inc. was created to act as a holding company, holding an ownership interest in Holdings LLC, our partnership. Following this structural change, we record an income tax provision/benefit relating to our share of Holdings LLC, and therefore the share of its earnings, held by the public.

Our provision for income taxes for the three months ended June 30, 2014 was $6.1 million, compared to a tax provision of $0.5 million for the three months ended June 30, 2013. The increase in our tax provision was primarily due to a full quarter's allocation of income from Holdings LLC to the Company. For the year ended December 31, 2013, the Company was only allocated taxable income for the period after the IPO.

Net Income (Loss)



Net income for the three months ended June 30, 2014 was $21.7 million, an increase of $43.3 million, from a net loss of ($21.6) million for the three months ended June 30, 2013. This was primarily due to the increase in unrealized gains on VIE and other finance receivables, long-term debt and derivatives, an increase in interest income primarily due to the increase in our finance receivable balances, a decrease in compensation and benefits expenses, as well as general and administrative expenses primarily due to cost savings associated with the closing of our Boynton Beach office.

46



--------------------------------------------------------------------------------

Table of Contents

Comparison of Consolidated Results for the Six Months Ended June 30, 2014 and 2013

Revenues



Total revenues for the six months ended June 30, 2014 were $260.1 million, an increase of $10.2 million, or 4.1%, from $249.9 million for the six months ended June 30, 2013. The increase was primarily attributable to an increase of $13.9 million in interest income and an increase of $4.0 million in gain (loss) on note receivable, at fair value that resulted from the repayment and maturity of the notes receivables during the respective periods. This was partially offset by a $6.2 million decrease in unrealized gains on VIE and other finance receivables, long-term debt and derivatives.

Interest income for the six months ended June 30, 2014 was $94.5 million, an increase of $13.9 million, or 17.2%, from $80.6 million for the six months ended June 30, 2013, due to an increase in our finance receivables balance.

Unrealized gains on VIE and other finance receivables, long-term debt, and derivatives was $157.6 million for the six months ended June 30, 2014, a decrease of $6.2 million from $163.8 million for the six months ended June 30, 2013, primarily due to the impact of higher average interest rates and a 3.0% decrease in total receivables purchased in the first half of 2014.

Realized and unrealized gains on marketable securities, net, was $4.4 million for the six months ended June 30, 2014, a decrease of $0.6 million from $5.0 million for the six months ended June 30, 2013, primarily due to lower investment returns on marketable securities. The decrease is primarily offset by a corresponding decrease in installment obligations expense (income), net. These amounts relate to the marketable securities and installment obligations payable on our unaudited condensed consolidated balance sheet. The marketable securities are owned by us, but are held to fully offset our installment obligations liability. Therefore, increases or decreases in gain on marketable securities do not impact our net income.

Operating Expenses



Total expenses for the six months ended June 30, 2014 were $189.8 million, an increase of $9.2 million, or 5.1%, from $180.6 million for the six months ended June 30, 2013.

Advertising expense, which consists of our marketing costs including direct mail, television, internet, and other related expenses remained consistent at $33.9 million for the six months ended June 30, 2014, and $33.8 million for the six months ended June 30, 2013.

Interest expense, which includes interest on our securitization debt, warehouse facilities and the term loan, increased 18.6% to $101.9 million for the six months ended June 30, 2014, from $86.0 million for the six months ended June 30, 2013. The increase is primarily driven by an increase in debt from securitizations and was partially offset by a decrease in the principal amount of our term loan which occurred in December 2013.

Compensation and benefits expense decreased 15.5% to $19.8 million for the six months ended June 30, 2014, compared to $23.4 million for the six months ended June 30, 2013, primarily driven by cost savings associated with the downsizing of the Boynton Beach office.

General and administrative costs decreased 12.3%, to $9.1 million for the six months ended June 30, 2014, from $10.4 million for the six months ended June 30, 2013, primarily due to a decrease in expenses related to information technology, rent and utilities primarily due to cost savings associated with the closing of our Boynton Beach office that was partially offset by an increase in insurance costs.

47



--------------------------------------------------------------------------------

Table of Contents

Professional and consulting costs decreased 1.5% to $9.0 million for the six months ended June 30, 2014 from $9.1 million for the six months ended June 30, 2013, primarily due to a decrease in outside legal fees associated with litigation costs and consulting fees that was partially offset by an increase in audit fees.

