SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
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or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number: 1-13654
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LIBERTY FINANCIAL COMPANIES, INC.
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(Exact name of registrant as specified in its charter)
Massachusetts 04-3260640
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
600 Atlantic Avenue, Boston, Massachusetts 02210-2214
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(Address of principal executive offices) (Zip Code)
(617) 722-6000
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(Registrant's telephone number, including area code)
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(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d)of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. [X] Yes [ ] No
There were 46,150,643 shares of the registrant's Common Stock, $.01 par
value, and 324,759 shares of the registrant's Series A Convertible Preferred
Stock, $.01 par value, outstanding as of October 15, 1998.
Exhibit Index - Page 21 Page 1 of 135
LIBERTY FINANCIAL COMPANIES, INC.
QUARTERLY REPORT ON FORM 10-Q FOR PERIOD ENDED SEPTEMBER 30, 1998
TABLE OF CONTENTS
Part I. FINANCIAL INFORMATION Page
Item 1. Financial Statements
Consolidated Balance Sheets as of September 30,
1998 and December 31, 1997
Consolidated Income Statements for the Three Months
and Nine Months Ended September 30, 1998 and 1997
Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 1998 and 1997
Consolidated Statement of Stockholders' Equity
for the Nine Months Ended September 30, 1998
Notes to Consolidated Financial Statements
Item 2. Management's Discussion and Analysis of Results
of Operations and Financial Condition
Part II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
Signatures
Exhibit Index
LIBERTY FINANCIAL COMPANIES, INC.
CONSOLIDATED BALANCE SHEETS
(in millions)
September 30 December 31
1998 1997
------------ -------------
Unaudited
ASSETS
Assets:
Investments $12,580.8 $12,343.5
Cash and cash equivalents 1,387.6 1,290.1
Accrued investment income 162.3 165.0
Deferred policy acquisition costs 281.5 232.0
Value of insurance in force 55.3 53.3
Deferred distribution costs 124.3 108.1
Intangible assets 297.7 199.0
Other assets 272.3 131.4
Separate account assets 1,433.5 1,329.2
----------- -----------
$16,595.3 $15,851.6
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Policyholder balances $12,342.5 $12,086.1
Notes payable to affiliates 229.0 229.0
Revolving credit facilities 123.5 26.5
Payable for investments purchased
and loaned 931.4 722.1
Other liabilities 280.2 310.4
Separate account liabilities 1,395.1 1,264.0
----------- ------------
Total liabilities 15,301.7 14,638.1
----------- ------------
Series A redeemable convertible preferred
stock, par value $.01; authorized, issued
and outstanding 324,759 shares in 1998 and
327,006 shares in 1997 15.1 14.6
----------- ------------
Stockholders' Equity:
Common stock, par value $.01; authorized
100,000,000 shares, issued 45,987,826
shares in 1998 and 44,706,398 shares in 1997 0.5 0.4
Additional paid-in capital 896.5 866.5
Accumulated other comprehensive income 54.7 83.0
Retained earnings 331.3 251.5
Cost of common stock held in treasury
(9,465 shares at December 31, 1997) 0.0 (0.3)
Unearned compensation (4.5) (2.2)
----------- ------------
Total stockholders' equity 1,278.5 1,198.9
----------- ------------
$16,595.3 $15,851.6
=========== ============
See accompanying notes to consolidated financial statements.
LIBERTY FINANCIAL COMPANIES, INC.
CONSOLIDATED INCOME STATEMENTS
(in millions, except per share data)
Unaudited
Three Months Ended Nine Months Ended
September 30 September 30
------------------- -------------------
1998 1997 1998 1997
-------- -------- -------- --------
Investment income $202.7 $212.0 $612.4 $632.2
Interest credited to policyholders (143.3) (150.9) (425.6) (445.4)
-------- -------- -------- --------
Investment spread 59.4 61.1 186.8 186.8
-------- -------- -------- --------
Net realized investment gains 4.2 6.1 4.0 22.1
-------- -------- -------- --------
Fee income:
Investment advisory and administrative
fees 58.4 56.1 174.5 161.8
Distribution and service fees 13.2 12.6 39.0 36.6
Transfer agency fees 11.9 12.3 36.6 35.6
Surrender charges and net commissions 8.2 9.5 26.2 27.0
Separate account fees 5.4 4.7 15.5 12.7
-------- -------- -------- --------
Total fee income 97.1 95.2 291.8 273.7
-------- -------- -------- --------
Expenses:
Operating expenses (78.5) (77.8) (238.5) (229.2)
Amortization of deferred policy
acquisition costs (15.5) (18.3) (52.8) (54.0)
Amortization of deferred distribution
costs (9.8) (8.5) (27.9) (25.4)
Amortization of value of insurance in
force (1.2) (2.2) (3.9) (7.3)
Amortization of intangible assets (3.6) (3.7) (10.7) (10.2)
Interest expense, net (2.7) (4.1) (10.5) (13.0)
-------- -------- -------- --------
Total expenses (111.3) (114.6) (344.3) (339.1)
-------- -------- -------- --------
Pretax income 49.4 47.8 138.3 143.5
Income tax expense (15.9) (14.9) (43.6) (45.6)
-------- -------- -------- --------
Net income $33.5 $32.9 $94.7 $97.9
======== ======== ======== ========
Net income per share - basic $0.73 $0.74 $2.08 $2.23
======== ======== ======== ========
Net income per share - assuming
dilution $0.71 $0.70 $2.00 $2.10
======== ======== ======== ========
See accompanying notes to consolidated financial statements.
