FUND AMERICAN
1994 ANNUAL REPORT
Fund American Enterprises Holdings, Inc. (the "Company" and, together with its
subsidiaries, "Fund American") is a Vermont-based financial services holding
company. The Company's principal operating activities are conducted through its
wholly-owned subsidiary Source One Mortgage Services Corporation and its
subsidiaries ("Source One"). Source One is one of the nation's largest mortgage
banking companies. Fund American also owns a passive investment portfolio,
consisting mainly of common equity securities and other investments.
Operating affiliates added to the Fund American family during 1994
include: (i) a 23% voting interest in Financial Security Assurance Holdings Ltd.
("FSA"), a leading Aaa/AAA writer of financial guarantee insurance, and (ii) a
33% stake in Main Street America Holdings, Inc., a unit of National Grange
Mutual Insurance Company, a New Hampshire-based property and casualty insurer.
In March 1995 the Company received its license from the Insurance
Commissioner of the State of New Hampshire to engage its newly formed
subsidiary, White Mountains Insurance Company ("White Mountains"), in the sale
of property-casualty insurance. White Mountains is expected to expand its
operations to other states as additional approvals are obtained.
Prospectively, Fund American intends to further develop or pursue
investments in or acquisitions of one or more operating businesses, primarily in
the insurance or other financial services industries in which management has
knowledge and experience.
________________________________________________________________________________
BOOK VALUE PER SHARE
[graph appears here]
LETTER FROM JACK BYRNE, CHAIRMAN
Dear Shareholder,
Our 1994 reported financial results for your enterprise were terrible, primarily
due to a poor year from our investment portfolio and an accounting write-down at
Source One. We ended the year weighing $68.95 in GAAP book value per share, 11%
less than a year ago. This is not a diet we wish to repeat.
Our principal operating affiliates, Financial Security Assurance (FSA) and
Source One Mortgage Services Corporation, also encountered tough markets in
1994. Despite pretty good operating
results, FSA's adjusted book value
increased by only 1% this year, and Source
One had its third lackluster year in a
row. Moreover, we changed our method of
determining the accounting value of Source
One's $40 billion servicing portfolio,
which resulted in a $68 million write-down
of that asset. Finally, at the parent
[PHOTO 1 APPEARS HERE] company level, the market gods frowned on
our investment holdings in 1994. Our
common stocks declined 8% for the year.
Markets come and markets go; this is a
year when markets went, particularly for
our holdings. However, we repositioned the
portfolio for liquidity and in fact
liquidated over $200 million.
The future of our enterprise is in our
operating businesses and we had some
success on that front. Last year I told you Fund American's patient search for
compatible operating opportunities was like Cinderella waiting for the proper
prince. I am pleased to tell you that 1994 was the year we finally tried on some
glass slippers that fit.
In April, we joined with US West and Financial Security Assurance, the New York
City-based financial guaranty insurer, to participate in FSA's successful public
offering. We currently have a 25% economic interest in FSA. I serve as the
non-executive Chairman of the Board along with two of my Fund American
colleagues. We have found FSA to be an innovative organization, in a dynamic
business, with a strong reservoir of talented executives.
2
In December, we concluded a transaction with the National Grange Mutual in
Keene, New Hampshire, to become a 33% owner of their downstream stock company,
Main Street America. Main Street has a strong local presence and is devoted to
delivering personal service and value to its insurance customers. Once again, we
found managers with a focus on underwriting who add strength to our entire
enterprise. We are pleased to be associated with Phil Koerner and his management
team.
Speaking of management strength, we were fortunate to attract Morgan Davis,
formerly President of Fireman's Fund Commercial Insurance, to direct the
formation of White Mountains Insurance Company, our property and casuality
start-up also headquartered in new Hampshire. Morgan brings more than twenty
years of major company property-casualty insurance experience.
While some of the glass slippers fit, we also endured rejection by more than one
ugly step-sister; our midyear auction for Source One collided with a meltdown in
the mortgage banking environment. We also pursued a couple of large public
acquisitions in 1994 which failed to materialize. This is not the first time we
have concluded a long, tortuous climb to the summit of a large transaction, only
to slide back down without planting a banner. On the other hand, we didn't step
off any cliffs. We will continue to search for one more special relationship
where we can bring more than money to the table. Before long, I expect our
patience and prudence will be rewarded with more potential winners like FSA,
White Mountains, and Main Street America. If we do not find such opportunities
within a reasonable period, we will continue to make our excess capital
available to shareholders, as we did in 1994 and early 1995.
We strengthened our Board this year with the addition of Bob Cochran, CEO of
FSA, and Tom Kemp, Executive Vice President of Fund American and a valued
colleague for more than two decades. Bob Cochran brings prudent judgement, a
broad background in structured finance, and a distinguished legal career. Tom
Kemp's thirty years of insurance and reinsurance expertise is an invaluable
asset to both Fund American and White Mountains, where he will be Chairman. In
the pages which follow, you will find commentary by each of our General Managers
on the growing promise of our operating businesses.
We planted some of our seed corn in 1994, but the harvest will be many years
off. Meantime, the corn in the silo lost value in 1994. On to 1995.
Respectfully submitted,
/s/John J. Byrne
John J. Byrne
Chairman
March 15, 1995
3
AFFILIATE OPERATIONS
[FSA LOGO APPEARS HERE]
In 1994 municipal bond issuances declined sharply from the record levels of the
last two years, when large numbers were refinanced to take advantage of lower
interest rates.
The decline in volume led some of our competitors to cut premiums to a level
that would not produce an adequate return. We refused to join in a self-
defeating price war. As a result, we deployed less capital in this market than
we would have liked, but the capital we did deploy in 1994 will provide solid
returns for years to come.
For 1995 we expect municipal bond volume to approximate the $160 billion issued
in 1994. However, we do expect the number of insured issues to increase, in part
because the bankruptcy of Orange County, California has reminded the market of
the value of insurance.
In the last two years, other municipal bond insurers have followed us into the
asset-backed bond market. While their participation increases competition, it
also will help us broaden the market for this type of credit enhancement.
Our challenge for 1995 is to expand our business prudently and to deploy our
capital wisely. We are well-positioned to do so, with a solid foundation in the
large municipal market, a leadership position in the growing asset-backed
market, and an established track record in the rapidly expanding international
markets.
/s/ Robert P.Cochran
Robert P. Cochran, President and CEO
Financial Security Assurance
[SOURCE ONE LOGO APPEARS HERE]
During 1994 we were in a rising interest rate environment. Total industry
volume of mortgage loans plummeted from approximately $1 trillion in 1993 to
about $700 billion. Forecasts call for a further drop to around $600 billion in
1995.
This environment has had a significant, but differing, impact on the two
principal segments of our business, loan production and loan servicing.
The lower loan volume resulted in severe overcapacity throughout the industry,
causing predatory pricing as lenders stretched to maintain market share. We
chose not to chase volume this way and downsized our origination network by more
than half. We also centralized most of the sales support activities to reduce
costs and better position ourselves for the next cycle of originations.
The same business conditions that made for a difficult origination environment
created a favorable climate for servicing. As interest rates increased and
mortgage prepayments slowed, the value of our servicing portfolio increased
significantly during 1994. We opted to take advantage of this increase in value
through the sale of approximately $10 billion of servicing, which should close
by the end of the first quarter 1995. The sale will create a better balance
between our restructured origination capabilities and the anticipated run-off of
our remaining $30 billion servicing portfolio.
We expect 1995 to have many of the characteristics of 1994: reduced
originations, industry overcapacity, predatory pricing and downsizing. In this
difficult environment, we believe the actions we took in 1994 will prove to be
beneficial in achieving our 1995 goals.
/s/James A. Conrad
James A. Conrad, President and CEO
Source One Mortgage Services Corp.
4
THE FUND AMERICAN FAMILY
Source One Mortgage Services Corporation has been part of the Fund American
family since 1986. Several other companies joined our small circle just this
year: Financial Security Assurance in April, and Main Street America and White
Mountains at year-end. Below, each management team discusses their enterprise.
SOURCE ONE MORTGAGE SERVICES CORPORATION
Jim Conrad, President and CEO
Bob Richards, Chairman
The company that was to become Source One was founded
in 1946. Source One originates, sells and services
residential mortgages. Built around the American dream
of home ownership, our company grew from a single office
with four employees to one of the nation's leading
mortgage bankers. Headquartered in Farmington Hills,
Michigan, Source One finished 1994 with a $40 billion
servicing portfolio. Nineteen hundred Source One
employees serve more than 550,000 customers through 161
branches around the country.
[PHOTO 2 APPEARS HERE]
We create value by (1) producing loans through a large,
multi-channeled production franchise with significant
retail origination capabilities, (2) building and
administering a large, high-quality servicing portfolio,
and (3) employing technology to drive down servicing and
production costs. We strive to be the low cost operator
on both sides of the business.
PRODUCTION
Source One's retail network is one of the most geographically diverse in the
industry, spanning 28 states. We have located our 161 branches to focus on
demographically attractive growth areas. Wholesale originations are coordinated
through the company's Whole Loan, Broker, and Correspondent sales channels and
come from a network of banks, thrift institutions, and mortgage brokers. Source
One's multiple origination channels make it possible to shift production as
market conditions warrant, emphasizing the mode which is most economically
advantageous at the time.
SERVICING
Our servicing operation has achieved cost, quality and productivity standards
significantly better than the industry. This efficiency is the result of
economies of scale, sophisticated collection and loss-mitigation techniques, and
a flexible customized in-house computer system designed to deliver superior
customer service and reduce the per-unit labor content. The exceptional
productivity of our employees is recognized throughout the industry.
5
FAIR LENDING
Since the beginning, we have been committed to providing equal credit
opportunity to all of our customers. We followed fair lending principles long
before current legislation was proposed, and we continue to provide on-going
training in this important area for all employees.
In addition, we initiated an affordable
housing plan designed to help low and
moderate income people achieve their dream
of home ownership. Our counselors educate
affordable housing candidates at every step [PHOTO 3 APPEARS HERE]
of the mortgage application process, and
provide financial counseling prior to loan
application and throughout the life of the
loan.
As an example of our commitment, we were instrumental in organizing a major
homebuying fair in Detroit which drew more than 3,000 potential low and moderate
income first time homebuyers. As we told you last year, we are proud to say
that for nearly fifty years we have been financing the future for America's
homeowners.
FINANCIAL SECURITY ASSURANCE
Bob Cochran, President and CEO
Roger Taylor, Managing Director and Chief Operating Officer
A little over ten years ago, a group of us who had participated in the early
development of municipal bond insurance got together to create a new company
that would apply the same concept to the asset-backed
bond market. We had seen first-hand how financial
guarantees added efficiency and liquidity to the
municipal bond market, and we believed that insurance
could do the same in the then-emerging asset-backed bond
[PHOTO 4 APPEARS HERE] market. We established FSA in July 1985 with about $200
million of capital. FSA was the first Triple-A rated
monoline bond insurer to promote the use of financial
guaranty insurance in the taxable domestic and
international debt markets.
FSA guarantees scheduled principal and interest payments on securities. Issuers
use our guaranty to lower their cost of funds and broaden the distribution of
their securities. Investors rely on the guaranty not only for default protection
but also to enhance liquidity, mitigate the risk of issuer downgrades and
simplify the investment decision concerning complex securities.
Source One mortgage lenders explain our products to participants in the Detroit
Homebuying Fair. Source One's service was rated the best in the country by
Dalbar, Inc., an Independent, Boston-based customer satisfaction survey firm.
Bob Cochran, right and Roger Taylor head FSA's management team.
6
Today we are the fourth largest financial guaranty insurer, with over half a
billion dollars in shareholders' equity. We are the recognized leader in the
asset-backed market and have developed a substantial and growing position in the
municipal bond insurance market. FSA-guaranteed securities are originated and
distributed in markets around the world.
One of the fundamental strengths of the financial guaranty insurance business is
that transactions we have already insured provide an annuity of future earnings,
because premiums are earned over the life of each insured bond. This gives us a
stable and predictable base of earnings each year going forward, regardless of
year-to-year variations in new business originations.
MUNICIPAL BOND MARKET
With Federal support for schools, hospitals, highways and other municipal
facilities in decline, municipal bonds are the primary financing tools of state
and local governments. Every year, more than 35% of newly issued long-term
municipal bonds are insured by FSA or one of the other Aaa/AAA bond insurers,
and we expect this percentage to grow. While the total market has more than
tripled in size since 1980, the amount insured has grown more than forty times
larger.
ASSET-BACKED MARKET
The asset-backed market is still in a high-growth phase and presents increasing
opportunities for financial guarantors. FSA virtually invented financial
guaranty insurance for asset-backed securities and, for a decade, has led the
market in terms of expertise, technology and the breadth of our involvement.
A large portion of this market consists of issues backed by "commodity" assets,
such as single-family mortgages, auto loans and credit card receivables. We
have succeeded in this part of the market by helping to create customized
securitization programs for issuers that come to market regularly. These
programs, which may be modified to meet issuers changing needs, are a continuing
source of reliable relationship business.
INTERNATIONAL MARKET
FSA was the first monoline guarantor to operate outside the United States,
providing a guaranty for the first U.K. residential mortgage-backed transaction
in 1987. We participated in many other "firsts" since then, including the first
Eurobonds backed by Australian and New Zealand home mortgages, and the first
securitizations of senior loans by French banks. Through our London-based U.K.
subsidiary, we have a "passport" to all the member countries of the European
Union. Our representative office in Sydney has helped FSA become the leading
private guarantor in Australia and has been a base of operations throughout the
Pacific Rim. And through our joint marketing agreement with the Tokio Marine
and Fire Insurance Company, Limited, Japan's oldest and largest property &
casualty insurer, we are supporting Tokio Marine in developing the market for
financial guarantees in Japan.
[PHOTO 5 APPEARS HERE]
Jeff Kramer, left vice president of FSA's Asset Finance Group, on-site at
Chicago's largest authorized Harley-Davidson Motorcycle dealership, with Steven
Dell, CEO of Eaglemark Financial Services, Inc., which provides loans to
purchasers of Harley-Davidson motorcycles. During 1994, FSA guaranteed three
transactions backed by Harley-Davidson motorcycle contracts totaling
approximately $86 million.
7
As we enter 1995, FSA is in a strong capital position. We have the lowest ratio
of insured risk to capital of the top four bond insurers and the highest S&P
margin of safety. We believe that with our superior capital strength and the
financial expertise of our extraordinary people, FSA will continue its success
in its core markets and find new ways to build the company's value.
WHITE MOUNTAINS INSURANCE COMPANY
Tom Kemp, Chairman
Morgan Davis, President and CEO
We formed our property & casualty start-up
at the end of the year, and received our
license from the State of New Hampshire on
[PHOTO # 6 March 3, 1995. Our intention is to build a
APPEARS HERE] book of medium to large commercial business
from the ground up, "brick by brick."
White Mountains' objective is to fill the
market gaps that are developing as many old,
large, national, multiline companies
restructure. The industry has endured
extended market pressures from pricing
competition, economic pressure from
contracting bond portfolios and swelling
long-tail claims, and political pressures
from regulators and ratings agencies. In
this environment, companies are restricting
their writings by line, by geographic
distribution, and by class and risk.
As these insurers restructure and attempt to specialize, they are abandoning
profitable market areas they deem too difficult or expensive to administer from
afar. As a result, local agents are left with fewer choices to satisfy their
customer's needs. Quite often, with the dramatic contraction of suppliers,
agents and their customers have to "take what they can get."
We plan to expand the agent's options.
White Mountains will offer larger business customers the coverages and services
they need in a professional, quality manner, from a local provider who has a
better understanding of the risks involved. The agents we have shared our
concept with are enthusiastic. White Mountains will have its executive offices
in Hanover, New Hampshire, and initially a field office in Manchester, New
Hampshire. We expect to outsource much of our back office support from a third
party to keep expenses low.
We are excited to be building a company with an entrepreneurial culture that is
not encumbered by past underwriting mistakes or bureaucratic baggage.
MAIN STREET AMERICA
Phil Koerner, President and CEO
Tom Van Berkel, Senior Vice President
Over 70 years ago, National Grange Mutual Insurance Company (NGM) was founded to
provide members of the National Grange affordable auto insurance without the
cost of
Tom Kemp, left, Chairman of White Mountains Insurance Company and Morgan Davis,
CEO, show off their newly issued New Hampshire license.
8
"reckless city driver's smash-ups." Clearly our industry, technologies, and the
world around us have metamorphosed dramatically. However, a common purpose and
philosophy connect our seven decades of insurance protection, providing us with
a sense of tradition and stability as we move into the next century.
We were founded to provide affordable insurance for a specific group of people
to whom we could provide value. Today, our mission is much the same: we offer
an array of insurance products and services to people whose needs we understand
and to whom we can provide outstanding service. We have built our organization
around our Mission and our customers.
[PHOTO 7 APPEARS HERE]
Primarily, we sell personal and commercial lines products to Main Street
Americans. This phrase does not describe the location of our customers, but
rather the nature of the risks and the types of insureds we seek out --
customers who are proud of what they own and take measures to protect their
possessions. Our products are geared toward these customers. We offer
homeowners, automobile, contractors and business owners insurance with broad-
based applicability. Often, we say that we have vanilla products with sizzle
endorsements; the products themselves are straightforward in serving the people
of our niche, while the sizzle endorsements contain unique coverages. Together
with our relationships and the service we provide, they help differentiate us.
