<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 June 30, 1998
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 August 13, 1998, 5,842,266 shares of Common Stock with a par value of
$1.00 per share were outstanding.
<PAGE>
FUND AMERICAN ENTERPRISES HOLDINGS, INC.
Table of Contents
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION Page No.
---------
<S> <C>
Item 1. Financial Statements
Condensed Consolidated Balance Sheets,
June 30, 1998 (Unaudited), and December 31, 1997 3
Condensed Consolidated Income Statements (Unaudited),
Three Months and Six Months Ended June 30, 1998 and 1997 4
Condensed Consolidated Statements of Cash Flows (Unaudited),
Six Months Ended June 30, 1998 and 1997 5
Notes to Condensed Consolidated Financial
Statements (Unaudited) 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 8-13
PART II. OTHER INFORMATION
Items 1 through 6 14
SIGNATURES 15
</TABLE>
2
<PAGE>
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>
<CAPTION>
June 30, December 31,
1998 1997
------------------- -------------------
(Unaudited)
<S> <C> <C>
Assets
Fixed maturity investments, at fair value (cost: $170.6 and $165.4) $ 173.9 $ 168.3
Common equity securities, at fair value (cost: $83.6 and $64.7) 153.0 104.2
Other investments (cost: $62.4 and $100.2) 109.3 167.9
Short-term investments, at amortized cost (which approximated market value) 30.5 62.8
-------------- ------------
Total investments 466.7 503.2
Cash 4.3 7.0
Capitalized mortgage servicing rights, net of accumulated amortization 204.4 181.0
Mortgage loans held for sale 568.2 519.3
Other mortgage origination and servicing assets 193.2 191.0
Insurance premiums receivable 56.7 56.1
Reinsurance recoverable on paid and unpaid losses 8.1 9.6
Investments in unconsolidated insurance affiliates 523.4 382.7
Other assets 187.3 183.0
-------------- ------------
Total Assets $ 2,212.3 $ 2,032.9
-------------- ------------
-------------- ------------
Liabilities
Short-term debt $ 601.7 $ 571.4
Long-term debt 304.8 304.3
Unearned insurance premiums 80.2 78.0
Loss and loss adjustment expense reserves 77.6 71.9
Accounts payable and other liabilities 392.5 289.7
-------------- ------------
Total liabilities 1,456.8 1,315.3
-------------- ------------
Minority Interest - preferred stock of subsidiary 44.0 44.0
-------------- ------------
Shareholders' Equity
Common stock at $1 par value per share - authorized 125,000,000 shares;
issued 30,882,077 and 31,015,463 shares 30.9 31.0
Common paid-in surplus 354.4 355.9
Retained earnings 1,004.0 1,008.9
Common stock in treasury, at cost - 25,034,939 shares (871.0) (871.0)
Net unrealized investment gains, after tax 193.2 148.8
-------------- ------------
Total shareholders' equity 711.5 673.6
-------------- ------------
Total Liabilities, Minority Interest and Shareholders' Equity $ 2,212.3 $ 2,032.9
-------------- ------------
-------------- ------------
</TABLE>
3
<PAGE>
FUND AMERICAN ENTERPRISES HOLDINGS, INC.
CONDENSED CONSOLIDATED INCOME STATEMENTS
Unaudited
(millions, except per share amounts)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended Three Months Ended
------------------ ---------------- ------------------
June 30, June 30, March 31,
1998 1997 1998 1997 1998 1997
--------- -------- -------- ------- ------- --------
<S> <C> <C> <C> <C> <C> <C>
Revenues:
Gross mortgage servicing revenue $ 18.6 $ 19.0 $ 41.1 $ 48.6 $ 22.5 $ 29.6
Amortization and impairment of capitalized
mortgage servicing (14.7) (16.4) (29.4) (25.8) (14.7) (9.4)
Net gain (loss) on financial instruments 3.8 4.4 5.5 (1.7) 1.7 (6.1)
--------- -------- -------- ------- ------- --------
Net mortgage servicing revenue 7.7 7.0 17.2 21.1 9.5 14.1
Net gain on sales of mortgages 25.5 1.4 42.2 9.3 16.7 7.9
Gain (loss) on sales of mortgage servicing and
assumption of subservicing .9 (1.1) 9.0 (4.3) 8.1 (3.2)
Other mortgage operations revenue 7.6 4.7 13.7 9.0 6.1 4.3
Earned property and casualty insurance premiums 41.2 35.8 78.7 71.3 37.5 35.5
Earnings from unconsolidated insurance affiliates 7.7 4.6 15.2 9.8 7.5 5.2
Other insurance operations revenue 1.9 2.0 4.2 4.5 2.3 2.5
Net investment income 25.1 15.1 47.1 29.7 22.0 14.6
--------- -------- -------- ------- ------- --------
Total revenues 117.6 69.5 227.3 150.4 109.7 80.9
--------- -------- -------- ------- ------- --------
Expenses:
Compensation and benefits 33.1 24.9 63.0 50.4 29.9 25.5
Insurance losses and loss adjustment expenses 28.1 24.1 54.6 48.3 26.5 24.2
General expenses 24.1 21.1 45.0 41.0 20.9 19.9