Provision for losses on finance receivables decreased 17.3% to $2.2 million for the six months ended June 30, 2014 from $2.7 million for the six months ended June 30, 2013, primarily due to a reduction in specific reserves recognized that was offset by an increase in reserves for pre-settlements and structured settlements.

Restructuring Expense



In April 2013, we announced our intention to restructure our Boynton Beach office. In connection with this announcement, we recorded a restructuring charge of $3.2 million which was recorded in the following statement of operations line items: $2.8 million in compensation and benefits and $0.4 million in general and administrative. The associated workforce reductions were substantially completed as of December 31, 2013.

Income Before Taxes



For the six months ended June 30, 2014, we earned income before taxes of $70.2 million, an increase of 1.5%, or $1.0 million, from $69.2 million for the six months ended June 30, 2013, primarily due to the increase of interest income due to an increase in our finance receivables balance and an increase in the realized gains (losses) on notes receivable, at fair market value due to the repayment and maturity of notes receivable during the respective periods. This increase was offset by an increase in interest expense primarily due to the increase in debt from securitizations that was partially offset by a decrease in the principal amount of our term loan.

Income Taxes



Until the time of our IPO in November 2013, we and the majority of our subsidiaries operated in the U.S. as non-income tax paying entities, and were treated as pass-through entities for U.S. federal and state income tax purposes and generally as corporate entities in non-U.S. jurisdictions. In addition, certain of our wholly owned subsidiaries are operating as corporations within the U.S. and subject to U.S. federal and state income tax. As non-income tax paying entities, the majority of our net income or loss is attributable to the members of Common Interests in Holdings LLC. In connection with our IPO, JGWPT Holdings Inc. was created to act as a holding company, holding an ownership interest in Holdings LLC, our partnership. Following this structural change, we record an income tax provision/benefit relating to our share of Holdings LLC, and therefore the share of its earnings, held by the public.

Our provision for income taxes for the six months ended June 30, 2014 was $14.0 million, compared to a tax provision of $1.2 million for the six months ended June 30, 2013. The increase in our tax provision was primarily due to the allocation of income from Holdings LLC to the Company for all of 2014. For the year ended December 31, 2013, the Company was only allocated taxable income for the period after the IPO.

Net Income



Net income for the six months ended June 30, 2014 was $56.2 million, a decrease of $11.8 million, or 17.4%, from net income of $68.1 million for the six months ended June 30, 2013, primarily due to the increase of interest expense due to the increase in debt from securitizations that was partially offset by a decrease in the principal amount of our term loan, and an increase in provision for income taxes primarily due to the allocation of income from Holdings LLC to the Company for all of 2014. This was offset by an increase in interest income due to an increase in our finance receivables balance and an increase in the realized gains (losses) on notes receivable, at fair market value due to the repayment and maturity of notes receivable during the first half of the year.

48



--------------------------------------------------------------------------------

Table of Contents

Liquidity and Capital Resources

Cash Flows



The following table sets forth a summary of our cash flows for the six months ended June 30, 2014 and 2013.

Six Months Ended June 30, 2014 2013 Net cash used in operating activities $ (180,535 )$ (163,343 ) Net cash provided by investing activities 4,738 5,444 Net cash provided by financing activities 172,148 84,912 Net decrease in cash and cash equivalents (3,649 ) (72,987 ) Cash and cash equivalents at beginning of period 39,061 103,137



Cash and cash equivalents at end of period $ 35,412$ 30,150

Six Months Ended June 30, 2014 and 2013

Cash Flow from Operating Activities

Net cash used in operating activities was $180.5 million and $163.3 million for the six months ended June 30, 2014 and 2013, respectively. The cash used in operating activities does not reflect the financing of our purchased receivables which is an integral part of our business and is reflected in the cash flow from financing activities. This $17.2 million increase in cash used in operating activities was primarily driven by an $11.8 million decrease in net income as a result of decreasing interest rates and a $14.4 million decrease in purchases of finance receivables, net of collections.

Cash Flow from Investment Activities

Net cash provided by investment activities was $4.7 million for the six months ended June 30, 2014 compared to net cash provided by investment activities of $5.4 million for the six months ended June 30, 2013. This $0.7 million decrease was primarily driven by the collection of a note receivable from an affiliate in the prior year, offset by a decrease in purchases of fixed assets, net of sales proceeds.

