<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 March 31, 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 May 8, 1998, 5,855,420 shares of Common Stock with a par value of $1.00
per share were outstanding.
<PAGE>
FUND AMERICAN ENTERPRISES HOLDINGS, INC.
Table of Contents
PART I. FINANCIAL INFORMATION Page No.
--------
Item 1. Financial Statements
Condensed Consolidated Balance Sheets,
March 31, 1998 (Unaudited) and December 31, 1997 3
Condensed Consolidated Income Statements (Unaudited),
Three Months Ended March 31, 1998 and 1997 4
Condensed Consolidated Statements of Cash Flows (Unaudited),
Three Months Ended March 31, 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 8-12
PART II. OTHER INFORMATION
Items 1 through 6 13
SIGNATURES 14
<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>
March 31, December 31,
1998 1997
--------- ---------
(Unaudited)
<S> <C> <C>
Assets
Fixed maturity investments, at fair value (cost: $166.1 and $165.4) $ 168.5 $ 168.3
Common equity securities, at fair value (cost: $81.1 and $64.7) 154.4 104.2
Other investments (cost: $82.1 and $103.1) 127.3 167.9
Short-term investments, at amortized cost (which approximated market value) 55.6 62.8
-------- --------
Total investments 505.8 503.2
Cash 7.9 7.0
Capitalized mortgage servicing rights, net of accumulated amortization 160.3 181.0
Mortgage loans held for sale 583.3 519.3
Other mortgage origination and servicing assets 236.1 191.0
Insurance premiums receivable 57.4 56.1
Reinsurance recoverable on paid and unpaid losses 7.9 9.6
Investments in unconsolidated insurance affiliates 494.8 382.7
Other assets 199.4 183.0
-------- --------
Total Assets $2,252.9 $2,032.9
======== ========
Liabilities
Short-term debt $ 669.2 $ 571.4
Long-term debt 354.6 304.3
Unearned insurance premiums 80.3 78.0
Loss and loss adjustment expense reserves 74.5 71.9
Accounts payable and other liabilities 335.3 289.7
-------- --------
Total liabilities 1,513.9 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 30,892,666 and 31,015,463 shares 30.9 31.0
Common paid-in surplus 354.5 355.9
Retained earnings 1,001.2 1,008.9
Common stock in treasury, at cost - 25,034,939 shares (871.0) (871.0)
Net unrealized investment gains, after tax 179.4 148.8
-------- --------
Total shareholders' equity 695.0 673.6
-------- --------
Total Liabilities, Minority Interest and Shareholders' Equity $2,252.9 $2,032.9
======== ========
</TABLE>
See Notes to Condensed Consolidated Financial Statements
-3-
<PAGE>
FUND AMERICAN ENTERPRISES HOLDINGS, INC.
