<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the period ended September 30, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 1-8993
FUND AMERICAN ENTERPRISES HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
Delaware 94-2708455
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
80 South Main Street, Hanover, New Hampshire 03755-2053
(Address of principal executive offices including zip code)
(603) 643-1567
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [ X ] No [ ]
As of November 12, 1997, 6,377,757 shares of Common Stock with a par value of
$1.00 per share were outstanding.
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FUND AMERICAN ENTERPRISES HOLDINGS, INC.
Table of Contents
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION Page No.
--------
<S> <C> <C>
Item 1. Financial Statements
Condensed Consolidated Balance Sheets,
September 30, 1997 (Unaudited), and December 31, 1996 3
Condensed Consolidated Income Statements (Unaudited),
Three Months and Nine Months Ended September 30, 1997 and 1996 4
Condensed Consolidated Statements of Cash Flows (Unaudited),
Nine Months Ended September 30, 1997 and 1996 5
Notes to Condensed Consolidated Financial
Statements (Unaudited) 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 7-12
PART II. OTHER INFORMATION
Items 1 through 6 13
SIGNATURES 14
</TABLE>
2
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
FUND AMERICAN ENTERPRISES HOLDINGS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(dollars in millions, except per share amounts)
<TABLE>
SEPTEMBER 30, DECEMBER 31,
1997 1996
------------- ------------
(Unaudited)
<S> <C> <C>
Assets
Common equity securities, at fair value (cost: $87.5 and $101.1)................... $ 156.6 $ 160.8
Fixed maturity investments, at fair value (cost: $150.3 and $154.5)................ 152.5 155.4
Other investments (cost: $117.0 and $119.7)........................................ 194.4 176.5
Short-term investments, at amortized cost (which approximated market value)........ 88.9 67.5
------------- ------------
Total investments............................................................ 592.4 560.2
Cash............................................................................... 6.8 4.8
Capitalized mortgage servicing rights, net of accumulated amortization............. 167.1 410.9
Mortgage loans held for sale....................................................... 484.0 314.9
Other mortgage origination and servicing assets.................................... 187.9 183.0
Receivable from sale of mortgage servicing......................................... 33.0 --
Insurance premiums receivable...................................................... 55.8 52.2
Reinsurance recoverable on paid and unpaid losses.................................. 38.5 40.0
Investments in unconsolidated insurance affiliates................................. 319.1 226.9
Other assets....................................................................... 138.6 187.7
------------- ------------
Total Assets....................................................................... $2,023.2 $1,980.6
------------- ------------
------------- ------------
Liabilities
Short-term debt.................................................................... $ 490.5 $ 407.9
Long-term debt..................................................................... 304.1 424.2
Unearned insurance premiums........................................................ 76.9 72.6
Loss and loss adjustment expense reserves.......................................... 71.3 65.4
Accounts payable and other liabilities............................................. 317.4 279.5
------------- ------------
Total liabilities.............................................................. 1,260.2 1,249.6
------------- ------------
Minority Interest - preferred stock of subsidiary.................................. 44.0 44.0
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Shareholders' Equity
Common stock at $1 par value per share - authorized 125,000,000 shares;
issued 31,416,099 and 31,940,202 shares.......................................... 31.4 31.9
Common paid-in surplus............................................................. 360.5 366.5
Retained earnings.................................................................. 1,031.2 1,067.1
Common stock in treasury, at cost - 25,034,939 shares.............................. (871.0) (871.0)
Net unrealized investment gains, after tax......................................... 166.9 92.5
------------- ------------
Total shareholders' equity................................................... 719.0 687.0
------------- ------------
Total Liabilities, Minority Interest and Shareholders' Equity...................... $2,023.2 $1,980.6
------------- ------------
------------- ------------
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
3
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FUND AMERICAN ENTERPRISES HOLDINGS, INC.