Interest expense 22.4 11.8 41.2 23.4 18.8 11.6
--------- -------- -------- ------- ------- --------
Total expenses 107.7 81.9 203.8 163.1 96.1 81.2
--------- -------- -------- ------- ------- --------
Pretax operating earnings (loss) 9.9 (12.4) 23.5 (12.7) 13.6 (.3)
--------- -------- -------- ------- ------- --------
Net realized investment gains 1.7 16.2 4.2 25.8 2.5 9.6
--------- -------- -------- ------- ------- --------
Pretax earnings 11.6 3.8 27.7 13.1 16.1 9.3
Income tax provision 5.0 3.2 12.2 7.6 7.2 4.4
--------- -------- -------- ------- ------- --------
After tax earnings 6.6 .6 15.5 5.5 8.9 4.9
Loss on early extinguishment of debt - (6.0) - (6.0) 0.0 0.0
--------- -------- -------- ------- ------- --------
Net income (loss) 6.6 (5.4) 15.5 (.5) 8.9 4.9
Change in net unrealized investment gains, after tax 13.8 44.5 44.4 38.1 30.6 (6.4)
--------- -------- -------- ------- ------- --------
Comprehensive net income $ 20.4 $ 39.1 $ 59.9 $ 37.6 $ 39.5 $ (1.5)
--------- -------- -------- ------- ------- --------
--------- -------- -------- ------- ------- --------
Basic earnings per share:
After tax earnings $ 1.13 $ .09 $ 2.63 $ .81
Net income (loss) 1.13 (.80) 2.63 (.07)
Comprehensive net income 3.48 5.82 10.16 5.53
Diluted earnings per share:
After tax earnings $ 1.00 $ .08 $ 2.33 $ .74
Net income (loss) 1.00 (.73) 2.33 (.06)
Comprehensive net income 3.11 5.29 9.10 5.03
</TABLE>
See Notes to Condensed Consolidated Financial Statements
4
<PAGE>
FUND AMERICAN ENTERPRISES HOLDINGS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Unaudited
(millions)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
--------------------
1998 1997
-------- -------
<S> <C> <C>
Cash flows from operations:
Net income (loss) $ 15.5 $ (.5)
Charges (credits) to reconcile net income to cash flows from operations:
Undistributed earnings from unconsolidated insurance affiliates (11.5) (6.6)
Net realized investment gains (4.2) (24.2)
Net unrealized loss on financial instruments .3 1.3
Mortgage loan production (5,219.0) (1,467.7)
Mortgage loan sales and amortization 5,170.1 1,581.2
(Gain) loss on sale of mortgage servicing rights and assumption
of subservicing (9.0) 4.3
Increase in unearned insurance premiums 2.2 2.9
Increase in insurance premiums receivable (.6) (2.7)
Depreciation and amortization of mortgage servicing assets and other 33.0 27.6
Net change in current and deferred income taxes receivable and payable 4.8 5.7
Net change in miscellaneous other assets .4 30.7
Net change in accounts payable and other liabilities 79.4 3.4
Other, net 6.9 21.3
--------- ---------
Net cash flows provided from operating activities 68.3 176.7
--------- ---------
--------- ---------
Cash flows from investing activities:
Net decrease in short-term investments 32.3 23.0
Sales of common equity securities and other investments 38.7 46.0
Sales and maturities of fixed maturity investments 34.9 44.1
Purchases of common equity securities and other investments (14.1) (23.5)
Purchases of fixed maturity investments (42.1) (41.2)
Investments in unconsolidated insurance affiliates (70.3) -
Net proceeds from sales of mortgage servicing rights 63.8 226.5
Collections on other mortgage origination and servicing assets 134.8 177.0
Additions to other mortgage origination and servicing assets (139.9) (218.5)
Additions to capitalized mortgage servicing rights (122.1) (61.1)
Collections on notes receivable 7.0 -
Net purchases of fixed assets (2.3) (.3)
--------- ---------
Net cash flows (used for) provided from investing activities (79.3) 172.0
--------- ---------
--------- ---------
Cash flows from financing activities:
Net issuances (repayments) of short-term debt 30.3 (166.0)
Issuances of long-term debt 50.0 -
Repayments of long-term debt (50.1) (129.9)
Purchases of common stock retired (17.2) (51.8)
Cash dividends paid to common shareholders (4.7) (2.7)
--------- ---------
Net cash provided from (used for) financing activities 8.3 (350.4)
--------- ---------
Net decrease in cash during period (2.7) (1.7)
Cash balance at beginning of period 7.0 4.8
--------- ---------
Cash balance at end of period $ 4.3 $ 3.1
---------- ---------
---------- ---------
Supplemental cash flows information:
Interest paid $ (41.2) $ (25.6)
Net income taxes paid $ (7.6) $ (7.3)
</TABLE>
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' consolidated and
unconsolidated insurance operations are conducted through its subsidiaries and
affiliates in the businesses of property and 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").