CONDENSED CONSOLIDATED INCOME STATEMENTS
Unaudited
(millions, except per share amounts)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
------------------
1998 1997
------- -------
<S> <C> <C>
Revenues:
Gross mortgage servicing revenue $ 22.5 $ 29.6
Amortization and impairment of capitalized mortgage servicing (14.7) (9.4)
Net gain (loss) on financial instruments 1.7 (6.1)
------- -------
Net mortgage servicing revenue 9.5 14.1
Net gain on sales of mortgages 16.7 7.9
Gain (loss) on sale of mortgage servicing rights and assumption of subservicing 8.1 (3.2)
Other mortgage operations revenue 6.1 4.3
Earned property and casualty insurance premiums 37.5 35.5
Earnings from unconsolidated insurance affiliates 7.5 5.2
Other insurance operations revenue 2.3 2.5
Net investment income 22.0 14.6
------- -------
Total revenues 109.7 80.9
------- -------
Expenses:
Compensation and benefits 29.9 25.5
Insurance losses and loss adjustment expenses 26.5 24.2
General expenses 20.9 19.9
Interest expense 18.8 11.6
------- -------
Total expenses 96.1 81.2
------- -------
Pretax operating earnings (loss) 13.6 (.3)
Net realized investment gains 2.5 9.6
------- -------
Pretax earnings 16.1 9.3
Income tax provision 7.2 4.4
------- -------
Net income 8.9 4.9
Change in net unrealized investment gains, after tax 30.6 (6.4)
------- -------
Comprehensive net income (loss) $ 39.5 $ (1.5)
======= =======
Net income per share:
Basic $ 1.50 $ .71
Diluted 1.33 .65
Comprehensive net income (loss) per share:
Basic $ 6.66 $ (.22)
Diluted 5.97 (.20)
</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>
Three Months Ended
March 31,
--------------------
1998 1997
-------- --------
<S> <C> <C>
Cash flows from operations:
Net income $ 8.9 $ 4.9
Charges (credits) to reconcile net income to cash flows from operations:
Undistributed earnings from unconsolidated insurance affiliates (5.8) (3.6)
Net realized investment gains (2.5) (9.6)
Net unrealized loss on financial instruments .1 5.9
Mortgage loan production (2,374.7) (641.0)
Mortgage loan sales and amortization 2,310.7 706.2
(Gain) loss on sale of mortgage servicing rights and assumption of subservicing (8.1) 3.2
Increase in unearned insurance premiums 2.3 3.2
Increase in insurance premiums receivable (1.3) (1.7)
Depreciation and amortization of mortgage servicing assets and other 16.4 10.9
Net change in current and deferred income taxes receivable and payable (4.8) 4.4
Net change in miscellaneous other assets (1.3) 25.2
Net change in miscellaneous other liabilities (26.3) (1.6)
Other, net 3.0 4.3
-------- --------
Net cash flows (used for) provided from operating activities (83.4) 110.7
-------- --------
Cash flows from investing activities:
Net decrease in short-term investments 7.2 33.2
Sales of common equity securities and other investments 6.9 31.3
Sales and maturities of fixed maturity investments 23.4 16.1
Purchases of common equity securities and other investments (3.0) (3.0)
Purchases of fixed maturity investments (26.4) (24.4)
Investments in unconsolidated insurance affiliates (70.0) --
Net proceeds from sales of mortgage servicing rights 43.8 81.2
Collections on other mortgage origination and servicing assets 40.1 130.6
Additions to other mortgage origination and servicing assets (19.6) (186.7)
Additions to capitalized mortgage servicing rights (53.8) (35.6)
Collections on notes receivable 7.0 --
Net purchases of fixed assets (1.0) (1.5)
-------- --------
Net cash flows (used for) provided from investing activities (45.4) 41.2
-------- --------
Cash flows from financing activities:
Net issuances (repayments) of short-term debt 98.0 (149.5)
Issuances of long-term debt 50.0 --
Purchases of common stock retired (15.7) (1.1)
Cash dividends paid to common shareholders (2.3) (1.4)
Other (.3) --
-------- --------
Net cash provided from (used for) financing activities 129.7 (152.0)
-------- --------
Net increase (decrease) in cash during period .9 (.1)
Cash balance at beginning of period 7.0 4.8
-------- --------
Cash balance at end of period $ 7.9 $ 4.7
======== ========
Supplemental cash flows information:
Interest paid $ (17.9) $ (7.9)
Net income taxes paid $ (11.9) $ (2.8)
</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. Accounting Standards Recently Adopted
Comprehensive Income
The Company adopted the provisions of Statement of Financial Accounting
Standards ("SFAS") No. 130, "Reporting Comprehensive Income" as of December 31,
1997. SFAS No. 130 establishes standards for the reporting and display of
comprehensive income and its components (such as changes in net unrealized
investment gains and losses) in a financial statement that is displayed with the
same prominence as other financial statements. In accordance with the adoption
of SFAS No. 130, the Company reports comprehensive net income on its income
statement. All prior period income statements have been restated to reflect
application of this statement. Additionally, the Company has provided
supplemental comprehensive earnings per share computations.
