ITEM 1. BUSINESS
ORGANIZATIONAL CHART (AS OF SEPTEMBER 30, 2000)
[ORGANIZATION CHART]
The above chart lists the principal operating subsidiaries and their ownership for Summit Securities, Inc. and all subsidiaries (the "Consolidated Group").
NATIONAL SUMMIT CORP.: Parent Company, inactive except as owner of Summit (as defined herein). Wholly owned by C. Paul Sandifur, Jr., President of Metropolitan (as defined herein).
SUMMIT SECURITIES, INC.: Invests in Receivables (as defined herein) principally funded by proceeds from Receivable investments, other investments and securities offerings.
METROPOLITAN INVESTMENT SECURITIES, INC.: Broker/dealer marketing securities offered by Summit and Metropolitan, mutual funds, and general securities.
SUMMIT PROPERTY DEVELOPMENT, INC.: Provides real estate development services to others, with the principal clients being Metropolitan and its subsidiaries.
SUMMIT GROUP HOLDING COMPANY: Inactive except as owner of Old Standard Life Insurance Company.
OLD STANDARD LIFE INSURANCE COMPANY: Invests in Receivables and other investments principally funded by proceeds from Receivable investments and from annuity sales.
OLD WEST ANNUITY & LIFE INSURANCE COMPANY: Invests in Receivables and other investments principally funded by proceeds from Receivable investments and from annuity sales.
INTRODUCTION
BACKGROUND
The Consolidated Group consists of Summit Securities, Inc. ("Summit" or the "Registrant") and several subsidiaries, including two insurance companies, Old Standard Life Insurance Company ("Old Standard") and Old West Annuity & Life Insurance Company ("Old West"), a securities broker/dealer, Metropolitan Investment Securities, Inc. ("MIS") and a property development services company, Summit Property Development, Inc.
Summit, Old Standard and Old West are engaged in the business of investing in cash flowing assets, consisting of obligations collateralized by real estate, structured settlements, annuities, lottery prizes and other investments ("Receivables"), investment securities and other assets through funds provided by annuity sales, receivable cash flow, certificate (debt obligation) sales, preferred stock sales, earnings and sales of investments, sales of Receivables, including sales through securitization, and the resale of repossessed real estate. Currently, the Consolidated Group is focusing its Receivable investing activities on loans collateralized by commercial real estate. The Consolidated Group's goal is to achieve a positive spread between the return on its Receivable and other investments and its cost of funds. Summit may also engage in other businesses or activities without restriction in accordance with the provisions of its Articles of Incorporation. Summit is affiliated, due to the common control by C. Paul Sandifur, Jr., with Metropolitan Mortgage & Securities Co., Inc. ("Metropolitan"), which has as its principal subsidiaries Metwest Mortgage Services, Inc. ("Metwest") and Western United Life Assurance Company ("Western United"). These affiliates provide services to the Consolidated Group for a fee and engage in various business transactions with the Consolidated Group. See "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS" under Item 13 and "NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--NOTE 16" under Item 8.
Summit was originally organized as a wholly owned subsidiary of Metropolitan. On September 9, 1994, Metropolitan and C. Paul Sandifur, Jr. completed a sale of the common stock of Summit to National Summit Corp. National Summit Corp. is a holding company wholly owned by C. Paul Sandifur Jr. Mr. Sandifur holds effective control of Metropolitan. Prior to the sale, Mr. Sandifur held effective control of Summit, through Metropolitan. Following the sale, Mr. Sandifur continues to hold effective control of Summit through National Summit Corp. See "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS" under Item 13.
As of September 30, 2000, Summit's personnel consisted of its officers and directors, and various administrative personnel. See "MANAGEMENT" under Item 10. Most of those individuals are also employed by Metropolitan. It is anticipated that the Metropolitan employees will continue to devote substantially all of their time to their duties related to their respective positions with Metropolitan and its other affiliates subject to the necessary commitment of time to ensure that Summit fulfills its obligations to holders of its preferred stock or debt securities, and its duties under the Indenture pursuant to which it issues investment certificates ("Certificates") and such other duties and responsibilities as Summit may undertake in the conduct of its business or as may be required by law. No additional Summit employees are expected to be necessary or hired during the foreseeable future.
On September 30, 2000, Summit and its subsidiaries employed a total of 37 employees.
FACTORS AFFECTING FUTURE OPERATING RESULTS
The provisions of the Private Securities Litigation Reform Act of 1995 (the "Act"), became effective in December 1995. The Act provides a "safe harbor" for companies which make forward-looking statements providing prospective information. The "safe harbor" under the Act relates to protection for companies with respect to litigation filed on the basis of such forward-looking statements.
Summit wishes to take advantage of the "safe harbor" provisions of the Act and is therefore including this section in its Annual Report on Form 10-K. The statements contained in this Annual Report, if not historical, are forward-looking statements and involve risks and uncertainties which are described below and elsewhere herein that could cause actual results to differ materially from the results, financial or otherwise, or other expectations described in such forward-looking statements. These statements are identified with the words such as "may," "will," "expect," "intend," "anticipate," "believe," "continue," "seeks," "plans," variations of those terms or the negative of those terms, or words of similar meaning. Therefore, forward-looking statements should not be relied upon as a prediction of actual future results or occurrences.
Summit's future results may be affected by certain risks and uncertainties including the following:
RECEIVABLE INVESTMENTS
BACKGROUND
Historically, the Consolidated Group's Receivable acquisitions have been made pursuant to an agreement with Metropolitan. During the fiscal year ended September 30, 2000, the majority of the Consolidated Group's acquisitions were Commercial Loans underwritten and originated in coordination with Metropolitan and the Consolidated Group. Management anticipates that this emphasis will continue. However, the Consolidated Group may also acquire loans pursuant to the agreement with Metropolitan. In 2000, the Consolidated Group paid to Metropolitan approximately $111,000 as compensation to Metropolitan for Receivable acquisition services.
Unless otherwise indicated in this section and in the section entitled "SECURITIES INVESTMENTS," or the context otherwise requires, references to a year (e.g., 2000) refer to the fiscal year of the Consolidated Group ended September 30 of that year.
Metwest, a subsidiary of Metropolitan, provides Receivable collection and servicing for a fee to Summit, Old Standard and Old West. During 2000, the Consolidated Group paid Receivable collection and servicing fees of approximately $404,000 to Metwest.
Management believes that the terms and conditions of the agreements with Metropolitan and Metwest are at least as favorable to members of the Consolidated Group as those that could have been obtained by a non-affiliated third party. The agreements are non-exclusive and may be terminated in whole or part by prior written notice to the other party.
TYPES OF RECEIVABLES
The Consolidated Group's Receivable acquisitions include two principal types of Receivables: (a) Receivables collateralized by real estate and (b) alternative cash flows consisting of lotteries, structured settlements, annuities, and other cash flowing assets. Commercial loans originated by the Consolidated Group are originated and underwritten in coordination with Metropolitan and the Consolidated Group. All other Receivable acquisitions of the Consolidated Group are acquired through and underwritten by Metropolitan.
SECONDARY MORTGAGE MARKETS
The market for the acquisition or sale of existing real estate Receivables is commonly referred to as the secondary mortgage market. The secondary mortgage market includes individual Receivables which are held and sold by individual investors. The secondary mortgage market includes the sale of seller financed real estate Receivables and the sale and resale of pools of Receivables which can be seller financed, or originated by brokers or a financial institution. The Consolidated Group sells both individual Receivables and pools of Receivables.
COMMERCIAL LOAN ORIGINATIONS
The Consolidated Group (principally Old Standard) originates commercial loans collateralized by various types of commercial properties. These commercial loans are generally small to mid-sized loans that are originated for less than $15 million.
The Consolidated Group currently projects expansion of the origination of commercial loans during 2001. Current projections include the possibility that principally all of the Consolidated Group's Receivable acquisitions during 2001 may be new commercial loan originations. This projection is in part due to management's current perception that this market may be inadequately served by current lenders, who are not flexible in their underwriting and pricing policies and who are not able to quickly underwrite and close such loans, particularly in the temporary, bridge and development commercial loan markets. The
Consolidated Group also underwrites and originates commercial loans which are held by Metropolitan, Western United and Metwest.
The Consolidated Group obtains leads for such loans through mortgage brokers. The borrowers submit loan applications directly to the Consolidated Group.
Commercial loans originated by the Consolidated Group are underwritten applying criteria which may include the following: evaluating the borrower's credit and credit scores, obtaining a current interior appraisal of the collateral, obtaining title insurance and calculating debt-to-income levels and combined loan-to-value ratios. The sum of the underwriting evaluation and the speed within which a borrower needs a decision all determine the interest rate and loan-to-value ratio which the Consolidated Group will require. A higher risk evaluation would result in a higher required interest rate and a lower loan-to-value ratio. The Consolidated Group typically lends, through its insurance companies, at 50-75% loan-to-value ratios, and may require multiple collateral in order to adequately collateralize a particular loan.
For the fiscal year ended September 30, 2000, the average weighted annual yield (including fees and points) was approximately 16.2% on the Consolidated Group's commercial loans closed during the fiscal year. Frequently, the loans closed have required short-term balloon payments (approximately two to five years). However, because the Consolidated Group individually underwrites and prices these loans, the current terms may not be a reflection of the terms which may be negotiated in future transactions.
RECEIVABLE ACQUISITION VOLUME
The Consolidated Group's real estate Receivable and other Receivable investment acquisition activities grew from approximately $77.0 million in 1998 to $112.1 million in 1999 and to $148.9 million in 2000. During 2000, the average monthly acquisition volume was approximately $12.4 million. The majority of acquisitions were commercial loan originations.
RECEIVABLE ACQUISITIONS: SOURCES, STRATEGIES AND UNDERWRITING
The following information describes Metropolitan's Receivable acquisition and underwriting procedures as of September 30, 2000. These practices may be amended, supplemented and changed at any time at the discretion of Metropolitan and the Consolidated Group.