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 1997 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. Derivative Securities
Source One utilizes derivative contracts, consisting of interest rate floor
contracts and principal- only swaps, in an attempt to offset the effect on
earnings of impairment of its capitalized servicing asset caused by changes in
market interest rates. These financial instruments are carried at fair value on
the balance sheet with unrealized and realized gains reported as net gains on
financial instruments on the income statement.
The interest rate contracts derive their value from differences between the
floor strike rate specified in the contract and prevailing market interest rates
and are not subject to total losses in excess of their original cost. As of June
30, 1998, Source One's open interest rate contracts had a fair value of $2.3
million and had an original cost of $2.5 million. As of June 30, 1998, the open
interest rate contracts had a total notional principal amount of $.4 billion and
had remaining terms ranging from 4.5 to 5 years. As of June 30, 1997, Source
One's open interest rate contracts with a total notional value of $1.1 billion
had a fair value of $2.4 million and had an original cost of $5.4 million.
The principal-only swap transactions derive their value from changes in the
value of referenced principal-only securities. As of June 30, 1998, Source One's
open principal-only swap transactions had a fair value of $2.5 million. Source
One's exposure to losses on the principal-only swap transactions is related to
changes in the market value of the underlying principal-only securities over the
life of the contract. As of June 30, 1998, the open principal-only swap
transactions had an original notional principal amount of $74.1 million and had
remaining terms of 2.5 to 5 years. As of June 30, 1997, Source One's open
principal-only swap transactions with an original notional principal amount of
$98.1 million had a fair value of $4.3 million.
Note 3. Earnings Per Share
Basic earnings per share amounts are based on the weighted average number of
the Company's common stock ("Shares") outstanding. Diluted earnings per share
amounts are based on the weighted average number of Shares and the net effect
of potential dilutive Shares outstanding. Potential dilutive Shares include
stock options and warrants. The following table outlines the Company's
computation of earnings per share for the three and six-months ended June 30,
1998 and 1997:
6
<PAGE>
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
------------------------------------------
1998 1997 1998 1997
----- ---- ---- ----
<S> <C> <C> <C> <C>
Basic earnings per share numerators (in millions):
After tax earnings $ 6.6 $ .6 $ 15.5 $ 5.5
------- -------- ------- --------
------- -------- ------- --------
Net income (loss) $ 6.6 $ (5.4) $ 15.5 $ (.5)
------- -------- ------- --------
------- -------- ------- --------
Comprehensive net income $ 20.4 $ 39.1 $ 59.9 $ 37.6
------- -------- ------- --------
------- -------- ------- --------
Diluted earnings per share numerators (in million):
After tax earnings $ 6.6 $ .6 $ 15.5 $ 5.5
After tax dilution to earnings from unconsolidated insurance
affiliates (.1) - (.2) -
------- -------- ------- --------
------- -------- ------- --------
Diluted after tax earnings $ 6.5 $ .6 $ 15.3 $ 5.5
------- -------- ------- --------
------- -------- ------- --------
Diluted net income (loss) $ 6.5 $ (5.4) $ 15.3 $ (.5)
------- -------- ------- --------
------- -------- ------- --------
Diluted comprehensive net income (loss) $ 20.3 $ 39.1 $ 59.7 $ 37.6
------- -------- ------- --------
------- -------- ------- --------
Earnings per share denominators (in thousands):
Basic earnings per share numerator (average common shares 5,854 6,727 5,894 6,813
outstanding)
Dilutive stock options and warrants to acquire common stock (a) 668 675 669 675
------- -------- ------- --------
Diluted earnings per share denominator 6,522 7,402 6,563 7,488
------- -------- ------- --------
------- -------- ------- --------
Basic earnings per share (in dollars):
After tax earnings $ 1.13 $ .09 $ 2.63 $ .81
------- -------- ------- --------
------- -------- ------- --------
Net income (loss) $ 1.13 $ (.80) $ 2.63 $ (.07)
------- -------- ------- --------
------- -------- ------- --------
Comprehensive net income $ 3.48 $ 5.82 $10.16 $ 5.53
------- -------- ------- --------
------- -------- ------- --------
Diluted earnings per share and assumed conversions (in dollars):
After tax earnings $ 1.00 $ .08 $ 2.33 $ .74
------- -------- ------- --------
------- -------- ------- --------
Net income (loss) $ 1.00 $ (.73) $ 2.33 $ (.06)
------- -------- ------- --------
------- -------- ------- --------
Comprehensive net income $ 3.11 $ 5.29 $ 9.10 $ 5.03
------- -------- ------- --------
------- -------- ------- --------
</TABLE>
(a) Includes the net dilutive effects for each period presented of warrants to
acquire 1,000,000 Shares at $21.66 per Share and stock options to acquire
2,000 Shares at $24.82 per Share.