Cash Flow from Financing Activities

Net cash provided by financing activities was $172.1 million and $84.9 million for the six months ended June 30, 2014 and 2013, respectively, representing an increase of $87.2 million which was primarily attributable to a $125.8 million increase in issuance of VIE long-term debt offset by a $86.0 million decrease in repayments of long-term debt and derivatives and a $16.9 decrease in gross proceeds from revolving facilities. The increase was also primarily attributable to non-recurring transactions that occurred during the first half of 2013. During the six months ended June 30, 2013, we entered into a new credit facility which generated net proceeds of $557.2 million. In connection with the entry into this new credit facility, we made a cash distribution of $459.6 million to Common Interestholders and repaid $143.5 million in repayments under our existing debt obligations.

Funding Sources



We utilize a number of different funding sources to finance our different business lines. These sources are targeted to allow us to maximize our cash proceeds from the different assets that we purchase.

49



--------------------------------------------------------------------------------

Table of Contents

Structured Settlements and Annuities

We finance our guaranteed structured settlement and annuity payment stream purchases through four separate warehouse facilities with $750.0 million of aggregate capacity: (i) a $300.0 million syndicated warehouse facility with Barclays and Natixis with a revolving period that ends in July 2016; (ii) a $300.0 million warehouse facility with Credit Suisse with a revolving period that ends in November 2016; (iii) a $100.0 million warehouse facility with PartnerRe with a 2 year evergreen feature, that requires the lender to give us 24 months' notice prior to terminating the facility's revolving line of credit; and (iv) a $50.0 million warehouse facility with Deutsche Bank with a revolving period that ends in October 2016. Subsequent to the expiration or termination of their respective revolving lines of credit, each of our warehouse facilities has an amortization period of between 18 and 24 months before the final maturity, allowing us time to exit or refinance the warehouse facility after the revolving period has ended.

Our warehouse facilities are structured with advance rates that range from 92.5% to 95.5% and discount rates that range from 7.5% to 9.2%. The discount rate is either fixed over the term of the facility or is based on a fixed spread over a floating swap rate, which we then fix through interest rate swaps at the time of the borrowing. The discount rate is used to discount the payment streams we have purchased, and these discounted payment streams are then multiplied by the advance rate to determine the amount of funds that are available to us under the warehouse facilities. Our purchases of structured settlement and annuity payment streams are at higher discount rates than the discount rates applied to those payment streams under the warehouse facilities. As a result, the funds available to be drawn under our warehouse facilities exceed the purchase price for the payment streams we purchase. This excess cash is used to support our business and cover a portion of our operating expenses.

We undertake non-recourse term securitizations once we have aggregated in our warehouse facilities a sufficient aggregate value of structured settlement and annuity payment streams to undertake a securitization. At the close of each such securitization, the outstanding amount under each of the warehouse facilities is repaid. The amount of net proceeds we receive from securitizations is typically in excess of the amount of funds required to repay the warehouse facilities, resulting in a positive cash flow at the time of securitization. We completed three securitizations in 2013 and two securitizations in 2014. On February 18, 2014, we closed our 2014-1 securitization with an aggregate issuance amount of $233.9 million and a discount rate of 4.24% which generated net proceeds to the Company of $88.9 million. On July 23, 2014, we closed our 2014-2 securitization with an aggregate issuance amount of $227.6 million and a discount rate of 3.95% which generated net proceeds to the Company of $68.6 million before the pre-funding component of the securitization which we expect to close before September 30, 2014.

We intend, subject to market conditions, management discretion and other relevant factors, to continue to undertake approximately three securitizations per year in the future. The counterparties to the structured settlement and annuity payment streams we purchase have mostly investment grade credit ratings. In 2013, approximately 86% of the counterparties to structured settlement payment streams that we purchased were rated "A3" or better by Moody's. This reduced credit risk, together with the long weighted average life and low pre-payment risk, results in a desirable asset class that can be securitized and sold in the asset-backed security market. Since 1997, our securitization entities, including our two securitizations in 2014, have undertaken over $5.6 billion in total issuance volume, representing $8.8 billion of payment streams over 39 securitizations.