CONDENSED CONSOLIDATED INCOME STATEMENTS
Unaudited
(millions, except per share amounts)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -----------------
1997 1996 1997 1996
--------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenues:
Gross mortgage servicing revenue................................... $ 20.8 $ 33.0 $ 69.4 $ 101.1
Amortization and impairment of capitalized mortgage servicing...... (19.3) (16.1) (43.5) (26.1)
Net gain (loss) on financial instruments........................... 6.0 (.2) 4.3 (5.1)
--------- -------- -------- --------
Net mortgage servicing revenue................................... 7.5 16.7 30.2 69.9
Net gain on sales of mortgages..................................... 6.4 7.7 15.7 32.2
Gain (loss) on sale of mortgage servicing.......................... - 10.1 (4.3) 10.1
Other mortgage operations revenue.................................. 4.8 4.1 13.8 13.6
Earned property and casualty insurance premiums.................... 36.7 30.4 108.0 75.7
Earnings from unconsolidated insurance affiliates.................. 5.0 3.1 14.8 6.1
Other insurance operations revenue................................. 2.4 2.0 6.9 7.3
Net investment income.............................................. 16.6 15.8 46.3 44.8
--------- -------- -------- --------
Total revenues................................................... 79.4 89.9 231.4 259.7
--------- -------- -------- --------
Expenses:
Compensation and benefits.......................................... 22.2 25.3 72.6 73.2
Losses and loss adjustment expenses................................ 24.6 21.7 72.9 52.2
General expenses................................................... 19.6 22.7 62.2 63.2
Interest expense................................................... 12.3 11.5 35.7 38.5
--------- -------- -------- --------
Total expenses................................................... 78.7 81.2 243.4 227.1
--------- -------- -------- --------
Pretax operating earnings (loss).................................... .7 8.7 (12.0) 32.6
Net realized investment gains (losses).............................. 21.8 (1.6) 47.6 28.1
--------- -------- -------- --------
Pretax earnings..................................................... 22.5 7.1 35.6 60.7
Income tax provision................................................ 7.1 3.4 14.7 24.7
--------- -------- -------- --------
After tax earnings.................................................. 15.4 3.7 20.9 36.0
Loss on early extinguishment of debt, after tax..................... - - (6.0) -
--------- -------- -------- --------
Net income.......................................................... $ 15.4 $ 3.7 $ 14.9 $ 36.0
--------- -------- -------- --------
--------- -------- -------- --------
Earnings per share:
After tax earnings................................................. $ 2.18 $ .46 $ 2.84 $ 4.38
Net income......................................................... 2.18 .46 2.03 4.38
</TABLE>
See Notes to Condensed Consolidated Financial Statements
4
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FUND AMERICAN ENTERPRISES HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Unaudited
(millions)
Nine Months Ended
September 30,
--------------------------
1997 1996
------------ -----------
Cash flows from operations:
Net income......................................... $ 14.9 $ 36.0
Charges (credits) to reconcile net income
to cash flows from operations:
Undistributed earnings from unconsolidated
insurance affiliates........................... (9.8) (3.9)
Net realized investment gains.................... (47.6) (28.1)
Extraordinary loss on early
exitinguishment of debt........................ 6.0 -
Net (increase) decrease in mortgage
loans held for sale............................ (169.1) 107.5
Loss (gain) on sale of mortgage servicing........ 4.3 (10.1)
Increase in unearned insurance premiums.......... 4.3 38.4
Increase in insurance premiums receivable........ (3.6) (8.7)
Increase in deferred insurance policy
acquisition costs.............................. (.9) (6.6)
Depreciation and amortization.................... 48.5 32.3
Increase in receivable from sale of servicing.... 33.0 -
Net unrealized (gain) loss on
financial instruments.......................... (4.7) 4.9
Changes in current income taxes receivable
and payable.................................... 8.2 9.0
Deferred income tax (benefit) expense............ (4.2) 15.1
Net increase in acounts payable and
other liabilities.............................. 37.9 41.3
Other, net....................................... 26.5 (17.5)
------------ -----------
Net cash flows (used for) provided from
operating activities............................. (56.3) 209.6
------------ -----------
Cash flows from investing activities:
Net (increase) decrease in short-term investments (21.4) 33.2
Sales of common equity securities and
other investments.............................. 108.2 196.5
Sales and maturities of fixed maturity investments 62.3 98.3
Purchases of common equity securities and
other investments............................... (42.8) (58.1)
Purchases of fixed maturity investments........... (58.4) (145.8)
Acquisition of consolidated affiliate............. - (13.2)
Investments in unconsolidated insurance affiliates - (107.6)
Net proceeds from sales of mortgage
servicing rights................................ 241.5 11.7
Collections on and sales of other mortgage
origination and servicing assets................ 240.4 131.6
Additions to other mortgage origination
and servicing assets............................ (251.3) (154.4)
Additions to capitalized mortgage servicing rights (111.1) (62.3)
Net purchases of fixed assets..................... (2.3) (4.8)
------------ -----------
Net cash flows provided from (used for)
investing activities.............................. 165.1 (74.9)
------------ -----------
Cash flows from financing activities:
Net (repayments) issuances of short-term debt..... 81.5 (58.1)
Repayments of long-term debt...................... (131.0) (29.7)
Purchases of common stock retired................. (53.3) (39.8)
Dividends paid to common shareholders............. (4.0) (4.5)
Other............................................. - (.9)
------------ -----------
Net cash used for financing activities.............. (106.8) (133.0)
------------ -----------
Net increase in cash during period.................. 2.0 1.7
Cash balance at beginning of period................. 4.8 2.7
------------ -----------
Cash balance at end of period.......................$ 6.8 $ 4.4
------------ -----------
------------ -----------
Supplemental cash flows information:
Interest paid.....................................$ (34.7) $ (33.8)
Net income taxes paid.............................$ (10.8) $ (.7)
See Notes to Condensed Consolidated Financial Statements.