Note 4. Accounting Standards Recently Adopted and Issued
In December 1996 the Financial Accounting Standards Board ("the FASB") issued
SFAS No. 127, "Deferral of the Effective Date of Certain Provisions of SFAS No.
125" which deferred the adoption of certain transfer and collateral provisions
of SFAS No. 125 to periods beginning after December 31, 1997. The adoption of
SFAS No. 127, did not have a material effect on Fund American's current
financial position or results of operations.
In June 1998 the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" which requires companies to record all
derivatives on the balance sheet as either assets or liabilities and measure
those instruments at fair value. The manner in which companies are to record
gains and losses resulting from changes in the values of those derivatives
depends on the use of the derivative and whether it qualifies for hedge
accounting. SFAS No. 133 is effective beginning in 2000 with earlier adoption
permitted. The adoption of SFAS No. 133, is not expected to have a material
effect on Fund American's financial position or results of operations.
7
<PAGE>
Note 5. Subsequent Events
On July 10, 1998 Fund American sold all its holdings (1,014,250 common shares)
of White River Corporation ("White River") to a third party for cash proceeds of
$92.1 million. The total cash received by Fund American included the sales
proceeds associated with shares which were being held for delivery upon the
exercise of existing employee stock options (295,432 common shares). Fund
American's net liability to option holders as of the sale date totalled $17.8
million of which $.1 million was immediately paid in cash and the balance has
been deferred pursuant to the Company's nonqualified retirement plan. Fund
American's realized gain associated with the sale of its holdings of White River
will be recorded during the 1998 third quarter.
Pursuant to a Stock Purchase Agreement dated July 1, 1998, Fund American has
agreed to acquire the remaining 50% of Folksamerica that it does not currently
own at an estimated purchase price of $169.1 million plus the assumption of
$55.6 million of Folksamerica's existing indebtedness. The purchase price for
Fund American's additional investment in Folksamerica is expected to be paid
using $50.0 million in borrowings under Fund American's credit facility and with
proceeds from sales of short-term investments. The transaction is expected to
occur in mid- August at which time Folksamerica will become a wholly-owned
subsidiary of Fund American.
Item 2. Management's Discussion and Analysis
RESULTS OF OPERATIONS -- THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 1998
AND 1997
Fund American reported comprehensive net income of $59.9 million, or $9.10 per
diluted share, for the six months ended June 30, 1998, compared to comprehensive
net income of $37.6 million, or $5.03 per diluted share, for the comparable 1997
period. For the 1998 second quarter Fund American reported comprehensive net
income of $20.4 million, or $3.11 per diluted share, versus comprehensive net
income of $39.1 million, or $5.29 per diluted share, in the 1997 second quarter.
Book value per common and common equivalent share increased to $111.10 at June
30, 1998, an increase of $8.91 from the December 31, 1997 book value per share
of $102.19.