We are also involved in other areas of the insurance business. Our subsidiary
Information Systems & Services Corporation (ISS) helps us to profit from the
excellent insurance processing systems we developed for NGM. Currently, ISS
provides processing and other insurance services to companies across the nation.
Guiderland Reinsurance Company is a subsidiary offering reinsurance products and
services to other insurance companies. With shared resources and one
organizational body of expertise, these companies work synergistically with NGM
to provide a multitude of insurance services.
As an organization, we have an expression
that we extend to all our insurance publics:
"We take you personally." What started as a
service slogan has become a description of
how we behave toward our customers and co-
[PHOTO # 8 workers. We know that the way we treat one
APPEARS HERE] another and meet the needs of our co-workers
sets the tone for how our customers are
treated on a daily basis, so we honor the
importance of taking one another personally.
These core beliefs are affirmed by the fact
that we have had consistently successful
results for a decade. This pattern of success
enabled us to enter a mutually rewarding
relationship with Fund American. This pattern
of success, and our new relationship, is
something for which all of us at NGM take
considerable pride.
#7
Phil Koemer,right.President and CEO of National Grange Mutual, and Torn
Van Berkel,Senior Vice President.
#8
National Grange Mutual/Main Street America home office in Keene,N.H.
9
FUND AMERICAN
SELECTED CONSOLIDATED FINANCIAL DATA
------------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31,
----------------------------------------------------------------------
Millions, except per share amounts 1994 1993 1992 1991 1990
------------------------------------------------------------------------------------------------------------------------------------
INCOME STATEMENT DATA:
Revenues $ 229 $ 251 $ 214 $ 234 $ 275
Expenses 226 234 191 162 g 232
----------------------------------------------------------------------
Pretax operating earnings 3 17 23 72 43
Net investment gains 39 124 65 112 158
----------------------------------------------------------------------
Pretax earnings 42 141 88 184 201
Income tax provision 21 71 34 64 72
----------------------------------------------------------------------
After tax earnings 21 70 54 120 129
Income from discontinued operations,
after tax - - - - 24
Gain from sale of discontinued
operations, after tax - - 1 1,306 h -
Loss on early extinguishment of debt,
after tax - - - (29) g -
Cumulative effect of accounting change
- purchased mortgage servicing, after
tax (44) a - - - -
Cumulative effect of accounting change
- postretirement benefits, after tax - - (2) e - -
Cumulative effect of accounting change
- income taxes - - (24) f - -
Cumulative effect of transition
adjustment for prior
period net unrealized investment
losses, after tax - - - (84) i -
----------------------------------------------------------------------
Net income (loss) $ (23) $ 70 $ 29 $ 1,313 $ 153
--------------------------------------------------------------======================================================================
Primary earnings per share:
After tax earnings $ 1.20 $ 5.68 $ 2.71 $ 4.87 $ 2.49
Net income (loss) (3.51) a 5.68 .74 67.14 h 3.08
Fully diluted earnings per share:
After tax earnings 1.20 5.68 2.70 4.85 2.55
Net income (loss) (3.51) a 5.68 .73 53.14 h 3.03
Cash dividends per share of common stock - - - .68 .68
ENDING BALANCE SHEET DATA:
Assets of continuing operations $1,807 $ 3,305 $ 3,129 $ 2,964 $ 3,220
Total assets 1,807 3,305 3,129 2,964 h 12,432
Short-term debt 254 1,537 1,513 1,013 g 2,372
Long-term debt 547 601 423 324 g 688
Minority interest - preferred stock of
subsidiary 100 b - - - -
Shareholders' equity 661 c 905 d 988 c 1,496 1,592
Book value per common and equivalent share 68.95 a 77.27 d 80.65 75.49 h 30.65
====================================================================================================================================
(a) Reflects the prior years' cumulative effect of a change in Source One's
methodology used to measure impairment of its purchased mortgage servicing
rights asset. See Note 5 of the Notes to Consolidated Financial Statements.
(b) Reflects the issuance by Source One in the first quarter of 1994 of
perpetual preferred stock. See Note 11 of the Notes to Consolidated
Financial Statements.
(c) Reflects redemptions of the Company's Voting Preferred Stock Series D, par
value $1.00 per share (the "Series D Preferred Stock") and repurchases of
shares of the Company's Common Stock, par value $1.00 per share ("Shares").
See Note 12 of the Notes to Consolidated Financial Statements.
(d) Reflects the distribution of approximately 74% of the outstanding shares of
Common Stock of White River Corporation ("White River") to shareholders on
December 22, 1993 (the "Distribution").
(e) Reflects the prior years' cumulative effect of the adoption of Statement of
Financial Accounting Standards ("SFAS") No. 106, "Employers' Accounting for
Postretirement Benefits Other Than Pensions." See Note 1 of the Notes to
Consolidated Financial Statements.
(f) Reflects the prior years' cumulative effect of the adoption of SFAS No.
109, "Accounting for Income Taxes." See Note 1 of the Notes to
Consolidated Financial Statements.
(g) Reflects the repayment during the first quarter of 1991 of all the parent
company's debt outstanding at December 31, 1990, and the corresponding
reduction in interest expense.
(h) Reflects the sale of Fireman's Fund Insurance Company ("Fireman's Fund").
See Note 2 of the Notes to Consolidated Financial Statements.
(i) Prior to 1991, such net unrealized investment losses were recorded as a
direct adjustment to shareholders' equity, with no corresponding charge to
net income.
10
FUND AMERICAN
MANAGEMENT'S DISCUSSION AND ANALYSIS
CONSOLIDATED RESULTS
RESULTS OF The Company reported a consolidated
OPERATIONS net loss of $23.2 million for the
YEARS ENDED year ended December 31, 1994, which
DECEMBER 31, compares to net income of $70.4
1994, 1993 million for 1993 and $29.2 million
AND 1992 for 1992. The 1994 reported loss
includes a $68.1 million pretax
charge related to the prior years'
cumulative effect of an accounting
change in the manner by which Source
One measures impairment of its
purchased mortgage servicing rights
asset. The 1992 net income amount
includes $25.7 million of charges
related to the prior years'
cumulative effect of adopting two
accounting pronouncements and $47.9
million of pretax writedowns related
to Source One's capitalized mortgage
servicing asset.
Book value per common and common
equivalent share was $68.95 at December
31, 1994, which compares to $77.27 at
December 31, 1993. The 1994 accounting
change and unrealized investment
portfolio losses combined to produce the
net decline in book value per share from
1993 to 1994.
After tax earnings for 1994 were
$21.1 million versus $70.4 million and
$54.2 million for 1993 and 1992,
respectively. The decrease from 1993 to
1994 is primarily due to $73.4 million
of pretax unrealized gains recorded in
earnings for 1993. Under an accounting
rule adopted as of December 31, 1993,
Fund American now records changes in
unrealized gains and losses as a direct
adjustment to shareholders' equity with
no credit or charge to net income. The
increase in after tax earnings from 1992
to 1993 reflects higher net investment
gains included in the income statement.
MORTGAGE ORIGINATION AND SERVICING
OPERATIONS
Effective January 1, 1994, Source One
changed the methodology used to
measure impairment of its purchased
mortgage servicing rights asset.
Previously, Source One measured the
asset's impairment on a disaggregated
basis and used a cost of capital
charge to measure the value of future
servicing cash flows. The new
accounting methodology measures the
asset's impairment on a disaggregated
basis and discounts the asset's
estimated future cash flows using
current market rates. Source One's
management believes that the use of
current market rates to discount cash
flows versus the use of a cost of
capital charge is a preferable
accounting method because it
represents a more conservative and
informative financial statement
presentation of the purchased
mortgage servicing rights asset. The
adoption of the new accounting
methodology, recorded as a cumulative
adjustment as of January 1, 1994,
resulted in a $68.1 million pretax,
$44.3 million after tax charge to
income for 1994. The prospective
effect of the accounting change was a
$2.5 million net pretax charge to
income for 1994.
Source One did not change the
methodology used to measure impairment of
its capitalized excess servicing asset.
Source One continues to measure impairment
using the original discount rate to
discount estimated future excess servicing
cash flows.
During 1993 and 1992 the entire
mortgage banking industry experienced
substantial prepayments in mortgage
servicing portfolios due to refinancings
caused by declines in market interest
rates for mortgage loans. Considering
the substantial amount of refinancing
during 1992, Source One decided to
prospectively measure the recoverability
of its purchased mortgage servicing
rights asset on a disaggregated basis
using a cost of capital charge to
measure the value of future servicing
cash flows.
11
Application of this accounting methodology
resulted in a $38.2 million pretax
reduction in net mortgage servicing
revenue for 1992. In addition, during 1992
Source One recorded unscheduled
amortization totalling $9.7 million to
reflect the effect of high prepayments on
the capitalized mortgage servicing asset.
The high level of prepayments continued in
1993 due to further declines in market
interest rates for mortgage loans,
resulting in additional pretax writedowns
of the capitalized mortgage servicing
asset totalling $32.0 million during 1993.
Net servicing revenue was $82.4 million
for the year ended December 31, 1994.
Excluding the effects of the $32.0 million
and $38.2 million writedowns of the
capitalized mortgage servicing asset in
1993 and 1992, respectively, net servicing
revenue would have been $85.5 million for
1993 and $86.6 million for 1992. The
decrease in net servicing revenue for 1994
compared to 1993 reflects lower weighted
average net servicing fee rates on newly
originated loans partially offset by
slower amortization of the capitalized
mortgage servicing asset. The decrease in
1993 was primarily due to a lower average
servicing portfolio compared to 1992. A
summary of the mortgage loan servicing
portfolio activity follows:
-----------------------------------------------------------------------
Year Ended December 31,
---------------------------------
Billions 1994 1993 1992
-----------------------------------------------------------------------
Beginning balance $ 38.4 $ 37.3 $ 41.0
Mortgage loan production 4.6 11.5 7.6
Servicing acquisitions 3.7 6.4 2.3
Payoffs (4.7) (13.6) (11.5)
Servicing released, principal
amortization and foreclosures (2.4) (3.2) (2.1)
----------------------------------
Ending balance $ 39.6 $ 38.4 $ 37.3
=======================================================================
The increase in market interest rates for
mortgage loans resulted in a sharp
decrease in loan prepayments from the
mortgage loan servicing portfolio during
1994. Source One's prepayment rates for
the years ended December 31, 1994, 1993
and 1992 were 13%, 39% and 30%,
respectively.
The payoff rate used to estimate
future servicing cash flows for measuring
impairment is based on current median
prepayment estimates by interest rate and
origination date, as compiled by several
large brokerage firms. During 1994 the
discount rate used to discount the future
cash flows of the purchased mortgage
servicing rights asset was based on
current market interest rates used for
mortgage servicing sales as quoted by
industry brokers. The discount rate ranged
from 8.59% to 12.55% for the year ended
December 31, 1994. In 1993 and 1992 the
interest component used to measure the
value of the future cash flows of the
purchased mortgage servicing rights asset
was developed based on the most recent
twelve-month average cost of capital
including the actual cost of debt and
dividends paid on Source One's equity
capital. These rates were 2.72% and 3.00%
for the years ended December 31, 1993 and
1992, respectively.
In June 1994 the Financial Accounting
Standards Board issued an exposure draft
entitled "Accounting for Mortgage
Servicing Rights and Excess Servicing
Receivables and for Securitization of
Mortgage Loans." The exposure draft, in
its current form, would require entities
to (i) capitalize originated servicing
rights and (ii) measure impairment of all
capitalized servicing on a disaggregated
basis by stratifying the capitalized
mortgage servicing asset based on the risk
characteristics of the underlying loans.
Impairment would be recognized through a
valuation allowance for an individual
stratum with a
12
corresponding charge to expense. The
proposed statement would be applied
prospectively in years beginning after
December 15, 1995 to transactions
involving the capitalization of originated
servicing rights and to impairment
evaluations to all capitalized servicing
rights. Retroactive application would be
prohibited. The proposed statement, if
adopted in its current form, could have a
substantial impact on Source One's
financial condition and results of
operations in the future. However, since
no final pronouncement has been issued,
management is not able to predict with any
reliability whether such pronouncement may
ultimately be adopted and what impact, if
any, it would have on Source One's
financial condition and results of
operations.
During the second quarter of 1994
Source One sold the rights to service $3.9
billion of mortgage loans to a third party
for cash proceeds of $70.2 million. Source
One has continued to service these loans
pursuant to a subservicing agreement.
Accordingly, the related $19.9 million
gain from the sale was deferred and is
being recognized in income over the five-
year life of the subservicing agreement.
For the year ended December 31, 1994,
Source One recognized $2.7 million of the
deferred gain which is included in net
servicing revenue. The mortgage servicing
portfolio at December 31, 1994 includes
loans subserviced for others having a
principal balance totalling $4.3 billion.
In February 1995 Source One reached a
definitive agreement to sell $9.8 billion
of its mortgage servicing portfolio to a
third party for estimated proceeds of
$190.0 million. The transaction is
expected to result in a pretax gain in the
first quarter of 1995 of approximately
$28.2 million. The portion of Source One's
mortgage servicing portfolio that will be
sold consists of approximately 115,000
loans with a weighted average interest
rate of 7.72% and is representative of
the entire mortgage servicing portfolio.
The sale of mortgage servicing was
undertaken by Source One to take advantage
of the substantial increase in the value
of servicing rights that has been created
by the rise in interest rates during 1994.
The decreases in mortgage loan
production and payoffs in 1994 reflect an
increase in market interest rates and a
corresponding reduction in refinancing
activity from prior year levels.
Production related to refinance activity
represented approximately 50%, 67% and 60%
of total mortgage loan production for the
years ended December 31, 1994, 1993 and
1992, respectively.
The net gain on sales of mortgages
decreased to $29.5 million for the year
ended December 31, 1994 from $34.8 million
in 1993. The net gain on sales of
mortgages totalled $17.1 million for the
year ended December 31, 1992. The decrease
in the net gain from 1993 to 1994 reflects
lower mortgage loan sales volume due to
the reduction in mortgage loan production
and increased pricing subsidies on newly
originated loans during the second half of
1994. The increase in the net gain from
1992 to 1993 was attributable to larger
mortgage loan sales volume due to
increased mortgage loan production and a
more favorable secondary market
environment.
Other mortgage operations revenue
decreased to $23.9 million for the year
ended December 31, 1994 from $29.2 million
in 1993. Other mortgage operations revenue
was $21.0 million for the year ended
December 31, 1992. Loan processing fees,
which generally represent approximately
80% of other mortgage operations revenue,
tend to decrease or increase as mortgage
loan production decreases or increases,
respectively.
13
INVESTMENT OPERATIONS
The total return from Fund American's investment
activities is shown below:
-------------------------------------------------------------------------------------
Year Ended December 31,
-----------------------------
Millions 1994 1993 1992
-------------------------------------------------------------------------------------
Net investment income and other revenue:
Source One $ 71.5 $117.0 $103.6
Other 18.7 16.5 24.0
-----------------------------
Total net investment income and other revenue 90.2 133.5 127.6
-----------------------------
Net realized investment gains 38.8 50.6 11.0
Change in net unrealized investment
gains and losses:
Included in net income - 73.4 54.3
Recorded directly to shareholders' equity (84.3) 69.9 17.9
-----------------------------
Total net investment gains (losses), before tax (45.5) 193.9 83.2
-----------------------------
Total net investment return, before tax $ 44.7 $327.4 $210.8
=====================================================================================
Fund American's net investment income is comprised
primarily of interest income earned on mortgage loans
originated by Source One. The decrease in Source One's
net investment income from 1993 to 1994 is mainly
attributable to decreased interest income from mortgage
loans held for sale related to the lower mortgage loan
production experienced during 1994. The increase in
other net investment income from 1993 to 1994 resulted
from a second quarter 1994 transfer of $112.0 million of
common equity securities from Source One to its parent,
Fund American Enterprises, Inc. ("FAE", a subsidiary of
the Company), in exchange for shares of Source One's
common stock held by FAE. Prior to such transfer, the
net investment income relating to the securities
transferred was included in net investment income of
Source One. The decrease in other net investment income
from 1992 to 1993 resulted from net sales of investment
securities. Cash basis sales and maturities of common
equity securities and other investments, net of
purchases, totalled $151.9 million, $115.0 million and
$263.4 million for the years ended December 31, 1994,
1993 and 1992, respectively.
Net realized investment gains during 1994, before
tax, included $22.6 million of gains from the sale of
The Louisiana Land and Exploration Company common stock
and $21.7 million of gains from the sale of American
Express Company common stock. Net realized gains during
1993, before tax, included $14.0 million of gains from
the sale of A. H. Belo common stock and $13.2 million of
gains from the sale of San Juan Basin Royalty Trust
units. Net realized investment gains during 1992, before
tax, included $46.6 million of gains from the sale of
MBIA Inc. common stock.
Total investment gains and losses during the three
years ended December 31, 1994 have been substantially
affected by changes in market prices for crude oil and
natural gas. At December 31, 1994, 62% of Fund
American's portfolio of common equity securities was
invested in the energy, natural resources and related
industries sector. Fund American believes that the oil
and natural gas industries are highly cyclical and,
therefore, anticipates continued volatility in the value
of its investment portfolio in the future.