5
<PAGE>
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Unaudited
Note 1. Basis of Presentation
The accompanying condensed consolidated financial statements include the
accounts of Fund American Enterprises Holdings, Inc. (the "Company") and its
subsidiaries (collectively, "Fund American"). Fund American's principal
businesses are conducted through White Mountains Holdings, Inc. and its
operating subsidiaries ("White Mountains"). White Mountains is a financial
services holding company that houses the Company's insurance and mortgage
banking operations. White Mountains' insurance operations are conducted through
its subsidiaries and affiliates in the businesses of property-casualty
insurance, reinsurance and financial guaranty insurance. White Mountains'
mortgage banking operations are conducted through Source One Mortgage Services
Corporation and its subsidiaries ("Source One"). Source One is one of the
nation's largest mortgage banking companies.
The financial statements have been prepared in accordance with generally
accepted accounting principles and include all adjustments (consisting of normal
recurring adjustments) considered necessary by management to fairly present the
financial position, results of operations and cash flows of Fund American.
These interim financial statements may not be indicative of financial results
for the full year and should be read in conjunction with the Company's 1996
Annual Report on Form 10-K. Certain amounts in the prior period financial
statements have been reclassified to conform with the current presentation.
Note 2. Application of New Accounting Standards
In June 1996, the Financial Accounting Standards Board (the "FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishment of Liabilities".
SFAS No. 125 eliminates the distinction between "normal" servicing rights and
excess servicing receivable and changes Source One's method of measuring the
value of its capitalized excess servicing asset. SFAS No. 125 is effective for
all transfers of financial assets occurring after December 31, 1996.
Retroactive application of SFAS No. 125 is not permitted. The adoption of
certain provisions of SFAS No. 125, which occurred in the 1997 first quarter,
did not materially effect Source One's financial results. The adoption of
certain other provisions of SFAS No. 125 has been deferred to 1998.
In February 1997, the FASB issued SFAS No. 128, "Earnings Per Share". SFAS No.
128 will serve to simplify the computation of earnings per share and to make the
U.S. standard more compatible with existing international standards. FASB No.
128 will become effective for all periods ending after December 15, 1997.
Earlier application is not permitted. The adoption of SFAS No. 128 is not
expected to change the method by which the Company currently calculates its
earnings per share but will change the Company's presentation of earnings per
share by eliminating the "primary earnings per share" disclosure (which
considers the effects of common equivalent shares) in favor of a more simplistic
"basic earnings per share" disclosure (which generally considers only common
shares outstanding).
Note 3. Earnings Per Share
Primary earnings per share amounts are based on the weighted average number of
common and dilutive common equivalent shares outstanding of 7,061,682 and
7,977,711 for the three-month periods ended September 30, 1997 and 1996,
respectively, and 7,344,466 and 8,220,149 for the nine-month periods ended
September 30, 1997 and 1996, respectively. Fully diluted earnings per share
amounts are based on the weighted average number of common shares outstanding,
assuming full dilution, of 7,061,688 and 7,977,743 for the three-month periods
ended September 30, 1997 and 1996, respectively, and 7,344,479 and 8,220,229 for
the nine-month periods ended September 30, 1997 and 1996, respectively.
Item 2. Management's Discussion and Analysis
6
<PAGE>
Results of Operations -- Three-Month and Nine-Month Periods Ended September 30,
1997 and 1996
Fund American reported net income of $14.9 million, or $2.03 per share, for the
nine month period ended September 30, 1997, compared to net income of $36.0
million, or $4.38 per share, for the nine month period ended September 30, 1996.