LIBERTY FINANCIAL COMPANIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions)
Unaudited
Nine Months Ended
September 30
--------------------
1998 1997
--------- --------
Cash flows from operating activities:
Net income $94.7 $97.9
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 54.3 54.3
Interest credited to policyholders 425.6 445.4
Net realized investment gains (4.0) (22.1)
Net amortization on investments 101.9 22.0
Change in deferred policy acquisition costs (25.8) (10.3)
Net change in other assets and liabilities (26.1) 0.3
--------- --------
Net cash provided by operating activities 620.6 587.5
--------- --------
Cash flows from investing activities:
Investments purchased available for sale (5,207.4) (3,006.4)
Investments sold available for sale 4,060.6 1,414.2
Investments matured available for sale 938.2 1,230.5
Change in policy loans, net (24.8) (15.0)
Change in mortgage loans, net 4.3 4.6
Acquisitions, net of cash acquired (96.4) 0.0
Other 11.3 (15.7)
--------- --------
Net cash used in investing activities (314.2) (387.8)
--------- --------
Cash flows from financing activities:
Withdrawals from policyholder accounts (1,371.6) (948.9)
Deposits to policyholder accounts 1,089.3 738.4
Securities lending (25.0) 415.9
Change in revolving credit facilities 97.0 (20.0)
Exercise of stock options 5.8 6.3
Dividends paid (4.4) (3.5)
--------- --------
Net cash (used in) provided by financing
activities (208.9) 188.2
--------- --------
Increase in cash and cash equivalents 97.5 387.9
Cash and cash equivalents at beginning of period 1,290.1 875.8
--------- ---------
Cash and cash equivalents at end of period $1,387.6 $1,263.7
========= =========
See accompanying notes to consolidated financial statements.
LIBERTY FINANCIAL COMPANIES, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(in millions)
Unaudited
Accum.
Addt'l. Other Total
Common Paid-In Comprehen. Retained Treas. Unearned Stockholders'
Stock Capital Income Earnings Stock Compen. Equity
------- ------- ---------- -------- ------ --------- ------------
Balance,
December
31, 1997 $0.4 $866.5 $83.0 $251.5 $(0.3) $(2.2) $1,198.9
Effect of
stock-based
compensation
plans 0.1 11.1 0.3 (2.3) 9.2
Common stock
issued for
acquisitions 9.0 9.0
Accretion to
face value of
preferred stock (0.6) (0.6)
Common stock
dividends 9.9 (13.6) (3.7)
Preferred
stock
dividends (0.7) (0.7)
Net income 94.7 94.7
Other
comprehensive
income,
net of tax (28.3) (28.3)
------- ------- ---------- -------- ------ --------- ------------
Balance,
September
30, 1998 $0.5 $896.5 $54.7 $331.3 $0.0 $ (4.5) $1,278.5
======= ======= ========== ======== ====== ========= ============
See accompanying notes to consolidated financial statements.
LIBERTY FINANCIAL COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Unaudited
1. General
The accompanying unaudited consolidated financial statements include all
adjustments, consisting of normal recurring accruals, that management
considers necessary for a fair presentation of the Company's financial
position and results of operations as of and for the interim periods
presented. Certain footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to the rules and
regulations of the Securities and Exchange Commission. Therefore, these
consolidated financial statements should be read in conjunction with the
audited consolidated financial statements contained in the Company's 1997
Annual Report to Stockholders. The results of operations for the three
months and nine months ended September 30, 1998 are not necessarily
indicative of the results to be expected for the full year. Certain
previously reported amounts have been reclassified to conform to the
current period presentation.
2. Industry Segment Information
The Company is an asset accumulation and management company which
operates in two industry segments: retirement-oriented insurance
(principally annuities) and asset management. The annuity insurance
business is conducted at Keyport Life Insurance Company ("Keyport").
Keyport generates investment spread income from the investment portfolio
which supports policyholder balances associated with its fixed and indexed
annuity business and its closed block of single premium whole life
insurance. The annuity insurance business also derives fee income from the
administration of fixed, indexed and variable annuity contracts. The asset
management business is conducted principally at The Colonial Group, Inc.
("Colonial"), an investment advisor, distributor and transfer agent to
mutual funds, Stein Roe & Farnham Incorporated ("Stein Roe"), a diversified
investment advisor, Newport Pacific Management, Inc. ("Newport"), an
investment advisor to mutual funds and institutional accounts specializing
in Asian equity markets, The Crabbe Huson Group, Inc. ("Crabbe Huson"), an
investment advisor to mutual funds and institutional accounts, Progress
Investment Management Company, an investment advisor to institutional
accounts, and Liberty Asset Management Company ("LAMCO"), an investment
advisor to mutual funds. The asset management business derives fee income
from investment products and services.
Approximately 66% of the Company's income before interest expense,
amortization of intangible assets, net realized gains and income taxes for
the nine months ended September 30, 1998 was attributable to the Company's
annuity insurance business, with the remaining 34% attributable to the
Company's asset management activities. This compares to approximately 63%
and 37%, respectively, for the nine months ended September 30, 1997.
3. Investments
Investments, all of which pertain to the Company's annuity insurance
operations, were comprised of the following (in millions):
September 30 December 31
1998 1997
------------ -----------
Fixed maturities $11,447.2 $11,246.5
Equity securities 55.5 40.8
Mortgage loans 56.4 60.7
Policy loans 579.5 554.7
Other invested assets 442.2 440.8
------------ -----------
Total $12,580.8 $12,343.5
============ ===========
The Company's general investment policy is to hold fixed maturity assets
for long-term investment and, accordingly, the Company does not have a
trading portfolio. To provide for maximum portfolio flexibility and enable
appropriate tax planning, the Company classifies its entire fixed
maturities investments as "available for sale" which are carried at fair
value.