Metropolitan has developed marketing techniques, sources and underwriting practices for each of the different types of Receivables. In general, the real estate Receivables acquired or originated by Metropolitan for the Consolidated Group consist of non-conventional, A-, B and C credit grade loans. These types of Receivables possess characteristics which differ from the conventional lending market in that either the borrower or the property would not qualify for "A" credit grade lending or the seller or borrower chose non-conventional financing. With this type of lending, the lender generally focuses on the quality of the collateral as the ultimate recourse in the event of the borrower's default rather than the ability of a borrower to repay.
INDIVIDUAL RECEIVABLE ACQUISITION SOURCES
Historically, the majority of Metropolitan's real estate Receivables are acquired through individual Receivable acquisitions. See "--Current Mix of Receivable Investment Holdings." Metropolitan's principal source for private market Receivables has been independent brokers located throughout the United States. These independent brokers typically deal directly with private individuals or organizations who own and wish to sell a Receivable.
Metropolitan's acquisition strategy is designed to provide flexible structuring and pricing alternatives to the real estate Receivable seller, and quick closing times. Metropolitan believes these are key factors to Metropolitan's ability to attract and purchase Receivables. In order to enhance its position in this market, Metropolitan has improved its acquisition strategies by centralizing acquisition activities and implementing
flexible and strategic pricing and closing programs. Metropolitan is exploring other methods and sources for Receivable acquisitions in order to increase volume, decrease cost, and enhance its competitive position. There can be no assurance that any new strategies or programs developed will achieve these goals.
CAPITAL MARKETS (LOAN POOL) ACQUISITION SOURCES
Previously Metropolitan acquired pools of real estate Receivables through the capital markets group. These loans may have been seller originated or institutionally originated. They may have been acquired by Metropolitan from brokers, banks, savings and loan organizations, mortgage brokerage firms and other financial institutions. Metropolitan intends to this acquisition method during 2000.
Capital markets department acquisitions were typically negotiated through direct contact with the selling broker or portfolio departments at the various selling institutions, or are acquired through bidding at an auction. The closing costs per loan for institutional acquisitions were generally lower than private secondary mortgage market acquisitions. However, the investment yield generally was lower than yields available in the private market.
LOAN ORIGINATIONS SOURCES
Metwest previously originated first lien residential mortgage loans, including both fixed and adjustable interest rate loans. Metwest is currently licensed or exempt to originate such mortgage loans as a wholesale lender in 32 states and as a retail lender in 34 states. Metwest discontinued its origination of wholesale and retail loans in January of 2001.
Metwest previously originated real estate loans through licensed mortgage brokers who submitted loan applications on behalf of the borrower. Before Metwest entered into a broker agreement, the mortgage broker had to demonstrate that it was properly licensed, experienced and knowledgeable in lending. During 2000, Metwest originated an average of approximately 286 real estate loans per month, including loans to facilitate the resale of repossessed real estate.
CORRESPONDENT LENDING
Beginning in 1997, Metropolitan began acquiring loans through loan correspondent agreements. Under these agreements, Metropolitan agreed to purchase loans at a specified yield immediately after their origination, so long as they comply with Metropolitan's underwriting guidelines. Metropolitan discontinued originations through this source in January of 2001. Such loans previously originated through correspondent lending may be insured by a primary mortgage guarantee insurance policy. Each correspondent makes standard representations and warranties with respect to each loan and has certain limited repurchase obligations.
REAL ESTATE RECEIVABLE UNDERWRITING
Prior to discontinuance of the origination activities, Metropolitan's loan correspondent underwriting guidelines and Metwest's real estate loan acquisition and origination underwriting guidelines applied criteria which included the following: evaluating the borrower's credit (which generally may include credit scores), income and debt to income ratios, obtaining and reviewing a current appraisal of the collateral, evaluating the property type, comparing the loan amount to the collateral value and evaluating the economics of the region where the collateral is located. For certain, but not all, of the loans with higher loan-to-value ratios, mortgage insurance may be required. In addition, title insurance in an amount equal to the Receivable balance at the time of acquisition was generally obtained. Generally, a lower credit rating would result in a higher required down payment, higher collateral value to loan amount and/or a higher interest rate or yield (through a discounted purchase price). Unlike the seller financed real estate Receivables, the loans originated by Metwest, certain pool acquisitions and the loans purchased through
Metropolitan's loan correspondent program have standardized documentation and terms. Real estate Receivables acquired or originated for inclusion in securitization pools generally have more stringent underwriting guidelines than other acquired or originated real estate loans.
LOTTERIES, STRUCTURED SETTLEMENTS AND ANNUITIES SOURCES
Metropolitan also negotiates the purchase of Receivables which are not collateralized by real estate or other assets, such as structured settlements, annuities and lottery prizes. The lottery prizes generally arise out of state operated lottery games which are typically paid in annual installments to the prize winner. The structured settlements generally arise out of the settlement of legal disputes where the prevailing party is awarded a sum of money, payable over a period of time, generally through the creation of an annuity. Other annuities generally consist of investments which cannot be liquidated directly with the issuing insurance company. Metropolitan's primary source for these investments is private brokers who specialize in these types of Receivables.
LOTTERIES, STRUCTURED SETTLEMENTS AND ANNUITIES UNDERWRITING
In the case of all annuity purchases, Metropolitan's underwriting guidelines generally include a review of: (1) an application for sale of structured benefits which requests certain information regarding (i) the annuitant, including current employment, (ii) the annuity policy, and (iii) the nature of the claim and, if applicable, injuries sustained in connection with the structured settlement; (2) a copy of the executed settlement agreement or judgment, if applicable; and (3) a copy of the executed annuity policy together with any qualified assignments. In certain circumstances, Metropolitan waives certain of these submission requirements if, in its sole best judgment, it determines that the failure to have those documents would not impair the acquiring company's interest in the structured settlement. Upon submission of the file, the closing department obtains a credit report regarding the annuitant and the most current credit rating of the annuity issuer. Furthermore, Metropolitan conducts a Uniform Commercial Code ("UCC") search by county or state where applicable, on the annuitant in each state or county, as applicable, where the annuitant resided over the last five years and where the annuity issuer is located in order to ensure that no prior liens exist on the structured settlement payments.
When underwriting a structured settlement, Metropolitan will review the credit report, the annuitant's completed purchase application, the results of the UCC search, and the terms of the settlement and annuity policy, among other things. Metropolitan will not knowingly purchase settlements paid to a trust containing a spendthrift clause nor will it purchase settlements where the payments are the annuitant's sole source of income, where the loss of income would significantly damage the livelihood of the annuitant or where the payments are used exclusively for the payment of medical necessities. Metropolitan will not purchase payments from a minor without a court order approving the transaction or from annuitants who are currently members of the armed forces or from annuitants that do not otherwise have the legal capacity to contract without a court order. Metropolitan will not purchase settlements from annuitants that evidence a pattern of fraudulent behavior. In underwriting a structured settlement, Metropolitan will confirm that the settlement is not a workers' compensation settlement agreement or retirement or pension benefit.
In the case of lottery prizes, the underwriting guidelines generally require a review of both the documents providing proof of the prize and the credit rating of the insurance company or other entity that is making the lottery prize payments. Where the lottery prize is from a state run lottery, the underwriting guidelines generally require a confirmation from the respective lottery commission of the prize winner's right to sell the prize and an acknowledgment from the lottery commission of their receipt of notice of the sale. In many states, the sale of a state lottery prize requires that the winner obtain a court order permitting the sale. In those states, Metropolitan requires a certified copy of the court order.
OTHER RECEIVABLES
Metropolitan continually seeks opportunities in new Receivable markets. These programs account for a minimal amount of Metropolitan's current and projected Receivable acquisition volume. However, if new opportunities arise for the acquisition of new types of Receivables, Metropolitan is not limited from pursuing these opportunities.
YIELD AND DISCOUNT CONSIDERATIONS
Summit, Old Standard and Old West each establish their own yield requirements for Receivable acquisitions. Yield requirements are established in light of capital costs, market conditions, the characteristics of particular classes or types of Receivables and the risk of default by the Receivable payor. See also "Receivable Acquisitions: Sources, Strategies and Underwriting."
Receivables may be purchased by the Consolidated Group from Metropolitan or another party at a price that is less than the face amount of the Receivable. The difference between the price paid by the Consolidated Group and the face amount of the Receivable is the "discount." The Consolidated Group attempts to purchase Receivables at prices which will maintain a positive interest spread for the Consolidated Group. For Receivables of all types, the discounts originating at the time of purchase, net of capitalized acquisition costs, are amortized on an individual basis using the level yield (interest) method over the remaining contractual term of the Receivable.
The Consolidated Group establishes the yield requirements for Receivable investments by assuming that all payments on the Receivables will be made and that a certain percentage of unpaid balances will be prepaid on an annual basis (15% for 2000). During 2000, the Consolidated Group's average initial yield requirement ranged from 9.5% to 14% for Receivables collateralized by real estate. However, to the extent that Receivables are purchased at a discount and payments are received earlier than anticipated, the discount is earned more quickly resulting in an increase in the yield. Conversely, to the extent that payments are received later than anticipated, the discount is earned less quickly resulting in a lower yield.
A greater effective yield also can be achieved through negotiating amendments to the Receivable agreements. These amendments may involve adjusting the interest rate and/or monthly payments, extension of financing in lieu of a required balloon payment or other adjustments. As a result of these amendments, the cash flow may be extended, maintained or accelerated, the latter of which increases the yield realized on a Receivable purchased at a discount from its face value through accelerating recognition of the discount.
CURRENT MIX OF RECEIVABLE INVESTMENT HOLDINGS
The Consolidated Group's investments in Receivables include Receivables collateralized by first or second liens, primarily on single family residential property and commercial properties. Management believes that the yield earned on the mortgages collateralized by commercial property is higher than the yield on Receivables collateralized by single family residential property, while the credit risks are lower for the mortgage collateralized by single family residential property. Management also believes that much of the risk in the residential mortgage portion of the portfolio is dissipated by the large numbers of relatively small individual Receivables, the geographic dispersion of the collateral and the collateral value to investment amount requirements.