The components of Fund American's change in net unrealized investment gains,
after tax, are as follows:
- -------------------------------------------------------------------------------
Three Months Ended
March 31,
-----------------
Millions 1998 1997
- -------------------------------------------------------------------------------
Net realized investment gains $ 2.5 $ 9.6
Income tax expense applicable to net
realized investment gains (.9) (3.4)
-----------------
Net realized investment gains, after tax $ 1.6 $ 6.2
=================
Net investment gains (losses) arising during the period $ 49.6 $ (.3)
Income tax benefit (expense) applicable to net
investment gains (17.4) .1
-----------------
Net investment gains (losses) arising during the period,
after tax 32.2 (.2)
Net investment gains reclassed to realized gains for
investments sold, after tax (1.6) (6.2)
-----------------
Change in net unrealized investment gains, after tax $ 30.6 $ (6.4)
===============================================================================
-6-
<PAGE>
Earnings per Share
The Company adopted the provisions of SFAS No. 128, "Earnings Per Share" in
December 1997. SFAS No. 128 simplified the computation of earnings per share and
is intended to make the U.S. standard more compatible with existing
international standards. The adoption of SFAS No. 128 did not materially change
the method by which the Company computes its earnings per share but replaces the
Company's historic presentation of "primary earnings per share" and "fully
diluted earnings per share" with a presentation of "basic earnings per share"
and "diluted 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, warrants and preferred stock redeemable for Shares.
The following table outlines the Company's computation of earnings per share for
the three months ended March 31, 1998 and 1997:
- --------------------------------------------------------------------------------
Three Months Ended
March 31,
-----------------
1998 1997
- --------------------------------------------------------------------------------
Basic earnings per share numerators (in millions):
Net income $ 8.9 $ 4.9
=================
Comprehensive net income $ 39.5 $ (1.5)
- --------------------------------------------------------------=================
Diluted earnings per share numerators (in million):
Net income $ 8.9 $ 4.9
After tax dilution to earnings from unconsolidated
insurance affiliates (.1) --
-----------------
Diluted net income $ 8.8 $ 4.9
=================
Diluted comprehensive net income (loss) $ 39.4 $ (1.5)
- --------------------------------------------------------------=================
Earnings per share denominators (in thousands):
Basic earnings per share numerator (average common shares
outstanding) 5,935 6,900
Dilutive stock options and warrants to acquire common
stock (a) 670 675
-----------------
Diluted earnings per share denominator 6,605 7,575
- --------------------------------------------------------------=================
Basic earnings per share (in dollars):
Net income $ 1.50 $ .71
=================
Comprehensive net income (loss) $ 6.66 $ (.22)
- --------------------------------------------------------------=================
Diluted earnings per share and assumed conversions (in dollars):
Net income $ 1.33 $ .65
=================
Comprehensive net income (loss) $ 5.97 $ (.20)
===============================================================================
(a) Includes the net dilutive effects of: (i) warrants to acquire 1,000,000
Shares at $21.66 per Share at March 31, 1998 and 1997; and (ii) stock
options to acquire 2,000 Shares at $24.82 per Share and 3,000 Shares at an
average price of $27.41 per Share at March 31, 1998 and 1997,
respectively.
-7-
<PAGE>
Certain Provisions of SFAS No. 125
In December 1996 the Financial Accounting Standards Board 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.
Note 3. 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 March 31, 1998, Source One's open
interest rate contracts had a fair value of $7.5 million and had an original
cost of $4.7 million. As of March 31, 1998, the open interest rate contracts had
a total notional principal amount of $.7 billion and had remaining terms ranging
from 2 to 5 years. The principal-only swap transactions derive their value from
changes in the value of referenced principal-only securities. As of March 31,
1998, Source One's principal-only swap transactions had a fair value of $13.1
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 March 31, 1998, the open
principal-only swap transactions had an original notional principal amount of
$98.1 million and had remaining terms of 2 to 4 years.