14
Prior to December 31, 1993 Source One carried
its portfolio of common equity securities at the lower
of its aggregate cost or market value as of the balance
sheet date. Changes in Source One's market valuation
allowance for this portfolio were recorded as a direct
adjustment to shareholders' equity (net of tax) with no
credit or charge to net income. Additionally, prior to
December 31, 1993, common equity securities and other
investments held by Fund American, other than securities
held by Source One, were carried at fair value as of the
balance sheet date with related unrealized gains and
losses included in net income.
As of December 31, 1993 Fund American adopted SFAS
No. 115, "Accounting for Certain Investments in Debt and
Equity Securities." Under the provisions of SFAS No.
115, substantially all of Fund American's portfolio of
common equity securities and other investments were
classified as securities available for sale. The
statement requires that investments classified as
securities available for sale be reported at fair value
as of the balance sheet date, with related unrealized
gains and losses excluded from earnings and reported as
a net amount in a separate component of shareholders'
equity. Therefore, for periods beginning after December
31, 1993, all of Fund American's net unrealized gains
and losses are reported as a direct adjustment to
shareholders' equity with no credit or charge to net
income.
A review of certain significant holdings in Fund
American's portfolio of common equity securities at
December 31, 1994 follows. Dollar amounts refer to the
aggregate market value at December 31, 1994 of Fund
American's holdings of each security discussed.
Energy, Natural Resources and Related Industries.
-------------------------------------------------
The energy and natural resources industries,
particularly the crude oil and natural gas industries,
are highly competitive, require significant capital
expenditures and are subject to extensive regulation at
both the national and local levels. Fund American
believes that the values of securities of companies
engaged in those businesses are relatively volatile due
to fluctuations in the prices of crude oil, natural gas
and other natural resources. Fund American's holdings
within the energy, natural resources and related
industries sector consist in great part of large blocks
of securities of a small number of issuers. This
concentration may make the value of Fund American's
portfolio more volatile than the value of a more
diversified portfolio.
The Louisiana Land & Exploration Company ("LLX";
$106.5 million). LLX is one of the largest independent
exploration and production companies in the nation. LLX
explores for, produces and markets crude oil and natural
gas in the United States and certain foreign countries.
Fund American believes that LLX's operations are
affected by, among other things, changes in the prices
of crude oil and natural gas, general economic
conditions and LLX's ability to successfully produce and
replace crude oil and natural gas reserves.
San Juan Basin Royalty Trust ("San Juan"; $70.1
million). San Juan units receive a 75% net overriding
royalty interest from certain of Southland Royalty
Company's leasehold and royalty interests in the San
Juan Basin of Northwestern New Mexico. Fund American
believes that changes in crude oil and natural gas
prices and in the level of development and production
expenditures by the operator of San Juan may affect the
distributions to unitholders of San Juan and, therefore,
the market prices of the units of San Juan. In addition,
Fund American believes that the tax and accounting
issues involved in owning units in San Juan may make
such units unappealing to many investors.
15
Other Significant Holdings.
--------------------------
American Express Company ("AXP"; $70.9 million).
AXP is a financial services, travel and information
services company which is actively traded on the New
York Stock Exchange. Fund American believes that its
investment in the common stock of AXP is highly liquid.
EXPENSES
Interest expense decreased to $78.8 million in 1994
which compares to $103.1 million for 1993 and $77.5
million for 1992. The decrease in interest expense from
1993 to 1994 relates primarily to a decrease in short-
term borrowings. Source One's inventory of mortgage
loans held for sale, which decreased during 1994 as a
result of lower mortgage loan production, is funded
mainly with short-term debt. The increase in interest
expense from 1992 to 1993 relates primarily to the
issuance by the parent company of $150.0 million in
principal amount of medium-term notes in the first
quarter of 1993 and an increase in the average balance
of total debt outstanding at Source One. The increase in
the average balance of Source One's debt from 1992 to
1993 reflects a higher average balance of mortgage loans
held for sale related to increased mortgage loan
production.
Compensation and benefits expense increased to
$69.2 million in 1994 from $63.5 million in 1993 and
$61.1 million in 1992. Source One nets mortgage loan
origination fees, less certain direct costs, against
compensation and benefits expense. The high amount of
originations experienced by Source One during 1993
resulted in significantly more origination fees
offsetting compensation and benefits for 1993 than in
1994. Excluding the effects of such loan origination
fees, compensation and benefits expense decreased $39.0
million from 1993 to 1994, reflecting significant
reductions in production-related personnel at Source One
during 1994.
General expenses of $77.7 million for 1994 compare
to 1993 and 1992 amounts of $67.5 million and $53.0
million, respectively. The increase in general expenses
from 1993 to 1994 is due to the expansion of Source
One's mortgage loan production network throughout 1993
and early 1994. Efforts to reduce Source One's operating
expenses in response to the contraction in mortgage
originations began to take effect in the third quarter
of 1994.
Source One's provision for mortgage loan losses,
included in general expenses, was $8.2 million in 1994
which compares to $3.7 million for 1993 and $4.9 million
for 1992. The increase from 1993 to 1994 is primarily
due to charge-offs of certain commercial real estate
owned properties and higher average loss volumes
relating to certain California residential mortgage
loans.
Fund American adopted during 1992 the provisions of
SFAS No. 106 which relates to employee postretirement
benefits other than pensions. The prior years'
cumulative effect of SFAS No. 106, recorded as of
January 1, 1992, was $1.9 million and was net of a $1.0
million income tax benefit.
16
INCOME TAXES
The income tax provision related to pretax earnings for
1994, 1993 and 1992 represents an effective tax rate of
49.3%, 50.1% and 38.2%, respectively. The income tax
provision for 1994, 1993 and 1992 reflects $4.6 million,
$2.4 million and $4.5 million of expense, respectively,
related to certain tax reserve adjustments. The tax
provision for 1993 also includes $13.0 million of
current income tax relating to taxable capital gains
triggered by the Distribution of approximately 74% of
the shares of Common Stock of White River to
shareholders on December 22, 1993. Such gains were not
recognized for financial reporting purposes pursuant to
generally accepted accounting principles ("GAAP"). The
1993 provision also includes $4.7 million of deferred
income tax reflecting a tax reserve established on White
River's books of record as of December 22, 1993, the
date of the Distribution. The reserve offsets White
River's deferred tax asset calculated on a stand-alone
basis as of that date.
Fund American has recorded a net deferred Federal
income tax asset of $21.4 million as of December 31,
1994. The deferred tax asset includes a $23.9 million
net benefit related to various operating items partially
offset by a $2.5 million net liability related to
unrealized gains on investment securities.
Fund American adopted during 1992 the provisions of
SFAS No. 109 which established new accounting rules for
income taxes. The catch-up charge to net income for SFAS
No. 109 was $23.8 million, or $1.88 per share for the
full year 1992. The SFAS No. 109 adjustments relate
principally to deferred tax liabilities on intangible
assets arising from Fund American's acquisition of
Source One in 1986. SFAS No. 109 requires the recording
of deferred tax liabilities as if these assets were to
be sold.
OTHER
On December 22, 1993 the Company distributed
approximately 74% of the outstanding shares of Common
Stock of White River to its shareholders. White River
commenced operations on September 24, 1993, concurrent
with the purchase and other transfer of selected assets
and the assumption of certain liabilities from Fund
American. The assets sold or otherwise transferred by
Fund American to White River included primarily $84.0
million of common equity securities, $147.1 million of
securities classified as other investments and $25.8
million of short-term investments. White River's initial
capitalization consisted of a $50.0 million demand note
payable to Fund American, $7.0 million of redeemable
preferred stock and $200.0 million of common
shareholder's equity. Of the shares of Common Stock of
White River retained by Fund American, 980,507, or
approximately 15% of the total shares of Common Stock of
White River outstanding as of September 24, 1993, were
reserved by Fund American for delivery upon exercise of
existing employee stock options and warrants.
On January 2, 1991, pursuant to an agreement
originally announced on August 2, 1990, the Company sold
its principal operating business, Fireman's Fund, to
Allianz of America, Inc. for $2,908.7 million in cash.
Fireman's Fund included substantially all Fund
American's property-casualty insurance operations. The
reported gain from the sale, calculated in accordance
with GAAP, was $1,305.7 million after tax for the year
ended December 31, 1991. An additional $.7 million gain
was recorded during 1992 as a result of adjustments to
the net proceeds of the sale related to certain employee
benefit plans. The 1991 gain includes a $75.0 million
tax benefit related to the Company's estimated tax loss
on the sale. The amount of tax benefit from the sale
ultimately realized by the Company may be significantly
more or less than the Company's current estimate due to
possible changes in or new interpretations of tax
17
rules, possible amendments to Fund American's 1990 or
prior years' Federal income tax returns, the results of
Internal Revenue Service audits and other matters
affecting the amount of the deductible tax loss. The
Company has included in other liabilities an estimated
reserve related to such matters affecting the amount of
the deductible tax loss and other tax matters. Such
reserve totalled $78.6 million as of December 31, 1994.
LIQUIDITY AND PARENT COMPANY
CAPITAL
RESOURCES The primary sources of cash inflows for the Company are
investment income, sales of investment securities and
dividends received from its operating subsidiaries.
Since the sale of Fireman's Fund, the Company has been
gradually liquidating its portfolio of passive
investment securities. Management's primary strategic
goal is to reinvest the Company's passive investments
(or proceeds from sales thereof), together with other
resources available to the Company, into operating
businesses in which management has knowledge and
experience. Management believes that this strategy will,
over time, further enhance shareholder value if
appropriate opportunities can be found. Management
currently intends to develop or pursue investments in or
acquisitions of one or more businesses, primarily in the
mortgage origination and servicing, insurance or other
financial services industries. Such acquisitions could
be made by means of purchases of securities for cash or
in exchange for certain of Fund American's investment
holdings. In connection with any acquisitions, Fund
American may sell or otherwise dispose of a portion of
its assets.
In May 1994 the Company purchased 2,000,000 shares
of FSA common stock from U S WEST Capital Corp., a
wholly-owned subsidiary of U S WEST, Inc., as part of an
initial public offering of 8,082,385 shares of FSA's
common stock at the initial offering price of $20.00 per
share. The Company's initial stake represented a 7.6%
ownership of FSA. The Company's Chairman, John J. Byrne,
also became Chairman of FSA. FSA conducts operations
principally through Financial Security Assurance Inc., a
wholly-owned monoline financial guarantee insurance
subsidiary with Aaa/AAA claims-paying ratings. FSA is
principally engaged in guaranteeing municipal bonds and
residential mortgage and other asset-backed securities.
Following receipt of regulatory approvals, in
September 1994 the Company acquired additional rights
and securities whereby it substantially increased its
holdings and voting control in FSA. Such additional
rights and securities include (i) various fixed price
options and shares of convertible preferred stock which,
in total, give the Company the right to acquire over the
next five to ten years up to 4,560,607 additional shares
of FSA common stock for aggregate consideration of
$125.7 million, and (ii) a "call right" which, in
general, gives the Company the right through November
13, 1995, to acquire up to 9,000,000 additional shares
of FSA common stock for per share consideration equal to
the higher of (a) market price or (b) a fixed price
ranging from $29.00 to $30.50. The Company also has a
right of first offer through November 13, 1995, relating
to the same 9,000,000 shares of common stock. All shares
of FSA common stock owned or acquired by the Company as
described above are subject to certain restrictions on
transfer, voting provisions and other limitations and
requirements set forth in a Shareholders' Agreement, a
Registration Rights Agreement and a Voting Trust
Agreement.
The Company purchased an additional 460,200 shares
of FSA Common Stock on the open market in the first
quarter of 1995 for $8.8 million which raised its voting
control of FSA to approximately 23%.
18
In December 1994 the Company purchased a 33%
interest of property-casualty insurer Main Street
America Holdings, Inc. ("MSA"), a unit of National
Grange Mutual Insurance Company ("NGM"), for $25.0
million in cash. MSA shares in 40% of NGM's business
through a reinsurance agreement.
On February 7, 1995 the Company capitalized its
newly formed subsidiary, White Mountains, with $25.0
million in cash. In March 1995 White Mountains received
its license from the Insurance Commissioner of the State
of New Hampshire to engage in the sale of property
casualty insurance. White Mountains is expected to
expand its operations to other states as additional
approvals are obtained.
In June 1994 the Company entered into a revolving
credit agreement with a syndicate of banks. Under the
agreement, through June 1, 1995, the Company and certain
of its subsidiaries may borrow at market interest rates
up to $75.0 million. The credit agreement contains
certain customary covenants, including a $525.0 million
minimum tangible net worth requirement and a minimum
asset coverage requirement. At December 31, 1994 the
Company had no borrowings outstanding under this
agreement.
During January and February 1993 the Company issued
$150.0 million in principal amount of medium-term notes
for net cash proceeds of $148.0 million after related
costs. Proceeds from the issuance of the notes were used
to repay an existing $100.0 million revolving credit
facility and for general corporate purposes. In June
1994 the Company repurchased $25.0 million in principal
amount of the notes. At December 31, 1994 the remaining
outstanding notes had an average maturity of 8.38 years
and an average yield to maturity of 7.82%.
On July 13, 1992 the Company redeemed 51,389 shares
of the Series D Preferred Stock for $185.0 million. In
August 1994 the Company redeemed an additional 22,778
shares of the Series D Preferred Stock for $82.0
million. The redemption price for the shares of Series D
Preferred Stock redeemed was equal to the stock's
liquidation preference. In accordance with the terms of
the Series D Preferred Stock, the redemption date for
the remaining 20,833 shares of the Series D Preferred
Stock outstanding was extended from July 31, 1994 to
July 31, 1995 and the annual dividend rate was increased
from 7.75% to 8.75% on August 1, 1994. The Company may,
at its option, extend the redemption date for the Series
D Preferred Stock for one more year, to July 31, 1996,
which would require a further increase in the dividend
rate to 9.75%.
During 1994, 1993 and 1992 the Company repurchased
1,128,057 Shares, 536,247 Shares and 5,314,518 Shares,
respectively, for $78.8 million, $41.8 million and
$371.7 million, respectively. The bulk of the Shares
repurchased during 1992 were acquired pursuant to a Plan
of Complete Liquidation which was terminated in June
1992. The Shares repurchased during 1993 and 1994
represent a return of excess capital to the Company's
shareholders.
On February 21, 1995 the Company commenced a self-
tender offer for 750,000 Shares for $75.00 per Share in
cash, or an aggregate purchase price of $56.4 million
including related costs. The tender offer expires on
March 20, 1995 and, if fully subscribed, would exhaust
the Company's remaining Share repurchase authorization.
19
The Company currently does not pay regular cash
dividends to holders of Shares, and the Company's Board
of Directors (the "Board") currently does not intend to
reinstate regular periodic dividends on Shares. However,
the Board currently intends to reconsider from time to
time the declaration of regular periodic dividends on
Shares with due consideration given to the financial
characteristics of Fund American's remaining invested
assets and operations and the amount and regularity of
its cash flows at the time. There can be no assurance,
therefore, as to whether or when the Board will declare
additional dividends on Shares.
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
liquidity needs.
Source One's working capital requirements have
historically been funded through its revolving credit
and commercial paper programs. These borrowings are used
to fund mortgage loan production until the sale of such
mortgage loans in the secondary market. Declines in
mortgage loan production have led to a reduction in the
balance of mortgage loans held for sale during 1994,
resulting in a corresponding decrease in Source One's
short-term borrowings.
In August 1994 Source One replaced its then
existing credit agreements with three new credit
facilities totalling $900.0 million. At Source One's
request, such facilities were reduced to an aggregate
amount of $800.0 million in November 1994. The new
facilities, together with $325.0 million aggregate
principal amount of publicly issued debt securities, are
secured primarily by Source One's mortgage loans held
for sale and mortgage loan servicing portfolio. One
facility in the amount of $250.0 million matures on July
31, 1995 and the remaining two facilities in the amounts
of $150.0 million and $400.0 million mature on June 30,
1997 and July 31, 1997, respectively. At December 31,
1994 there was $195.0 million outstanding under these
secured credit facilities.
Source One's secured credit facilities currently
contain covenants which limit its ability to pay
dividends or make distributions on its capital in excess
of $9.0 million of cash dividends on preferred stock
each year. Source One is in the process of re-
negotiating this covenant to increase the
dividend/distribution capacity thereunder. The covenants
also require Source One to maintain a certain level of
total tangible net worth and a certain ratio of debt to
total tangible net worth. Source One is currently in
compliance with all such covenants.
Under the credit agreements described above, Source
One receives interest expense credits as a result of
holding escrow and custodial funds in trust accounts at
non-affiliated banks.
Source One also has a revolving credit agreement
under which it can borrow up to $10.0 million. At
December 31, 1994 and 1993, there was $3.8 million and
$2.5 million outstanding under this agreement,
respectively.
Prior to August 1994 Source One could borrow at
floating rates up to $725.0 million under revolving
credit agreements. Source One also had bid loan
facilities to augment those credit agreements which
allowed Source One to borrow additional amounts in a bid
process. At December 31, 1993 Source One had $725.0
million outstanding under the revolving credit
agreements and $236.9 million outstanding in bid loans.
20
Source One has a $650.0 million domestic and Euro
commercial paper program. The weighted average number of
days to maturity of commercial paper outstanding at
December 31, 1994 was 10 days. At December 31, 1994 and
1993 there was $26.1 million and $574.0 million of
commercial paper outstanding, respectively.