The following table presents consolidated information regarding the Consolidated Group's investments in Receivables collateralized by all types of real estate, as of September 30, 2000 and 1999:
As of September 30, 2000, approximately 98% of the Consolidated Group's investments in Receivables were collateralized by first lien positions on real estate and 2% in second lien positions. The Receivables which are collateralized by residential and commercial properties represented approximately 10% and 57%, respectively, of such investments as of September 30, 2000.
The Consolidated Group's Receivables at September 30, 2000 were collateralized by properties located throughout the United States with not more than 3% (by dollar amount) in any single state except as follows:
SUMMIT SECURITIES, INC. AND SUBSIDIARIES RECEIVABLES COLLATERALIZED BY REAL ESTATE SEPTEMBER 30, 2000
Less than 1% of the Receivables are subject to variable interest rates. Contractual interest rates principally range from 6% to 14% with approximately 92% of the face value of the Receivables within this range. The following table segregates the Consolidated Group's real estate Receivable portfolio by type, size, and lien position.
The principal amount of Receivables subject to delinquent principal or interest is defined as being in arrears for more than three months but which are still accruing interest.
The future maturities of the aggregate amounts of Receivables (face amount) are as follows:
The Consolidated Group held 1,672 Receivables collateralized by real estate, as of September 30, 2000. The average contractual interest rate (weighted by principal balances) on these Receivables on that date was approximately 12.4%. See "NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Note 4" under Item 8.
SUMMIT SECURITIES, INC. AND SUBSIDIARIES RECEIVABLES COLLATERALIZED BY REAL ESTATE SEPTEMBER 30, 1999
Approximately 1% of the Receivables are subject to variable interest rates. Interest rates range from 0% to 18% with rates principally (77% of face value) within the range of 8% to 13%. The following table segregates the Consolidated Group's real estate Receivable portfolio by type, size, and lien position.
The principal amount of Receivables subject to delinquent principal or interest is defined as being in arrears for more than three months but which are still accruing interest.
The future maturities of the aggregate amounts of Receivables (face amount) are as follows:
The Consolidated Group held 2,243 Receivables collateralized by real estate, as of September 30, 1999. The average contractual interest rate (weighted by principal balances) on these Receivables on that date was approximately 11.8%. See "NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Note 4" under Item 8.
DELINQUENCY EXPERIENCE AND COLLECTION PROCEDURES
The principal amount of Receivables collateralized by real estate, held by the Consolidated Group (as a percentage of the total outstanding principal amount of such Receivables) which was in arrears for more than ninety days at September 30, 2000 was 6.6% compared to 6.2% and 4.2% at September 30, 1999 and 1998, respectively. Management expects higher delinquency rates, because Receivables purchased or originated by the Consolidated Group are typically not of the same quality as mortgages that are originated for sale to agencies such as the Federal National Mortgage Association (Fannie Mae), because of the increasing concentration of acquisitions in commercial loans and because loans which have no current delinquency can be sold, while delinquent loans cannot be sold. Management also believes that these higher delinquency rates will be generally offset by higher yields and the value of the underlying collateral. In addition, the Consolidated Group maintains an allowance for losses on delinquent real estate Receivables. See "--Allowance for Losses on Receivables." As a result, management believes losses from resales of repossessed properties are generally lower than might otherwise be expected given the delinquency rates. In addition, the Consolidated Group is compensated for the risk associated with delinquencies through Receivable yields that are greater than typically available through the conventional, "A" credit lending markets.
Metwest provides Receivable collections and servicing to Summit, Old Standard and Old West pursuant to specific procedures. Collections efforts of delinquent amounts of Receivables are organized in a step stage format which staggers the intensity of the collection effort based upon the delinquency severity and allowing the more experienced collectors to handle the more delinquent accounts. The Consolidated Group's commercial underwriting resources are active in the monitoring and collection process of commercial loans. Metwest utilizes a computer generated payment behavior and scoring system to determine at which point a borrower will be called on a late payment which sometimes may be as soon as the first day of delinquency. If the system determines that a call should be placed to a borrower prior to the tenth day of delinquency a front-end collector will place a collection call to the payor. Generally, if a payment becomes seven days past due, a late notice will automatically be sent to the payor notifying the payor of the delinquency and the applicable late charge. When 10 days delinquent, the Receivable will be assigned to a second stage collector who will attempt to make verbal contact with the payor no later than the twenty-ninth day of delinquency if the payment and behavior scoring system indicates that a call should be placed at that time. The collector works closely with a more senior collector in a team environment. If no satisfactory arrangement is made by the twenty-second day of delinquency a pre-litigation (demand) letter will be sent to the payor. Additionally at the thirtieth day of delinquency the senior collector for that team will attempt to make contact with the payor. If verbal contact or satisfactory arrangements are not made by the forty-fifth day, a decision matrix is used to determine whether to forward the file: (i) to the loan modification center for a workout solicitation or acceleration; (ii) to the foreclosure department; or (iii) to the pre-foreclosure committee for review to determine the best method for solving the delinquency (either through additional workout attempts or through foreclosure). Generally, for those loans for which verbal contact has been made, a collector will work with the borrower to bring the loan current, or refer the loan to the loan modification center for a work out. Collectors continue to attempt to make contact with the payor, unless otherwise referred to the foreclosure department or the loan modification center, through the sixtieth day of delinquency. Collection activity may also involve the initiation of legal proceedings against the Receivable obligor. Legal proceedings, when necessary, are generally initiated within approximately 75 days after the initial default. If accounts are reinstated prior to completion of the legal action, as a condition of reinstatement, attorney fees, costs, expenses and late charges are generally collected from the payor, or added to the Receivable balance, in some cases.
When a lottery, structured settlement or annuity becomes delinquent, Metwest attempts to commence collection efforts within four days of a missed payment. Generally, these collection efforts consist of sending a letter to the Receivable seller and following up with telephone contact. If these steps have not
resolved the delinquency, legal action to enforce payment is commenced within approximately two weeks from the date of delinquency.
ALLOWANCE FOR LOSSES ON RECEIVABLES
The Consolidated Group establishes an allowance for losses on Receivables based on an evaluation of delinquent Receivables. The Consolidated Group reviews the results of its resales of repossessed real estate to identify market trends and to document the Consolidated Group's historical experience on such sales. The Consolidated Group then adjusts its allowance for losses requirement as appropriate, based upon such observed trends in delinquencies and losses on resales. The allowance for losses was 2.9%, 2.7% and 1.4% of the face value of Receivables collateralized by real estate at September 30, 2000, 1999 and 1998, respectively.
The following is an analysis of the allowance for losses on real estate contracts and mortgage notes receivable.
The provision for losses on real estate contracts and mortgage notes receivable, including commercial loans, is determined as the amount required to establish the allowance at the level determined in accordance with the policy described above. Because primarily all of the receivables are collateralized by real estate, the Consolidated Group considers its delinquency and loss experience in determining the likelihood that receivables that are currently performing may become delinquent, and the loss that may be experienced should foreclosure become the means of satisfaction. The Consolidated Group manages its risk of loss upon default through the underwriting process, which is performed by Metropolitan, which reviews demographics, real estate market trends, property value and overall economic conditions related to the real property collateralizing a receivable. Management does not expect that the loss experience related to the receivables will increase materially during the next full year of operations.
REPOSSESSED PROPERTIES
Summit, Old Standard and Old West own various repossessed properties that are held for sale. At September 30, 2000, 13 properties, acquired in satisfaction of debt, with a combined carrying amount of approximately $4.6 million were held, of which the largest single property had a carrying value of approximately $3.2 million. This single large property of residential lots is located the State of Hawaii and the Consolidated Group is actively marketing the property for sale.
RECEIVABLE SALES
The Consolidated Group sells pools of Receivables when it considers it profitable to do so. Such sales often occur in conjunction with sales of Receivables by Metropolitan and generally occur through one of two methods: (a) securitization or (b) direct sales. Management believes that in addition to the profits which may be earned, the sale of Receivables provides a number of benefits including allowing the Consolidated Group to diversify its funding base and provide liquidity. The sale of Receivables allows the Consolidated Group to continue to expand its investing activities without increasing its total asset size.
Historically, the majority of the Consolidated Group's receivable sales have been through securitizations. The Consolidated Group did not participate in any securitizations during 2000 and does
not anticipate doing so during the next fiscal year. Generally, a securitization involves the sale of certain specified Receivables to a bankruptcy remote single purpose trust. The trust issues certificates which represent an undivided ownership interest in the Receivables transferred to the trust. Typically, the certificates consist of several different classes, including senior certificates, residual interest certificates and may also include intermediate classes of subordinated certificates. The senior certificates are sold to investors who are generally institutional investors. If a market exists, some or all of the subordinate certificates are also sold to investors. The companies which sell their Receivables to the trust receive a cash payment representing their respective interest in the sales price for the senior certificates and any subordinate certificates sold. The selling companies receive an interest in any unsold subordinate certificates, and also typically receive an interest in the residual interest certificates. Such interests are generally initially apportioned based upon the respective companies' contribution of Receivables to the pool of Receivables sold to the trust and may be resecuritized.
In the typical securitization structure, the Receivable payments are distributed first to the senior certificates, next to the subordinated certificates, if any, and finally to the residual interests. As a result, the residual interest is the interest first affected by any loss of income due to the failure of the Receivable to pay as scheduled. The rights of the senior certificate holders can be further enhanced by subordinating the rights of the subordinate certificate holders to receive distributions or by establishing a reserve fund. The holders of the residual interest value such interest in their respective financial statements based upon certain assumptions regarding anticipated losses and prepayments. To the extent actual prepayments and losses are greater or less than the assumptions, the companies holding the residual interests will experience a gain or a loss. When determining the expected cash flow, the Consolidated Group must estimate the future rates of prepayments, defaults, and default loss severity (the loss realized upon liquidation of collateral from repossessed loans) as they affect the amount and timing of the estimated cash flows. During the quarter ended June 30, 2000, the Consolidated Group adjusted its assumptions based on the actual historical performance and expectations of future performance of the loan pools.