For the 1997 third quarter Fund American reported net income of $15.4 million,
or $2.18 per share, versus net income of $3.7 million, or $.46 per share, in
1996. The 1997 nine month results include a $6.0 million after tax
extraordinary loss on early extinguishment of debt recorded in the second
quarter by Source One. The 1996 nine month results include a $27.5 million
pretax, $17.9 million after tax, recovery of Source One's valuation allowance
associated with its capitalized mortgage loan servicing asset due to an increase
in market interest rates.
Book value per common and common equivalent share increased to $102.14, an
increase of $11.33 from the December 31, 1996 book value per share of $90.81.
Consolidated Insurance Operations.
Valley Insurance Companies ("Valley"), a Northwest region property-casualty
company which writes personal and commercial lines, posted a combined ratio of
100.4% for the 1997 year-to-date period versus a 101.0% for the comparable 1996
period. Valley had $59.0 million of earned premium in the 1997 year-to-date
period, an increase of $7.1 million from the comparable1996 amount. The
operations of Charter Insurance Companies ("Charter"), which writes non-standard
automobile insurance in Texas, posted a combined ratio of 92.7% for the 1997
year-to-date period versus 97.9% for the comparable 1996 period. Charter had
$46.8 million of earned premium in the 1997 year-to-date period, an increase of
$23.7 million from the comparable 1996 amount. Premiums for Charter's
automobile policies written prior to 1996 were fully ceded to a former affiliate
of Charter. White Mountains Insurance Company, a newly formed New England
region property-casualty company which writes commercial lines, had $2.2 million
of earned premium in the 1997 year-to-date period. A summary of White
Mountains' consolidated insurance operating results follows:
- --------------------------------------------------------------------------------
Three Months Nine Months
Ended Sept. 30, Ended Sept. 30,
---------------- ---------------
Dollars in millions 1997 1996 1997 1996
- --------------------------------------------------------------------------------
Net written premium $39.1 $34.8 $112.9 $114.0
Ending statutory surplus $91.8 $80.3
Valley:
Loss and loss adjustment expense 66.7% 67.7% 64.8% 64.5%
Underwriting expense 34.7% 39.1% 35.6% 36.5%
----- ----- ----- -----
Combined 101.4% 106.8% 100.4% 101.0%
----- ----- ----- -----
----- ----- ----- -----
Charter:
Loss and loss adjustment expense 62.8% 76.3% 68.9% 78.1%
Underwriting expense 24.2% 22.7% 23.8% 19.8%
----- ----- ----- -----
Combined 87.0% 99.0% 92.7% 97.9%
----- ----- ----- -----
----- ----- ----- -----
White Mountains Insurance Company:
Loss and loss adjustment expense 127.9% 91.0% 109.6% 91.7%
Underwriting expense 45.8% 62.0% 53.6% 53.0%
----- ----- ----- -----
Combined 173.7% 153.0% 163.2% 144.7%
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Unconsolidated Insurance Operations.
7
<PAGE>
The Company's unconsolidated insurance affiliates consist of a 25% economic
interest in Financial Security Assurance Holdings Ltd. ("FSA"), a 50% interest
in Folksamerica Holding Company, Inc. ("Folksamerica") and a 33% interest in
Main Street America Holdings, Inc. ("MSA"). Fund American's earnings from these
affiliates increased to $14.8 million for the first nine months of 1997, from
$6.1 million for the comparable 1996 period. The increase is primarily due to
strong operating results at FSA and MSA and the inclusion in 1997 of earnings
from Folksamerica (which was acquired in June 1996). The strong operating
results at FSA in 1997 were the result of a steady domestic transaction flow as
well as several large, high premium European transactions. FSA's adjusted book
value at September 30, 1997 was $37.88, up $3.35 from $34.53 at December 31,
1996. Folksamerica's operations performed well despite a continuing
highly-competitive reinsurance market. Folksamerica's September 30, 1997 book
value per share increased to $14.54, an increase of $2.42 from its 1996 year-end
value of $12.12 per share. MSA's underwriting results for the first nine months
of 1997 produced a combined ratio of 102.9% vs. a 108.9% combined ratio for the
1996 comparable period.
Mortgage Banking Operations.