4. Net Income Per Share
On December 10, 1997, the Company effected a three-for-two common stock
split in the form of a 50 percent stock dividend. The following table sets
forth the computation of net income per share-basic and net income per
share-assuming dilution:
Three Months Ended Nine Months Ended
September 30 September 30
----------------------- ---------------------
1998 1997 1998 1997
----------- ---------- ---------- ---------
Numerator:
Net income $33.5 $32.9 $94.7 $97.9
Preferred stock dividends (0.2) (0.2) (0.7) (0.7)
----------- ---------- ---------- ---------
Numerator for net
income per share - basic
- income available to common
stockholders 33.3 32.7 94.0 97.2
Effect of dilutive securities:
Preferred stock dividends 0.2 0.2 0.7 0.7
----------- ---------- ---------- ----------
0.2 0.2 0.7 0.7
----------- ---------- ---------- ----------
Numerator for net income per
share - assuming dilution -
income available to common
stockholders after assumed
conversions $33.5 $32.9 $94.7 $97.9
Denominator:
Denominator for
net income per
share - basic - weighted -
average shares 45,440,311 44,093,736 45,110,661 43,606,920
Effect of dilutive securuties:
Employee stock options 1,339,023 2,436,131 1,651,337 2,410,223
Convertible preferred stock 514,493 517,929 516,090 518,130
----------- ---------- ---------- ----------
Dilutive potential common shares 1,853,516 2,954,060 2,167,427 2,928,353
----------- ---------- ---------- ----------
Denominator for net income per
share - assuming dilution
- adjusted weighted-average
shares and assumed
conversions 47,293,827 47,047,796 47,278,088 46,535,273
=========== ========== ========== ==========
Net income per share - basic $0.73 $0.74 $2.08 $2.23
=========== ========== ========== ==========
Net income per share - assuming
dilution $0.71 $0.70 $2.00 $2.10
=========== ========== ========== ==========
5. Recent Accounting Change
As of January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS
130"). SFAS 130 establishes new rules for the reporting and display of
comprehensive income and its components; however, the adoption of SFAS 130
had no impact on the Company's net income or stockholders' equity. SFAS
130 requires unrealized gains or losses on the Company's available-for-sale
securities, which prior to adoption were reported separately in
stockholders' equity, to be included in accumulated other comprehensive
income. Prior year financial statements have been reclassified to conform
to the requirements of SFAS 130.
Comprehensive income was comprised of the following (in millions):
Three Months Ended Nine Months Ended
September 30 September 30
------------------- -------------------
1998 1997 1998 1997
--------- ------- --------- --------
Net income $33.5 $32.9 $94.7 $97.9
Other comprehensive income, net of tax:
Change in net unrealized
investment gains (30.8) 24.5 (28.3) 26.7
--------- -------- -------- --------
Comprehensive income $2.7 $57.4 $66.4 $124.6
========= ======== ======== ========
6. Recent Accounting Pronouncement
In June 1998, Statement of Financial Accounting Standards No. 133
"Accounting for Derivative Instruments and Hedging Activities," was
issued. This statement standardizes the accounting for derivative
instruments and the derivative portion of certain other contracts that have
similar characteristics by requiring that an entity recognize those
instruments at fair value. This statement also requires a new method of
accounting for hedging transactions, prescribes the type of items and
transactions that may be hedged, and specifies detailed criteria to be met
to qualify for hedge accounting. This statement is effective for fiscal
years beginning after June 15, 1999. Earlier adoption is permitted. The
Company is evaluating the impact of this statement. Upon adoption, the
Company will be required to record a cumulative effect adjustment to
reflect this accounting change. At this time, the Company has not
completed its analysis and evaluation of the requirements and the impact of
this statement.
7. Acquisitions
On August 13, 1998, the Company entered into an agreement to acquire
100% of the capital stock of Societe Generale Asset Management Corp.
("SGAM"), a registered investment advisor with approximately $4.1 billion
of assets under management as of September 30, 1998. The purchase price
for this transaction is $205.0 million, subject to adjustment in certain
circumstances, consisting of $198.0 million in cash and $7.0 million in the
Company's common stock. In addition, the Company has agreed to pay up to
an additional $11.0 million in deferred payments contingent upon the
attainment of certain earnings objectives by SGAM. The acquisition, which
is subject to certain closing conditions, is expected to be completed in
early 1999 and will be accounted for as a purchase.
On August 31, 1998, the Company completed an agreement to acquire
certain assets and assume certain liabilities of Progress Investment
Management Company, a registered investment advisor to institutional
accounts with approximately $2.1 billion in assets under management as
of September 30, 1998. On September 30, 1998, the Company completed an
agreement to acquire certain assets and assume certain liabilities of Crabbe
Huson, a registered investment advisor with approximately $3.3 billion in
assets under management as of that date. The combined purchase price for
these transactions was approximately $104.6 million, including costs of
acquisitions, and consisted of $95.6 million in cash and $9.0 million
in the Company's common stock. In addition, the Company has agreed to
pay up to an additional $61.5 million in cash and common stock over five
years, contingent upon the attainment of certain earnings objectives. These
transactions were accounted for as purchases and resulted in the recording
of goodwill and other intangible assets of approximately $102.1 million.
8. Credit Facility
In connection with the Crabbe Huson acquisition, the Company entered
into a $100.0 million revolving credit facility with a commercial bank (the
"Bridge Facility"). The Bridge Facility matures on March 30, 1999 and
bears interest at a per annum rate equal to LIBOR plus twenty-five basis
points. The Company borrowed $90.0 million under the Bridge Facility to
finance the acquisition of Crabbe Huson.
Management's Discussion and Analysis of Results of Operations and Financial
Condition
Results of Operations
Net Income was $33.5 million or $0.71 per share for the quarter ended
September 30, 1998 compared to $32.9 million or $0.70 per share for the
quarter ended September 30, 1997. For the first nine months of 1998, net
income was $94.7 million or $2.00 per share compared to $97.9 million or
$2.10 per share for the first nine months of 1997. The decrease for the nine
months resulted largely from lower net realized investment gains in 1998
compared to 1997 and higher operating expenses. Partially offsetting these
items were higher fee income and lower interest expense, net and income tax
expense.
Pretax Income was $49.4 million for the quarter ended September 30, 1998
compared to $47.8 million for the quarter ended September 30, 1997. For the
first nine months of 1998, pretax income was $138.3 million compared to
$143.5 million for the first nine months of 1997. The decrease for the nine
months resulted largely from lower net realized investment gains in 1998
compared to 1997 and higher operating expenses. Partially offsetting these
items were higher fee income and lower interest expense, net.
Investment Spread is the amount by which investment income earned on the
Company's investments exceeds interest credited on policyholder balances.
Investment spread was $59.4 million for the quarter ended September 30, 1998
compared to $61.1 million for the quarter ended September 30, 1997. The
amount by which the average yield on investments exceeds the average interest
credited rate on policyholder balances is the investment spread percentage.