Consolidated Insurance Operations. Fund American's consolidated insurance
operations consist of Valley Insurance Companies ("Valley"), a Northwest region
property and casualty insurer which writes personal and commercial lines,
Charter Insurance Companies ("Charter"), which writes non-standard automobile
insurance in Texas and Oklahoma, and White Mountains Insurance Company ("WMIC"),
a growing Northeast region property and casualty company which writes commercial
lines. Valley had a combined ratio of 102.6% for the 1998 first half versus
99.9% for the comparable 1997 period. Valley had $46.6 million of net written
premium in the 1998 first half, an increase of $6.5 million from the
comparable1997 amount. Charter had a combined ratio of 94.4% for the 1998 first
half versus 95.4% for the comparable 1997 period. Charter had $31.6 million of
net written premium in the 1998 first half, a decrease of $.4 million from the
comparable 1997 amount. WMIC had $2.8 million of net written premium in the 1998
first half, an increase of $1.1 million from the comparable 1997 amount. A
summary of White Mountains' consolidated insurance operating results follows:
8
<PAGE>
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
-------------------------------------------
Dollars in millions 1998 1997 1998 1997
- ------------------- ---- ---- ---- ----
<S> <C> <C> <C> <C>
Ending statutory surplus $ 105.4 $ 89.7
Valley:
Net written premium $ 25.6 $ 22.0 $ 46.6 $ 40.1
Earned premium $ 24.3 $ 19.5 $ 45.3 $ 38.6
Loss and loss adjustment expense 67.3% 65.4% 68.2% 63.8%
Underwriting expense 34.2% 33.8% 34.4% 36.1%
----------- --------- -------- --------
Combined 101.5% 99.2% 102.6% 99.9%
----------- --------- -------- --------
----------- --------- -------- --------
Charter:
Net written premium $ 13.7 $ 12.7 $ 31.6 $ 32.0
Earned premium $ 15.6 $ 15.6 $ 30.9 $ 31.5
Loss and loss adjustment expense 70.0% 69.8% 69.9% 71.9%
Underwriting expense 27.0% 26.3% 24.5% 23.5%
----------- --------- -------- --------
Combined 97.0% 96.1% 94.4% 95.4%
----------- --------- -------- --------
----------- --------- -------- --------
White Mountains Insurance Company:
Net written premium $ 1.7 $ 1.0 $ 2.8 $ 1.7
Earned premium $ 1.3 $ .7 $ 2.5 $ 1.2
Loss and loss adjustment expense 61.1% 77.5% 85.4% 95.3%
Underwriting expense 50.5% 62.1% 54.1% 60.6%
----------- --------- -------- --------
Combined 111.6% 139.6% 39.5% 155.9%
----------- --------- -------- --------
----------- --------- -------- --------
</TABLE>
Valley's underwriting results for the 1998 first half include higher than
anticipated storm and fire losses which occurred during the first quarter of
1998. However, Valley's 1998 second quarter combined ratio improved by 2.4
points versus that of the 1998 first quarter and written premiums for the 1998
second quarter increased 21.9% over that of the 1998 first quarter. Charter's
underwriting results for the 1998 first half produced a favorable combined ratio
but its written premiums for the second quarter of 1998 were 23.5% less than
that of the 1998 first quarter due to increased competition in the Texas
non-standard automobile insurance market. WMIC's underwriting results are not
yet considered to be meaningful due to its small and growing book of business.
The combined statutory surplus of Fund American's consolidated insurance
subsidiaries increased 17.5% to $105.4 million from June 30, 1997 to June 30,
1998 due principally to: (i) unrealized gains in the common stock investment
portfolios of these insurance companies, and (ii) overall satisfactory
underwriting results.
Unconsolidated Insurance Operations. Fund American's unconsolidated insurance
affiliates consist of a 26% economic interest in Financial Security Assurance
Holdings Ltd. ("FSA"), a 50% interest in Folksamerica Holding Company, Inc.
("Folksamerica") and a 50% interest in Main Street America Holdings, Inc.
("MSA"), an affiliate of National Grange Mutual Insurance Company ("NGM"). Fund
American's pretax earnings from these affiliates increased to $15.2 million for
the first half of 1998, from $9.8 million for the comparable 1997 period. The
increase is primarily due to solid operating results at FSA and recent increases
in Fund American's investments in Folksamerica (December 1997) and MSA (March
1998). FSA produced $158.0 million of present value premiums in the 1998 first
half, compared with $129.7 million for the comparable 1997 period. Since
year-end 1997, FSA's market value per share has increased nearly 22% to $58.75
at June 30, 1998. Folksamerica's operations also performed well despite a
continuing highly- competitive reinsurance market. Folksamerica's annualized
return on equity is 24.5% for the 1998 year-to-date period, however,
9
<PAGE>
its premium growth has come almost entirely from acquisitions. MSA's reported
underwriting results for the first half of 1998 produced a combined ratio of
101.3% vs. 103.3% for the comparable 1997 period. MSA's reported combined
ratio for 1998 is more favorable than NGM's due to the change in its pooling
arrangement resulting from an increase in Fund American's ownership of MSA
during the 1998 first quarter. See "Liquidity and Capital Resources - White
Mountains and subsidiaries".
In addition to recording equity in earnings from its investments in the common
stock of unconsolidated insurance affiliates, Fund American also records net
unrealized investment gains and losses as a result of changes in the value of
its options and convertible securities to acquire the common stock of certain of
its unconsolidated insurance affiliates and changes in its equity in the net
unrealized investment gains and losses of its unconsolidated insurance
affiliates. See "Investment Operations".