The Consolidated Group may experience changes in the fair value of its residuals, which are recorded at estimated fair value and accounted for as "available-for-sale" securities. Temporary declines in the fair value of residuals that are "available-for-sale" are excluded from earnings and reported as a separate component of shareholders' equity. The Consolidated Group will continue to periodically assess the assumptions used in valuing the cash flows and the related carrying value of its residuals and subordinated securities. During the third quarter of 2000, the Emerging Issues Task Force issued EITF 99-20 "Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets" ("EITF 99-20"). This EITF will change the manner in which the Consolidated Group determines whether a decline in fair value of its investment is other than temporary. The Consolidated Group must adopt the provisions of EITF 99-20 on April 1, 2001, but has not fully determined the effect of implementing EITF 99-20. As such, there may be declines in fair value of investments, which are currently recorded in equity as other comprehensive losses, which will be considered to be permanent impairments resulting in a charge against earnings upon adoption.
During the fiscal year ended September 30, 2000, the Consolidated Group did not participate in any securitizations. Through September 30, 2000, the Consolidated Group (principally Summit and Old Standard) had participated as a seller of Receivables in five real estate Receivable securitizations and one structured settlement Receivable securitization with Metropolitan. The Consolidated Group's percentage of each real estate securitization has been less than approximately 10% in each transaction. The Consolidated Group's percentage of the structured settlement securitization was approximately 42%. In each securitization, Metropolitan has typically used either futures contracts or securities "short sales" to hedge or protect the profits for all or a portion of the transaction. The price to the Consolidated Group at settlement for each securitization includes their proportionate share of hedging transactions related to each securitization. See "NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Note 4" under Item 8.
The Consolidated Group (principally Summit and Old Standard) has participated as Sellers in securitizations with Metropolitan and Western United. In these securitizations, the rights of the senior certificate holders were enhanced though subordinating the right of subordinate certificate holders to receive distributions with respect to the mortgage loans to such rights of senior certificate holders. The selling companies initially retained their respective residual interests but recently, certain of such residual interests were resecuritized. At September 30, 2000, the residual interests held by Summit and Old Standard from the prior securitizations aggregated approximately $3.1 million.
In addition to sales through securitizations, the Consolidated Group may sell pools of Receivables directly to purchasers. These sales are typically without recourse, except that for a period of time the selling company is generally required to repurchase or replace any Receivables which do not conform to the representations and warranties made at the time of sale. During 2000, Summit, Old Standard, and Old West received proceeds of approximately $9.7 million from the sale of portfolios of real estate Receivables through direct sales and received proceeds of approximately $1.7 million from the direct sale of other Receivable investments. During 2000 gains on these direct sales were approximately $0.4 million.
ANNUITY OPERATIONS
INTRODUCTION
The Consolidated Group raises significant funds through its insurance subsidiaries, Old Standard and Old West. Old Standard was incorporated in Idaho in 1988, and was acquired by the Consolidated Group from Metropolitan on May 31, 1995. Old Standard had total assets of approximately $203 million at September 30, 2000. Old Standard markets its annuity products through over 300 independent sales representatives under contract. These representatives may also sell insurance products for other companies. Old Standard is licensed as an insurer in Idaho, Iowa, Montana, North Dakota, Oregon, South Dakota, Washington and Utah. During calendar 2000, the most recent year for which statistical information is available, Old Standard's individual annuity market share in Idaho was 3%, ranking it the tenth largest producer of annuities in Idaho during the period.
The Consolidated Group acquired Arizona Life Insurance Company ("Arizona Life") on December 28, 1995. Arizona Life subsequently changed its name to Old West. As of September 30, 2000, Old West had total assets of approximately $83 million. Old West is licensed in Arizona, California, Delaware, Idaho, New Mexico, Texas and Utah.
Management intends to expand the insurance operations into other states as opportunities arise, which may include the acquisition of other insurance companies.
There are no specific regulatory limitations imposed by Idaho or Arizona on the percent of assets which Old Standard or Old West may invest in Receivables collateralized by first position liens on real estate. As of September 30, 2000, 55% of Old Standard's assets were invested in Receivables collateralized by real estate, and 5% in lotteries. As of September 30, 2000, 39% of Old West's assets were invested in Receivables collateralized by real estate. As of September 30, 2000, the balance of Old Standard's and Old West's investments were principally invested in corporate and government securities. See "REGULATION."
Generally, loans which are acquired through the institutional secondary mortgage market qualify as "mortgage related securities" pursuant to the Secondary Mortgage Market Enhancement Act ("SMMEA"). SMMEA generally provides that qualifying loans may be acquired to the same extent that obligations which are issued by or guaranteed as to principal and interest by the United States government, its agencies or instrumentalities can be acquired. Such acquisitions are exempt from certain state insurance regulations including loan to collateral value and appraisal regulations.
ANNUITIES
During the last three years, Old Standard and Old West have derived 100% of their premiums from annuity sales including both annuities reinsured from Western United and their own direct annuity sales. Management believes that annuity balances have continued to grow due to market acceptance of the products (due largely to a competitive rate), and changes in tax laws that removed the attractiveness of competing tax-advantaged products.
Old Standard's and Old West's annuities also qualify as investments under several of the tax-advantaged programs.
During 2001, the Consolidated Group anticipates correlating premium cash flows substantially with the cash flows availability from Receivable investments, in order to maximize the earnings from the interest spread. Additionally, the premium cash flows and resulting total asset growth will be influenced by the ability of Summit to make additional capital contributions to Old Standard and Old West, and the ability to securitize or otherwise sell Receivables.
Flexible and single premium annuities are offered with short, intermediate and traditional surrender fee periods. At September 30, 2000, deferred policy acquisition costs were approximately 4.7% of annuity reserves. Since surrender charges typically do not exceed 5% of policy amounts, increasing termination rates may have an adverse impact on the insurance subsidiaries' earnings, requiring faster amortization of these costs. During the years ended September 30, 1998, 1999 and 2000, the amortization of deferred policy acquisition costs was approximately $1,195,000, $2,365,000 and $2,870,000, respectively. An actuary has reviewed the calculations.
Annuity lapse rates are calculated by dividing cash outflows related to partial and full surrenders, periodic payments and death benefits by average annuity reserves. For the years ended September 30, 1998, 1999 and 2000, annualized lapse rates were approximately, 11.6%, 12.0% and 23.8% respectively. The change in lapse rates from 1999 to 2000 was primarily attributable to maturities of one-year products issued in 1999.
The life insurance subsidiaries of the Consolidated Group are required to file statutory financial statements with state insurance regulatory authorities in their states of domicile. Accounting principles used to prepare these statutory financial statements differ from generally accepted accounting principles ("GAAP"). A reconciliation of GAAP net income to statutory net income for the years ended September 30, 2000, 1999 and 1998, respectively, is as follows:
REINSURANCE
Reinsurance is the practice whereby an insurance company enters into agreements ("treaties") with other insurance companies in order to assign or assume some of the insured risk for which a premium is paid, while the reinsured retains the remaining risk. Although reinsurance treaties provide a contractual basis for shifting a portion of the insured risk to other insurers, the primary liability for payment of claims remains with the original insurer. Most life insurers obtain reinsurance on a portion of their risks in the ordinary course of business. The amount of risk that a company is willing to retain is based primarily on considerations of the amount of insurance it has in force and upon its ability to sustain unusual surrender fluctuations.
Old Standard has entered into a reinsurance agreement with Western United that became effective July 1, 1998 and remained in effect at September 30, 2000. Under this agreement, Western United reinsured with Old Standard 75% of the risk on 15 different annuity products. The premiums ceded during the fiscal year ended September 30, 1999 and 2000 were approximately $44.7 million and $27.4 million, respectively. Western United received ceding allowances equal to actual commission plus 1.5% of the premium, which was approximately $2.3 million and $1.5 million during the fiscal years ended September 30, 1999 and 2000 respectively.
This agreement has allowed Old Standard to acquire annuities at greater speeds and at lower premium rates than management believes would have been available through direct sales. Under its contractual terms, the agreement is an ongoing arrangement with no stated expiration or termination date, although either party may stop and restart at their discretion upon providing a 30-day advance written notice. It is expected that approximately $30 million will be ceded under this treaty during fiscal 2001. Western United receives a fee from Old Standard for servicing the reinsured policies, which fee is 40 basis points annually on the cash value of the reinsured policies.
In December 1998, Old Standard ceded a block of single premium deferred annuities in the amount of approximately $37.5 million to its wholly owned subsidiary Old West. The ceding allowance was approximately $2.1 million. The reinsurance was a one-time transaction. Future reinsurance between Old Standard and Old West currently is not anticipated. The objective of the transaction was to position Old West for consistent future profitability. In addition, management believes that the increase in Old West's asset size will better position Old West in its market place. It is expected that Old Standard will, in return, benefit from the profitability of its subsidiary.
RESERVES
Applicable state law requires that the annuity reserve be sufficient to meet Old Standard's and Old West's future obligations under annuity contracts currently in force. Reserves are recalculated each year to reflect amounts of insurance in force, issue ages of new contract holders, duration of contracts and variations in contract terms. Since such reserves are based on certain actuarial assumptions, no representation is made that the ultimate liability will not exceed these reserves. Old Standard and Old West utilize an actuary to review the reserve amount for compliance with applicable statutes.
The actuarially determined reserve is reported in statutory financial statements as required by state insurance regulatory authorities. Accounting principles used to prepare these statutory financial statements differ from generally accepted accounting principles (GAAP). Annuity reserves were approximately $237.6 million at September 30, 2000 based on GAAP financial reporting.
SECURITIES INVESTMENTS
At September 30, 2000 and 1999, 83% and 93%, respectively, of the Consolidated Group's securities, excluding stock investment in affiliated companies, were held by its insurance subsidiaries.