Life Contingent Structured Settlements and Life Contingent Annuities

We finance our purchases of life contingent structured settlement and life contingent annuity payment streams through a committed permanent financing facility with PartnerRe with a capacity of $100.0 million. This facility allows us to purchase life contingent structured settlement and life contingent annuity payment streams without assuming any mortality risk. This facility is structured as a permanent facility, whereby the life contingent structured settlement and life contingent annuity payment streams we purchase are financed for their entire life and remain within the facility until maturity. The payment streams purchased are funded at a fixed advance rate of 94%,

50



--------------------------------------------------------------------------------

Table of Contents

while the discount rate used to value the payment streams is variable, depending on the characteristics of the payment streams. The life contingent structured settlement and life contingent annuity payment streams that we purchase are discounted at a higher rate than the discount rates applied to those payment streams under the committed permanent financing facility, with the result that the funds available to be drawn under the facility exceed the purchase price for the payment streams we purchase. This positive cash flow is used to support our business and cover a portion of our operating expenses. As of June 30, 2014, our permanent financing facility with PartnerRe had a capacity of $100.0 million for our life contingent annuity and structured settlement businesses.

Lotteries



Historically, we have funded the purchase of lottery payment streams through non-recourse financing as well as a diversified institutional funding base of more than five institutional investors who purchase lottery payment streams directly from us. These investors are either insurance companies or asset managers. Lottery payment streams are purchased by the investors and the transactions are structured as an asset sale to the investor. We earn the difference between the discount rate at which we purchase the lottery payment stream from the lottery prizewinner and the discount rate at which we sell the lottery payment stream to the investor.

Recently, we have also been purchasing lottery payment streams utilizing our balance sheet and we have structured two of our guaranteed structured settlement and annuity warehouse facilities to allow us to finance lottery payment streams. This allows us to aggregate a pool of such payment streams that we subsequently securitize together with structured settlement and annuity payment streams. Lottery payment streams were included in our three securitizations during 2013 and our two securitizations in 2014. We intend to continue to securitize lottery payment streams in the future. We believe that our ability to securitize lottery payment streams has the potential to assist us to achieve an industry-leading cost of capital and to drive our future growth in this asset class.

Pre-Settlement Funding



We finance our pre-settlement funding through a revolving credit facility with Capital One Bank. The $35.0 million facility is structured with a revolving period that ends in December 2014 and a subsequent 24 month amortization period. The advance rate applicable to pre-settlement funding financed through the facility is 84%. Due to the shorter duration of pre-settlement funding, we do not require a facility with as large a capacity as for the other asset types above, as the pre-settlement funding transactions revolve more frequently. Positive cash flow is typically generated from the difference between the amount of proceeds we receive on settlement and the amount funded to the plaintiff.

Term Loan



We have (i) a widely syndicated senior secured term loan which matures in February 2019, and (ii) a widely syndicated $20.0 million revolving commitment that matures in August 2017. On December 6, 2013, we repaid $123.0 million of our senior secured term loan with proceeds from our IPO, reducing the outstanding amount to $449.5 million immediately after repayment. In connection with this repayment, we amended the terms governing the loan to reduce the applicable margin from 6.5% to 5.0% for Base Rate Loans and from 7.5% to 6.0% for Eurodollar Loans and reduced the interest rate floor from 2.5% to 2.0% for Base Rate Loans and from 1.5% to 1.0% for Eurodollar Loans. No changes were made to the financial covenants contained in the credit agreement and as a result of the repayment, no further principal payments are required to be made on the senior secured term loan until its maturity in February 2019. The revolving commitment has the same interest rate terms as the senior secured term loan.

Residual Financing



On May 6, 2014, we amended the terms of our Residual Term Facility with a financial institution. The amendment primarily increased the principal balance from $70.0 million to $110.0 million. This facility is now secured by 24 of our securitization residuals and is structured with a $110.0 million A1 Note due in May 2021. Prior to the amendment, the facility was structured with a $56.0 million A1 Note due in September 2018 and a $14.0 million A2 Note due in September 2019. The amendment also decreased the interest rate on the Residual

51



--------------------------------------------------------------------------------

Table of Contents

Term Facility to 7.0% from 8.0% and eliminated the requirement to make the additional $2.0 million annual principal payments.