The investment spread percentage for the quarter ended September 30, 1998 was
1.63% compared to 1.80% for the quarter ended September 30, 1997. For the
first nine months of 1998 and 1997, investment spread was $186.8 million. The
investment spread percentage was 1.76% for the first nine months of 1998
compared to 1.89% for the first nine months of 1997.
Investment income was $202.7 million for the quarter ended September 30,
1998 compared to $212.0 million for the quarter ended September 30, 1997. The
decrease of $9.3 million in 1998 compared to 1997 primarily relates to a
$16.9 million decrease resulting from a lower average investment yield,
partially offset by a $7.6 million increase as a result of the higher level
of average invested assets. The 1998 investment income was net of $17.9
million of S&P 500 Index call option amortization expense related to the
Company's equity-indexed annuities compared to $13.6 million in 1997. The
average investment yield was 6.27% for the quarter ended September 30, 1998
compared to 6.82% for the quarter ended September 30, 1997. For the first
nine months of 1998, investment income was $612.4 million compared to $632.2
million for the first nine months of 1997. The decrease of $19.8 million in
1998 compared to 1997 primarily relates to a $45.8 million decrease resulting
from a lower average investment yield, partially offset by a $26.0 million
increase as a result of the higher level of average invested assets. The 1998
investment income was net of $53.1 million of S&P 500 Index call option
amortization expense related to the Company's equity-indexed annuities
compared to $31.2 million in 1997. The average investment yield was 6.41% for
the first nine months of 1998 compared to 6.91% for the first nine months of
1997.
Interest credited to policyholders totaled $143.3 million for the quarter
ended September 30, 1998 compared to $150.9 million for the quarter ended
September 30, 1997. The decrease of $7.6 million in 1998 compared to 1997
primarily relates to an $11.5 million decrease resulting from a lower average
interest credited rate, partially offset by a $3.9 million increase as a
result of a higher level of average policyholder balances. Policyholder
balances averaged $12.4 billion (including $10.6 billion of fixed products,
consisting of fixed annuities and the closed block of single premium whole
life insurance, and $1.8 billion of equity-indexed annuities) for the quarter
ended September 30, 1998 compared to $12.0 billion (including $10.7 billion
of fixed products and $1.3 billion of equity-indexed annuities) for the
quarter ended September 30, 1997. The average interest credited rate was
4.64% (5.31% on fixed products and 0.85% on equity-indexed annuities) for the
quarter ended September 30, 1998 compared to 5.02% (5.52% on fixed products
and 0.85% on equity-indexed annuities) for the quarter ended September 30,
1997. Keyport's equity-indexed annuities credit interest to the policyholder
at a "participation rate" equal to a portion (ranging for existing policies
from 40% to 95%) of the change in value of the S&P 500 Index. Keyport's
equity-indexed annuities also provide full guarantee of principal if held to
term, plus interest at 0.85% annually. For each of the periods presented, the
interest credited to equity-indexed policyholders related to the
participation rate is reflected net of income recognized on the S&P 500 Index
call options resulting in a 0.85% net credited rate. For the first nine
months of 1998, interest credited to policyholders totaled $425.6 million
compared to $445.4 million for the first nine months of 1997. The decrease of
$19.8 million in 1998 compared to 1997 primarily relates to a $32.5 million
decrease resulting from a lower average interest credited rate, partially
offset by a $12.7 million increase as a result of a higher level of average
policyholder balances. Policyholder balances averaged $12.2 billion
(including $10.5 billion of fixed products, consisting of fixed annuities and
the closed block of single premium whole life insurance, and $1.7 billion of
equity-indexed annuities) for the first nine months of 1998 compared to $11.8
billion (including $10.7 billion of fixed products and $1.1 billion of
equity-indexed annuities) for the first nine months of 1997. The average
interest credited rate was 4.65% (5.31% on fixed products and 0.85% on
equity-indexed annuities) for the first nine months of 1998 compared to 5.02%
(5.44% on fixed products and 0.85% on equity-indexed annuities) for the first
nine months of 1997.
Average investments in the Company's general account (computed without
giving effect to SFAS 115), including a portion of the Company's cash and
cash equivalents, were $12.9 billion for the quarter ended September 30, 1998
compared to $12.4 billion for the quarter ended September 30, 1997. For the
first nine months of 1998, such average investments were $12.7 billion
compared to $12.2 billion for the first nine months of 1997. These increases
primarily relate to net insurance cash flows for the twelve months ended
September 30, 1998.
Net Realized Investment Gains were $4.2 million for the quarter ended
September 30, 1998 compared to $6.1 million for the quarter ended September
30, 1997. For the first nine months of 1998, net realized investment gains
were $4.0 million, which is net of losses of $7.6 million for certain fixed
maturity investments where the decline in value was determined to be other
than temporary, compared to $22.1 million for the first nine months of 1997.
Sales of fixed maturity investments generally are made to maximize total
return.
Investment Advisory and Administrative Fees are based on the market value
of assets managed for mutual funds, private clients and institutional
investors. Investment advisory and administrative fees were $58.4 million for
the quarter ended September 30, 1998 compared to $56.1 million for the
quarter ended September 30, 1997. For the first nine months of 1998,
investment advisory and administrative fees were $174.5 million compared to
$161.8 million for the first nine months of 1997. These increases during 1998
compared to 1997 primarily reflect a higher level of average fee-based assets
under management.
Average fee-based assets under management were $40.7 billion for the
quarter ended September 30, 1998 compared to $38.4 billion for the quarter
ended September 30, 1997. For the first nine months of 1998, average
fee-based assets were $40.2 billion compared to $36.9 billion for the first
nine months of 1997. These increases during 1998 compared to 1997 resulted
from both acquisitions and net sales for the twelve months ended September
30, 1998. Investment advisory and administrative fees were 0.57% and 0.58% of
average fee-based assets under management for the quarters ended September
30, 1998 and 1997, respectively. For the first nine months of 1998 and 1997,
such percentages were 0.58%.
The amount of fee-based assets under management is affected by product
sales and redemptions and by changes in the market values of such assets
under management. Fee-based assets under management and changes in such
assets are set forth in the tables below (in billions).