For the 1997 year-to-date period, Source One had a net loss applicable to common
stock of $13.8 million versus net income of $24.7 million for the comparable
1996 period. Source One's 1997 results include the following one-time charges:
(i) a $6.0 million after tax extraordinary loss on early extinguishment of debt
and (ii) restructuring and compensation charges of $3.1 million pretax, $2.0
after tax, associated with Source One's plan to reduce its operating costs and
improve its financial performance. Source One's 1996 results include a $27.5
million pretax, $17.9 million after tax, recovery of Source One's valuation
allowance associated with its capitalized mortgage loan servicing asset due to
an increase in market interest rates. For the 1997 third quarter, Source One
had net income applicable to common stock of $.1 million versus net income of
$7.3 million for the comparable 1997 period. Source One's 1997 year-to-date and
third quarter results include $6.3 million and $3.1 million of pretax earnings,
respectively, associated with the Company's investment in FSA which was
contributed to Source One during 1997 to provide additional credit support to
Source One's mortgage banking operations.
A summary of Source One's mortgage loan production and mortgage servicing
portfolio activities follows:
- --------------------------------------------------------------------------------
Three Months Nine Months
Ended Sept. 30, Ended Sept. 30,
------------------ --------------------
Millions 1997 1996 1997 1996
- --------------------------------------------------------------------------------
Mortgage loan production:
Retail originations $ 420 $ 371 $ 1,013 $ 1,471
Wholesale originations 829 420 1,704 1,632
--------- --------- --------- ---------
Total $ 1,249 $ 791 $ 2,717 $ 3,103
- --------------------------------------------------------------------------------
Mortgage loan servicing portfolio (a):
Beginning balance $ 28,583 $ 31,329 $ 29,201 $ 31,831
Mortgage loan production 1,249 791 2,717 3,103
Regular payoffs (831) (634) (2,127) (2,417)
Other (357) (3,839) (1,147) (4,870)
--------- --------- --------- ---------
Ending balance $ 28,644 $ 27,647 $ 28,644 $ 27,647
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
(a) Includes loans subserviced for others of $18,216 million and $3,796 million
as of September 30, 1997 and 1996, respectively.
8
<PAGE>
The decrease in mortgage loan production and payoffs for the 1997 year-to-date
period and third quarter versus the comparable 1996 periods reflects higher
market interest rates and a corresponding decrease in refinancing activity.
Additional information regarding Source One's mortgage loan servicing portfolio
is shown below:
- --------------------------------------------------------------------------------
Sept. 30, Dec. 31,
1997 1996
- --------------------------------------------------------------------------------
Mortgage loan servicing portfolio (a):
Number of loans 462,234 478,779
Weighted average interest rate 8.41% 8.48%
Percent delinquent (includes loans in
process of foreclosure) 6.78% 7.17%
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
(a) Includes loans subserviced for others of $18,216 million and $2,791 million
as of September 30, 1997 and December 31, 1996, respectively.
Source One's gross mortgage servicing revenue decreased to $20.8 million and
$69.4 million for the three and nine-month periods ended September 30, 1997,
respectively, from $33.0 million and $101.1 million for the comparable 1996
periods. The decrease in gross mortgage servicing revenue during the 1997
periods is primarily the result of Source One's February 28, 1997 sale of
servicing rights with respect to approximately $17.0 billion of mortgage
loans. Source One's net mortgage servicing revenue decreased to $7.5 million
and $30.1 million for the three and nine-month periods ended September 30,
1997, respectively, from $16.7 million and $69.9 million for the comparable
1996 periods. During 1997 Source One had pretax impairment on its
capitalized mortgage loan servicing asset of $8.2 million (due to decreases
in market interest rates during 1997 as compared to 1996) versus $27.5
million of pretax recoveries for the 1996 comparable period. The following
table illustrates the recent change in Source One's servicing portfolio mix
as a result of the sale:
- --------------------------------------------------------------------------------
Sept. 30, Dec. 31,
Millions 1997 1996
- --------------------------------------------------------------------------------
Mortgage loan servicing portfolio owned $ 10,428 $ 26,410
Mortgage loan servicing portfolio subserviced for others 18,216 2,791
-------- --------
Total mortgage loan servicing portfolio $ 28,644 $ 29,201
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
In connection with the February 1997 servicing sale, Source One recorded a $4.3
million pretax loss ($2.8 million after tax) during the 1997 year-to-date
period. Source One will continue to subservice the mortgage loans pursuant to a
subservicing agreement at least until March 1998, June 1998 and August 1998 for
Federal Home Loan Mortgage (FHLMC) loans, Government National Mortgage
Association (GNMA) loans and Federal National Mortgage Association (FNMA) loans,
respectively. The subservicing period can be extended for two years beyond
these dates at the option of the purchaser. Source One is currently negotiating
a proposed extension of the subservicing period which would include a decrease
in the current subservicing fee. During the third quarter of 1996, Source One
sold the rights to service $3.3 billion of its mortgage loan servicing portfolio
for net proceeds of $55.9 million which resulted in a pretax realized gain of
$10.1 million.