The following table outlines the nature and carrying value of securities investments held by Old Standard and Old West at September 30, 2000:
Investments of the insurance subsidiaries are subject to the direction and control of investment committees appointed by their respective Board of Directors. All such investments must comply with applicable state insurance laws and regulations. See "REGULATION." Investments primarily include corporate, government agency, and direct government obligations.
Old Standard and Old West are authorized by their respective investment policies to use financial futures instruments for the purpose of hedging interest rate risk relative to the securities portfolio or
potential trading situations. In both cases, the futures transaction is intended to reduce the risk associated with price movements for a balance sheet asset. Securities may be sold "short" (the sale of securities which are not currently in the portfolio and therefore must be purchased to close out the sale agreement) as another means of hedging interest rate risk, to benefit from an anticipated movement in the financial markets. See "RECEIVABLE INVESTMENTS--Receivable Sales." At September 30, 2000, the Consolidated Group had no outstanding hedge transactions or open short sales positions. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--Asset/Liability Management" under Item 7.
METHOD OF FINANCING
The Consolidated Group's continued growth is expected to depend on its ability to market its securities and annuities to the public and to invest the proceeds in higher-yielding investments. Financing needs are intended to be met primarily by the sale of its annuities, certificates, preferred stock, sales of Receivables, and collateralized borrowings. Such funds may be supplemented by short-term bank financing and borrowing from affiliates. Old Standard has established secured lines of credit through several lending institutions, principally consisting of brokerage firms and including the Federal Home Loan Bank of Seattle. As of September 30, 2000, the Consolidated Group had $7,000,000 in short-term collateralized borrowings outstanding.
The availability of Receivables offered for investment in the national market is believed by management to be adequate to meet the needs of the Consolidated Group.
BROKER/DEALER ACTIVITIES
MIS is a securities broker/dealer, and member of the National Association of Securities Dealers, Inc. It markets the securities products of Summit and of Metropolitan. In addition, MIS currently markets several families of mutual funds, and general securities. MIS is licensed as a broker/dealer in 47 states. MIS had net income of approximately $209,000 during 2000. Management is considering staffing, management systems and budget changes which are designed to expand the market and improve the profitability of MIS. There can be no assurance that these efforts will continue to be successful. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" under Item 7 and Item 13.
PROPERTY DEVELOPMENT SERVICES
Summit Property Development, Inc. provides real estate development services for a fee. Currently, its principal clients are Metropolitan and Western United. Such services may include but are not limited to the following: sales, marketing, market analysis, architectural services, design services, subdividing properties, and coordination with regulatory groups to obtain the approvals which are necessary to develop a particular property. Summit Property Development does not own any real estate itself. Summit Property Development, Inc. produced operating losses for the Consolidated Group during the fiscal year ended September 30, 2000 of approximately $485,000 on revenues of approximately $1,975,000. Management is considering staffing changes, exploring new marketing methods and exploring strategic alliances with other companies to expand the activities and improve the profitability of the Summit Property Development, Inc. There can be no assurance that these efforts will be successful. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" under Item 7 and Item 13.
COMPETITION
Summit, Old Standard and Old West's ability to compete for Receivable investments (except for commercial loans) is currently dependent upon Metropolitan's Receivable acquisition network. Metropolitan competes with various real estate financing firms, real estate brokers, banks and individual investors for the Receivables it acquires. In Receivable acquisitions, the Consolidated Group competes with financial institutions many of which are larger, have access to more resources and have greater name recognition. Management believes its primary competitive factors are the amounts offered and paid to Receivable sellers and the speed with which the processing and funding of the transaction can be completed. Competitive advantages enjoyed by Summit, Old Standard and Old West include access to Metropolitan's Receivable acquisition network, which allows access to markets throughout the United States and flexibility in structuring Receivable acquisitions. To the extent other competing Receivable investors may develop faster closing times or more flexible investment policies, they may experience a competitive advantage.
Summit, Old Standard and Old West compete in the secondary mortgage market as sellers of pools of Receivables through direct sales. This market is a multi-billion dollar industry and includes many financial institutions and government participants. Competitors generally have access to larger resources, better name recognition and greater transaction volumes and economies of scale.
Summit's and MIS's securities products face competition for investors from other securities issuers, other broker/dealers and from other types of financial institutions, many of which are much larger, and have greater name recognition than MIS.
Summit competes with many other lending institutions in its commercial loan origination program. The commercial lending market is a multi-billion dollar market including competitors with vastly greater resources, economies of scale and name recognition. Summit believes that its flexible underwriting, pricing guidelines and closing speed enhance its ability to compete in this market. There can be no assurance that Summit's commercial loan origination program will be successful in expanding these activities, or that they will be profitable, if expanded.
The life insurance and annuity business is highly competitive. Premium rates, annuity yields and commissions to agents are particularly sensitive to competitive forces. Old Standard's and Old West's management believe that their respective companies are in an advantageous position in this regard because of their earning capability through investments in Receivables compared to that of most other life insurance companies. Old Standard has been assigned an A.M. Best Co. ("Best") rating of "B" (fair) and Old West has been assigned a Best rating of "B" (fair). Best bases its rating on a number of complex financial ratios, the length of time a company has been in business, the nature and quality of investments in its portfolio, depth and experience of management and various other factors. Best's ratings are supplied primarily for the benefit of the policyholders and insurance agents.
REGULATION
Old Standard and Old West are subject to the Insurance Holding Company Act as administered by the Office of the State Insurance Commissioner of the States of Idaho and Arizona, respectively. Old West is also considered to be commercially domiciled in the State of Texas due to the percent of its sales to residents of Texas. As such, Old West is subject to holding company and related regulations in the State of Texas. Each act regulates transactions between insurance companies and their affiliates. It requires that the insurance companies provide prior notification to the respective Insurance Commissioners of certain transactions between an insurance company and Summit or any other affiliate. In certain instances, approval from the respective Insurance Commissioner is required prior to engaging in an affiliated transaction.
Old Standard and Old West are subject to extensive regulation and supervision by the Offices of the State Insurance Commissioner of Idaho and Arizona, respectively. To a lesser extent they are also subject to regulation by each of the other states in which they operate. These regulations are directed toward supervision of such things as granting and revoking licenses to transact business on both the insurance company and agent levels, approving policy forms, prescribing the nature and amount of permitted investments, establishing solvency standards and conducting extensive periodic examinations of insurance company records. Such regulation is intended to protect annuity contract and policy owners, rather than investors in an insurance company.
All states in which the insurance subsidiaries operate have laws requiring solvent life insurance companies to pay assessments to protect the interests of policyholders of insolvent life insurance companies. Assessments are levied on all member insurers in each state based on a proportionate share of premiums written by member insurers in the lines of business in which the insolvent insurer engaged. A portion of these assessments can be offset against the payment of future premium taxes. However, future changes in state laws could decrease the amount available for offset.
The net amounts expensed (recaptured) by Old Standard and Old West for guaranty fund assessments and charged to operations for the years ended September 30, 2000, 1999 and 1998 were approximately $(263,000), $270,000 and $119,000, respectively. This estimate was based on updated information provided by the National Organization of Life and Health Insurance Guaranty Associations regarding insolvencies occurring during 1990 through 1998. Management does not believe that the amount of future assessments associated with known insolvencies after 1998 will be material to its financial condition, results of operations or cash flows. These estimates are subject to future revisions based upon the ultimate resolution of the insolvencies and resultant losses. Management cannot reasonably estimate the additional effects, if any, upon its future assessments pending the resolution of the above described insolvencies.
Old Standard and Old West are subject to regulatory restrictions on their ability to pay dividends. Such restrictions affect Summit's and Old Standard's ability to receive dividends. The unassigned statutory surplus deficit of Old Standard and Old West totaled approximately $361,000 and $3,082,000, respectively, as of September 30, 2000 and are currently restricted from paying dividends.
For statutory purposes, Old Standard's and Old West's capital and surplus and their ratio of capital and surplus to admitted assets were as follows as of the dates indicated:
Although the States of Idaho and Arizona require only $2.0 million and $450,000, respectively, in capital and surplus to conduct insurance business, the insurance companies have attempted to maintain a capital and surplus ratio of at least 5% of total admitted assets which management considers adequate for regulatory and rating purposes.
Idaho and Arizona have enacted the Risk Based Capital Model Law which requires an insurance company to maintain minimum amounts of capital and surplus based on complex calculations of risk factors that encompass the invested assets and business activities. At September 30, 2000, the insurance subsidiaries' capital and surplus levels exceeded the calculated minimum requirements.
MIS is subject to extensive regulation and supervision by the National Association of Securities Dealers, Inc., the Securities and Exchange Commission and various state regulatory authorities. These regulations include licensing requirements, record keeping requirements, net capital requirements, supervision requirements and sales practice standards.
ITEM 2.
ITEM 2. PROPERTIES
The principal offices of Summit and its subsidiaries are located in an office building owned by Metropolitan located at 601 West First Avenue, Spokane, Washington 99201-5015. See "Item 1.--INTRODUCTION."
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Other than ordinary routine litigation incidental to its business, there are no material legal proceedings or actions pending or threatened against Summit Securities, Inc., or to which its property is subject.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Registrant's security holders during the fourth quarter ended September 30, 2000.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
1. (a) MARKET INFORMATION. There is no market for the Registrant's common stock.
(b) HOLDERS. At September 30, 2000, there was one common stockholder, National Summit Corp.
(c) DIVIDENDS. The Registrant paid dividends per share of $100 and $0 during fiscal 2000 and 1999, respectively.