Item 2. Management's Discussion and Analysis
Results of Operations -- Three-Month Periods Ended March 31, 1998 and 1997
Fund American reported comprehensive net income of $39.5 million, or $5.97 per
diluted share, for the three month period ended March 31, 1998, compared to a
comprehensive net loss of $1.5 million, or a loss of $.20 per diluted share, for
the comparable 1997 period. Excluding changes in after tax net unrealized
investment gains, Fund American reported net income of $8.9 million, or $1.33
per diluted share, for the three month period ended March 31, 1998, compared to
a net income of $4.9 million, or $.65 per diluted share, for the comparable 1997
period.
Book value per common and common equivalent share increased to $107.87, an
increase of $5.68 from the December 31, 1997 book value per share of $102.19.
Consolidated Insurance Operations.
White Mountains' 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 New England region property and
casualty company which writes commercial lines. Valley had a combined ratio of
103.9% for the 1998 first quarter versus 100.7% for the comparable 1997 period.
Valley had $21.0 million of net written premium in the 1998 first quarter, an
increase of $3.0 million from the comparable1997 amount. Charter had a combined
ratio of 92.3% for the 1998 first quarter versus 95.6% for the comparable 1997
period. Charter had $17.8 million of net written premium in the 1998 first
quarter, a decrease of $1.6 million from the comparable 1997 amount. WMIC had
$1.1 million of net written premium in the 1998 first quarter, an increase of
$.3 million from the comparable 1997 amount.
A summary of White Mountains' consolidated insurance operating results follows:
-8-
<PAGE>
- --------------------------------------------------------------------------------
Three Months
Ended March 31,
-------------------
Dollars in millions 1998 1997
-------------------
Ending statutory surplus $ 101.7 $ 82.6
===================
Valley:
Net written premium $ 21.0 $ 18.0
Earned premium $ 21.0 $ 19.0
Loss and loss adjustment expense 69.2% 61.9%
Underwriting expense 34.7% 38.8%
-------------------
Combined 103.9% 100.7%
===================
Charter:
Net written premium $ 17.8 $ 19.4
Earned premium $ 15.3 $ 15.9
Loss and loss adjustment expense 69.7% 73.8%
Underwriting expense 22.6% 21.8%
-------------------
Combined 92.3% 95.6%
===================
White Mountains Insurance Company:
Net written premium $ 1.1 $ .8
Earned premium $ 1.2 $ .6
Loss and loss adjustment expense 113.0% 115.8%
Underwriting expense 59.5% 58.7%
-------------------
Combined 172.5% 174.5%
================================================================================
Valley's first quarter 1998 underwriting results included higher than
anticipated storm and fire losses which adversely effected its loss and loss
adjustment expense ratio. However, Valley's first quarter 1998 expense ratio
improved from that of the comparable 1997 period and its net written premium
increased 16.7% to $21.0 million during the period. Charter's first quarter 1998
underwriting results produced a favorable 92.3% combined ratio. However,
Charter's net written premium decreased 8.2% to $17.8 million during 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.
Unconsolidated Insurance Operations.
The Company'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 (which
was increased from 33% to 50% on March 27, 1998) in Main Street America
Holdings, Inc. ("MSA"). Fund American's pretax earnings from these affiliates
increased to $7.5 million for the first quarter of 1998, from $5.2 million for
the comparable 1997 period. The increase is primarily due to solid operating
results at FSA and the December 1997 increase in Fund American's investment in
Folksamerica. FSA produced $50.7 million of present value premiums in the 1998
first quarter, compared with $42.4 million for the comparable 1997 period. Since
year-end 1997, FSA's market value per share has increased 13.2% to $54.63 at
March 31, 1998. Folksamerica's operations performed well despite a continuing
highly-competitive reinsurance market. Folksamerica's March 31, 1998 book value
per share increased to $15.98 from $15.03 per share at December 31, 1997, an
increase of 6.3% for the quarter. MSA's underwriting results for the first
quarter of 1998 produced a combined ratio of 100.5% vs. 101.9% for the
comparable 1997 period.