Source One utilizes interest rate floor contracts and principal only swap
agreements to mitigate the effect on earnings of higher amortization and
impairment of its capitalized servicing asset caused by changes in market
interest rates. Net mortgage servicing revenue for the nine month period
ended September 30, 1997 has been enhanced by $4.3 million of pretax net
gains on financial instruments which represents an increase in the market
value of Source One's investments in interest rate floor contracts and
principal only swap agreements. Net mortgage servicing revenue for the
comparable 1996 period has been reduced by $5.1 million of pretax net losses
on financial instruments which represents a decrease in the market value of
these financial instruments during the 1996 period.
9
<PAGE>
The interest rate floor contracts derive their value from differences between
the floor rate specified in the contract and market interest rates. The floor
yields range from 5.47% to 6.24%. To the extent that market interest rates
increase, the value of the floors declines. However, Source One is not exposed
to losses in excess of its initial investment in the floors. The interest rate
floor contracts are carried at fair value with related realized and unrealized
gains and losses included in net loss on financial instruments in the
consolidated income statements. As of September 30, 1997, the carrying value of
Source One's open interest rate floor contracts totalled $5.6 million with a
total notional principal amount of $1.2 billion. The floors have terms ranging
from approximately one to five years.
The value of the principal-only swaps is determined by changes in the value of
referenced principal-only strips. As of September 30, 1997, the carrying value
of Source One's principal-only swap transactions totalled $8.6 million, with an
original notional principal amount of $98.1 million. The principal-only swap
transactions are carried at fair value with related realized and unrealized
gains and losses included in net loss on financial instruments in the
consolidated income statements. The principal-only swaps have remaining terms
of approximately three to four years.
Net gain on sales of mortgages decreased to $15.7 million for the nine month
period ended September 30, 1997 from $32.2 million for the comparable 1996
period. The 1997 amount includes a $3.0 million pretax charge, recorded
during the 1997 second quarter, related to mortgage loans held for investment
which have been identified for sale and marked down from amortized cost to
current market value. The balance of the 1997 decline is due primarily to
decreased capitalized mortgage originated mortgage servicing rights ("OMSR")
production and the related decrease in mortgage loan sales volume during
1997, as compared to 1996, and a change in Source One's loan production mix
which included a heavier volume of correspondent production which generates
lower OMSR income.
Investment Operations. Fund American's investment income is comprised primarily
of interest income earned on mortgage loans originated by Source One and the
fixed maturity investments of its consolidated insurance operations. Net
investment income was $46.3 million and $44.8 million, respectively, for the
1997 and 1996 nine-month periods.
Total net investment gains and losses, before tax, were as follows:
- --------------------------------------------------------------------------------
Nine Months
Ended Sept. 30,
Millions 1997 1996
- --------------------------------------------------------------------------------
Net realized investment gains $ 47.6 $ 28.1
Net unrealized investment gains (a) 114.5 27.1
------- ------
Total net investment gains, before tax $ 162.1 $ 55.2
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
(a) Includes net unrealized investment gains from investments in unconsolidated
insurance affiliates.
Realized investment gains of $47.6 million for the first nine months of 1997
resulted principally from the sales of 834,895 shares of the common stock of
Veritas DGC Inc. for net proceeds of $20.9 million, 628,581 shares of the common
stock of Travelers Property Casualty Corp. for net proceeds of $22.9 million and
388,140 shares of the common stock of Mid Ocean Limited for net proceeds of
$22.6 million. Realized gains of $28.2 million for the comparable 1996 period
resulted principally from sales of 2,042,572 shares of the common stock of
Zurich Reinsurance Centre Holdings, Inc. for net proceeds of $61.8 million and
2,928,100 shares of the common stock of The Louisiana Land and Exploration
Company for net proceeds of $125.1 million.
10
<PAGE>
Expenses and Income Taxes.