2. RECENT SALES OF UNREGISTERED SECURITIES. None.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
SUMMIT SECURITIES, INC. SELECTED CONSOLIDATED FINANCIAL DATA
The selected financial data shown below summarizes certain consolidated financial information of the Consolidated Group's for the five years in the period ended September 30, 2000.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the attached audited consolidated financial statements and notes thereto for the three year period ended September 30, 2000.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FOR THE THREE FISCAL YEARS ENDED SEPTEMBER 30, 2000
INTRODUCTION
Summit, Old Standard and Old West are engaged in the business of investing in cash flowing assets, consisting of obligations collateralized by real estate, structured settlements, annuities, lottery prizes and other investments, investment securities and other assets through funds provided by annuity sales, sale of Receivables, collateralized borrowings, certificate (debt obligation) sales, preferred stock sales, earnings on investments and the resale of repossessed real estate. During the fiscal year ended September 30, 2000 and currently, the Consolidated Group is focusing its Receivable investing activities on loans collateralized by commercial real estate. The Consolidated Group's goal is to achieve a positive spread between the return on its Receivables and other investments and its cost of funds. Summit may also engage in other businesses or activities without restriction in accordance with the provisions of its Articles of Incorporation. Summit is affiliated, due to the common control by C. Paul Sandifur, Jr., with Metropolitan, which has as its principal subsidiaries Metwest and Western United. These affiliates provide services to the Consolidated Group for a fee and engage in various business transactions with the Consolidated Group. See "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS" under Item 13.
The Consolidated Group strives to maximize its risk-adjusted return by investing in non-conventional real estate Receivables and originating small to mid-sized commercial loans. Non-conventional Receivables are typically Receivables not originated by a regulated financial institution and not underwritten to FNMA or FHA underwriting guidelines. Normally, either the borrower or the collateral will not meet FNMA or FHA underwriting guidelines to qualify for conventional financing and the seller will be required to provide the financing to complete the sale. Commercial loans are generally small to mid-sized loans that are originated for less than $5 million and are collateralized by various types of commercial properties including multi-family properties. The Consolidated Group anticipates that a substantial majority of its Receivable acquisitions during 2001 will be new commercial loan originations. See "RECEIVABLE INVESTMENTS" under Item 1.
Seller financed Receivables are the types of non-conventional residential Receivables normally acquired by the Consolidated Group. While higher delinquency rates are expected in connection with its investment in non-conventional Receivables, the Consolidated Group believes this risk is generally offset by the value of the underlying collateral and the superior interest yields realized over normal conventional financing.
ANALYSIS OF OPERATIONS
As the national economy has experienced moderate growth over the past three years, the Consolidated Group's financial results were not materially impacted by general economic factors because of: (a) the wide geographic dispersion of its Receivables; (b) the relatively small average size of its residential mortgage Receivables; (c) strong underwriting and loan-to-value requirements for commercial lending; and (d) a continuing strong demand for tax-advantaged products, such as annuities.
The Consolidated Group's net income after income taxes was approximately $4.1 million for the fiscal year ended September 30, 2000 as compared to $2.8 million and $2.5 million for the comparable 1999 and 1998 periods, respectively. The increase in 2000 over 1999 and the increase in 1999 over 1998 was primarily
attributable to an increase in net interest sensitive income and commission fees that were partially offset by an increase in other operating expenses including salaries and commissions.
INTEREST SENSITIVE INCOME AND EXPENSE
Management continually monitors the interest sensitive income and expense of the Consolidated Group. Interest sensitive expense is predominantly related to annuity benefits, and the interest costs of certificates and collateralized borrowings, while interest sensitive income includes interest and earned discounts on Receivables, dividends and other income from the investment portfolio (other investment income).
The Consolidated Group is in an "asset sensitive" position in that its interest sensitive assets reprice or mature more quickly than do its interest sensitive liabilities. Consequently, in a rising interest rate environment, the net return from interest sensitive assets and liabilities will tend to increase, thus rising interest rates will have a positive impact on results of operations. Conversely, in a falling interest rate environment, the net return from interest sensitive assets and liabilities will tend to decline, thus falling interest rates will have a negative impact on results of operations. As with the impact on operations from changes in interest rates, the Consolidated Group's Net Present Value ("NPV") of financial assets and liabilities is subject to fluctuations in interest rates. The Consolidated Group continually monitors the sensitivity of net interest income and NPV to changes in interest rates. NPV is calculated based on the net present value of estimated cash flows utilizing market prepayment assumptions and market rates of interest provided by independent broker quotations and other public sources.
Computation of forecasted effects of hypothetical interest rate changes are based on numerous assumptions, including relative levels of market interest rates, loan prepayments and certificate redemptions, and should not be relied upon as indicative of actual future results.
The following table presents, as of September 30, 2000, the Consolidated Group's estimate of the change in the NPV of the financial assets and liabilities if interest rate levels generally were to increase or decrease by 1% and 2%, respectively. These calculations, which are highly subjective and technical, may differ from actual results. See "--Asset/Liability Management."
The calculations of present value have certain shortcomings. The discount rates utilized for Receivables and investment securities are based on estimated market interest rate levels of similar
receivables and securities nationwide, with prepayment levels generally assumed based on global statistics. The unique characteristics of the Consolidated Group's Receivables and investment securities may not necessarily parallel those assumed in the model, and therefore, would likely result in different discount rates, prepayment experiences, and present values. The discount rates utilized for investment certificates, annuity reserves and debt payable are based upon alternative types and sources of funds which are not necessarily indicative of the present value of such instruments. The present values are determined based on the discounted cash flows over the remaining estimated lives of the financial instruments and assumes that the resulting cash flows are reinvested in financial instruments with virtually identical terms. The total measurement of the Consolidated Group's exposure to interest rate risk as presented in the above table may not be representative of the actual values which might result from a higher or lower interest rate environment. A higher or lower interest rate environment will most likely result in different investment and borrowing strategies by the Consolidated Group designed to mitigate the effect on the value of, and the net earnings generated from, the Consolidated Group's net assets from any change in interest rates.
The excess of interest sensitive income over interest sensitive expense was approximately $11.7 million in 2000, $7.9 million in 1999 and $5.3 million in 1998. The increase from 1999 to 2000, as was the case from 1998 to 1999, was attributable to increased investments in the Receivable and investment securities portfolios, which was largely due to the continued growth of Old Standard and Old West. The Consolidated Group has increased its securities investments to approximately $107.5 million in 2000 from $94.7 million in 1999 and $18.1 million in 1998. During the same time period, the Consolidated Group has continued to invest in real estate contracts and other receivable investments with a total outstanding investment of approximately $206.1 million at September 30, 2000 as compared to $140.8 million and $148.7 million at September 30, 1999 and 1998, respectively.
NET GAINS (LOSSES) ON INVESTMENTS AND RECEIVABLES
During the three-year period ended September 30, 2000, the Consolidated Group operated in an environment of fluctuating interest rates. The five-year U.S. Treasury rate was approximately 5.7% in October 1997, hit a low of approximately 4.2% at September 30, 1998 and closed out September 2000 at approximately 5.9% after high of approximately 6.7% at January 31, 2000. Periods of declining interest rates have postively impacted earnings by increasing the value of predominately fixed rate receivables. This situation was evident in 1999 and 1998, as the Consolidated Group was able to realize gains of approximately $3.2 million and $2.1 million, respectively, from the sale of receivables. These gains resulted primarily from the Consolidated Group participating directly in receivable securitizations with Metropolitan. The Consolidated Group did not participate in any securitizations during 2000.
During the fiscal year ended September 30, 2000, the Consolidated Group's gain on investments, including mark-to-market adjustments on trading securities, increased to approximately $3.5 million from a loss of $0.2 million and a gain of $0.4 million during the same periods ended September 30, 1999 and 1998, respectively. The gains in the current period were the result of a $4.2 million net change in unrealized gains on mark-to-market trading investments which exceeded $0.7 million in realized losses on the sale of investments. The mark-to-market gains in the current period resulted primarily from investments that the Consolidated Group has made in certain limited partnership interests. The limited partnerships generally invest funds in both publicly and privately traded small and microcapitalization equity securities. During the current period, the value of the equity securities increased, thereby increasing the value of the Consolidated Group's investment. The loss in 1999 includes a $0.6 million net change in unrealized losses on trading investments that were partially offset by $0.4 million in realized gains while 1998 gains were the result of a $0.4 million net change in unrealized gains on trading investments.
FEES, COMMISSIONS, SERVICE AND OTHER INCOME
Fees, commissions, service and other income increased to approximately $8.4 million in 2000 from $4.5 million in 1999 and $4.8 million in 1998. Revenues in 2000 consisted primarily of commissions earned
by the Consolidated Group's broker/dealer subsidiary, MIS, and service fees earned by its property development subsidiary, Summit Property Development, Inc. MIS and Summit's property development subsidiary earned approximately $6.1 million in commissions (after eliminating commissions received by MIS from Summit) and approximately $2.0 million in service fees in 2000, respectively. The increase in revenue in 2000 of approximately $4.0 million resulted primarily from an increase in commissions earned by MIS.
OTHER EXPENSES
Operating expenses increased to approximately $15.2 million in 2000 from $9.8 million in 1999 and from $7.8 million in 1998. The 2000 increase in operating expenses was principally the result of an increase in MIS commissions paid of approximately $3.7 million and increased costs associated with its commercial lending and insurance operations. The 1999 increase in operating expenses was principally the result of increased commissions to agents, in particular commissions paid by Old Standard and Old West which increased by approximately $1.3 million and increased operating costs associated with its insurance operations which included an increase in amortization of deferred policy acquisition costs of approximately $1.2 million.
PROVISION FOR LOSSES ON REAL ESTATE CONTRACTS AND MORTGAGE NOTES RECEIVABLE
To provide for what management believes is an adequate allowance for probable losses, the provision for losses on real estate contracts and mortgage notes receivable has increased with the shift of the size and mix of the Receivables portfolio, including an increase in the number of commercial loans. Due to the prior and anticipated increase in commercial loan acquisitions and the Consolidated Group's relatively short experience with these types of assets, there can be no assurance that actual losses will not exceed management's expectations. The following table summarizes changes in the Consolidated Group's allowance for losses on real estate contracts and mortgage notes receivable:
The allowance for losses represents approximately 2.9%, 2.7% and 1.4% of the face value of Receivables collateralized by real estate at September 30, 2000, 1999 and 1998, respectively. These allowances are in addition to unamortized acquisition discounts of approximately $8.3 million at September 30, 2000, $2.6 million at September 30, 1999 and $5.0 million at September 30, 1998.