Mortgage Banking Operations.
-9-
<PAGE>
For the 1998 first quarter, Source One reported net income applicable to common
stock of $12.2 million versus a loss of $.7 million for the comparable 1997
period. Source One's 1998 first quarter results include $3.1 million of pretax
earnings associated with its investment in FSA, the majority of which was
contributed to Source One during the second quarter of 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
Ended March 31,
----------------
Millions 1998 1997
- -------------------------------------------------------------------------------
Mortgage loan servicing portfolio:
Owned servicing at beginning of period $11,627 $ 26,410
Retail mortgage loan production 687 268
Wholesale mortgage loan production 1,688 373
Regular payoffs (489) (424)
Sales of servicing and other (3,743) (17,361)
-----------------
Servicing portfolio owned 9,770 9,266
Subservicing portfolio 14,032 19,585
- -------------------------------------------------------------------------------
Total mortgage loan servicing portfolio $23,802 $ 28,851
===============================================================================
The increase in mortgage loan production and payoffs for the 1998 first quarter
versus the comparable 1997 period 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
------------------------------------------
March 31, Dec. 31, March 31, Dec. 31,
Ending mortgage loan servicing portfolio 1998 1997 1998 1997
- ------------------------------------------------------------- ---------------------
<S> <C> <C> <C> <C>
Principal balance (millions) $23,802 $26,546 $ 9,770 $11,627
Number of loans 384,358 438,261 142,496 184,289
Weighted average interest rate 8.28% 8.45% 8.12% 8.52%
Percent delinquent (includes loans in
process of foreclosure) 6.44% 7.53% 7.26% 8.40%
====================================================================================
</TABLE>
(a) Includes mortgage loans subserviced for others.
Source One's gross mortgage servicing revenue decreased to $22.5 million during
the 1998 first quarter from $29.6 million for the comparable 1997 period. The
decrease in gross mortgage servicing revenue during the 1998 period is primarily
the result of a significant sale of Source One's servicing rights during the
1997 first quarter as further described below. Net mortgage servicing revenue
for the 1998 first quarter includes $1.7 million of pretax net gains on
financial instruments versus $1.5 million of impairment. Net servicing revenue
for the 1997 first quarter was reduced by $6.1 million in pretax net losses on
financial instruments versus $6.4 million of impairment recoveries.
During the 1998 first quarter, Source One sold the rights to service $3.5
billion of non-recourse mortgage loans for $76.1 million. The 1998 servicing
sales and adjustments to prior servicing sales resulted in an $8.1 million gain
on sale of mortgage servicing. During the 1997 first quarter, Source One sold
the rights to service $17.0 billion of non-recourse mortgage loans for $266.9
million. In connection with the 1997 servicing sale, Source One recorded a $3.2
million pretax loss in the 1997 first quarter and continues to subservice these
mortgage loans pursuant to a subservicing agreement.
Net gain on sales of mortgages increased to $16.7 million for the 1998 first
quarter from $7.9 million for the comparable 1997 period. The increase primarily
reflects greater mortgage loan sales volumes experienced during
-10-
<PAGE>
the 1998 first quarter versus the comparable 1997 period.
Investment Operations.
Net investment income totalled $22.0 million for the1998 first quarter versus
$14.6 million for the comparable 1997 period. 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 common equity securities and other investments. The significant increase in
net investment income during the first quarter of 1998 is primarily the result
of strong mortgage loan originations by Source One during the period.