Insurance losses and loss adjustment expenses increased from $21.7 million and
$52.2 million in the 1996 third quarter and year-to-date, respectively, to $24.6
million and $72.9 million in the 1997 third quarter and year-to-date,
respectively, due primarily to increases in earned premium at Charter. The loss
and loss adjustment expense ratio for the 1997 third quarter and first nine
months was 67.0% and 67.5%, respectively, which compares to 71.4% and 69.0%,
respectively, for the comparable 1996 periods.
The income tax provision for the 1997 third quarter includes $2.0 million of tax
credits not previously recorded associated with the Company's investment in the
San Juan Basin Royalty Trust. Excluding the tax credit, Fund American's
effective income tax rate for the 1997 third quarter was 40.4%.
Liquidity and Capital Resources
Parent Company. In connection with Source One's February 28, 1997 sale of
approximately $17.0 billion of mortgage servicing rights to a third party, the
Company has made certain collection, payment and performance guarantees to the
buyer for a period of no more than ten years. The aggregate amount of the
Company's guaranty is initially limited to $20.0 million and is expected to
amortize down to $15.0 million.
On November 3, 1997 the Company commenced a "Dutch auction" tender offer for the
purchase of up to 1,000,000 shares of its common stock for no less than $105 per
share and no more than $125 per share. The tender offer is scheduled to close
on December 2, 1997. The Company anticipates that it will fund the purchase of
shares purchased pursuant to the tender offer through sales and maturities of
short-term investments and the sale of a portion of its passive investment
portfolio.
Prospectively, the primary sources of cash inflows for the Company will be
distributions received from its operating subsidiaries, sales of investment
securities and investment income.
White Mountains and subsidiaries. On November 1, 1996, Fund American signed a
definitive agreement (the "MSA Agreement") to increase its ownership of MSA from
33% to 50%. MSA currently shares in 40% of NGM's business through a quota share
reinsurance agreement which is expected to be increased to 60% pursuant to the
MSA Agreement. Also pursuant to the MSA Agreement, NGM will contribute certain
of its insurance, reinsurance and information and financial services
subsidiaries to MSA. The aggregate purchase price to be paid by Fund American
pursuant to the MSA Agreement is approximately $60.2 million, subject to certain
purchase price adjustments. Fund American expects to assign the additional
investment in MSA to White Mountains. The closing is dependent upon the receipt
of state regulatory approvals. White Mountains intends to finance the MSA
investment by borrowing $50.0 million pursuant to White Mountains' credit
facility, and through sales and maturities of investment securities.
As part of a previously disclosed reorganization plan, on July 31, 1997 (upon
receipt of various regulatory and banking approvals) White Mountains was merged
into Fund American Enterprises, Inc., a wholly-owned subsidiary of the Company
and the direct parent company of Source One, and the combined entity was
immediately renamed White Mountains Holdings, Inc.
11
<PAGE>
Source One. Through September 30, 1997, Source One received $241.5 million of
the estimated $271.5 million total proceeds from its February 1997 sale of
mortgage servicing rights, with the $33.0 million balance (including $3.0
million of accrued interest) reflected as a receivable on the September 30, 1997
balance sheet. Source One is currently evaluating its options as to how it will
utilize the remaining proceeds from the sale. These options include: (i)
purchasing additional mortgage servicing rights from third parties; (ii) further
reducing its outstanding indebtedness; (iii) reducing its outstanding preferred
or common shareholders' equity; or (iv) any combination of the foregoing.
Source One had previously announced that it had contracted to receive from Fund
American approximately $139 million (approximately $119 million net of
associated tax liabilities and other adjustments) of capital infusions during
1997 consisting primarily of common stock and options to acquire common stock of
FSA. During the 1997 first quarter, Fund American contributed net assets
totalling $40.5 million to Source One which did not require regulatory approval.
During the second quarter, Source One recorded the remaining $78.5 million of
contracted net assets. The capital infusions were undertaken to improve Source
One's debt ratings and reduce Source One's borrowing costs.
On May 22, 1997 Source One repurchased $119.6 million of its outstanding 8.875%
medium-term notes due October 15, 2001. Source One recognized a $6.0 million
after tax loss on the early retirement of the notes.
On July 25, 1997, Source One amended and restated its secured credit agreement
to reflect a reduction in its borrowing requirements resulting from the cash
proceeds received from the February 1997 servicing sale. The provisions of the
amended agreement decrease Source One's borrowing capacity from $750.0 million
to $500.0 million and reduce borrowing costs by lowering the facility fee.