PROVISION FOR LOSSES ON OTHER RECEIVABLE INVESTMENTS
During the year ended September 30, 2000, the Consolidated Group established a specific and general loss reserve on its investments in annuity and structured settlement cashflows as the industry has recently focused on state and federal collection laws and their applicability to delinquent annuity and structured settlement payments. Additionally, during the year ended September 2000, the Consolidated Group established a general reserve against a participation in finance leases purchased from an affiliate. The allowance for loss represents 3.3% of the net investment in other receivable investments as of September 30, 2000.
The following is an analysis of the allowance for losses on other receivable investments for the year ended September 30, 2000.
GAIN/LOSS ON OTHER REAL ESTATE OWNED
During 2000, the Consolidated Group realized a loss on the sale of real estate of approximately $44,000 compared to a gain of $143,000 in 1999 and a loss of $118,000 in 1998. At September 30, 2000, the Consolidated Group had approximately $4,791,000 million in real estate held for sale or 1.3% of total assets as compared to approximately $2,654,000 or 0.9% of total assets at September 30, 1999.
EFFECT OF INFLATION
During the three-year period ended September 30, 2000, inflation has had a generally positive impact on the Consolidated Group's operations. This impact has primarily been indirect in that the level of inflation tends to be reflected in the current level of interest rates which impact interest returns and cost of funds on the Consolidated Group's assets and liabilities. However, both interest rate levels in general and the cost of the Consolidated Group's funds and the return on its investments are influenced by additional factors such as the level of economic activity and competitive or strategic product pricing issues. The net effect of the combined factors on the earnings of the Consolidated Group has been a continuing improvement over the three-year period in the positive spread between the return on interest earning assets and the cost of interest bearing liabilities. The positive spread increased to 4.61% in 2000 from 1.8% in 1998. Inflation has not had a material effect on the Consolidated Group's operating expenses. Increases in operating expenses have resulted principally from increased product volumes or other business considerations including the acquisition of additional companies and the start-up of new business venture activities.
Revenues from real estate sold are influenced in part by inflation, as, historically, real estate values have fluctuated with the rate of inflation. However, the effect of inflation in this regard has not had a material effect on the real estate sales of the Consolidated Group nor is it expected to have a material effect in the near future.
ASSET/LIABILITY MANAGEMENT
As most of the Consolidated Group's assets and liabilities are financial in nature, the Consolidated Group is subject to interest rate risk. In fiscal 2001, more of the Consolidated Group's financial assets (primarily Receivables and fixed income investments) will reprice or mature more quickly than its financial liabilities (primarily annuities and certificates). In an increasing interest rate environment, this factor will tend to increase earnings as assets will generally be repriced at higher rates of interest while financial liabilities maintain their existing rates of interest. Conversely, in a declining interest rate environment, this factor will tend to decrease earnings.
The Consolidated Group may use financial futures instruments for the purpose of hedging interest rate risk relative to investments in the securities portfolio or potential trading situations. In both cases, the futures transaction is intended to reduce the risk associated with price movements for a balance sheet asset. Additionally, the Consolidated Group may sell securities "short" (the sale of securities which are not currently in the portfolio and therefore must be purchased to close out the sale agreement) as another means of economically hedging interest rate risk, or take a trading position in an attempt to benefit from
an anticipated movement in the financial markets. At September 30, 2000, the Consolidated Group had no outstanding hedge transactions or open short sales positions. See "SECURITIES INVESTMENTS" under Item 1.
During fiscal 2001, approximately $168,653,000 of interest sensitive assets (cash, Receivables and fixed income investments) are expected to reprice or mature. Interest sensitive liabilities, including annuity reserves of approximately $137,812,000 reprice during fiscal 2001, and approximately $21,710,000 of Certificates and other debt will mature during fiscal 2001. These estimates result in repricing of interest sensitive assets in excess of interest sensitive liabilities of approximately $9,131,000, or a ratio of interest sensitive assets to interest sensitive liabilities of approximately 106%.
The Consolidated Group is able to manage this asset to liability mismatch of approximately 1.06:1 by the fact that approximately 84% of the interest sensitive liabilities are annuity contracts which are subject to surrender charges. These contracts have maturities, which extend for as long as nine years with surrender charges of decreasing amounts during their term. At the option of the respective insurance subsidiaries, these contracts are subject to annual repricing. In periods of declining interest rates, this feature is beneficial as it allows the insurance subsidiaries to reprice their liabilities at lower market rates of interest. In periods of increasing interest rates, such liabilities are protected by surrender charges. Depending on the remaining surrender charges, the insurance subsidiaries have the option to extend any interest rate increase over a two to three year period, thereby making it not generally economical for an annuitant to pay the surrender charge in order to receive payment in lieu of accepting a rate of interest that is lower than current market rates of interest. As a result, the insurance subsidiaries may respond more slowly to increases in market interest rate levels thereby diminishing the impact on the Consolidated Group of the current mismatch in the interest sensitivity ratio. Additionally, through Receivable sales, the Consolidated Group has increased its ability to raise necessary liquidity to manage the liability to asset mismatch. If necessary, the proceeds from the sales could be used to retire maturing liabilities.
NEW ACCOUNTING RULES
In December of 1997, the American Institute of Certified Public Accountants issued Statement of Position 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments" ("SOP 97-3"). SOP 97-3 applies to all entities that are subject to guaranty-fund and other insurance-related assessments. Assessments covered by this SOP include any charge mandated by statute or regulatory authority that is related directly or indirectly to underwriting activities (including self-insurance), except for income taxes and premium taxes. The Consolidated Group adopted SOP 97-3 effective October 1, 1999. This adoption had no material effect on its consolidated financial statements.
In June of 1998, Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133"), was issued. SFAS No. 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, (collectively referred to as "Derivatives") and for hedging activities. It requires that an entity recognize all Derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. In June 1999 and 2000 Statement of Financial Accounting Standards No. 137, "Accounting for Derivative Instruments and Hedging Activities--Deferral of Effective Date of SFAS 133" ("SFAS No. 137") and Statement of Financial Accounting Standards No. 138 "Accounting for Certain Derivative Instruments and Certain Hedging Activities an amendment of SFAS 133" (SFAS No. 138") were issued. SFAS No. 137 amends SFAS No. 133 to become effective for all quarters of fiscal years beginning after June 15, 2000. The implementation of SFAS No. 133, as amended, will not have a material effect on the Consolidated Group's financial statements. As part of implementing SFAS 133 on October 1, 2000, the Consolidated Group's reclassified approximately $4.6 million of investments from held-to-maturity to available-for-sale.
In October of 1998, Statement of Financial Accounting, Standards No. 134, "Accounting for Mortgage-Banking Enterprise" ("SFAS 134"), was issued. SFAS 134 requires that after the securitization of mortgage loans held for sale, an entity engaged in mortgage banking activities classify the resulting mortgage-backed securities or other retained interests based on its ability and intent to sell or hold those investments. This statement conforms the subsequent accounting for securities retained after the securitization of mortgage loans by a mortgage banking enterprise with the subsequent accounting for securities retained after the securitization of other types of assets by a non-mortgage banking enterprise. This statement was applied by the Consolidated Group on January 1, 1999, and accordingly, trading securities with a carrying value of approximately $16.7 million were reclassified to the available-for-sale classification.
In December of 1999, the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial Statements." SAB 101 summarizes certain of the SEC's views on applying generally accepted accounting principles to revenue recognition in financial statements. On June 26, 2000, the SEC issued SAB 101B to defer the effective date of implementation of SAB 101 until no later than the fourth fiscal quarter of fiscal years beginning after December 31, 1999. The Consolidated Group is required to adopt SAB 101 by July 1, 2001. The Consolidated Group does not expect the adoption of SAB 101 to have a material impact on the consolidated financial statements.
During the third quarter of 2000, the Emerging Issues Task Force issued EITF 99-20 "Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets" ("EITF 99-20"). This EITF will change the manner in which the Consolidated Group determines whether a decline in fair value of its investment is other than temporary. The Consolidated Group must adopt the provisions of EITF 99-20 on April 1, 2001, but has not fully determined the effect of implementing EITF 99-20. As such, there may be declines in fair value of investments, which are currently classified as comprehensive losses, which will be considered to be permanent impairments resulting in a charge against earnings upon adoption.
On September 29, 2000, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities--A Replacement of FASB Statement No. 125" ("SFAS 140"). SFAS 140 is effective for transfers occurring after March 31, 2001 and for disclosures relating to securitization transactions and collateral for fiscal years ending after December 15, 2000. The Consolidated Group is in the process of evaluating the impact of SFAS 140 on its results of operations and financial condition.
LIQUIDITY AND CAPITAL RESOURCES
As a financial institution, the Consolidated Group's sources of liquidity are largely linked to its ability to renew, maintain or obtain additional sources of cash. The Consolidated Group has successfully met these requirements during the past three years and has continued to invest funds generated by financing activities, Receivables and investments.
During 2000, $189.2 million in funds provided by the Consolidated Group's various liquidity sources were used to (1) invest $164.1 million primarily in Receivables and investments and (2) fund $43.1 million in debt maturities, annuity product surrenders, and the payment of dividends.
During 1999, $246.1 million in funds provided by the Consolidated Group's various liquidity sources were used to (1) invest $186.9 million primarily in Receivables and investments, (2) fund $27.7 million of primarily debt maturities and annuity product surrenders and (3) fund $3.4 million in operating activities.
During 1998, $119.9 million in funds provided by the Consolidated Group's various liquidity sources were used to (1) invest $81.4 million primarily in Receivables and investments, (2) fund $23.9 million of primarily debt maturities and annuity product surrenders and (3) fund $8.9 million in operating activities.