In June 1992 Source One issued $100.0 million
principal amount of 9% debentures due in June 2012 under
terms of a $250.0 million shelf registration statement
filed in April 1992. The proceeds from issuance were
used for general corporate purposes.
In October 1991 Source One issued $160.0 million of
medium-term notes under terms of a $200.0 million shelf
registration statement filed in November 1988. The notes
are due in October 2001 and bear interest at a rate of
8.875%.
In 1989 Source One issued $40.0 million of medium-
term notes having a weighted average interest rate of
9.65% and due in 1996.
In 1986 Source One issued $125.0 million of 8.25%
debentures due November 1, 1996.
In March 1994 Source One issued 4,000,000 shares of
8.42% perpetual Cumulative Preferred Stock, Series A,
having an aggregate liquidation preference of $25.00 per
Share, for net cash proceeds of $96.9 million. The
Source One preferred stock is not redeemable prior to
May 1, 1999.
INFLATION Inflation affects Source One most significantly in
the area of loan originations. Interest rates normally
increase during periods of high inflation and decrease
during periods of low inflation. Historically, Source
One's loan originations have increased in response to
falling interest rates and have decreased during
periods of rising interest rates. However, higher
interest rate environments typically enhance the value
of Source One's mortgage loan servicing portfolio due
to related declines in refinancing activity. Lower
interest rates generally result in higher payoffs and,
therefore, typically reduce the value of the mortgage
loan servicing portfolio.
21
FUND AMERICAN
CONSOLIDATED BALANCE SHEETS
December 31,
Dollars in millions 1994 1993
ASSETS
Common equity securities, at market value (cost $294.2 and $464.3) $ 332.4 $ 585.5
Other investments (cost $163.6 and $120.3) 157.3 113.4
Short-term investments, at amortized cost (which approximated market value) 119.2 252.5
------------------------
Total investments 608.9 951.4
Cash 1.5 10.7
Capitalized mortgage servicing, net of accumulated amortization 530.5 666.7
Mortgage loans held for sale 210.5 1,298.5
Pool loan purchases 163.9 155.5
Mortgage claims receivable and real estate acquired,
less allowance for mortgage loan losses of $13.4 and $16.0 49.8 46.4
Investments in unconsolidated affiliates 69.7 -
Goodwill 28.0 30.4
Other assets 144.5 145.4
------------------------
Total assets $ 1,807.3 $ 3,305.0
============================================================================================================
LIABILITIES
Short-term debt $ 254.1 $ 1,536.8
Long-term debt 547.0 601.3
Accounts payable and other liabilities 245.1 261.9
-------------------------
Total liabilities 1,046.2 2,400.0
------------------------------------------------------------------------------------------------------------
MINORITY INTEREST - PREFERRED STOCK OF SUBSIDIARY 100.0 -
------------------------------------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY
Preferred stock - authorized 10,000,000 shares,
Series D voting preferred stock, issued 20,833 and 43,611 shares 75.0 157.0
Common stock - authorized 125,000,000 shares,
issued 33,597,147 and 34,725,204 shares 33.6 34.7
Common paid-in surplus 338.1 349.5
Retained earnings 1,098.2 1,198.6
Common stock in treasury, at cost: 25,187,210 and 25,317,210 shares (878.5) (884.9)
Net unrealized investment gains 19.7 74.5
Loan for common stock issued (25.0) (24.4)
------------------------
Total shareholders' equity 661.1 905.0
------------------------------------------------------------------------------------------------------------
Total liabilities, minority interest and shareholders' equity $ 1,807.3 $ 3,305.0
============================================================================================================
See Notes to Consolidated Financial Statements.
22
FUND AMERICAN
CONSOLIDATED INCOME STATEMENTS
Year Ended December 31,
Millions, except per share amounts 1994 1993 1992
REVENUES:
Mortgage servicing revenue $169.3 $187.1 $195.8
Amortization of capitalized mortgage servicing 86.9 133.6 147.4
Net mortgage servicing revenue 82.4 53.5 48.4
Net gain on sales of mortgages 29.5 34.8 17.1
Other mortgage operations revenue 23.9 29.2 21.0
Equity in earnings of unconsolidated affiliates 2.5 - -
Net investment income and other revenue 90.2 133.5 127.6
-----------------------------
Total revenues 228.5 251.0 214.1
-------------------------------------------------------------------------------------------------------------------------------
EXPENSES:
Interest expense 78.8 103.1 77.5
Compensation and benefits 69.2 63.5 61.1
General expenses 77.7 67.5 53.0
------------------------------
Total expenses 225.7 234.1 191.6
-------------------------------------------------------------------------------------------------------------------------------
Pretax operating earnings 2.8 16.9 22.5
----------------------------
Net realized investment gains 38.8 50.6 11.0
Change in net unrealized investment gains and losses - 73.4 54.3
----------------------------
NET INVESTMENT GAINS 38.8 124.0 65.3
----------------------------
Pretax earnings 41.6 140.9 87.8
Income tax provision 20.5 70.5 33.6
----------------------------
AFTER TAX EARNINGS 21.1 70.4 54.2
Gain from sale of discontinued operations, after tax - - .7
Cumulative effect of accounting change -
purchased mortgage servicing, after tax (44.3) - -
Cumulative effect of accounting change - postretirement benefits, after tax - - (1.9)
Cumulative effect of accounting change - income taxes - - (23.8)
-----------------------------
NET INCOME (LOSS) (23.2) 70.4 29.2
Less dividends on preferred stock 9.9 12.2 19.9
-----------------------------
Net income (loss) applicable to common stock $(33.1) $ 58.2 $ 9.3
--------------------------------------------------------------------------------------------------=============================
PRIMARY EARNINGS PER SHARE:
After tax earnings $ 1.20 $ 5.68 $ 2.71
Gain from sale of discontinued operations, after tax - - .06
Cumulative effect of accounting changes (4.71) - (2.03)
------------------------------
Net income (loss) $ (3.51) $ 5.68 $ .74
-------------------------------------------------------------------------------------------------==============================
FULLY DILUTED EARNINGS PER SHARE:
After tax earnings $ 1.20 $ 5.68 $ 2.70
Gain from sale of discontinued operations, after tax - - .06
Cumulative effect of accounting changes (4.71) - (2.03)
------------------------------
Net income (loss) $ (3.51) $ 5.68 $ .73
===============================================================================================================================
See Notes to Consolidated Financial Statements.
23
FUND AMERICAN
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Net
Common unrealized Loan for
stock and Common investment common
Preferred paid-in Retained stock in gains stock
Millions Total stock surplus earnings treasury (losses) issued
------------------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1991 $1,496.5 $ 342.0 $450.0 $1,687.2 $(946.9) $(35.8) $ -
Net income 29.2 - - 29.2 - - -
Dividends to preferred stockholders (18.7) - - (18.7) - - -
Redemption of preferred stock (185.0) (185.0) - - - - -
Purchases of common stock retired (371.7) - (58.8) (312.9) - - -
Stock options and warrants exercised
and performance shares awarded 50.0 - (1.1) (9.6) 60.7 - -
Loan for common stock issued (23.8) - - - - - (23.8)
Change in net unrealized investment
gains and losses, after tax 11.8 - - - - 11.8 -
-----------------------------------------------------------------------------------------
Balances at December 31, 1992 988.3 157.0 390.1 1,375.2 (886.2) (24.0) (23.8)
Net income 70.4 - - 70.4 - - -
Dividends to preferred stockholders (12.2) - - (12.2) - - -
Distribution of subsidiary to common
stockholders (146.9) - - (146.9) - - -
Purchases of common stock retired (41.8) - (5.9) (35.9) - - -
Stock options exercised and
performance shares awarded 2.0 - - .7 1.3 - -
Change in net unrealized investment
gains and losses, after tax 23.7 - - - - 23.7 -
Cumulative effect of change in
accounting for investment
securities, after tax 22.1 - - (52.7) - 74.8 -
Other (.6) - - - - - (.6)
------------------------------------------------------------------------------------------
Balances at December 31, 1993 905.0 157.0 384.2 1,198.6 (884.9) 74.5 (24.4)
Net loss (23.2) - - (23.2) - - -
Dividends to preferred stockholders (9.4) - - (9.4) - - -
Redemption of preferred stock (82.0) (82.0) - - - - -
Purchases of common stock retired (78.8) - (12.5) (66.3) - - -
Stock warrants exercised 4.9 - - (1.5) 6.4 - -
Change in net unrealized investment
gains and losses, after tax (54.8) - - - - (54.8) -
Other (.6) - - - - - (.6)
-------------------------------------------------------------------------------------------
BALANCES AT DECEMBER 31, 1994 $ 661.1 $ 75.0 $371.7 $1,098.2 $(878.5) $ 19.7 $(25.0)
==============================================================================================================================
See Notes to Consolidated Financial Statements.
24
FUND AMERICAN
CONSOLIDATED STATEMENTS OF CASH FLOWS
----------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31,
Millions 1994 1993 1992
----------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ (23.2) $ 70.4 $ 29.2
Charges (credits) to reconcile net income (loss) to cash flows from
operations:
Net realized investment gains (38.8) (50.6) (11.0)
Change in net unrealized investment gains and losses - (73.4) (54.3)
Gain from sale of discontinued operations, after tax - - (.7)
Cumulative effect of accounting change - purchased mortgage
servicing, after tax 44.3 - -
Cumulative effect of accounting change - postretirement benefits, after - - 1.9
tax
Cumulative effect of accounting change - income taxes - - 23.8
Decrease (increase) in mortgage loans held for sale 1,088.0 (182.4) (318.8)
Depreciation and amortization of mortgage origination
and servicing assets and goodwill 99.2 142.3 155.1
Capitalized excess mortgage servicing income (16.7) (58.1) (47.1)
Change in current income taxes receivable and payable 22.6 21.2 101.5
Deferred income tax provision (benefit) (1.4) 37.2 14.4
Change in other assets 24.8 (26.9) (7.0)
Change in accounts payable and other liabilities (7.3) (26.1) 9.3
Other, net 2.4 9.7 5.5
--------------------------------------
Net cash flows provided from (used for) operating activities 1,193.9 (136.7) (98.2)
----------------------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Net decrease (increase) in short-term investments 133.3 (10.2) (2.4)
Sales and maturities of common equity securities and other investments 338.2 360.4 282.1
Purchases of common equity securities and other investments (186.3) (245.4) (18.7)
Investments in unconsolidated affiliates (44.0) - -
Collections on mortgage origination and servicing assets 232.3 213.3 179.5
Additions to capitalized mortgage servicing (90.1) (72.2) (119.6)
Proceeds from sales of mortgage servicing 70.2 - -
Additions to other mortgage origination and servicing assets (242.8) (255.9) (247.0)
Purchases of fixed assets, net (3.6) (11.2) (7.4)
Sale of discontinued operations - - (7.9)
-------------------------------------
Net cash provided from (used for) investing activities 207.2 (21.2) 58.6
----------------------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Net (decrease) increase in short-term debt (1,314.5) 21.5 498.5
Proceeds from issuances of long-term debt - 178.0 98.4
Repayments of long-term debt (23.9) - -
Proceeds from issuances of preferred stock by subsidiary 96.9 - -
Redemption of preferred stock (82.0) - (185.0)
Proceeds from issuances of common stock from treasury 2.8 2.1 29.4
Purchases of common stock retired (78.8) (41.8) (371.7)
Cash dividends paid to preferred shareholders (10.8) (12.7) (22.2)
-------------------------------------
Net cash (used for) provided from financing activities (1,410.3) 147.1 47.4
-----------------------------------------------------------------------------------------------------------------------------------
Net (decrease) increase in cash during year (9.2) (10.8) 7.8
Cash balance at beginning of year 10.7 21.5 13.7
------------------------------------
Cash balance at end of year $ 1.5 $ 10.7 $ 21.5
===================================================================================================================================
See Notes to Consolidated Financial Statements.
25
FUND AMERICAN
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF BASIS OF PRESENTATION
SIGNIFICANT The accompanying consolidated financial statements
ACCOUNTING include the accounts of Fund American Enterprises
POLICIES Holdings, Inc. (the "Company") and its subsidiaries
(collectively, "Fund American"). Fund American's
principal business is 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 ("GAAP"). All significant
intercompany transactions have been eliminated in
consolidation. The financial statements include all
adjustments considered necessary by management to fairly
present the financial position, results of operations
and cash flows of Fund American. Certain amounts in the
prior year financial statements have been reclassified
to conform with the current year presentation.
ACCOUNTING STANDARDS RECENTLY ADOPTED
As of December 31, 1994 Fund American adopted the
provisions of Statement of Financial Accounting
Standards ("SFAS") No. 119, "Disclosure about Derivative
Financial Instruments and Fair Value of Financial
Instruments," which requires the disclosure of the
amount, nature, terms, purpose and fair value of
derivative financial instruments. The adoption of SFAS
No. 119 resulted only in additional disclosure
requirements and had no effect on Fund American's
financial position or results of operations.
Prior to December 31, 1993 Source One carried its
portfolio of common equity securities at the lower of
its aggregate cost or market value as of the balance
sheet date. Changes in Source One's market valuation
allowance for this portfolio were recorded as a direct
adjustment to shareholders' equity (net of tax) with no
credit or charge to net income. Common equity securities
held by the Company and its subsidiaries other than
Source One were carried at market value, with related
unrealized gains and losses included in net income. As
of December 31, 1993 Fund American adopted SFAS No. 115,
"Accounting for Certain Investments in Debt and Equity
Securities." Under the provisions of SFAS No. 115,
substantially all of Fund American's portfolio of common
equity securities and other investments were classified
as securities available for sale. The statement requires
that investments classified as securities available for
sale be reported at fair value as of the balance sheet
date, with related unrealized gains and losses excluded
from earnings and instead reported as a net amount in a
separate component of shareholders' equity (net of tax).
During 1992 Fund American adopted SFAS No. 106,
"Employers' Accounting for Postretirement Benefits Other
Than Pensions." SFAS No. 106 requires the cost of such
benefits to be charged to expense during the years that
employees render services.
Also during 1992 Fund American adopted SFAS No. 109,
"Accounting for Income Taxes." SFAS No. 109 established
new accounting rules for income taxes. It requires an
asset and liability approach for financial accounting
and reporting for income taxes.
26
INVESTMENT SECURITIES
Other investments include: fixed income investments
carried at amortized cost which approximated fair value
as of December 31, 1994 and 1993; investment partnership
interests accounted for using the equity method and
carried at internally appraised fair value if such value
differs significantly from the equity basis; certain
preferred and common equity securities having no
established public market value and carried at
internally appraised fair value; certain securities
which, due to restrictions regarding resale, are carried
at a discount to the quoted market value for similar
unrestricted securities; mortgage loans held for
investment; and residual interests in real estate
mortgage investment conduits ("REMICs"). Mortgage loans
held for investment are stated at the lower of cost or
market value, determined on an individual loan basis at
the time the permanent investment decisions were made.
Related discounts, if any, are amortized to income over
the anticipated life of the investment. REMICs are
classified as held to maturity and are carried at
amortized cost using a method which approximates the
effective yield method of amortization.
Short-term investments are carried at amortized
cost which approximated market value as of December 31,
1994 and 1993. Short-term mortgage-backed securities are
classified as trading securities and are stated at fair
value with unrealized gains and losses, if any, reported
in income.
Realized gains and losses resulting from sales of
investment securities or from other than temporary
impairments of value are accounted for using the
specific identification method.
MORTGAGE ORIGINATION AND SERVICING
Fund American acquired Source One in 1986. The purchase
price in excess of historical book value allocated to
goodwill is being amortized over 20 years.
Mortgage loans held for sale are stated at the
lower of aggregate cost or market value.
Conventional residential mortgage loans are placed
on a non-accrual basis when delinquent 90 days or more
as to interest or principal. Interest on delinquent
Federal Housing Administration ("FHA") insured loans is
accrued at the insured rate beginning on the sixty-first
day of delinquency. Interest on delinquent Veterans
Administration ("VA") guaranteed loans is accrued at the
loan rate during the period of delinquency.
Gains and losses from sales of mortgage loans are
recognized when the proceeds are received. Loan
origination fees, net of certain direct costs, have been
deferred and are recognized as income when the related
mortgage loans are sold. Discounts from the origination
of mortgage loans held for sale are deferred and
recognized as adjustments to gains or losses on sales.
Capitalized mortgage servicing includes certain
costs incurred in the acquisition of mortgage servicing
contracts (purchased servicing rights) which are
deferred and amortized using a method that relates the
anticipated net servicing revenue to total projected net
servicing revenue to be received over the expected life
of the loan. The initial amount of capitalized servicing
recorded does not exceed the present value of estimated
future net servicing income. Capitalized servicing also
includes the present value of future servicing revenue
in excess of normal servicing revenue on originated
loans sold with servicing retained (excess servicing)
which is deferred and amortized under a method similar
to that which is used for purchased mortgage servicing
rights.
27
Effective January 1, 1994 Source One changed the
methodology used to measure impairment of its purchased
mortgage servicing rights asset. Previously, Source One
measured the asset's impairment on a disaggregated basis
and used a cost of capital charge to measure the value
of future servicing cash flows. The new accounting
methodology measures the asset's impairment on a
disaggregated basis and discounts the asset's estimated
future cash flows using current market rates. Source One
did not change the methodology used to measure
impairment of its excess servicing asset. Source One
continues to measure impairment using the original
discount rate to discount excess servicing cash flows.