Source One is currently considering further steps to restructure its debt
capital including (i) the issuance of approximately $50.0 million of additional
medium-term notes pursuant to an existing shelf registration and (ii) entering
into interest rate swaps whereby Source One's obligation to pay a fixed rate of
interest on a portion of its outstanding medium-term notes and debentures will
be swapped for an obligation to pay a floating rate of interest. Source One
believes that using floating rate debt to finance a larger portion of its
mortgage servicing assets is prudent, since the value of such assets generally
increases as interest rates increase, and declines as interest rates decrease.
Source One's investments, mortgage loans held for sale and mortgage loan
servicing portfolio provide a liquidity reserve since they may be sold to meet
cash needs.
12
<PAGE>
Part II. OTHER INFORMATION
Item 1. Legal Proceedings
None.
Item 2. Changes in Securities
None.
Item 3. Defaults upon Senior Securities
None.
Item 4. Submission of Matters to a Vote by Security Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
11 - Statement Re Computation of Per Share Earnings*
27 - Financial Data Schedule*
(b) Reports on Form 8-K
None.
*Filed herewith.
13
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FUND AMERICAN ENTERPRISES HOLDINGS, INC.
(Registrant)
Date: November 12, 1997 By: /s/
--------------------------------
Michael S. Paquette
Vice President and Controller
14
<PAGE>
EXHIBIT 11
FUND AMERICAN ENTERPRISES HOLDINGS, INC.
STATEMENT RE COMPUTATION OF PER SHARE EARNINGS
(in thousands, except per share earnings)
Unaudited
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- --------------------
<S> <C> <C> <C> <C>
1997 1996 1997 1996
--------- --------- --------- ---------
Primary earnings per share:
After tax earnings.................................................. $ 15,368 $ 3,666 $ 20,887 $ 35,966
Loss on early extinguishment of debt, after tax..................... -- -- (5,975) --
--------- --------- --------- ---------
Net income.......................................................... $ 15,368 $ 3,666 $ 14,912 $ 35,966
--------- --------- --------- ---------
--------- --------- --------- ---------
Earnings per share denominator:
Average common shares outstanding................................. 6,387 7,298 6,669 7,538
Dilutive options and warrants..................................... 675 680 675 682
--------- --------- --------- ---------
Shares for per share computation.................................. 7,062 7,978 7,344 8,220
--------- --------- --------- ---------
--------- --------- --------- ---------
Primary earnings per share:
After tax earnings................................................ $ 2.18 $ .46 $ 2.84 $ 4.38
Net income........................................................ 2.18 .46 2.03 4.38
Fully diluted earnings per share
After tax earnings.................................................. $ 15,368 $ 3,666 $ 20,887 $ 35,966
Loss on early extinguishment of debt, after tax..................... -- -- (5,975) --
--------- --------- --------- ---------
Net income.......................................................... $ 15,368 $ 3,666 $ 14,912 $ 35,966
--------- --------- --------- ---------
--------- --------- --------- ---------
Earnings per share denominator:
Average common shares outstanding................................. 6,387 7,298 6,669 7,538
Dilution for options and warrants................................. 675 680 675 682
--------- --------- --------- ---------
Shares for per share computation.................................. 7,062 7,978 7,344 8,220
--------- --------- --------- ---------
--------- --------- --------- ---------
Fully diluted earnings per share:
After tax earnings................................................ $ 2.18 $ .46 $ 2.84 $ 4.38
Net income........................................................ 2.18 .46 2.03 4.38
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000,000,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<CASH> 7
<SECURITIES> 592
<RECEIVABLES> 120
<ALLOWANCES> (13)
<INVENTORY> 0
<CURRENT-ASSETS> 636
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 2,023
<CURRENT-LIABILITIES> 491
<BONDS> 304
0
44
<COMMON> 719
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 2,023
<SALES> 0
<TOTAL-REVENUES> 231
<CGS> 0
<TOTAL-COSTS> 207
<OTHER-EXPENSES> (48)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 36
<INCOME-PRETAX> 36
<INCOME-TAX> 15
<INCOME-CONTINUING> 21
<DISCONTINUED> 0
<EXTRAORDINARY> 6
<CHANGES> 0
<NET-INCOME> 15
<EPS-PRIMARY> 2.03
<EPS-DILUTED> 2.03
</TABLE>