Fee-Based Assets Under Management
As of September 30
----------------------
1998 1997
--------- ---------
Mutual Funds:
Intermediary-distributed $16.7 $16.6
Direct-marketed 6.5 7.2
Closed-end 2.2 2.2
Variable annuity 1.2 1.3
--------- ---------
26.6 27.3
Private Capital Management 7.0 6.4
Institutional 10.7 5.4
--------- ---------
Total Fee-Based Assets Under Management* $44.3 $39.1
========= =========
______________
* As of September 30, 1998 and 1997, Keyport's insurance
assets of $13.2 billion and $12.8 billion, respectively,
bring total assets under management to $57.5 billion and
$51.9 billion, respectively.
Changes in Fee-Based Assets Under Management
Three Months Ended Nine Months Ended
September 30 September 30
------------------- -------------------
1998 1997 1998 1997
--------- --------- --------- ---------
Fee-based assets under management
- beginning $41.0 $37.5 $38.7 $35.9
Sales and reinvestments 2.1 1.9 6.2 5.2
Redemptions and withdrawals (1.7) (1.5) (4.8) (5.0)
Acquisitions 5.4 0.0 5.4 0.0
Market appreciation (depreciation) (2.5) 1.2 (1.2) 3.0
--------- --------- --------- ---------
Fee-based assets under management
- ending $44.3 $39.1 $44.3 $39.1
========= ========= ========= =========
Distribution and Service Fees are based on the market value of the
Company's intermediary-distributed mutual funds. Distribution fees of 0.75%
are earned on the average assets attributable to such funds sold with
contingent deferred sales charges, and service fees of 0.25% (net of amounts
passed on to selling brokers) are generally earned on the total of such
average mutual fund assets. These fees totaled $13.2 million for the quarter
ended September 30, 1998 compared to $12.6 million for the quarter ended
September 30, 1997. For the first nine months of 1998, distribution and
service fees were $39.0 million compared to $36.6 million for the first nine
months of 1997. These increases during 1998 compared to 1997 were primarily
attributable to the higher asset levels of mutual funds with contingent
deferred sales charges. As a percentage of weighted average assets,
distribution and service fees were approximately 0.71% for the quarters ended
September 30, 1998 and 1997. For the first nine months of 1998 and 1997, such
percentages were 0.72% and 0.70%, respectively.
Transfer Agency Fees are based on the market value of assets managed in
the Company's intermediary-distributed and direct-marketed mutual funds. Such
fees were $11.9 million on average assets of $24.4 billion for the quarter
ended September 30, 1998 and $12.3 million on average assets of $24.8 billion
for the quarter ended September 30, 1997. For the first nine months of 1998,
transfer agency fees were $36.6 million on average assets of $24.8 billion
and $35.6 million on average assets of $24.1 billion for the first nine
months of 1997. As a percentage of total average mutual fund assets under
management, transfer agency fees were approximately 0.20% for the quarters
ended September 30, 1998 and 1997. For the first nine months of 1998 and
1997, such percentages were also 0.20%.
Surrender Charges and Net Commissions are revenues earned on: a) the early
withdrawal of annuity policyholder balances and redemptions of the
intermediary-distributed mutual funds which were sold with contingent
deferred sales charges; b) the distribution of the Company's
intermediary-distributed mutual funds (net of the substantial portion of such
commissions that is passed on to the selling brokers); and c) the sales of
non-proprietary products in the Company's bank marketing businesses (net of
commissions that are paid to the Company's client banks and brokers). Total
surrender charges and net commissions were $8.2 million for the quarter ended
September 30, 1998 compared to $9.5 million for the quarter ended September
30, 1997. For the first nine months of 1998, total surrender charges and net
commissions were $26.2 million compared to $27.0 million for the first nine
months of 1997.
Surrender charges on fixed, equity-indexed and variable annuity withdrawals
generally are assessed at declining rates applied to policyholder withdrawals
during the first five to seven years of the contract; contingent deferred
sales charges on mutual fund redemptions are assessed at declining rates on
amounts redeemed generally during the first six years. Such charges totaled
$5.5 million for the quarters ended September 30, 1998 and 1997. For the
first nine months of 1998, surrender charges were $17.3 million compared to
$15.6 million for the first nine months of 1997. Total annuity withdrawals
represented 12.4% and 10.9% of the total average annuity policyholder and
separate account balances for the quarters ended September 30, 1998 and 1997,
respectively. For the first nine months of 1998 and 1997, the corresponding
percentages were 13.7% and 11.0%, respectively. Net commissions were $2.7
million for the quarter ended September 30, 1998 and $4.0 million for the
quarter ended September 30, 1997. For the first nine months of 1998, net
commissions were $8.9 million compared to $11.4 million for the first nine
months of 1997.
Separate Account Fees are primarily mortality and expense charges earned on
variable annuity and variable life policyholder balances. These fees, which
are based on the market values of the assets in separate accounts supporting
the contracts were $5.4 million for the quarter ended September 30, 1998
compared to $4.7 million for the quarter ended September 30, 1997. For the
first nine months of 1998, separate account fees were $15.5 million compared
to $12.7 million for the first nine months of 1997. Such fees represented
1.54% and 1.61% of average variable annuity and variable life separate
account balances for the quarters ended September 30, 1998 and 1997,
respectively. For the first nine months of 1998 and 1997, such percentages
were 1.50% and 1.56%, respectively.
Operating Expenses primarily represent compensation, marketing, and other
general and administrative expenses. These expenses were $78.4 million for
the quarter ended September 30, 1998 compared to $77.8 million for the
quarter ended September 30, 1997. For the first nine months of 1998,
operating expenses were $238.4 million compared to $229.2 million for the
first nine months of 1997. These increases during 1998 compared to 1997 were
primarily due to increases in compensation and marketing expenses. Operating
expenses expressed as a percent of average total assets under management were
0.59% for the quarter ended September 30, 1998 compared to 0.61% for the
quarter ended September 30, 1997. For the first nine months of 1998 and 1997,
such percentages were 0.60% and 0.62%, respectively.