Mortgage Banking Operations. For the 1998 first half Source One reported net
income applicable to common stock of $21.8 million versus a loss of $13.9
million for the comparable 1997 period. For the 1998 second quarter Source One
reported net income applicable to common stock of $9.6 million versus a loss of
$13.2 million for the comparable 1997 period. Source One's 1997 first half and
second quarter results include the negative effects of the following
non-recurring charges: (i) a $6.0 million after tax loss on the early retirement
of debt, (ii) a $2.0 million after tax charge related to mortgage loans held for
investment, and (iii) $1.1 million of after tax restructuring charges.
A summary of Source One's mortgage loan production and mortgage servicing
portfolio activities follows:
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
--------------------------------------------
Millions 1998 1997 1998 1997
- -------- ---------- -------- --------- ---------
<S> <C> <C> <C> <C>
Mortgage loan servicing portfolio:
Owned servicing at beginning of period $ 9,770 $ 9,266 $ 11,627 $ 26,410
Retail mortgage loan production 751 325 1,438 593
Wholesale mortgage loan production 2,093 502 3,781 875
Regular payoffs (320) (219) (809) (643)
Sales of servicing and other (764) (223) (4,507) (17,584)
---------- -------- --------- ---------
Servicing portfolio owned 11,530 9,651 11,530 9,651
Subservicing portfolio 13,320 18,932 13,320 18,932
---------- -------- --------- ---------
---------- -------- --------- ---------
Total mortgage loan servicing portfolio $ 24,850 $ 28,583 $ 24,850 $ 28,583
---------- -------- --------- ---------
---------- -------- --------- ---------
</TABLE>
The increase in mortgage loan production and payoffs for the 1998 periods versus
the comparable 1997 periods reflects lower market interest rates and a
corresponding increase in refinancing activity.
Additional information regarding Source One's mortgage loan servicing portfolio
is shown below:
<TABLE>
<CAPTION>
Total loans (a) Owned loans
-------------------- ----------------------
June 30, Dec. 31, June 30, Dec. 31,
Ending mortgage loan servicing portfolio 1998 1997 1998 1997
- ---------------------------------------- -------- -------- -------- --------
<S> <C> <C> <C> <C>
Principal balance (millions) $ 24,850 $ 26,546 $ 11,530 $ 11,627
Number of loans 390,211 438,261 160,049 184,289
Weighted average interest rate 8.17% 8.45% 7.96% 8.52%
Percent delinquent (includes loans in
process of foreclosure) 6.97% 7.53% 7.50% 8.40%
-------- -------- -------- --------
-------- -------- -------- --------
</TABLE>
(a) Includes mortgage loans subserviced for others.
10
<PAGE>
Source One's gross mortgage servicing revenue decreased to $18.6 million and
$41.1 million for the three and six month periods ended June 30, 1998,
respectively, from $19.0 million and $48.6 million for the comparable 1997
periods. The decreases in gross mortgage servicing revenue are primarily the
result of significant sales of mortgage servicing rights that have occurred
during 1997 and 1998 to-date. Net mortgage servicing revenue for the three and
six month periods ended June 30, 1998 includes $3.8 million and $5.5 million of
pretax net gains on financial instruments, respectively, versus $5.0 million and
$6.5 million of pretax impairment, respectively.
During the 1998 first half, Source One sold the rights to service $4.0 billion
of non-recourse mortgage loans for $86.4 million. The 1998 servicing sales and
adjustments to prior servicing sales resulted in a $9.0 million gain on sale of
mortgage servicing. During the 1997 first half, Source One sold the rights to
service $17.0 billion of non-recourse mortgage loans for cash proceeds of $266.9
million. In connection with the 1997 servicing sale, Source One recorded a $4.3
million pretax loss in the 1997 first half and continues to subservice these
mortgage loans pursuant to a subservicing agreement.
Net gain on sales of mortgages increased to $25.5 million and $42.2 million for
the three and six month periods ended June 30, 1998, respectively, from $1.4
million and $9.3 million for the comparable 1997 periods. The increase primarily
reflects greater mortgage loan sales volumes experienced during the 1998 second
quarter and first half versus the comparable 1997 periods.
Investment Operations. Fund American's investment income is comprised primarily
of interest income earned on mortgage loans originated by Source One (gross of
related interest expense on short-term borrowings used to finance such loans),
interest income associated with the fixed maturity investments of its
consolidated insurance operations and dividend income from its equity
investments. Net investment income increased to $25.1 million and $47.1 million
for the three and six month periods ended June 30, 1998, respectively, from
$15.1 million and $29.7 million for the comparable 1997 periods. The significant
increase in net investment income during the 1998 periods is primarily the
result of strong mortgage loan originations by Source One.