Securitization Debt



We elected fair value treatment under ASC 825 to measure the VIE long-term debt issued by securitization and permanent financing trusts and related VIE finance receivables. We have determined that measurement of the VIE long-term debt issued by securitization and permanent financing trusts at fair value better correlates with the fair value of the VIE finance receivables held by SPEs, which are held to provide the cash flow for the note obligations. The VIE debt issued by SPEs is non-recourse to the Company other subsidiaries. Certain of our subsidiaries continue to receive fees for servicing the securitized assets which are eliminated in consolidation. In addition, the risk to our non-SPE subsidiaries from SPE losses is limited to cash reserve and residual interest amounts.

Initial Public Offering



On November 14, 2013, we consummated our IPO, in which we sold 11,212,500 shares of our Class A common stock to the public. The aggregate net proceeds received from the offering were $141.3 million. We used $123.0 million of the net proceeds to repay a portion of our senior secured term loan, with the remainder used for general corporate purposes.

Other Financing



We maintain other permanent financing arrangements that have been used in the past for longer term funding purposes. Each of these arrangements has assets pledged as collateral, the cash flows from which are used to satisfy the loan obligations. These other financing arrangements are more fully described in the unaudited condensed consolidated financial statements contained in this Quarterly Report on Form 10-Q.

Short-Term Liquidity Needs



Our liquidity needs over the next 12 months are expected to be provided through the excess cash generated by our structured settlement, annuity, and lottery payment stream warehouse facilities, life contingent structured settlement and annuity permanent financing facilities as well as our lottery program. Our securitization program for structured settlements, annuities and lottery payment streams also is expected to provide for both a replenishment of our warehouse capacity as well as excess cash to operate the business and make interest payments. However, there can be no assurances that we will be able to continue to securitize our payment streams at favorable rates or obtain financing through borrowing or other means.

Long-Term Liquidity Needs



Our most significant needs for liquidity beyond the next 12 months are the repayment of the principal amount of our outstanding senior secured term loan and the repayment of our residual financing facility. We used a portion of the net proceeds of our IPO to repay a portion of our senior secured term loan. We expect to meet our remaining long-term liquidity needs through excess cash flow generated through our securitization program, bank borrowings, debt refinancings, and new debt and equity offerings. However, there can be no assurances that we will be able to continue to securitize our payment streams at favorable rates or obtain financing through borrowing or other means, refinance our debt or raise new debt or equity.

As a consequence of the initial sales and any future exchanges of Common Interests for shares of our Class A or Class C common stock, we may increase our share of the tax basis of the assets then owned by Holdings LLC. Any such increase in tax basis is anticipated to allow us the ability to reduce the amount of future tax payments to the extent that we have future taxable income. We are obligated, pursuant to our tax receivable

52



--------------------------------------------------------------------------------

Table of Contents

agreement with all Common Interestholders who hold in excess of approximately 1% of the Common Interests as of immediately prior to our IPO, to pay to such Common Interestholders, 85% of the amount of income tax we save for each tax period as a result of the tax benefits generated from the initial sales and any subsequent exchange of Common Interests for our Class A or Class C common stock and from the use of certain tax attributes. We expect to fund these long-term requirements under the tax receivable agreement with tax distributions received from Holdings LLC and, if necessary, loans from Holdings LLC.

Contractual Obligations and Commitments

On February 18, 2014, we closed our 2014-1 securitization with an aggregate issuance amount of $233.9 million and a discount rate of 4.24%. On July 23, 2014, we closed our 2014-2 securitization with an aggregate issuance amount of $227.6 million and a discount rate of 3.95%.

On March 18, 2014, we amended the terms of our $50.0 million permanent financing facility with PartnerRE to increase the maximum borrowing capacity to $100.0 million.

On May 6, 2014, the Company amended the terms of its Residual Term Facility with a financial institution. The amendment primarily increased the principal balance to $110.0 million, extended the maturity date to May 2021, decreased the interest rate to 7.0%, and eliminated the requirement to make the additional $2.0 million annual principal payments.

Critical Accounting Policies

The notes to our unaudited condensed consolidated financial statements include disclosure of our significant accounting policies and estimates. In establishing these policies within the framework of U.S. GAAP, management must make certain assessments, estimates, and choices that will result in the application of these principals in a manner that appropriately reflects our financial condition and results of operations. Critical accounting policies are those policies that we believe present the most complex or subjective measurements and have the most potential to affect our financial position and operating results. While all decisions regarding accounting policies are important, there are certain accounting policies and estimates that we consider to be critical. These critical policies, which are presented in detail in the notes to our unaudited condensed consolidated financial statements, relate to the policies below.