Amortization of Deferred Policy Acquisition Costs relates to the costs of
acquiring new business which vary with, and are primarily related to, the
production of new annuity business. Such costs include commissions, costs of
policy issuance and underwriting and selling expenses. Amortization was $15.5
million for the quarter ended September 30, 1998 compared to $18.3 million
for the quarter ended September 30, 1997. For the first nine months of 1998,
amortization of deferred policy acquisition costs was $52.8 million compared
to $54.0 million for the first nine months of 1997. Amortization expense
represented 26.1% and 30.0% of investment spread for the quarters ended
September 30, 1998 and 1997, respectively. For the first nine months of 1998
and 1997, the corresponding percentages were 28.3% and 28.9%, respectively.
Amortization of Deferred Distribution Costs relates to the deferred sales
commissions acquired in connection with the Colonial acquisition and the
distribution of mutual fund shares sold with contingent deferred sales
charges. Amortization was $9.8 million for the quarter ended September 30,
1998 compared to $8.5 million for the quarter ended September 30, 1997. For
the first nine months of 1998, amortization of deferred distribution costs
was $27.9 million compared to $25.4 million for the first nine months of
1997. These increases during 1998 compared to 1997 were primarily
attributable to the continuing sales of such fund shares during 1998 and 1997.
Amortization of Value of Insurance in Force relates to the
actuarially-determined present value of projected future gross profits from
policies in force at the date of acquisition. Amortization totaled $1.2
million for the quarter ended September 30, 1998 compared to $2.2 million for
the quarter ended September 30, 1997. For the first nine months of 1998,
amortization of value of insurance in force was $3.9 million compared to $7.3
million for the first nine months of 1997. These decreases during 1998
compared to 1997 were primarily due to reduced amortization related to a
change in mortality assumptions.
Amortization of Intangible Assets relates to goodwill and certain
identifiable intangible assets arising from business combinations accounted
for as purchases. Amortization was $3.6 million for the quarter ended
September 30, 1998 compared to $3.7 million for the quarter ended September
30, 1997. For the first nine months of 1998, amortization of intangible
assets was $10.7 million compared to $10.2 million for the first nine months
of 1997.
Interest Expense, Net was $2.7 million for the quarter ended September 30,
1998 compared to $4.1 million for the quarter ended September 30, 1997. For
the first nine months of 1998, interest expense, net was $10.5 million
compared to $13.0 million for the first nine months of 1997. These decreases
during 1998 compared to 1997 were due to lower interest expense related to
Colonial's credit facility which is utilized to finance the sale of shares of
mutual funds which have contingent deferred sales charges and to higher
interest income which is netted against interest expense.
Income Tax Expense was $15.9 million or 32.2% of pretax income for the
quarter ended September 30, 1998 compared to $14.9 million, or 31.2% of
pretax income for the quarter ended September 30, 1997. For the first nine
months of 1998, income tax expense was $43.6 million or 31.5% of pretax
income compared to $45.6 million, or 31.8% of pretax income for the first
nine months of 1997.
Financial Condition
Stockholders' Equity as of September 30, 1998 was $1.28 billion compared to
$1.20 billion as of December 31, 1997. Net income for the first nine months
of 1998 was $94.7 million and cash dividends on the Company's preferred and
common stock totaled $4.4 million. Common stock totaling $9.0 million was
issued in connection with the acquisition of Crabbe Huson and $5.7 million
was issued in connection with the exercise of stock options. In addition, the
exercise of certain stock options resulted in a federal income tax benefit to
the Company of $2.5 million which was credited to additional paid-in capital.
A decrease in accumulated other comprehensive income, net unrealized
investment gains, net of adjustments to deferred policy acquisition costs and
value of insurance in force, during the period decreased stockholders' equity
by $28.3 million.
Book Value Per Share amounted to $27.80 at September 30, 1998 compared to
$26.82 at December 31, 1997. Excluding net unrealized gains on investments,
book value per share amounted to $26.61 at September 30, 1998 and $24.97 at
December 31, 1997. As of September 30, 1998, there were 46.0 million common
shares outstanding compared to 44.7 million shares as of December 31, 1997.
Investments not including cash and cash equivalents totaled $12.6 billion
at September 30, 1998 compared to $12.3 billion at December 31, 1997. The
increase primarily reflects general account investment earnings.
The Company manages the substantial majority of its invested assets
internally. The Company's general investment policy is to hold fixed maturity
assets for long-term investment and, accordingly, the Company does not have a
trading portfolio. To provide for maximum portfolio flexibility and
appropriate tax planning, the Company classifies its entire fixed maturities
investments as "available for sale" and accordingly carries such investments
at fair value. The Company's total investments at September 30, 1998 and
December 31, 1997 reflected net unrealized gains of $204.6 million and $280.2
million, respectively, relating to its fixed maturity and equity portfolios.
Approximately $11.3 billion, or 81.6%, of the Company's general account
investments at September 30, 1998, was rated by Standard & Poor's
Corporation, Moody's Investors Service or under comparable statutory rating
guidelines established by the National Association of Insurance Commissioners
("NAIC"). At September 30, 1998, the carrying value of investments in below
investment grade securities totaled $1.2 billion, or 8.3% of general account
investments of $13.8 billion. Below investment grade securities generally
provide higher yields and involve greater risks than investment grade
securities because their issuers typically are more highly leveraged and more
vulnerable to adverse economic conditions than investment grade issuers. In
addition, the trading market for these securities may be more limited than
for investment grade securities.
Management of the Company's Investments
Asset-liability duration management is utilized by the Company to minimize
the risks of interest rate fluctuations and policyholder withdrawals. The
Company believes that its fixed and equity-indexed policyholder balances
should be backed by investments, principally comprised of fixed maturities,
that generate predictable rates of return. The Company does not have a
specific target rate of return. Instead, its rates of return vary over time
depending on the current interest rates, the slope of the yield curve and the
excess at which fixed maturities are priced over the yield curve. Its
portfolio strategy is designed to achieve acceptable risk-adjusted returns by
effectively managing portfolio liquidity and credit quality.