Pool loan purchases, which are carried at cost,
represent FHA insured, VA guaranteed and conventional
loans which were either delinquent or in the process of
foreclosure at the time they were purchased from
Government National Mortgage Association ("GNMA") or
Federal National Mortgage Association ("FNMA") mortgage-
backed security pools which Source One services or, to a
lesser degree, from private investors. Interest is
accrued on these purchased loans at a rate based on
expected recoveries.
Mortgage claims receivable represent claims filed
primarily with FHA and VA. These receivables are carried
at cost less an estimated allowance for amounts which
are not fully recoverable from the claims filed.
Real estate acquired is stated at the lower of net
realizable value or the recorded balance satisfied at
the date of acquisition, as determined on an individual
property basis. Costs related to holding the properties
are charged to expense as incurred.
The allowance for mortgage loan losses is based on
an analysis of the mortgage loan servicing portfolio
and, in management's judgment, is adequate to provide
for estimated losses.
Mortgage servicing revenue represents fees earned
for servicing real estate mortgage loans owned by
investors and late charge income. The servicing fees are
calculated based on the outstanding principal balances
of the loans serviced and are recognized together with
late charge income when received.
EARNINGS PER SHARE
For purposes of earnings per share, common stock
equivalents include stock options, warrants and non-cash
performance shares. The Voting Preferred Stock Series D,
par value $1.00 per share (the "Series D Preferred
Stock") is not a common stock equivalent.
Primary earnings per share amounts are based on the
weighted average number of common shares and dilutive
common stock equivalents outstanding. In the
calculation, income is adjusted for preferred stock
dividends. The weighted average shares used in the
primary computation were 9,405,093; 10,247,746 and
12,697,012 for the years ended December 31, 1994, 1993
and 1992, respectively.
Fully diluted earnings per share amounts are based
on the weighted average number of common shares
outstanding, assuming full dilution. Income is adjusted
for preferred stock dividends when the preferred shares
are anti-dilutive. The weighted average shares used in
the fully diluted computation were 9,408,785; 10,247,746
and 12,725,024 for the years ended December 31, 1994,
1993 and 1992, respectively.
28
FUTURE APPLICATION OF ACCOUNTING STANDARD
In June 1994 the Financial Accounting Board issued an
exposure draft entitled "Accounting for Mortgage
Servicing Rights and Excess Servicing Receivables and
for Securitization of Mortgage Loans." The exposure
draft, in its current form, would require entities to
measure impairment on a disaggregated basis by
stratifying the capitalized mortgage servicing asset
based on the risk characteristics of the underlying
loans. Impairment would be recognized through a
valuation allowance for an individual straturn with a
corresponding charge to expense. The proposed statement
would be applied prospectively in years beginning after
December 15, 1995 to transactions involving the
capitalization of originated servicing rights and to
impairment evaluations of all capitalized servicing
rights. Retroactive application would be prohibited,
although early adoption of the standard would be
allowed. The proposed statement, if adopted in its
current form, could have a substantial impact on Source
One's financial condition and results of operations in
the future. However, since no final pronouncement has
been issued, management is not able to predict with any
reliability whether such pronouncement may ultimately be
adopted and what impact, if any, it would have on Source
One's financial condition and results of operations.
2. SALE OF On January 2, 1991, pursuant to an agreement originally
SUBSIDIARY announced on August 2, 1990, the Company sold its
principal operating business, Fireman's Fund Insurance
Company (together withits insurance subsidiaries,
"Fireman's Fund"), to Allianz of America, Inc. The 1991
gain from the sale includes a $75.0 million tax benefit
related tothe Company's estimated tax loss on the sale.
The amount of tax benefit from the sale ultimately
realized by the Company may be significantly more or
less than the Company's current estimate due to possible
changes in or new interpretations of tax rules, possible
amendments to Fund American's 1990 or prior years'
Federal income tax returns, the results of Internal
Revenue Service audits and other matters affecting the
amount of the deductible tax loss. The Company has
included in other liabilities an estimated reserve
related to such matters affecting the amount of the
deductible tax loss and other tax matters. Such reserve
totalled $78.6 million at December 31, 1994 .
3. INVESTMENT Net investment income and other revenue consisted of the
SECURITIES following:
---------------------------------------------------------------------------------------------
Year Ended December 31,
-------------------------------------
Millions 1994 1993 1992
---------------------------------------------------------------------------------------------
Interest income
Mortgage loans held for sale $ 66.6 $ 88.0 $ 75.6
Short-term investments 7.8 6.4 14.8
Other 5.3 24.3 17.4
-------------------------------------
Total interest income 79.7 118.7 107.8
Dividend and royalty trust income 11.1 15.2 16.6
Other investment revenue .1 2.3 4.9
Less investment expenses (.7) (2.7) (1.7)
-------------------------------------
Net investment income and other revenue, before tax $ 90.2 $133.5 $127.6
=============================================================================================
29
Net realized investment gains and changes in net
unrealized investment gains and losses were as follows:
---------------------------------------------------------------------------------------------------
Year Ended December 31,
------------------------------------------
Millions 1994 1993 1992
---------------------------------------------------------------------------------------------------
Net realized investment gains $ 38.8 $ 50.6 $ 11.0
Net unrealized investment gains (losses):
Included in net income -- 73.4 54.3
Recorded directly to shareholders' equity (84.3) 69.9 17.9
------------------------------------------
Total net investment gains (losses), before tax $(45.5) $193.9 $ 83.2
===================================================================================================
The components of ending net unrealized gains and losses
on common equity securities and other investments were
as follows:
---------------------------------------------------------------------------------------------------
December 31,
------------------------------------------
Millions 1994 1993 1992
---------------------------------------------------------------------------------------------------
Unrealized gains $ 47.3 $145.8 $ 75.8
Unrealized losses (17.0) (31.2) (96.6)
------------------------------------------
Total net investment gains (losses), before tax $ 30.3 $114.6 $(20.6)
===================================================================================================
Non-cash exchanges of investment securities totalling
$.3 million and $39.8 during 1993 and 1992,
respectively, are not reflected in the Consolidated
Statements of Cash Flows.
4. Mortgage Source One services loans throughout the United States.
Origination Source One's portfolio of mortgages serviced, including
and loans subserviced, interim servicing contracts and those
Servicing under contract to acquire, totalled $39.6 billion and $38.4
billion as of December 31, 1994 and 1993, respectively,
including GNMA guaranteed mortgage-backed securities of $11.9
billion and $11.4 billion, respectively. The following table
summarizes the mortgage loan servicing portfolio:
---------------------------------------------------------------------------------------------------
Weighted average
-------------------------------------------------------
Outstanding Remaining
principal Loan Net contractual
balance balance Interest servicing life
(millions) (thousands) rate fee rate (months)
---------------------------------------------------------------------------------------------------
Loan Type:
Residential:
Conventional $25,279 $ 85 7.96% .397% 257
FHA 8,127 51 8.59 .440 287
VA 4,420 51 8.37 .431 275
Commercial 91 618 7.60 .177 176
-----------
37,917 70 8.14 .410 265
Interim servicing 1,651
-----------
Total servicing portfolio $39,568
===================================================================================================
30
The servicing fee rates in the preceding table are shown
after deducting applicable guarantee fees and before the
effect of amortization of capitalized servicing.
Guarantee fees range from six basis points for
governmental loans to approximately 30 basis points for
certain conventional loans. Certain loans sold to
private investors have no guarantee fees.
The following tables summarize Source One's
mortgage loan servicing portfolio by interest rate range
and by location of property:
------------------------------------------------------------------------------------------
December 31, 1994 December 31, 1993
--------------------------------- ---------------------------------
Aggregate Weighted Aggregate Weighted
Number principal average Number principal average
Interest rate of balance interest of balance interest
range loans (millions) rate loans (millions) rate
----------------- --------------------------------- ---------------------------------
5.99% and lower 6,597 $ 318 5.37% 9,685 $ 422 5.25%
6.00%-6.49% 11,887 800 6.21 10,680 639 6.17
6.50%-6.99% 37,415 3,339 6.71 24,124 2,107 6.70
7.00%-7.49% 89,649 7,316 7.16 56,399 4,187 7.15
7.50%-7.99% 93,328 7,748 7.61 66,450 5,380 7.62
8.00%-8.49% 57,323 4,220 8.09 53,227 3,889 8.10
8.50%-8.99% 78,998 4,465 8.60 81,721 4,553 8.61
9.00%-9.49% 36,115 2,168 9.08 39,272 2,382 9.08
9.50%-9.99% 59,174 3,383 9.60 75,228 4,531 9.60
10% and above 72,942 4,160 10.52 102,186 6,123 10.52
--------------------------------- ---------------------------------
Total 543,428 $37,917 8.14% 518,972 $34,213 8.53%
==========================================================================================
------------------------------------------------------------------------------------------
December 31, 1994 December 31, 1993
-------------------------------------- -----------------------------------
Percentage Percentage
Aggregate of principal Aggregate of principal
Number principal balance of Number principal balance of
of balance servicing of balance servicing
State loans (millions) portfolio loans (millions) portfolio
------------- -------------------------------------- -----------------------------------
California 79,621 $ 7,195 19.0% 82,694 $ 7,209 21.1%
Washington 42,584 3,502 9.2 37,938 2,950 8.6
New York 35,214 2,611 6.9 36,157 2,728 8.0
Michigan 33,174 1,865 4.9 28,667 1,356 4.0
Texas 26,411 1,863 4.9 17,065 1,058 3.1
Florida 29,955 1,642 4.9 25,576 1,452 4.2
Illinois 20,984 1,580 4.2 19,972 1,369 4.0
New Jersey 18,075 1,331 3.5 18,757 1,328 3.9
Virginia 20,429 1,256 3.3 21,132 1,206 3.5
Arizona 17,570 1,104 2.9 16,631 9.63 2.8
Other 219,411 13,768 36.3 214,383 12,594 36.8
-------------------------------------- -----------------------------------
Total 543,428 $37,917 100.0% 518,972 $34,213 100.0%
===========================================================================================
The tables include $4,294 million outstanding principal
balance of loans subserviced for others at December 31,
1994. The tables exclude $1,651 million and $4,190
million outstanding principal balance of interim
servicing as of December 31, 1994 and 1993,
respectively.
31
Escrow funds of approximately $277.9 million and
$281.7 million as of December 31, 1994 and 1993,
respectively, relating to mortgages serviced and
subserviced, were held in non-interest bearing accounts
at non-affiliated banks and are not included in the
consolidated financial statements.
Source One has in force an errors and omissions
policy in the amount of $20.0 million. Primary fidelity
coverage up to a limit of $45.0 million is provided
under a Fund American master policy, for which Source
One pays a portion of the premium.
5. CAPITALIZED Effective January 1, 1994 Source One changed the
SERVICING methodology used to measure impairment of its purchased
mortgage servicing rights asset. Previously, Source One
measured the asset's impairment on a disaggregated basis
and used a cost of capital charge to measure the value
of future servicing cash flows. The new accounting
methodology measures the asset's impairments on a
disaggregated basis and discounts the asset's estimated
future cash flows using current market rates. Source
One's management believes that the use of current market
rates to discount cash flows versus the use of a cost of
capital charge is a preferable accounting method because
it represents a more conservative and informative
financial statement presentation of the purchased
mortgage servicing rights asset. The adoption of the new
accounting methodology, recorded as a cumulative
adjustment as of January 1, 1994, resulted in a $68.1
million pretax charge to income for 1994. The
prospective effect of the accounting change was a $2.5
million net pretax charge to income for 1994.
If this accounting change had been applied
retroactively, the pro format effect would have
decreased after tax earnings by approximately $4.7
million, or $.46 per share, for the year ended December
31, 1993. Pro forma amounts for 1992 cannot be
reasonably determined since Source One does not have the
necessary data available to stratify the mortgage
servicing portfolio on a consistent basis. The following
table summarizes changes in Source One's capitalized
mortgage servicing asset:
------------------------------------------------------------------------------
Year Ended December 31,
--------------------------------
Millions 1994 1993 1992
------------------------------------------------------------------------------
Purchases Servicing:
Balance at beginning of year $ 570.2 $ 551.3 $ 560.0
Servicing acquisitions 69.7 117.5 119.6
Scheduled amortization (61.7) (90.1) (89.4)
Impairment and unscheduled amortization (12.8) (8.5) (38.9)
Sales of servicing (21.7) -- --
Cumulative effect of accounting change (68.1) -- --
--------------------------------
Balance at end of year 475.6 570.2 551.3
--------------------------------
Excess Servicing:
Balance at beginning of year 96.5 73.4 45.3
Additions 16.7 58.1 47.1
Scheduled amortization (12.1) (11.5) (10.0)
Impairment and unscheduled amortization (.4) (23.5) (9.0)
Sales of servicing (28.6) -- --
--------------------------------
Balance at end of year 72.1 96.5 73.4
Deferred gain on sales of servicing (17.2) -- --
--------------------------------
Total capitalized mortgage servicing $ 530.5 $ 666.7 $ 624.7
==============================================================================
32
During 1993 and 1992 the entire mortgage banking
industry experienced substantial prepayments in mortgage
servicing portfolios due to refinancings caused by
declines in market interest rates for mortgage loans.
Considering these substantial refinancings, in December
1992 Source One decided to prospectively measure the
recoverability of its capitalized mortgage servicing
asset on a disaggregated basis, resulting in a $38.2
million pretax reduction in net mortgage servicing
revenue for the year ended December 31, 1992. In
addition, during 1992 Source One recorded unscheduled
amortization totalling $9.7 million to reflect the
effects of high prepayments on the capitalized servicing
asset. The high level of prepayments continued in 1993
due to further declines in market interest rates for
mortgage loans, resulting in additional pretax
writedowns of the capitalized mortgage servicing asset
totalling $32.0 million during 1993.
Source One estimates the fair value of its
capitalized excess servicing asset by discounting the
anticipated cash flows to be received over the estimated
life of the related loans. Source One uses interest only
("I/O") strip interest rates as quoted by market
participants to determine the appropriate discount rate
and prepayment speed assumption rates that are based on
interest rates, loan types and maturity dates. The
discount rates used to capitalize excess servicing
ranged from 8.00% to 10.00% for the year ended December
31, 1994 and were 8.00% and 10.00% for the years ended
1993 and 1992, respectively. For the years ended
December 31, 1994, 1993 and 1992, the weighted average
discount rates inherent in the carrying amount of the
capitalized excess servicing asset were 9.12%, 9.03% and
10.82%, respectively.
The following tables summarize the remaining
unamortized purchased servicing asset by year of
origination:
--------------------------------------------------------------------------------
December 31, 1994
------------------------------------------------------------
Unamortized
purchased Remaining Weighted
servicing portfolio Weighted average
Year of asset balance average maturity
origination (millions) (millions) interest rate (years)
--------------------------------------------------------------------------------
1989 and prior $ 88.1 $ 4,636 9.06% 15.7
1987 43.9 2,084 8.67 19.9
1988 22.0 1,918 8.95 20.6
1989 30.5 1,432 9.03 22.7
1990 28.3 1,322 9.01 23.7
1991 40.2 1,905 8.46 23.9
1992 90.2 3,595 8.10 20.5
1993 106.9 9,997 7.21 22.1
1994 25.5 1,781 7.74 25.2
------------------------------------------------------------
Total $475.6 $28,670 8.13% 21.0
================================================================================
33
---------------------------------------------------------------------------------------------
December 31, 1993
--------------------------------------------------------------------
Unamortized
purchased Remaining Weighted
servicing portfolio Weighted average
Year of asset balance average maturity
origination (millions) (millions) interest rate (years)
---------------------------------------------------------------------------------------------
1986 and prior $121.9 $ 5,790 9.55% 17.0
1987 68.6 2,628 9.29 20.9
1988 28.4 1,278 10.13 23.1
1989 38.6 1,799 10.03 24.4
1990 39.2 1,557 9.98 25.2
1991 58.5 2,134 9.06 25.0
1992 109.9 5,062 8.14 22.5
1993 105.1 12,045 7.28 23.7
--------------------------------------------------------------------
Total $570.2 $32,293 8.50% 22.2
=============================================================================================
During the second quarter of 1994 Source One sold
the rights to service $3,868 million of mortgage loans
to a third party for cash proceeds of $70.2 million.
Source One has continued to service these loans pursuant
to a subservicing agreement. Accordingly, the related
$19.9 million gain from the sale was deferred and is
being recognized in income over the five-year life of
the subservicing agreement. For the year ended December
31, 1994 Source One recognized $2.7 million of the
deferred gain which is included in net servicing
revenue. At December 31, 1994 the remaining deferred
gain on the sale of servicing was $17.2 million and is
excluded from the above table. The mortgage loan
servicing portfolio at December 31, 1994 includes loans
subserviced for others having a principal balance
totalling $4,294 million.
The remaining unamortized purchased servicing asset
related to the acquisition of Source One in 1986 was
$40.7 million and $52.9 million at December 31, 1994 and
1993, respectively, and is included in "1986 & prior" on
the above table. The related remaining portfolio balance
was $2.0 billion and $2.7 billion, the weighted average
interest rate was 9.28% and 9.36%, and the weighted
average remaining maturity was 13.55 years and 14.58
years as of December 31, 1994 and 1993, respectively.