Revenue Recognition



Servicing, broker, and other fees in the unaudited condensed consolidated statements of operations primarily include broker fees and subservicing fees earned from servicing life settlement contracts. Broker fee income is recognized when the contract between the purchasing counterparty and the seller is closed for the sale of lottery winnings receivables.

On May 28, 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers which relates to how an entity recognizes the revenue it expects to be entitled to for the transfer of promised goods and services to customers. The ASU will replace certain existing revenue recognition guidance when it becomes effective in the fiscal year beginning after December 15, 2016. Early adoption is not permitted. The standard permits the use of either the retrospective or cumulative effect transition method. Management is currently evaluating the impact of the future adoption of the ASU on the Company's consolidated financial statements.

Debt Issuance Costs



Debt issuance costs related to liabilities for which we have elected the fair value option are expensed when incurred. Debt issuance costs related to liabilities for which we have not elected the fair value option are capitalized and amortized over the expected term of the borrowing or debt issuance. Capitalized amounts are included in other

53



--------------------------------------------------------------------------------

Table of Contents

assets in our condensed consolidated balance sheets and amortization of such costs is included in interest expense in the unaudited condensed consolidated statements of operations over the life of the debt facility.

Share-Based Compensation



We apply ASC 718 Compensation - Stock Compensation ("ASC 718"). ASC 718 requires that the compensation cost relating to share-based payment transactions, based on the fair value of the equity or liability instruments issued, be included in the Company's unaudited condensed consolidated statements of operations. The Company has determined that these share-based payment transactions represent equity awards under ASC 718 and therefore measures the cost of employee services received in exchange for share based compensation on the grant-date fair value of the award, and recognizes the cost over the period the employee is required to provide services for the award. For all grants of stock options, the fair value at the grant date is calculated using the Black-Sholes option pricing model based on the value of the issuing entities shares at the award date. Share-based compensation is included in compensation and benefits expense within the Company's unaudited condensed consolidated statements of operations.

Fair Value Measurements



Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in the orderly transaction between market participants at the measurement date. Fair value measurement establishes a fair value hierarchy that prioritizes the inputs of valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. These three levels of fair value hierarchy are defined as follows:

Level 1 - inputs to the valuation methodology are unadjusted quoted prices for identical assets or liabilities in active markets that are accessible at the measurement date.

Level 2 - inputs to the valuation methodology include quoted prices in markets that are not active or quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

Level 3 - inputs to the valuation methodology are unobservable, reflecting the entity's own assumptions about assumptions market participants would use in pricing the asset or liability.

A financial instrument's categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. Fair value is a market based measure considered from the perspective of a market participant who holds the asset or owes the liabilities rather than an entity specific measure. Therefore, even when market assumptions are not readily available, our own assumptions are set to reflect those that market participants would use in pricing the assets or liabilities at the measurement date. We use valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. We also evaluates various factors to determine whether certain transactions are orderly and may make adjustments to transactions or quoted prices when the volume and level of activity for an asset or liability have decreased significantly.

The above conditions could cause certain assets and liabilities to be reclassified from Level 1 to Level 2/Level 3 or Level 2 to Level 3. The inputs or methodology used for valuing the assets or liabilities are not necessarily an indication of the risk associated with the assets and liabilities.

Transfers of Financial Assets

Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the us, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge

54



--------------------------------------------------------------------------------

Table of Contents

or exchange the transferred assets, and (3) when we do not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity, the ability to unilaterally cause the holder to return specific assets or through an agreement that permits the transferee to require the transferor to repurchase the transferred financial assets that is so favorable to the transferee that it is probable that the transferee will require the transferor to repurchase them. Transfers that do not meet the criteria to be accounted for as sales are accounted for as secured borrowings.

The amendments to ASC 860 Transfers and Servicing ("ASC 860"), eliminated the concept of a qualified special purpose entity, changed the requirements for derecognizing financial assets, and required additional disclosures about transfers of financial assets, including securitization transactions and continuing involvement with transferred financial assets.