The Company conducts its investment operations to closely match the
duration of the assets in its investment portfolio to its policyholder
balances. The Company seeks to achieve an acceptable spread between what it
earns on its assets and interest credited on its policyholder balances by
investing principally in fixed maturities. The Company's fixed-rate products
incorporate surrender charges to encourage persistency and to make the cost
of its policyholder balances more predictable. Approximately 80.5% of the
Company's fixed annuity policyholder balances were subject to surrender
charges at September 30, 1998.
As part of its asset-liability management discipline, the Company conducts
detailed computer simulations that model its fixed-maturity assets and
liabilities under commonly used stress-test interest rate scenarios. Based on
the results of these computer simulations, the investment portfolio has been
constructed with a view toward maintaining a desired investment spread
between the yield on portfolio assets and the interest credited on
policyholder balances under a variety of possible future interest rate
scenarios. At September 30, 1998, the effective duration of the Company's
fixed maturities investments (including certain cash and cash equivalents)
was approximately 2.9. Effective duration is a common measure for the price
sensitivity of a fixed-income portfolio to changes in interest rates. It
measures the approximate percentage change in the market value of a portfolio
when interest rates change by 100 basis points. This measure includes the
impact of estimated changes in portfolio cash flows from features such as
prepayment and bond calls.
As a component of its investment strategy and to reduce its exposure to
interest rate risk, the Company utilizes interest rate swap agreements ("swap
agreements") and interest rate cap agreements ("cap agreements") to match
assets more closely to liabilities. Swap agreements are agreements to
exchange with a counterparty interest rate payments of differing character
(e.g. fixed-rate payments exchanged for variable-rate payments) based on an
underlying principal balance (notional principal) to hedge against interest
rate changes. The Company currently utilizes swap agreements to reduce asset
duration and to better match interest rates earned on longer-term fixed rate
assets with interest credited to policyholders. The Company had 38
outstanding swap agreements with an aggregate notional principal amount of
$2.3 billion and 45 outstanding swap agreements with an aggregate notional
principal amount of $2.6 billion as of September 30, 1998 and December 31,
1997, respectively.
Cap agreements are agreements with a counterparty which require the payment
of a premium for the right to receive payments for the difference between the
cap interest rate and a market interest rate on specified future dates based
on an underlying principal balance (notional principal) to hedge against
rising interest rates. The Company had interest rate cap agreements with an
aggregate notional amount of $250.0 million as of September 30, 1998 and
December 31, 1997.
With respect to the Company's equity-indexed annuities, the Company buys
call options on the S&P 500 Index to hedge its obligation to provide returns
based upon this index. The Company had call options with a book value of
$329.6 million and $323.3 million as of September 30, 1998 and December 31,
1997, respectively.
There are risks associated with some of the techniques the Company uses to
match its assets and liabilities. The primary risk associated with swap, cap
and call option agreements is counterparty nonperformance. The Company
believes that the counterparties to its swap, cap and call option agreements
are financially responsible and that the counterparty risk associated with
these transactions is minimal. In addition, swap and cap agreements have
interest rate risk and call options have stock market risk. These swap and
cap agreements hedge fixed-rate assets and the Company expects that any
interest rate movements that adversely affect the market value of swap and
cap agreements would be offset by changes in the market values of such fixed
rate assets. However, there can be no assurance that these hedges will be
effective in offsetting the potential adverse effects of changes in interest
rates. Similarly, the call options hedge the Company's obligations to
provide returns on equity-indexed annuities based upon the S&P 500 Index, and
the Company believes that any stock market movements that adversely affect
the market value of S&P 500 Index call options would be substantially offset
by a reduction in policyholder liabilities. However, there can be no
assurance that these hedges will be effective in offsetting the potentially
adverse effects of changes in S&P 500 Index levels. Keyport's profitability
could be adversely affected if the value of its swap and cap agreements
increase less than (or decrease more than) the change in the market value of
its fixed rate assets and/or if the value of its S&P 500 Index call options
increase less than (or decrease more than) the value of the guarantees made
to equity-indexed policyholders.
In June 1998, Statement of Financial Accounting Standards No. 133
"Accounting for Derivative Instruments and Hedging Activities," was issued.
This statement standardizes the accounting for derivative instruments and the
derivative portion of certain other contracts that have similar
characteristics by requiring that an entity recognize those instruments at
fair value. This statement also requires a new method of accounting for
hedging transactions, prescribes the type of items and transactions that may
be hedged, and specifies detailed criteria to be met to qualify for hedge
accounting. This statement is effective for fiscal years beginning after
June 15, 1999. Earlier adoption is permitted. The Company is evaluating the
impact of this statement. Upon adoption, the Company will be required to
record a cumulative effect adjustment to reflect this accounting change. At
this time, the Company has not completed its analysis and evaluation of the
requirements and the impact of this statement.
The Company routinely reviews its portfolio of investment securities. The
Company identifies monthly any investments that require additional
monitoring, and carefully reviews the carrying value of such investments at
least quarterly to determine whether specific investments should be placed on
a nonaccrual basis and to determine declines in value that may be other than
temporary. In making these reviews, the Company principally considers the
adequacy of collateral (if any), compliance with contractual covenants, the
borrower's recent financial performance, news reports, and other externally
generated information concerning the borrower's affairs. In the case of
publicly traded fixed maturities investments, management also considers
market value quotations if available.
Liquidity
The Company is a holding company whose liquidity needs include the
following: (i) operating expenses; (ii) debt service; (iii) dividends on
Preferred Stock and Common Stock; (iv) acquisitions; and (v) working capital
where needed by its operating subsidiaries. The Company's principal sources
of cash are dividends from its operating subsidiaries, and, in the case of
funding for acquisitions and certain long-term capital needs of its
subsidiaries, long-term borrowings, which to date have been from affiliates
of Liberty Mutual Insurance Company ("Liberty Mutual"). In connection with
the Crabbe Huson acquisition, the Company borrowed $90.0 million under the
Bridge Facility.