6. Mortgage The following tables summarize Source One's mortgage
Loans Held loans held for sale and pool loan purchases:
For Sale and
Pool Loan
Purchases
----------------------------------------------------------------------------------------
December 31,
-----------------------
Millions 1994 1993
----------------------------------------------------------------------------------------
Adjustable rate mortgage loans, weighted average
interest rates of 7.86% and 5.22% $ 46.4 $ 61.4
Fixed rate 7 year through 25 year mortgage loans,
weighted average interest rates of 8.81% and 6.82% 34.0 450.7
Fixed rate 30 year mortgage loans, weighted average
interest rates of 9.27% and 7.39% 131.3 786.5
-----------------------
Total principal amount 211.7 1,298.6
Less discounts (1.2) (.1)
-----------------------
Total mortgage loans held for sale $ 210.5 $1,298.5
========================================================================================
34
Principal balance
(millions) Number of loans
------------------- -----------------
December 31, 1994 1993 1994 1993
---------------------------------------------------------------------------
Loan type: FHA $102.8 $ 92.9 1,850 1,679
VA 41.9 40.7 719 658
Conventional 19.2 21.9 224 247
------------------------------------------
Total pool loan purchases $163.9 $155.5 2,793 2,582
===========================================================================
7. DEBT SHORT-TERM DEBT
Short-term debt outstanding consisted of the following:
--------------------------------------------------------------------------
December 31,
-------------------------
Millions 1994 1993
--------------------------------------------------------------------------
Parent Company:
Loan guarantee $ 30.0 $ -
-------------------------
Source One:
Commercial paper 26.1 574.0
Credit agreement borrowings 198.8 727.5
Bid loan borrowings - 236.9
Less net premiums and discounts (.8) (1.6)
-------------------------
Total Source One 224.1 1,536.8
-------------------------
Total short-term debt $254.1 $ 1,536.8
==========================================================================
The weighted average interest rates of short-term debt
outstanding during 1994 and 1993 were as follows:
==========================================================================
--------------------------------------------------------------------------
Year Ended December 31,
------------------------
1994 1993
--------------------------------------------------------------------------
Parent Company:
Revolving credit facility 5.11% 4.15%
Loan guarantee 5.36% 5.36%
Source One:
Commercial paper 3.92% 3.36%
Credit agreements and bid loans 5.03% 4.03%
==========================================================================
In June 1994 the Company entered into a revolving credit
agreement with a syndicate of banks. Under the
agreement, through June 1, 1995 the Company and certain
of its subsidiaries may borrow at market interest rates
up to $75.0 million. The credit agreement contains
certain customary covenants, including a $525.0 million
minimum tangible net worth requirement and a minimum
asset coverage requirement. At December 31, 1994 the
Company had no borrowings outstanding under the
agreement.
In August 1993 the Company sold a $30.0 million
principal amount secured loan receivable from the
Company's Chairman to a third party. The Company has
guaranteed repayment of the loan and, therefore, in
accordance with GAAP, has reflected the sale of the loan
as indebtedness on the balance sheet. The loan matures
on October 23, 1995. As of December 31, 1993 the loan
guarantee was classified as long-term debt.
35
Source One has a $650.0 million domestic and Euro
commercial paper program. The weighted average number of
days to maturity of commercial paper outstanding at
December 31, 1994 was 10 days. In August 1994 Source One
replaced its then existing credit agreements with three
new credit facilities totalling $900.0 million. At the
request of Source One, such facilities were reduced to
an aggregate amount of $800.0 million in November 1994.
The new facilities, together with $325.0 million
aggregate principal amount of publicly issued long-term
debt securities, are secured primarily by Source One's
mortgage loans receivable and the mortgage loan
servicing portfolio. One facility in the amount of
$250.0 million matures on July 31, 1995 and the
remaining two facilities in the amounts of $150.0
million mature on June 30, 1997 and July 31, 1997,
respectively.
Source One's secured credit agreement currently
contain convenants which limit its ability to pay
dividends or make distributions on its capital in excess
of $9.0 million of cash dividends on preferred stock
each year. Source One is in the process of renegotiating
this covenant to increase the dividend/distribution
capacity thereunder. These covenants also require Source
One to maintain a certain level of total tangible net
worth and a certain ratio of debt to total tangible net
worth. Source One is currently in compliance with all
such covenants.
Under the credit agreements described above,
Source One receives interest expense credits as a result
of holding escrow and custodial funds in trust accounts
at non-affiliated banks.
Source One also has a revolving credit agreement
under which it can borrow up to $10.0 million. As of
December 31, 1994 and 1993, there was $3.8 million and
$2.5 million outstanding under this agreement,
respectively.
Prior to August 1994 Source One could borrow at
floating rates up to $725.0 million under various
revolving credit agreements. Source One also had bid
loan facilities to augment these credit agreements which
allowed Source One to borrow additional amounts in a bid
process.
LONG-TERM DEBT
Long-term debt outstanding consisted of the following:
----------------------------------------------------------------------------
December 31,
-----------------------
Millions 1994 1993
-----------------------------------------------------------------------------
Parent Company:
Medium-term notes $125.0 $150.0
Loan guarantee - 30.0
Less net premiums and discounts
on notes (1.2) (1.5)
-----------------------
Total Parent Company 123.8 178.5
-----------------------
Source One:
Debentures, 8.25% due in 1996 125.0 125.0
Medium-term notes, due in 1996 40.0 40.0
Medium-term notes, 8.75% due in 2001 160.0 160.0
Debentures, 9% due in 2012 100.0 100.0
Less net premiums and discounts
on notes and debentures (1.8) (2.2)
------------------------
Total Source One 423.2 422.8
------------------------
Total long-term debt $547.0 $601.3
=============================================================================
36
During January and February 1993 the Company issued
$150.0 million in principal amount of medium-term notes
for net cash proceeds of $148.0 million after related
costs. Proceeds from the issuance of the notes were used
to repay an existing $100.0 million revolving credit
facility and for general corporate purposes. In June
1994 the Company repurchased $25.0 milion in principal
amount of its medium-term notes due February 2003. At
December 31, 1994 the remaining outstanding notes had an
average maturity of 8.38 years and an average yield to
maturity of 7.82%.
In 1986 Source One issued $125.0 million of 8.25%
debentures due November 1, 1996.
In 1989 Source One issued $40.0 million of
medium-term notes having a weighted average interest
rate of 9.65% and due in 1996.
In October 1991 Source One issued $160.0 million of
medium-term notes under terms of a $200.0 million shelf
registration statement filed in November 1988. The
notes are due in October 2001 and bear interest at a
rate of 8.875%.
In June 1992 Source One issued $100.0 million in
principal amount of 9% debentures due in June 2012 under
terms of a $250.0 million shelf registration statement.
The proceeds from issuance were used for general
corporate purposes.
Total interest paid by Fund American for both
short-term and long-term debt was $80.1 million, $98.1
million and $75.4 million in 1994, 1993 and 1992,
respectively.
8. INCOME TAXES The Company and its qualifying subsidiaries file a
consolidated Federal Income tax return. The Federal
Income tax provision is computed on the consolidated
taxable income of the Company and those subsidiaries.
The total income tax provision (benefit) consisted
of the following:
---------------------------------------------------------------------------------------
Year Ended December 31,
-------------------------------
Millions 1994 1993 1992
---------------------------------------------------------------------------------------
Tax on income before accounting changes:
Federal $ 20.2 $ 67.8 $ 29.7
State and local .3 2.7 3.9
-------------------------------
Income tax provision 20.5 70.5 33.6
Tax on cumulative effect of accounting change -
purschased mortgage servicing (23.8) - -
Tax on cumulative effect of accounting change -
postretirement benefits - - (1.0)
Cumulative effect of accounting change -
income taxes - - 23.6
-------------------------------
Total income tax provision (benefit) $ (3.3) $ 70.5 $ 56.4
--------------------------------------------------------===============================
Net income tax payments (recoveries) $ (.7) $ 12.0 $(108.7)
--------------------------------------------------------===============================
Tax provision (benefit) recorded directly to
shareholders' equity related to:
Exercises of employee stock options and warrants $ (2.0) $ (4.7) $ (19.0)
Changes in net unrealized
investment gains and losses $ (29.5) $ 24.1 $ 6.1
=======================================================================================
37
The components of the income tax provision follow:
---------------------------------------------------------------------------------------
Year Ended December 31,
------------------------------------
Millions 1994 1993 1992
----------------------------------------------------------------------------------------
Current provision $ 21.9 $ 33.3 $ 19.2
Deferred provision (benefit) (1.4) 37.2 14.4
------------------------------------
Income tax provision $ 20.5 $ 70.5 $ 33.6
========================================================================================
Pursuant to the liability method of accounting for income
taxes, deferred income taxes reflect the net tax effects of
temporary differences between the carrying amounts of assets
and liabilities for financial reporting purposes and the
amounts used for income tax return purposes. Significant
components of Fund American's net deferred Federal income tax
liability and asset follow:
-----------------------------------------------------------------------------------
December 31,
----------------------
Millions 1994 1993
------------------------------------------------------------------------------------
Deferred tax assets related to:
Capitalized mortgage servicing $ 18.7 $ -
Employee compensation and benefit accruals 12.2 10.7
Allowance for mortgage loan losses 4.7 5.5
Other items 6.1 3.8
----------------------
Total deferred tax assets 41.7 20.0
------------------------------------------------------------------------------------
Deferred tax liabilities related to:
Purchase accounting adjustments 11.2 12.8
Net unrealized investment gains 2.5 22.8
Capitalized mortgage servicing - 12.7
Other items 6.6 5.2
---------------------
Total deferred tax liabilities 20.3 53.5
------------------------------------------------------------------------------------
Net deferred Federal income tax liability (asset) $(21.4) $ 33.5
====================================================================================
A reconciliation of taxes calculated using Federal
statutory rates to the income tax provision follows:
-----------------------------------------------------------------------------------
Year Ended December 31,
------------------------------
Millions 1994 1993 1992
-----------------------------------------------------------------------------------
Federal statutory rate 35% 35% 34%
------------------------------
Tax provision at Federal statutory rate $ 14.6 $ 49.3 $ 29.9
Differences in taxes resulting from:
Minority interest dividends 2.3 - -
Purchase accounting adjustments .7 .8 .7
State and local income taxes .2 1.8 2.6
White River Distribution - 17.7 -
Dividends received deduction (2.2) (2.7) (2.2)
Equity income - (.6) (1.7)
Tax reserve adjustments 4.6 2.4 4.5
Other .3 1.8 (.2)
-------------------------------
Income tax provision $ 20.5 $ 70.5 $ 33.6
====================================================================================
38
In December 1993 the Company distributed to its
shareholders (the "Distribution") approximately 74% of
the outstanding shares of Common Stock of White River
Corporation ("White River"). The $17.7 million tax
provision resulting from the Distribution includes $13.0
million of current tax related to taxable capital gains
triggered by the Distribution which were not recognized
for financial reporting purposes pursant to GAAP. The
provision also includes a $4.7 million tax reserve
established on White River's books of record as of
December 22, 1993, the date of the Distribution. The
reserve offsets White River's deferred tax asset
calculated on a stand-alone basis as of that date.
Sections 382 and 383 of the Internal Revenue Code
of 1986, as amended (the "IRC"), impose limitations on
the use of certain tax benefits by a corporation that
undergoes a more than 50% ownership change. The tax
benefits which may be limited include loss carryforwards
and built-in losses and deductions existing on the date
of ownership change. The annual limitation for the
utilization of such benefits during a five-year post-
change period is generally calculated by multiplying the
value of the corporation (as defined by the IRC) at the
time of the ownership change by an interest rate (a
long-term tax-exempt bond rate defined by the IRC).
We regulatory guidance on the subject is not complete,
the Company believes that it had an ownership change
during 1992 so as to make the Section 382 and 383
limitations applicable to Fund American. Fund American
believes that the imposition of such limitations will
not have a material adverse effect on its financial
position or results of operations. However, such
limitations could serve to constrain the timing and
structure of gain or loss recognition transactions,
including assets sales, in the future.
9. Retirement On December 31, 1992 the Company terminated its defined
and Post- benefit plan, supplemental pension plan, incentive
Retirement savings plan and retiree medical plan. In 1993 the Plans
Plans Company established the Fund American Deferred Benefit
Plan (the "Deferred Benefit Plan"), a nonqualified
defined contribution plan for a select group of
management employees for the purpose of providing
retirement and postretirement benefits. The amount of
annual contributions to the new plan are determined
using actuarial assumptions and benefit levels similar
to those of the previous plans; however, participants in
the new plan may choose between two investment options
for their paln balances. During 1993 accrued benifits
under all the Company's terminated retirement plans we
either (i) distributed to or for the benefit of
employees or (ii) transferred to the Deferred Benefit
Plan. At December 31, 1994 the Company's liability to
participants pursuant to the Deferred Benefit Plan was
$1.4 million.
In 1993 the Company also established the Fund
American Voluntary Deferred Compensation Plan (the
"Deferred Compensation Plan"), a nonqualified plan for a
select group of management employees for the purpose of
deferring current compensation. Pursuant to the Deferred
Compensation Plan, participants may defer all or a
portion of qualifying remuneration payable by Fund
American, Participants in the Deferred Compensation Plan
may choose between two investment options for their plan
balances. At December 31, 1994 the Company's liability
to participants pursuant to the Deferred Compensation
Plan was $15.5 million.
39
Source One established its defined benefit pension plan as of July 1,
1986 for the benefit of its employees. Benefits under the Source One are based
on years of service and each employee's highest average aligble compensation
over five consective years in his last ten years of employment. Funding of
retirement costs complies with the minimum funding requirements specified by the
Employee Retirement Income Security Act. Cash contributions received by the
Source One plan for the years ended December 31, 1994, 1993 and 1992, totalled
$1.1 million, $1.9 million and $1.0 million, respectively.
Source One also has a supplemental pension plan which is a nonqualified,
unfunded benefit plan designed to provide supplementary retirement benefits for
employees whose pensionable compensation exceeds statutory limits.
The following table sets forth the pension cost and actuarial assumptions
used in determing the funded status of Fund American's qualified defined benefit
pension plans:
--------------------------------------------------------------------------------
Year Ended December 31,
----------------------------------
Dollars in millions 1994 1993 1992
--------------------------------------------------------------------------------
PENSION COST FOR PERIOD:
Service cost for period $ 1.6 $ 1.4 $ .9
Interest cost on projected benefit
obligation 1.3 1.2 .9
Actual return on plan assets 1.0 (1.3) (.9)
Net amortization and deferral (1.5) .9 .4
----------------------------------
Total pension cost $ 2.4 $ 2.2 $ 1.3
----------------------------------------------==================================
FUNDED STATUS AT END OF PERIOD:
Actuarial present value of benefit
obligation:
Accumulated benefit obligation, including
vested benefits of $11.0, $11.3 and $9.9 $ 12.6 $ 13.0 $ 10.3
Effect of future projected salary increases 5.1 5.3 4.3
----------------------------------
Total projected benefit obligation 17.7 18.3 14.6
Plan assets at fair value 13.1 13.3 11.1
----------------------------------
Projected benefit obligation in
excess of plan assets 4.6 5.0 3.5
Aggregate of items not yet recognized
in earnings (2.7) (4.4) (2.9)
----------------------------------
Pension cost accrued at end of period $ 1.9 $ .6 $ .6
----------------------------------------------==================================
ACTUARIAL ASSUMPTIONS:
Discount Rate 8.0% 7.0% 7.5-8.5%
Rate of increase in future compensation
levels 6.0% 6.0% 8.0%
Expected long-term rate of return on plan
assets 8.0% 8.0% 8.0%
================================================================================
Total accrued postretirement benefit costs included in accounts payable and
other liabilities was $3.2 million and $3.0 million at December 31, 1994 and
1993, respectively.
40
10. EMPLOYEE The 1985 Long-Term Incentive Plan (the "Incentive Plan")
STOCK PLAN provides for granting to officers and key employees of the
Company and its participating subsidiaries various types of
stock-based incentive awards including stock options and
performance shares. At December 31, 1994, 404,762 Shares of
the Company's Common Stock, par value $1.00 per share
("Shares"), remained available for grants under the Incentive
Plan.
Stock options are rights to purchase a specified number
of Shares at or above the fair market value of Shares at the
time an option is granted. Stock options generally vest over
a four-year period and expire no later than ten years after
the date on which they are granted.
Performance shares are conditional grants of a
specified maximum number of Shares or an equivalent amount of
cash. The grants are generally payable, subject to the
attainment of a specified return on equity, at the end of
three- to five-year periods or as otherwise determined by the
Human Resources Committee (the Committee") of the Company's
Board of Directors (the "Board"). The Committee consists
solely of non-management directors.
The following table details the transactions applicable
to non-qualified stock options to acquire Shares:
----------------------------------------------------------------------
Number Exercise price
----------------------------------------------------------------------
Balance at December 31,1991 1,236,386 $25.75-$52.83
Exercised during 1992 1,122,111 $25.75-$39.69
Expired or cancelled during 1992 150 $32.56
----------------------------
Balance at December 31, 1992 114,125 $25.75-$56.41
Exercised during 1993 107,000 $25.75-$59.87
----------------------------
BALANCE AT DECEMBER 31, 1993 AND 1994 7,125 $24.82-$32.60
======================================================================
Stock options exercised during 1992 included 272,111 stock
options exercised by employees of Fireman's Fund. The cost of
stock options exercised by employees of Fireman's Fund
subsequent to consummation of the sale of Fireman's Fund has
been deducted from the Company's gain from sale of
discontinued operations. All the 7,125 Fund American stock
options outstanding at December 31, 1994 and 1993 were held
by employees of Fund American and were fully vested and
exercisable.