Total net investment gains and losses, before tax, were as follows:
- -------------------------------------------------------------------------------
Three Months
Ended March 31,
------------------
Millions 1998 1997
- -------------------------------------------------------------------------------
Net realized investment gains $ 2.5 $ 9.6
Net unrealized gains from investment securities 10.9 (11.1)
Net unrealized gains from investments in unconsolidated
insurance affiliates 36.2 1.2
------------------
Total net investment gains (losses) arising during the
period, before tax $ 49.6 $ (.3)
===============================================================================
The 1997 first quarter includes $9.6 million of pretax realized gains resulting
principally from the sale of the majority of the Company's holdings of the
common stock of Veritas DGC Inc. No noteworthy investment sales occurred during
the comparable 1998 period.
Expenses and Income Taxes.
Compensation and benefits totalled $29.9 million for the 1998 first quarter
versus $25.5 million for the comparable 1997 period. The increase is primarily a
result of higher mortgage loan production volumes experienced by Source One
during the 1998 first quarter versus the 1997 comparable period.
Insurance losses and loss adjustment expenses totalled $26.5 million for the
1998 first quarter versus $24.2 million for the comparable 1997 period due
primarily to a comparable increase in earned property and casualty insurance
premiums during the period.
Interest expense totalled $18.8 million for the1998 first quarter versus $11.6
million for the comparable 1997 period. The increase in interest expense from
1997 to 1998 primarily reflects an increase in average indebtedness outstanding
at Source One which is mainly driven by mortgage loan production.
The income tax provision for the first quarter of 1998 and 1997 includes $2.8
million and $1.6 million, respectively, of state income tax expenses and tax
reserve adjustments. Excluding these amounts, Fund American's effective Federal
income tax rate for the first quarter of 1998 and 1997 was 27.4% and 30.6%,
respectively.
-11-
<PAGE>
Liquidity and Capital Resources
Parent Company. In connection with Source One's February 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.
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. 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 certain purchase price adjustments. The
purchase price for White Mountains' additional investment in MSA was paid with
$50.0 million in borrowings under White Mountains' credit facility and proceeds
from sales of short-term investments.
Source One. During the 1997 first quarter, Fund American contributed net assets
totalling $40.5 million to Source One consisting of $12.7 million of cash and
1,000,000 shares of the common stock of FSA. The capital infusion, which was
part of a restructuring plan concluded during the 1997 second quarter, was
undertaken to improve Source One's debt ratings and reduce Source One's
borrowing costs.
As a result of the 1997 capital infusions, White Mountains currently owns 97% of
the outstanding common stock of Source One and the Company owns the remaining
3%. During the 1998 first quarter, Source One declared and paid a $25.0 million
cash dividend to its common shareholders.
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.
The Company and its consolidated affiliates are currently expected to be year
2000 compliant by the third quarter of 1998. Fund American has been identifying,
modifying and testing its internal systems and controls that will be impacted by
the year 2000 issue. 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 approximately $1.7 million
has been expensed as of March 31, 1998. These figures do not include the cost of
normal software replacements and upgrades.
Fund American has also been closely monitoring the year 2000 issues of its third
party constituents (e.g. customers, suppliers, reinsurers, creditors,
borrowers...) and of its unconsolidated insurance affiliates. Based on
preliminary determinations, it is not 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
on a timely basis. 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. All of Fund American's unconsolidated insurance
affiliates are expected to be internally year 2000 compliant by the fourth
quarter of 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.
-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*
** 27.1 - Financial Data Schedule for the three-month period
ending March 31, 1998
** 27.2 - Restated Financial Data Schedule for the three-month
period ending March 31, 1997
(b) Reports on Form 8-K
In a Form 8-K dated March 27, 1998, the Company announced that White
Mountains had increased its ownership of MSA from 33% to 50%. MSA
currently 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 $70.1 million, subject to certain
purchase price adjustments.
* Not included herein as the information is contained elsewhere within
report. See Note 1 of the Notes to Condensed Consolidated Financial
Statements.
** 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: May 13, 1998 By: /s/____________________________
Michael S. Paquette
Senior Vice President and Controller
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