Total net investment gains and losses arising during the periods, before tax,
were as follows:
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
------------------ ------------------
Millions 1998 1997 1998 1997
- --------- ------- ------ ------ ------
<S> <C> <C> <C> <C>
Net realized investment gains $ 1.7 $ 16.2 $ 4.2 $ 25.8
Net unrealized gains (losses) from investment securities (1.4) 32.4 9.5 21.3
Net unrealized gains from investments in unconsolidated
insurance affiliates 22.6 36.1 58.8 37.3
------ ------ ------ -------
Total net investment gains arising during the period $ 22.9 $ 84.7 $ 72.5 $ 84.4
------ ------ ------ -------
------ ------ ------ -------
</TABLE>
The 1997 first half includes net realized investment gains of $25.8 million
resulting principally from sales of the common stock of Veritas DGC Inc. for net
proceeds of $9.8 million in the first quarter and sales of the common stock of
Travelers Property Casualty Corp. for net proceeds of $22.9 million in the
second quarter. No noteworthy investment sales occurred during the comparable
1998 periods.
The components of Fund American's change in net unrealized investment gains,
after tax, as recorded on the income statement are as follows:
11
<PAGE>
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
------------------- --------------------
Millions 1998 1997 1998 1997
- -------- ------- ------- ------- --------
<S> <C> <C> <C> <C>
Net realized investment gains $ 1.7 $ 16.2 $ 4.2 $ 25.8
Income tax expense applicable to net realized investment gains (.6) (5.7) (1.5) (9.0)
------- ------- -------- --------
Net realized investment gains, after tax $ 1.1 $ 10.5 $ 2.7 $ 16.8
------- ------- -------- --------
------- ------- -------- --------
Net investment gains arising during the period $ 22.9 $ 84.7 $ 72.5 $ 84.4
Income tax expense applicable to net investment gains (8.0) (29.7) (25.4) (29.5)
------- ------- -------- --------
Net investment gains arising during the period, after tax 14.9 55.0 47.1 54.9
Net investment gains reclassed to realized gains, after tax (1.1) (10.5) (2.7) (16.8)
------- ------- -------- --------
Change in net unrealized investment gains, after tax $ 13.8 $ 44.5 $ 44.4 $ 38.1
------- ------- -------- --------
------- ------- -------- --------
</TABLE>
The increases in after tax net unrealized investment gains recorded for three
and six month periods ended June 30, 1998 are primarily the result of increases
in the value of its FSA and Folksamerica options and/or convertible securities.
The increases in after tax net unrealized investment gains recorded for the
three and six month periods ended June 30, 1997 are primarily the result of
increases in the value of its FSA options and convertible securities and
increases in the value of Fund American's investments in the common stock of
Travelers Property Casualty Corp. and White River Corporation.
Expenses and Income Taxes. Compensation and benefits totalled $63.0 million for
the 1998 first half versus $50.3 million for the 1997 first half. The increase
is primarily a result of higher mortgage loan production volumes experienced by
Source One during 1998 first half versus the 1997 comparable period.
Insurance losses and loss adjustment expenses increased from $24.1 million and
$48.3 million in the 1997 second quarter and year-to-date, respectively, to
$28.1 million and $54.6 million in the 1998 second quarter and year-to-date,
respectively, due primarily to increases in earned premium at Valley and WMIC.
Fund American's consolidated loss and loss adjustment expense ratio for the 1998
second quarter and first half was 68.2% and 69.4%, respectively, which compares
to 67.3% and 67.7%, respectively, for the comparable 1997 periods.
Interest expense totalled $41.2 million for the1998 first half versus $23.3
million for the 1997 first half. The increase in interest expense is primarily
the result of a higher level of average indebtedness outstanding at Source One
during the 1998 period versus 1997 which is mainly driven by significantly
higher mortgage loan production.
Fund American's income tax provision for the first half of 1998 and 1997
includes $2.7 million and $2.5 million, respectively, of expense related to tax
reserve adjustments. Excluding these tax reserve adjustments, Fund American's
effective income tax rate for the first half of 1998 and 1997 was 34.4% and
39.2%, respectively.
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 current aggregate amount of
the Company's guaranty is approximately $15.0 million.
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.