VIE and Other Finance Receivables, at fair market value

We acquire receivables associated with structured settlement payments from individuals in exchange for cash (purchase price). These receivables are carried at fair value. Unearned income is determined as the amount the fair value exceeds the cost basis of the receivables. Unearned income on structured settlements is recognized as interest income using the effective interest method over the life of the related structured settlements. Changes in fair value are recorded in unrealized gains on finance receivables, long-term debt and derivatives in our unaudited condensed consolidated statements of operations.

We, through our subsidiaries, sells finance receivables to Special Purpose Entities ("SPE"), as defined in ASC 860. An SPE issues notes secured by undivided interests in the receivables. Payments due on these notes generally correspond to receipts from the receivables in terms of the timing of payments due. We retain a retained interest in the SPEs and are deemed to have control over these SPEs due to its servicing or subservicing role and therefore consolidate these SPEs.

Allowances for Losses on Receivables

On an ongoing basis we review the ability to collect all amounts owed on VIE and other finance receivables carried at amortized cost.

We reduce the carrying value of finance receivables by the amount of projected losses. Our determination of the adequacy of the projected losses is based upon an evaluation of the finance receivables collateral, the financial strength of the related insurance company that issued the structured settlement, current economic conditions, historical loss experience, known and inherent risks in the portfolios and other relevant factors. We will charge-off the defaulted payment balances at the time it determines them to be uncollectible. Because the projected losses are dependent on general and other economic conditions beyond our control, it is reasonably possible that the losses projected could differ materially from the currently reported amount in the near term.

We suspend recognizing income on receivables when it is probable that we will be unable to collect all payments according to the contractual terms of the underlying agreements. We consider all information available in assessing collectability. Collectability is measured on a receivable-by-receivable basis by either the present value of estimated future cash flows discounted at the effective rate, the observable market price for the receivable or the fair value of the collateral if the receivable is collateral dependent. Large groups of smaller balance homogeneous receivables, such as pre-settlement funding transactions, are collectively assessed for collectability.

Payments received on past due receivables and finance receivables the Company has suspended recognizing interest income on are applied first to principal and then to accrued interest and fee income. Additionally, the Company generally does not resume recognition of interest income on receivables once it has been suspended.

55



--------------------------------------------------------------------------------

Table of Contents

Notes Receivable, at fair market value

Notes receivable represent fixed rate obligations of a third party collateralized by retained interests from certain securitizations sponsored by us. Under the agreements, the obligor has the right to redeem the notes at fair value. The notes receivable are treated as debt securities, classified as available-for-sale, and carried at fair value in accordance with ASC Topic 320 Investments - Debt and Equity Securities. Unrealized gains on notes receivable arising during the period are reflected within accumulated other comprehensive gain in our unaudited condensed consolidated statements of comprehensive income (loss) and unaudited condensed consolidated statement of changes in stockholders' equity. The notes receivable are analyzed annually for other than temporary impairment.

Intangible Assets and Goodwill

Identifiable intangible assets, which consist primarily of our database and non-compete agreements, are amortized over their estimated useful lives of 10 and 3 years, respectively. Customer relationships are amortized over their useful lives of 3 to 15 years. Domain names are amortized over their estimated useful lives of 10 years. In addition, such identifiable intangible assets are tested for impairment whenever events or changes in circumstances suggest that an asset's carrying value may not be fully recoverable. An impairment loss, generally calculated as the difference between the estimated fair value and the carrying value of an asset, is recognized if the sum of the estimated undiscounted cash flows relating to the asset is less than the corresponding carrying value. Intangible assets deemed to have indefinite useful lives, which in our case includes a trade name, are not amortized and are subject to annual impairment tests. An impairment exists if the carrying value of the indefinite-lived intangible asset exceeds its fair value. No impairment was recognized for the intangible assets for the six months ended June 30, 2014 and 2013.

Goodwill results from the excess of the purchase price over the fair value of the net assets of an acquired business. Goodwill has an indefinite useful life and is subject to annual impairment tests whereby impairment is recognized if the estimated fair value of the Company is less than its net book value. Such loss is calculated as the difference between the estimated implied fair value of goodwill and its carrying amount. No impairment was recognized for goodwill for the six months ended June 30, 2014 and 2013.

56



--------------------------------------------------------------------------------

Table of Contents


For more stories on investments and markets, please see HispanicBusiness' Finance Channel



Source: Edgar Glimpses


Story Tools






HispanicBusiness.com Facebook Linkedin Twitter RSS Feed Email Alerts & Newsletters