Pursuant to the Incentive Plan 56,000 and 191,500
performance shares were granted in 1993 and 1992,
respectively. During 1993 and 1992, respectively, 75,375 and
4,925 performance shares were cancelled. In 1993 and 1992,
respectively, 205,375 and 1,150 performance shares were paid,
of which 27,672 and 650 were paid in the form of Shares and
the remainder in cash. No performance shares were granted,
cancelled or paid in 1994. At December 31, 1994, 124,250
performance shares were outstanding all of which were held by
employees of Fund American. On the performance shares
outstanding at December 31, 1994, 68,250, which were
outstanding prior to the Distribution are subject to anti-
dilution adjustments and are thereby valued as being
equivalent to one Fund American Share plus one-half share of
Common Stock of White River. The remaining 56,000 performance
shares outstanding at December 31, 1994 are valued as being
equivalent to one Fund American Share. The financial goal for
full payment of the performance shares is the achievement of
a 13% to 15% annual return on equity measured over the
applicable periods.
41
In 1985 the Company's Chairman purchased warrants
from American Express Company ("American Express")
entitling him to buy 1,700,000 Shares for $25.75 per
Share through January 2, 1996. Warrants to purchase
420,000 Shares and 130,000 Shares were exercised by the
Chairman during 1992 and 1994, respectively, leaving
warrants to purchase 1,150,000 Shares outstanding at
December 31, 1994. Pursuant to certain anti-dilution
adjustments related to the Distribution, the Chairman
received in 1993 warrants entitling him to purchase
640,000 White River Shares for $8.18 per share and the
exercise price for the Chairman's warrants to purchase
Fund American Shares was reduced to $21.66 per Share. The
Chairman excercised the White River warrants on November
19,1993.
Source One has various long-term incentive plans
which provide for the granting to key senior management
employees of Source One, stock-based and cash incentive
awards. Awards made pursuant to the plans are payable upon
the achievement of specified financial goals over multi-
year periods.
Source One also established a qualified employee
stock plan as of July 1,1986. Contributions to this plan
are determined at the discretion of Source One's Board of
Directors
11. Minority In March 1994 Source One issued 4,000,000 shares of 8.42%
Interest- perpetual Cumulative Preferred Stock, Series A (the
Preferred "Source One Preferred Stock"), for net cash proceeds of
Stock of $96.9 million. The Source One Preferred Stock has an
Subsidiary aggregate liquidation preference of $25.00 per share and
is not redeemable prior to May 1, 1999.
12. Shareholders' SERIES D AND E PREFERRED STOCK
Equity The Series D Preferred Stock had a cumulative annual
dividend rate of 7.75% and was initially redeemable for
cash or, at the Company's option, for Shares (based on the
then current market value of Shares) on July 31, 1994. On
August 1, 1994, the Company redeemed 22,778 shares of the
Series D Preferred Stock for $82.0 million, an amount
equal to the stock's liquidation preference. In accordance
with the terms of the Series D Preferred Stock, the annual
dividend rate for the remaining 20,833 shares of the
Series D Preferred Stock outstanding was increased to
8.75% and the stock's term was extended to July 31, 1995.
The Company may extend the redemption date of the Series D
Preferred Stock by one additional year to July 31, 1996,
which would require an increase in the dividend rate to
9.75%. Under certain circumstances, the dividend rate
could be increased if the corporate dividends received
deduction, currently provided for in Section 2439(a)(1) of
the IRC, is reduced below 70%. The Series D Preferred
Stock carries 100 votes per share and votes as a single
class with Shares.
The Company has given certain registration rights to
American Express which beneficially owns all of the
outstanding Series D Preferred Stock. American Express
must exchange the Series D Preferred Stock into Voting
Preferred Stock Series E, par value $1.00 per share (the
"Series E Preferred Stock"), prior to selling such stock
publicly. The terms of the Series E Preferred Stock would
be generally similar to those of the Series D Preferred
Stock, but the Series E Preferred Stock would carry one-
half the aggregate voting rights of the Series D Preferred
Stock.
42
COMMON SHARE REPURCHASES
During 1994, 1993 and 1992 the Company repurchased
1,128,057 Shares, 536,247 Shares and 5,314,518 Shares,
respectively, for $78.8 million, $41.8 million and
$371.7 million, respectively. The bulk of the Shares
repurchased during 1992 were acquired pursuant to a Plan
of Complete Liquidation which was terminated in June
1992. All Shares repurchased during 1991, 1992 and 1993
have been retired. At December 31, 1994 the Company had
outstanding authorization to purchase an additional
756,092 Shares.
LOAN FOR COMMON STOCK ISSUED
On December 30, 1992 pursuant to a request from the
Board, the Company's Chairman agreed to an early
exercise of stock options and warrants to purchase
1,000,000 Shares. The Board's request reflected concerns
regarding proposed tax legislation which could have
limited or eliminated the Company's tax benefits from
certain employee stock options and warrants exercised in
1993 and thereafter. To encourage exercise of the stock
options and warrants, the Company provided a $30.0
million secured loan to the Chairman. The non-recourse
loan bears interest at 4% and matures on October 23,
1995. In accordance with GAAP, the loan has been
reported on the December 31, 1994 and 1993, balance
sheets in other assets ($4.3 million and $4.2 million,
respectively) and shareholders' equity ($25.0 million
and $24.4 million,respectively). The $2.1 million
difference between the face value and the initial
estimated fair value of the loan has been reported as
compensation and benefits expense in the income
statement for the year ended December 31, 1992.
13. SHAREHOLDERS' The Board adopted in 1987, and in 1988 and 1993 amended,
RIGHTS PLAN a Shareholders' Rights Plan under which rights to
purchase preferred stock were distributed to
shareholders at the rate of one right for each Share
(the "Rights"). Each Right entitles the holder to
purchase one one-thousandth of a share of the Company's
Series A Cumulative Participating Preferred Stock
("Series A Preferred").
The Rights enable the holders to acquire
additional equity in either the Company or an "Acquiring
Person," and are exercisable if an unrelated person or
group (other than American Express or a wholly-owned
subsidiary thereof, any subsidiary of the Company, any
employee benefit plan of the Company or its subsidiaries
or certain affiliates of the Company and certain persons
who inadvertently and temporarily cross the 25%
threshold) acquires beneficial ownership of 25% or more
of the outstanding Shares (such a 25% or more beneficial
owner is deemed an "Acquiring Person"). Thereafter, the
Rights would trade separately from the Shares and
separate certificates representing the Rights would be
issued. The terms of the Series A Preferred are such
that each one-thousandth of a share would be entitled to
participate in dividends and to vote on an equivalent
basis with one whole Share, along with other
preferential dividend rights and preferential
distribution rights in liquidation.
Upon the existence of an Acquiring Person, the
Rights will entitle each holder of a Right to purchase,
at the exercise price, that number of one-thousandth of
a share of Series A Preferred equivalent to the number
of Shares which, at the time of the transaction, would
have a market value of twice the exercise price. If
certain acquisitions of the Company occur, a similar
right to purchase securities of the Company or the
entity acquiring the Company at a discount would arise.
43
Any Rights that are beneficially owned by an
Acquiring Person (or any affiliate or associate of an
Acquiring Person) are null and void and any holder of
any such Right (including any subsequent holder) will be
unable to exercise or transfer any such Right.
At any time after a person becomes an Acquiring
Person, the Board may mandatorily exchange all or some
of the Rights for consideration per Right equal to one-
half of the securities issuable upon the exercise of one
Right pursuant to the terms of the Rights Agreement (or
the common share equivalent) and without payment of the
exercise price.
The Rights, which do not have the right to vote
or receive dividends, expire November 25, 1997 and may
be redeemed by the Company at a price of $.01 per Right
at any time prior to the earlier of (i) such time as a
person becomes an Acquiring Person or (ii) the
expiration date. Under certain circumstances, the Board
may redeem the Rights only if a majority of the
disinterested directors (as defined in the Shareholders'
Rights Plan) agrees that the redemption is in the best
interests of the Company and its shareholders.
In 1987 the Company reserved 600,000 of its
authorized preferred shares as Series A Preferred for
issuance pursuant to the Shareholders' Rights Plan.
14. INDUSTRY Revenues, pretax earnings and ending identifiable assets
SEGMENTS for Fund American's industry segments are shown below:
-------------------------------------------------------------
Year Ended December 31,
-----------------------------------
Millions 1994 1993 1992
-------------------------------------------------------------
REVENUES:
Source One $ 207.2 $ 234.5 $ 190.1
Other 21.3 16.5 24.0
-----------------------------------
Total $ 228.5 $ 251.0 $ 214.1
-------------------------====================================
PRETAX EARNINGS:
Source One $ 5.3 $ 62.2 $ 17.3
Other 36.3 78.7 70.5
-----------------------------------
Total $ 41.6 $ 140.9 $ 87.8
-------------------------====================================
ENDING ASSETS:
Source One $1,210.0 $2,647.2 $2,456.9
Other 597.3 657.8 671.9
-----------------------------------
Total $1,807.3 $3,305.0 $3,128.8
=============================================================
15. FINANCIAL Fund American has only limited involvement with
INSTRUMENTS WITH derivative financial instruments and does not use
OFF-BALANCE SHEET derivative financial instruments for trading purposes.
RISK Fund American's use of derivative financial instruments
is primarily limited to (i) commitments to extend
credit, (ii) mandatory forward commitments and (iii) to
achieve a fixed interest rate on existing variable rate
obligations.
44
Source One is a party to financial instruments with
off-balance-sheet risk in the normal course of business
to meet the financing needs of its customers and reduce
its exposure to fluctuations in interest rates. These
financial instruments primarily include commitments to
extend credit and mandatory forward commitments. Those
instruments involve, to varying degrees, elements of
credit and market interest rate risk excess of the
amounts recognized in the consolidated balance sheets.
The contract or notional amounts of those instruments
reflect the extent of risk Source one has related to the
instuments.
Source One's exposure to credit loss in the event
of nonperformance by the other party to the financial
instrument for commitments to extend credit (mortgage
loan pipeline) is represented by the contractual
notional amount of those instruments. Source One's
mortgage loan pipeline for locked commitments which
are expected to close totalled $147.5 million and $967.7
million at December 31, 1994 and 1993, respectively.
Fixed rate commitments result in Source One having
market interest rate risk as well as credit risk.
Variable rate commitments result in only credit risk.
The amount of collateral required upon extension of
credit is based on management's credit evaluation of the
mortgagor and consists of the mortgagor's residential
property.
Source One obtains mandatory forward commitments
of up to 120 days to sell mortgage-backed securities to
hedge the market interest rate risk associated with the
portion of the mortgage loan pipeline that is expected
to close and all morgage loans receivable. At December
31, 1994 and 1993, Source One had approximately $351.2
million and $2,055.3 million, respectively, of mandatory
forward commitments outstanding. If secondary market
interest rates decline after Source One commits to an
interest rate for a loan, the loan may not close and
Source One may incur a loss from the cost of covering
its obligations under a related mandatory forward
commitment. If secondary market interest rates increase
after Source One commits to an interest rate for a loan
and Source One has not obtained a foward commitment,
Source One may incur a loss when the loan is subsequntly
sold.
Source One's risk management function closely
monitors the mortgage loan pipeline and mortgage loans
receivable balance to determine appropriate forward
commitment coverage on a daily basis in order to
manage the risk inherent in these off-balance-sheet
financial instruments. In addition, the risk management
area seeks to reduce counterparty risk by committing to
sell mortgage loans only to approved dealers with no
dealer having in excess of 20% of current commitments.
Source One currently transacts business with seven
approved dealers.
Source One sells loans through mortgage-backed
securities issued pursuant to programs of GNMA, FNMA,
the Federal Home Loan Mortgage Corporation ("FHLMC") or
through institutional investors. Most loans are
aggregated in pools of $1.0 million or more and are
purchased by institutional investors after having been
guaranteed by GNMA, FNMA or FHLMC. Substantially all
GNMA securities are sold by Source One without recourse
for loss of principal in the event of a subsequent
default by the mortgagor due to the FHA and VA
insurance underlying such securities.
45
Servicing agreements relating to mortgage-
backed securities issued pursuant to programs of
GNMA, FNMA or FHLMC require Source One to advance
funds to make the required payments in the event
of a delinquency by the borrower. Source One
expects that it would recover most funds advanced
upon cure of default by the borrower or
foreclosure. However, funds advanced in connection
with VA partially guaranteed loans and certain
conventional loans (which are at most partially
insured by private mortgage insurers) may not be
fully recovered due to potential declines in
collateral value. In addition, most of Source
One's servicing agreements for mortgage-backed
securities typically require the payment to
investors of a full month's interest on each loan
although the loan may be paid off (by optional
prepayment or foreclosure) other than on a month-
end basis. In this instance, Source One is
obligated to pay the investor interest at the note
rate from the date of loan payoff through the end
of the calendar month without reimbursement.
As of December 31, 1994, 1993, and 1992,
Source One serviced approximately $11.9 billion,
$11.4 billion and $14.0 billion of GNMA loans
(without substantial recourse), respectively, and
$3.7 billion, $4.8 billion and $9.1 billion of
conventional loans (with recourse), respectively.
Source One occasionally enters into a
variety of interest rate contracts including
interest rate swaps, interest rate collars and put
options. These agreements give rise to credit risk
due to the potential that counterparties may fail
to meet the terms of the agreements. Market
interest rate risk may also arise due to unmatched
asset, and liability positions.
To cover loan losses that may result from
these servicing arrangements and other losses,
Source One has provided an allowance for loan
losses of $13.4 million and $16.0 million on the
consolidated balance sheets at December 31, 1994
and 1993, respectively Source One's management
believes the allowance for loan losses is adequate
to cover reimbursed foreclosure advances and
principal losses.
16. Fair Value Carrying value approximates fair value for common
of Financial equity securities, short-term investments, cash,
Instruments other financial assets, short-term debt and other
financial liabilities. For each other class of
financial instrument for which it is practicable
to estimate fair value, the following methods and
assumptions were used to estimate such value:
Other Investments. The fair values of I/O
strips are estimated based on quoted market prices
for those or similar investments. For REMICs, fair
values are estimated using discounted cash flow
analyses reflecting I/O strip and LIBOR interest
rates, and Prepayment Speed Assumption ("PSA")
rates, taking into consideration the
characteristics of the related collateral. Fair
values of mortgage loans held for investment are
estimated using quoted market prices for
securities backed by similar loans, adjusting for
differences in loan characteristics. For other
long-term investments held by Source One, fair
value is estimated based on quoted market prices
for those or similar investments and by
discounting future cash flows using market
interest rates for similar types of investments.
For other investments held by the Company and its
affiliates other than Source One, fair values have
been determined using quoted market values or
internal appraisal techniques.
46
Capitalized Excess Mortgage Servicing. Fair value is estimated by
discounting the annual anticipated net revenue to be received over the life of
the related loans, discounted using quoted I/O strip interest rates and PSA
rates.
Mortgage Loans Held for Sale. Fair values are estimated using quoted
market prices for securities backed by similar loans and adjusting for
differences in loan characteristics.
Pool Loan Purchases. Fair values are estimated using (i) discounted cash
flow analyses using Source One's short-term incremental borrowing rate or (ii)
quoted market prices for securities backed by similar loans.
Mortgage Claims Receivable. Fair values are estimated by discounting
anticipated future cash flows using Source One's short-term incremental
borrowing rate.
Employee Loan Receivable. Fair value is estimated by discounting future
cash flows using market interest rates for similar types of borrowing
arrangements.
Long-Term Debt. Fair value is estimated by discounting future cash flows
using incremental borrowing rates for similar types of borrowing arrangements.
Off-Balance-Sheet Financial Instruments. Fair value for commitments to
sell mortgage loans is based on current settlement values for those commitments.
Fair value for commitments to extend credit is based on current quoted market
prices for securities backed by similar loans, adjusting for loan
characteristics.
The estimated fair values of Fund American's financial instruments were as
follows:
--------------------------------------------------------------------------------
December 31, 1994 December 31, 1993
Carrying Fair Carrying Fair
Millions amount value amount value
--------------------------------------------------------------------------------
FINANCIAL ASSETS:
Common equity securities $332.4 $332.4 $ 585.5 $ 585.5
Other investments 157.3 155.2 113.4 115.1
Short-term investments 119.2 119.2 252.5 252.5
Cash 1.5 1.5 10.7 10.7
Capitalized excess mortgage servicing 72.1 98.3 96.5 107.2
Mortgage loans held for sale (a) 210.5 211.4 1,298.5 1,290.1
Pool loan purchases 163.9 164.9 155.5 159.2
Mortgage claims receivable 33.3 32.4 37.9 37.6
Employee loan receivable 29.3 28.9 28.6 29.0
Other 27.5 27.5 30.0 30.0
--------------------------------------------------------------------------------
FINANCIAL LIABILITIES:
Short-term debt 254.1 254.1 1,536.8 1,536.8
Long-term debt 547.0 528.8 601.3 639.4
Other 38.4 38.4 15.0 15.0
--------------------------------------------------------------------------------
OFF-BALANCE-SHEET FINANCIAL INSTRUMENTS:
Mandatory forward commitments - 349.0 - 2,067.0
Commitments to extend credit expected
to close - 148.2 - 978.6
================================================================================
(a) For purposes of this disclosure, fair value has been computed separately
for mortgage loans held for sale, mortgage loan pipeline and mandatory
forward commitments. When mortgage loans held for sale and pipeline are
matched to commitments, fair value is greater than the carrying amount as
of December 31, 1994 and 1993.