12
<PAGE>
White Mountains and subsidiaries. On March 27, 1998, upon receipt of state
and federal regulatory approvals, White Mountains increased its ownership of
MSA from 33% to 50%. As a result of the transaction, MSA now shares in 60% of
the insurance operations of National Grange Mutual Insurance Company of
Keene, New Hampshire and holds certain insurance, reinsurance and financial
services subsidiaries. The aggregate purchase paid by White Mountains to
purchase its additional investment in MSA was $70.0 million, subject to a
future purchase price adjustment which is currently expected to be no more
than $3.5 million.
Source One. 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.
YEAR 2000 STATUS
Since 1996 Fund American has been identifying, modifying and testing its
internal systems and controls to ensure that these systems can accurately
process transactions involving the year 2000 and beyond with no material adverse
effects to its customers or disruption to its business operations. The Company
and its consolidated affiliates are currently expected to be year 2000 compliant
by year-end 1998 when its testing phase is complete. Fund American estimates
that its total pretax cost of becoming internally year 2000 compliant, excluding
its unconsolidated insurance affiliates, is approximately $2.5 million of which
the majority of this amount has been expensed as of June 30, 1998. This estimate
does not include the cost of hardware and software replacements and upgrades
made in the normal course of business.
Fund American has also been closely monitoring the year 2000 issues of its third
party constituents (e.g. customers, suppliers, reinsurers, creditors,
borrowers...). Based on this evaluation, it is not currently expected that Fund
American will be materially adversely affected by its third party constituents.
This determination has been made as a result of an extensive interview process
which requests that constituents demonstrate an ability to become year 2000
compliant by year-end 1998. For those constituents who are deemed to be unlikely
to remedy their own year 2000 issues in a timely manner, Fund American is in the
process of either replacing that constituent or establishing similar
relationships with new parties that are currently year 2000 compliant.
All of Fund American's unconsolidated insurance affiliates are expected to be
internally year 2000 compliant by year-end 1998 and each affiliate is in the
process of determining its third party exposures in a similar manner to that of
Fund American. Fund American's portion of the total cost of the year 2000 issue
for its unconsolidated insurance affiliates are not expected to be material.
FORWARD LOOKING STATEMENTS
From time to time, the Company may publish forward-looking statements relating
to such matters as anticipated financial performance, business prospects, new
products and similar matters. This information is often subject to various risks
and uncertainties. The Company notes that numerous factors could cause actual
results and experience to differ materially from anticipated results or other
expectations expressed in its forward-looking statements.
13
<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
At the Company's 1998 Annual Meeting of Shareholders, which was held
on May 28, 1998 in Hanover, New Hampshire, shareholders approved
proposals (as further contained in the Company's 1998 Proxy
Statement) calling for the Election of Directors and the Appointment
of Independent Auditors. With respect to the Election of Directors,
4,022,812 votes were cast in favor of the proposal and 62,027 votes
were withheld. With respect to the Appointment of Independent
Auditors, 4,068,677 votes were cast in favor of the proposal, 2,028
votes were cast against the proposal and 14,134 votes abstained.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
11 - Statement Re Computation of Per Share Earnings*
27.1 - Financial Data Schedule for the six-month
period ended June 30, 1998**
27.2 - Restated Financial Data Schedule for the
six-month period ended June 30, 1997**
(b) Reports on Form 8-K
None.
* Not included herein as the information is contained elsewhere within
report. See Note 1 of the Notes to Condensed Consolidated Financial
Statements.
** Filed herewith.
14
<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: August 13, 1998 By: /s/
------------------------------------
Michael S. Paquette
Senior Vice President and Controller
15
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 4
<SECURITIES> 467
<RECEIVABLES> 132
<ALLOWANCES> (13)
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 2,212
<CURRENT-LIABILITIES> 0
<BONDS> 305
0
44
<COMMON> 385
<OTHER-SE> 327
<TOTAL-LIABILITY-AND-EQUITY> 2,212
<SALES> 0
<TOTAL-REVENUES> 231
<CGS> 0
<TOTAL-COSTS> 163
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 1
<INTEREST-EXPENSE> 41
<INCOME-PRETAX> 27
<INCOME-TAX> 12
<INCOME-CONTINUING> 15
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 15
<EPS-PRIMARY> 2.63
<EPS-DILUTED> 2.33
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-01-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> JUN-30-1997
<CASH> 0
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 0
<CURRENT-LIABILITIES> 0
<BONDS> 0
0
0
<COMMON> 0
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 0
<SALES> 0
<TOTAL-REVENUES> 176
<CGS> 0
<TOTAL-COSTS> 140
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 4
<INTEREST-EXPENSE> 23
<INCOME-PRETAX> 13
<INCOME-TAX> 8
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> (6)
<CHANGES> 0
<NET-INCOME> (1)
<EPS-PRIMARY> (.07)
<EPS-DILUTED> (.06)
</TABLE>