Current Rhode Island insurance law applicable to Keyport permits the
payment of dividends or distributions, which, together with dividends and
distributions paid during the preceding 12 months, do not exceed the lesser
of (i) 10% of Keyport's statutory surplus as of the preceding December 31 or
(ii) Keyport's statutory net gain from operations for the preceding fiscal
year. Any proposed dividend in excess of this amount is called an
"extraordinary dividend" and may not be paid until it is approved by the
Commissioner of Insurance of the State of Rhode Island. As of September 30,
1998, the amount of dividends that Keyport could pay without such approval
was an additional $65.3 million. Keyport had not paid any dividends since
its acquisition in 1988, until Keyport paid a $5.0 million dividend on
September 30, 1998.
The terms of Colonial's existing credit facility place certain restrictions
on Colonial's ability to pay dividends. Under the terms of the facility,
Colonial could pay dividends of up to $42.4 million as of September 30,
1998. No assurances can be given that future regulatory changes and credit
agreements will not create additional limitations on the ability of the
Company's subsidiaries to pay dividends.
Based upon the historical cash flow of the Company, the Company's current
financial condition and the Company's expectation that there will not be a
material adverse change in the results of operations of the Company and its
subsidiaries during the next twelve months, the Company believes that cash
flow provided by operating activities over this period will provide
sufficient liquidity for the Company to meet its working capital, capital
investment and other operational cash needs, its debt service obligations,
its obligations to pay dividends on the Preferred Stock and its intentions to
pay dividends on the Common Stock. The Company will require additional
external financing in order to finance the acquisition of SGAM. Such
acquisition, which is subject to the satisfaction of certain conditions, is
scheduled to close in early 1999. The Company anticipates that it would
require external sources of liquidity in order to finance material
acquisitions where the purchase price is not paid in equity.
Each of the Company's business segments has its own liquidity needs and
financial resources. In the Company's annuity insurance operations,
liquidity needs and financial resources pertain to the management of the
general account assets and policyholder balances. In the Company's asset
management business, liquidity needs and financial resources pertain to the
investment management and distribution of mutual funds, wealth management and
institutional accounts. The Company expects that, based upon their
historical cash flow and current prospects, these operating subsidiaries will
be able to meet their liquidity needs from internal sources and, in the case
of Colonial, from its credit facility used to finance sales of mutual fund
shares sold with contingent deferred sales charges.
Keyport uses cash for the payment of annuity and life insurance benefits,
operating expenses and policy acquisition costs, and the purchase of
investments. Keyport generates cash from annuity premiums and deposits, net
investment income and from the sales and maturities of fixed investments.
Annuity premiums, maturing investments and net investment income have
historically been sufficient to meet Keyport's cash requirements. Keyport
monitors cash and cash equivalents in an effort to maintain sufficient
liquidity and has strategies in place to maintain sufficient liquidity in
changing interest rate environments. Consistent with the nature of its
obligations, Keyport has invested a substantial amount of its general account
assets in readily marketable securities. As of September 30, 1998, $10.2
billion, or 73.6% of Keyport's general account investments are considered
readily marketable.
To the extent that unanticipated surrenders cause Keyport to sell for
liquidity purposes a material amount of securities prior to their maturity,
such surrenders could have a material adverse effect on the Company. Although
no assurances can be given, Keyport believes that liquidity to fund
anticipated withdrawals would be available through incoming cash flow and the
sale of short-term or floating-rate instruments, thereby precluding the sale
of fixed maturity investments in a potentially unfavorable market.
Year 2000
Many companies and organizations have computer programs that use only two
digits to identify a year in the date field. These programs were designed
and developed without considering the impact of the upcoming change in the
century. If not corrected, this could cause a system failure or
miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions.
In addressing the Year 2000 issue, the Company has substantially completed
an inventory of its computer programs and assessed its Year 2000 readiness.
The Company's computer programs include internally developed programs,
third-party purchased programs and third-party custom developed programs.
For programs which were identified as not being Year 2000 ready, the Company
is in the process of implementing a remedial plan which includes repairing or
replacing the programs and appropriate testing for Year 2000. The Company is
also in the process of identifying and reviewing its non-information
technology systems with respect to Year 2000 issues. In addition, the
Company has initiated communication with third parties to determine the
extent to which the Company's interface systems are vulnerable to those third
parties' failure to remediate their own Year 2000 issues.
The Company is developing, and will continue to develop, contingency plans
for dealing with any adverse effects that become likely in the event the
Company's remediation plans are not successful or third parties fail to
remediate their own Year 2000 issues. If necessary modifications and
conversions are not made, or are not timely completed, or if the systems of
the companies on which the Company's interface system relies are not timely
converted, the Year 2000 issues could have a material impact on the
operations of the Company. However, the Company believes that with
modifications to existing software and conversions to new software, the Year
2000 issue will not pose significant operational problems for its computer
systems.
In the opinion of management, the cost of addressing the Year 2000 issue is
not expected to have a material adverse effect on the Company's financial
condition or its results of operation.
Effects of Inflation
Inflation has not had a material effect on the Company's consolidated
results of operations. The Company manages its investment portfolio in part
to reduce its exposure to interest rate fluctuations. In general, the market
value of the Company's fixed maturity portfolio increases or decreases in
inverse relationship with fluctuations in interest rates, and the Company's
net investment income increases or decreases in direct relationship with
interest rate changes. For instance, if interest rates decline, the Company's
fixed maturity investments generally will increase in market value, while net
investment income will decrease as fixed maturity investments mature or are
sold and the proceeds are reinvested at reduced rates. However, inflation may
result in increased operating expenses that may not be readily recoverable in
the prices of the services charged by the Company.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
10.32 The Colonial Group, Inc. Credit Agreement dated as of April 10, 1998
with BankBoston N.A.
12 Statement re Computation of Ratios
27 Financial Data Schedule
(b) Reports on Form 8-K
On September 30, 1998, the Company filed a current report on Form 8-K
in connection with a lawsuit described therein.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
LIBERTY FINANCIAL COMPANIES, INC.
/s/ J. Andy Hilbert
--------------------------------
J. Andy Hilbert
(Duly Authorized Officer and
Chief Financial Officer)
Date: November 5, 1998
Exhibit Index
Exhibit No. Description Page
- ----------- ------------ -----
10.32 The Colonial Group, Inc. Credit Agreement
dated as of April 10, 1998 with BankBoston N.A.
12 Statement re Computation of Ratios
27 Financial Data Schedule