47
Other financial assets includes investment income
receivable and accounts receivable from securities
sales. Other financial liabilities includes accrued
interest payable, accounts payable on securities
purchases and dividends payable to shareholders.
The estimated fair value amounts for Fund
American's financial instruments have been determined
using available market information and valuation
methodologies. Such estimates provided herein are not
necessarily indicative of the amounts that could be
potentially realized in a current market exchange.
It is not practicable to estimate the fair value
of conventional loans sold with recourse, which is an
off-balance-sheet financial instrument representing
Source One's obligation to repurchase loans sold which
subsequently default, without incurring excessive costs.
17. RELATED PARTY American Express and its affiliates have, from time to
TRANSACTIONS time, provided various services to Fund American
including investment banking services, brokerage
services, underwriting of debt and equity securities and
financial consulting services. In addition, Source One
has from time to time sold certain mortgage loans to
subsidiaries of American Express. American Express
beneficially owns all outstanding shares of the Series
D Preferred Stock.
In December 1993 BYRNE & sons, l.p. ("BYRNE &
sons"), a partnership in which the Company's Chairman,
John J. Byrne, is the sole general partner, made its
initial investment in the Merastar Partners Limited
Partnership and the Southern Heritage Limited
Partnership (the "Partnerships"). The Partnerships are
involved in various property-casualty insurance
ventures. Shortly after making its initial investment,
BYRNE & sons offered one-third of its interest in the
Partnerships to Fund American on equal terms and
conditions. In May 1994 Fund American accepted the offer
and paid BYRNE & sons an amount equal to one-third of
BYRNE & sons' cost for the Partnerships plus interest at
a 6.0% annual rate.
48
Fund American from time to time uses
aircraft for corporate travel purposes owned by
Haverford Transportation Inc. ("HTI"). Fund
American reimburses HTI for its operating costs
associated with Fund American's use of HTI
aircraft. Mr. Byrne and K. Thomas Kemp, Executive
Vice President of the Company, are the sole
shareholders of HTI. Fund American believes that
its arrangement with HTI is on terms that are more
favorable to Fund American than would generally be
available if secured through an arrangement with a
third party.
White River and its affiliates have in the
past provided various services to Fund American
including investment advisory and accounting
services. In addition, Fund American has provided
to White River a $50.0 million term loan and a
revolving credit facility of up to $40.0 million.
Pursuant to the terms of the credit agreement
between White River and the Company, White River
has the right to use certain of its investment
portfolio securities to repay borrowings under the
term loan and revolving credit facility. Gordon S.
Macklin, a director of the Company, is the non-
executive Chairman of White River.
George J. Gillespie, III, a director of the
Company, is a General Partner of Cravath, Swaine &
Moore, which has been retained by Fund American
from time to time to perform legal services.
Arthur Zankel, a director of the Company, is
a General Partner of First Manhattan Co., which
has been retained by Fund American from time to
time to perform non-discretionary investment
advisory services and brokerage services.
Fund American believes that all the above
transactions were on terms that were reasonable
and competitive. Additional transactions of this
nature may be expected to take place in the
ordinary course of business in the future.
49
Fund American
REPORT ON MANAGEMENT RESPONSIBILITIES
The financial information included in this annual report, including the
audited consolidated financial statements, has been prepared by the management
of Fund American. The consolidated financial statements have been prepared in
accordance with generally accepted accounting principles and, where necessary,
include amounts based on informed estimates and judgments. In those instances
where there is no single specified accounting principle or standard, management
makes a choice from reasonable, accepted alternatives which are believed to be
most appropriate under the circumstances. Financial information presented
elsewhere in this annual report is consistent with that shown in the financial
statements.
Fund American maintains internal financial and accounting controls
"internal controls" designed to provide reasonable and cost effective assurance
that assets are safeguarded from loss or unauthorized use, that transactions
are recorded in accordance with management's policies and that financial records
are reliable for preparing financial statements. The internal controls
structure is documented by written policies and procedures which are
communicated to all appropriate personnel and is updated as necessary. Fund
American's business ethics policies require adherence to the highest ethical
standards in the conduct of its business. Compliance with these controls,
policies and procedures is continuously maintained and monitored by management.
Fund American's internal audit staff evaluates and reports on the adequacy
of and adherence to these internal controls, policies and procedures. In
addition, Ernst & Young LLP provides an and objective, independent review and
evaluation of the structure of internal controls to the extent they consider
necessary in their audit of Fund American's consolidated financial statements.
Management reviews all recommendations of the internal auditors and independent
auditors concerning the structure of internal controls and responds to such
recommendations with corrective actions, as appropriate.
The Audit Committee of the Board is comprised of all non-management
directors and has general responsibility for the oversight and surveillance of
the accounting, reporting and financial control practices of Fund American. The
Audit Committee, which reports to the full Board, annually reviews the
effectiveness of the independent auditors, Fund American's internal auditors and
management, with respect to the financial reporting process and the adequacy of
internal controls. Both the internal auditors and the independent auditors have,
at all times, free access to the Audit Committee, without members of management
present, to discuss the results of their audits, the adequacy of internal
controls and any other matter that they believe should be brought to the
attention of the Audit Committee.
/s/ John J. Byrne /s/ A. L. Waters /s/ M. S. Paquette
John J. Byrne Allan L. Waters Michael S. Paquette
Chairman of the Board, Senior Vice President Vice President and
President and Chief and Chief Financial Controller
Executive Officer Officer
50
Fund American
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Shareholders
Fund American Enterprises Holdings, Inc.
We have audited the accompanying consolidated balance sheets of Fund
American Enterprises Holdings, Inc., as of December 31, 1994 and 1993, and the
related consolidated income statements and statements of shareholders' equity
and cash flows for each of the three years in the period ended December 31,
1994. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Fund American
Enterprises Holdings, Inc. at December 31, 1994 and 1993, and the consolidated
results of its operations and its cash flows for each of the three years in the
period ended December 31, 1994, in conformity with generally accepted accounting
principles.
In 1994 the Company changed its method of accounting for purchased mortgage
servicing rights, in 1993 the Company changed its method of accounting for
certain investment securities, and in 1992 the Company changed certain
accounting methods as discussed in Note 1.
Ernst & Young LLP
New York, New York
January 27, 1995
51
Fund American
SELECTED QUARTERLY FINANCIAL DATA
(Unaudited)
Selected quarterly financial data for 1994 and 1993 is shown in the following
table. The quarterly financial data includes in the opinion of management, all
recurring adjustments necessary for a fair presentation of the results of
operations for the interim periods.
----------------------------------------------------------------------------------------------------------------
1994 Three Months Ended 1993 Three Months Ended
----------------------------------- -----------------------------------
Millions, except per share amounts Dec.31 Sept.30 June 30 Mar.31 Dec. 31 Sept.30 June 30 Mar.31
-----------------------------------------------------------------------------------------------------------------
Revenues $ 41.4 $ 44.4 $71.7 $ 71.0 $ 64.2 $64.4 $63.7 $58.7
Expenses 52.0 56.4 59.7 57.6 74.9 59.7 54.2 45.3
-------------------------------------------------------------------------
Pretax operating earnings (loss) (10.6) (12.0) 12.0 13.4 (10.7) 4.7 9.5 13.4
Net investment gains (losses) (4.2) 20.6 20.9 1.5 (68.0) 52.5 53.9 85.6
------------------------------------------------------------------------
Pretax earnings (loss) (14.8) 8.6 32.9 14.9 (78.7) 57.2 63.4 99.0
Income tax provision (benefit) (2.7) 4.3 13.0 5.9 (7.8) 21.7 21.6 34.8
------------------------------------------------------------------------
After tax earnings (loss) (12.1) 4.3 19.9 9.0 (70.9) 35.5 41.6 64.2
Cumulative effect of accounting change-
purchased mortgage servicing, after tax - - - (44.3) - - - -
------------------------------------------------------------------------
Net Income (loss) $(12.1) $ 4.3 $19.9 $(35.3) $(70.9) $35.5 $41.6 $64.2
----------------------------------------========================================================================
Primary earnings per share:
After tax earnings (loss) $(1.64) $ .24 $1.72 $ .60 $(7.78) $3.18 $3.76 $5.89
Net income (loss) (1.64) .24 1.72 (3.86) (7.78) 3.18 3.78 5.89
Fully diluted earnings per share:
After tax earnings (loss) (1.64) .24 1.62 .60 (7.78) 2.95 3.42 5.13
Net income (loss) (1.64) .24 1.62 (3.86) (7.78) 2.95 3.42 5.13
================================================================================================================
The quarterly trading range for shares of common stock during 1994 and 1993 is presented below:
----------------------------------------------------------------------------------------------------------------
1994 1993
------------------ --------------------
High Low High Low
----------------------------------------------------------------------------------------------------------------
Quarter ended:
December 31 $79 1/4 $70 1/2 $92 3/8 $73 1/2
September 30 78 3/8 69 3/4 90 1/4 82
June 30 70 3/8 60 1/2 86 1/2 79 3/4
March 31 77 64 3/4 80 1/2 71 5/8
================================================================================================================
52
Fund American
COMMON EQUITY SECURITIES AND OTHER INVESTMENTS
(Unaudited)
Common Equity Securities
--------------------------------------------------------------------------------------------------------------------------
December 31, 1994
------------------------------------------------
Percent
of total
Shares Market market
Shares and units in thousands, dollars in millions or units Cost value value
--------------------------------------------------------------------------------------------------------------------------
Energy, natural resources and related industries:
The Louisiana Land and Exploration Company 2,928 $ 97.9 $106.5 32.0%
San Juan Basin Royalty Trust 10,995 59.9 70.1 21.1
Sabine Royalty Trust 962 3.6 9.6 2.9
Lone Star Technologies, Inc. 988 9.0 6.9 2.1
Cross Timbers Royalty Trust 683 5.4 6.9 2.1
Digicon, Inc. 2,775 6.0 3.8 1.1
Aggregate of holdings less than $5.0 million 1.3 1.6 .5
-----------------------------------------------
Total energy, natural resources and related industries 183.1 205.4 61.8
All other:
American Express Company 2,401 52.8 70.9 21.3
Lehman Brothers Holdings, Inc. 1,019 14.6 15.0 4.5
Home Holdings, Inc. 755 7.7 7.1 2.1
Frequency Electronics, Inc. 593 5.0 2.6 .8
Aggregate of holdings less than $5.0 million 31.0 31.2 9.5
-----------------------------------------------
Total common equity securities $294.2 $332.4 100.0%
==========================================================================================================================
Other Investments
--------------------------------------------------------------------------------------------------------------------------
December 31, 1994
--------------------------------
Cost or
amortized Carrying
Millions cost value
--------------------------------------------------------------------------------------------------------------------------
Source One:
Mortgage loans held for investment $ 19.8 $ 19.8
REMICs 4.9 4.9
Aggregate of holdings less than $5.0 million 1.2 1.2
Parent Company and other subsidiaries:
White River Corporation note 50.0 50.0
US West, Inc. preferred shares 48.6 48.6
White River Corporation restricted common shares 19.8 17.1
Zurich Reinsurance Centre Holdings, Inc. restriced common shares 10.0 7.5
Southern Heritage/Merastar partnerships 5.0 5.0
Aggregate of holdings less than $5.0 million 4.3 3.2
--------------------------------
Total other investments $163.6 $157.3
==========================================================================================================================
53
FUND AMERICAN
DIRECTORS AND COMMITTEES
BOARD OF DIRECTORS
Class I (terms ending in 1995):
HOWARD L. CLARK Former Chairman - American Express Company
K. THOMAS KEMP Executive Vice President
GORDON S. MACKLIN Chairman - White River Corporation
Class II (terms ending in 1996):
GEORGE J. GILLESPIE, III Partner - Cravath, Swaine & Moore
JOHN J. BYRNE Chairman, President and CEO
Class III (terms ending in 1997):
HOWARD L. CLARK, JR. Vice Chairman - Lehman Brothers
ROBERT P. COCHRAN President and CEO - Financial Security
Assurance Holdings Ltd.
ARTHUR ZANKEL Co-Managing Partner - First Manhattan Co.
___________________________________________
COMMITTEES
AUDIT COMMITTEE OF THE BOARD OF DIRECTORS
The Audit Committee, consisting of all non-management directors, has
general responsibility for the oversight and surveillance of the accounting,
reporting and financial control practices of Fund American. The Audit Committee
annually reviews the qualifications of the independent auditors, makes
recommendations to the Board as to their selection, and reviews the plan, fees
and results of their audit.
Howard L. Clark, Jr., Chairman
HUMAN RESOURCES COMMITTEE OF THE BOARD OF DIRECTORS
The Human Resources Committee, consisting of all non-management
directors, oversees Fund American's compensation and benefit policies and
programs, including administration of the Incentive Plan, the Deferred
Compensation Plan and the Deferred Benefit Plan. The Human Resources Committee
also sets the annual salaries and bonuses for elected officers and certain other
key employees.
Gordon S. Macklin, Chairman
54
Fund American
OFFICERS
FUND AMERICA ENTERPRISES HOLDINGS,
INC.:
John J. Byrne/*/ Chairman, President and Chief Executive
Officer/1,2/
Dennis P. Beaulieu Corporate Secretary
K. Thomas Kemp/*/ Executive Vice President/1,2,3,/
Michael S. Paquette Vice President and Controller
Allan L. Waters Senior Vice President and Chief
Financial Officer/1,2/
FUND AMERICAN ENTERPRISES, INC.:
John J. Byrne/*/ Chairman
Terry L. Baxter/*/ President and Secretary/1,3/
SOURCE ONE MORTGAGE SERVICES
CORPORATION:
Robert W. Richards/*/ Chairman
Michael C. Allemang/*/ Executive Vice President and Chief
Financial Officer
James A. Conrad/*/ President and Chief Executive Officer
Robert R. Densmore/*/ Executive Vice President and Secretary
WHITE MOUNTAINS INSURANCE HOLDINGS, INC.:
John J. Byrne/*/ Chairman
Dennis P. Beaulieu/*/ Vice President and Secretary
Morgan W. Davis/*/ Senior Vice President and Chief Operating
Officer
K. Thomas Kemp/*/ President and Chief Executive Officer
Michael S. Paquette/*/ Vice President and Controller
Allan L. Waters/*/ Senior Vice President and Chief Financial
Officer
WHITE MOUNTAINS INSURANCE COMPANY:
K. Thomas Kemp/*/ Chairman
Dennis P. Beaulieu/*/ Secretary and Chief Financial Officer
Morgan W. Davis/*/ President and Chief Executive Officer
Michael S. Paquette/*/ Vice President and Controller
___________________________________________
* Individual is also a director of the company listed
/1/ Also a director of Source One Mortgage Services Corporation
/2/ Also a director of Financial Security Assurance Holdings Ltd.
/3/ Also a director of Main Street America Holdings, Inc.
55
FUND AMERICAN
CORPORATE INFORMATION
PRINCIPAL OFFICE STOCK EXCHANGE INFORMATION
Fund American Enterprises Holdings, Inc The Company's Common Stock (symbol
The 1820 House FCC) is listed on the New York
Norwich, Vermont 05055-0850 Stock Exchange.
(802)649-3633
ANNUAL MEETING
FORM 10-K
The 1995 Annual Meeting of
The financial statements shareholders will be held on
contained in this Wednesday, May 24, 1995, at the
report, in the opinion of management, Norwich Inn, Norwich, Vermont,
substantially conform with or exceed the at 9:00 a.m.
financial statement information required
in the "Form 10-K, Annual Report" to be filed
with the Securities and Exchange Commission INDEPENDENT AUDITORS
near the end of March 1995. Certain
supplemental information appears in the Ernst & Young LLP
Form 10-K which is not disclosed within 787 Seventh Avenue
this document. COPIES OF THE FORM 10-K ARE New York, New York 10019-6018
AVAILABLE WITHOUT CHARGE UPON WRITTEN REQUEST
TO THE CORPORATE SECRETARY'S OFFICE AT THE SHAREHOLDER INQUIRIES
NORWICH, VERMONT ADDRESS.
Written shareholder inquiries should
be sent to the Corporate Secretary at
the Norwich, Vermont address. Written
TRANSFER AGENT AND REGISTRAR FOR COMMON STOCK inquiries from the investment community
should be directed to the Investor
First Chicago Trust Company of New York Relations Department at the same address.
P.O. Box 2532
Jersey City, New Jersey 07303-2532
Shareholders may obtain information about
transfer requirements, replacement dividend
checks, duplicate 1099 forms and changes
of address by calling the Transfer Agent's
Telephone Response Center at (201) 324-0498.
Please be prepared to provide your tax
identification or social security number,
description of securities and address of
record. Other inquiries concerning your
shareholder account should be addressed in
writing to the Transfer Agent and Registrar.
56