During 2001, anticipated principal, interest and dividend payments on outstanding certificates, other debt payments and preferred stock distributions are expected to be approximately $28.9 million. During 2000, the principal portion of the payments received on the Consolidated Group's Receivables and proceeds from sales of real estate and Receivables were $84.7 million. A decrease in the prepayment rate on these Receivables or a decrease in the ability to sell Receivables would reduce future cash flows from Receivables and might adversely affect the Consolidated Group's ability to meet its principal, interest and dividend payments.
The Consolidated Group expects to maintain adequate levels of liquidity in the foreseeable future by continuing its securities offerings and annuity sales. At September 30, 2000, cash or cash equivalents were $24.2 million, or 6.7% of total assets. Including securities that are either trading or available-for-sale, total liquidity was $121.6 million, $129.8 million, and $25.6 million as of September 30, 2000, 1999 and 1998, respectively, or 33.8% 44.0% and 12.4% of total assets, respectively. During 1999 and 1998, access to new "capital markets" through Receivable securitizations allowed the Consolidated Group to both increase liquidity and accelerate earnings through the gains recorded on the securitizations.
For statutory purposes, Old Standard and Old West perform cash flow testing under several different rate scenarios as required by the States of Idaho and Arizona, respectively. The results of these tests are filed annually with the Insurance Commissioner of the respective states. At the end of calendar year 1999, the results of this cash flow testing process were satisfactory.
At September 30, 2000, the Consolidated Group had no material commitments for any capital expenditures outside of commitments related to its normal investing activities. Additionally, the Consolidated Group had no knowledge of any environmental liabilities associated with any of its real estate asset investments.
Management believes that cash flow from financing activities and liquidity provided from current investments will be sufficient for the Consolidated Group to conduct its business and meet its anticipated obligations as they mature during fiscal 2001. Summit has not defaulted on any of its obligations since its founding in 1990.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Summit is in a "asset sensitive" position in that its interest sensitive assets reprice or mature more quickly than do its interest sensitive liabilities. Consequently, in a rising interest rate environment, the net return from interest sensitive assets and liabilities will tend to increase, thus rising interest rates will have a positive impact on results of operations. Conversely, in a falling interest rate environment, the net return from interest sensitive assets and liabilities will tend to decline, thus falling interest rates will have a negative impact on results of operations. As with the impact on operations from changes in interest rates, Summit's Net Present Value ("NPV") of financial assets and liabilities is subject to fluctuations in interest rates. Summit continually monitors the sensitivity of net interest income and NPV to changes in interest rates. NPV is calculated based on the net present value of estimated cash flows utilizing market prepayment assumptions and market rates of interest provided by independent broker quotations and other public sources. Any computation of forecasted effects of hypothetical interest rate changes are based on numerous assumptions, including relative levels of market interest rates, loan prepayments and redemptions of certificates, and should not be relied upon as indicative of actual future results.
For additional quantitative information about market risk of the Registrant, see "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--Interest Sensitive Income and Expense" under Item 7.
For qualitative information about market risk of the Registrant, see "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--Asset/Liability Management" under Item 7.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements and related financial information required to be filed are attached to and incorporated into this Report. Reference is made to page of this Annual Report for an index to the consolidated financial statements.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
MANAGEMENT DIRECTORS AND EXECUTIVE OFFICERS (AS OF SEPTEMBER 30, 2000)
All officers are appointed by and serve at the discretion of the Board of Directors. Directors serve for one-year terms or until their successor is duly elected and qualified.
Tom Turner was elected President on October 31, 1995. Prior to serving as President, he had served as Secretary/Treasurer since September 28, 1994. He has been and continues to be an employee of Metropolitan since 1985, as a financial analyst. From 1983 to 1985, Mr. Turner was employed by Olsten Temporary Services. Prior to 1983, Mr. Turner was self-employed, principally doing business in the real estate industry.
Philip Sandifur was elected Vice President on September 24, 1994, and is the son of C. Paul Sandifur, Jr., who is the sole shareholder of National Summit Corp., the parent company of Summit and also the controlling shareholder of Metropolitan. Philip graduated in 1993 from Santa Clara University, receiving a BA in Business. He is currently active with the Consolidated Group's commercial lending activities. From 1994 to 1997, he was principally active as President of Summit Trading Services, Inc., a wholly owned subsidiary of Summit's parent company, National Summit.
Gregory Strate was elected Secretary, Treasurer, and Director of Summit in 2000. Since August of 1998, Mr. Strate has worked as a manager for Old Standard's commercial lending division, first as a commercial underwriter and then, in September of 1999, he was promoted to manager of commercial lending. From April of 1978 to July of 1998, Mr. Strate was the vice president and commercial loan officer of Washington Trust Bank.
Robert Potter was elected a Director of Summit on March 14, 1995. He is an outside director, not active in the day-to-day business of Metropolitan or Summit. From 1987 to present, Mr. Potter has served as President of Jobs Plus, Inc., a nonprofit corporation formed to diversify and broaden the economic base of Kootenai County, Idaho. Prior to 1987, Mr. Potter was employed for approximately 6 months as Chief Operating Officer of Incomnet Inc., and prior to that he worked for approximately 30 years with AT&T.
The directors of Summit are elected for one-year terms at annual shareholder meetings. The officers of Summit serve at the discretion of the Board of Directors.
Summit's officers and directors continue to hold their respective positions with Metropolitan and do not anticipate that their responsibilities with Summit will involve a significant amount of time. They will, however, devote such time to the business and affairs of Summit as may be necessary for the proper discharge of their duties.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth the aggregate compensation received by Summit's executive officers and other highly compensated executives during the fiscal years specified. All other executive officers of Summit received less than $100,000 in compensation. No executive officer is a party to, or a participant in, any pension plan, contract or other arrangement providing for cash or non-cash compensation except Metropolitan's 401(k) plan.
SUMMARY COMPENSATION TABLE (AS OF SEPTEMBER 30, 2000)
* The salary received by Mr. Turner is principally paid by and related to his responsibilities as an employee of Metropolitan. Mr. Turner devotes such time as is necessary to the business of Summit, and Summit contributes to his salary commensurate with the time devoted.
DIRECTOR COMPENSATION
Other than Robert Potter, the directors do not receive any compensation for services rendered on behalf of Summit. Robert Potter receives $500 per year and $100 per meeting plus travel expenses.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Summit does not have a formal compensation committee of the Board of Directors. Executive officer compensation is determined by C. Paul Sandifur, Jr., the sole common shareholder of the holding company of the Consolidated Group. There are no compensation committee interlocks between the above described individuals and another entity's compensation committee. None of the above described individuals serves as an executive officer of another entity outside the Consolidated Group.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
PRINCIPAL SHAREHOLDERS
The following table sets forth information with respect to the beneficial owners of more than five percent of Summit's voting common stock as of September 30, 2000.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS NAMES AND RELATIONSHIP OF PARTIES/PERSONS INVOLVED IN RELATED PARTY TRANSACTIONS
Summit was originally organized as a wholly owned subsidiary of Metropolitan. On September 9, 1994, the controlling interest in Summit was acquired by National Summit Corp., a Delaware corporation which is wholly owned by C. Paul Sandifur, Jr. Following this sale, Metropolitan has continued to provide, for a fee, principally all the management services to Summit. See "RECEIVABLE INVESTMENTS" under Item 1.
Mr. Sandifur holds effective control of Metropolitan. Prior to the sale, Mr. Sandifur held effective control of Summit through Metropolitan. Following the sale, Mr. Sandifur continues to control Summit through National Summit Corp. Currently, no officer or director of Summit is an officer or director of Metropolitan.
DESCRIPTION OF RELATED PARTY TRANSACTIONS
Transactions between Metropolitan, its subsidiaries and companies within the Consolidated Group take place in the normal course of business. Such transactions include the purchase or sale of Receivables from or to affiliated companies, borrowing or lending money from or to affiliated companies, rental of office space, provision of administrative and data processing support, accounting and legal services. See "NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Note 16" under Item 8. In addition, Metropolitan and its subsidiaries provide services to various companies within the Consolidated Group, as described more fully herein below.
Summit, Old Standard and Old West obtain substantially all of their Receivable management and servicing support (except for commercial loan originations) from Metropolitan through a Management, Receivable Acquisition and Servicing Agreement. In 2000, the Consolidated Group paid compensation to Metropolitan for Receivable acquisitions of approximately $111,000 and fees for servicing by Metwest of approximately $404,000. See "RECEIVABLE INVESTMENTS" under Item 1 and "NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Note 16" under Item 8. Management believes that such Agreements are on terms at least as favorable as could be obtained from non-affiliated parties.
Old Standard has entered into a reinsurance agreement with Western United, which became effective July 1, 1998 and remained in effect at September 30, 2000. Under this agreement, Western United reinsured with Old Standard 75% of the risk on 15 different annuity products and premium ceded during the fiscal years ended September 30, 1999 and 2000 was approximately $44.7 million and $27.4 million, respectively. Western United received ceding allowances equal to actual commission plus 1.5% of premium, which was approximately $2.3 million and $1.5 million during the fiscal year ended September 30, 1999 and 2000, respectively.
This agreement has allowed Old Standard to acquire annuities at greater speeds and at lower premium rates than management believes would have been available through direct sales. Under its contractual terms, the agreement is an ongoing arrangement with no stated expiration or termination date, although either party may stop and restart at their discretion upon providing a 30-day advance written notice. It is expected that approximately $30 million will be ceded under this treaty during fiscal 2001. Western United receives a fee from Old Standard for servicing the reinsured policies, which fee is 40 basis points annually on the cash value of the reinsured policies.
Summit has entered into Selling Agreements with MIS to provide for the sale of the Certificates and Preferred Stock pursuant to which MIS will be paid commissions up to a maximum of 6% of the investment amount in each transaction. During the fiscal year ended September 30, 2000, Summit paid or
accrued commissions to MIS in the amount of $355,739 for the sale of $9,183,528 of certificates and commissions of $812,913 upon the sale of $13,328,235 of preferred stock. During the fiscal year ended September 30, 2000, Summit also paid commissions to MIS in the amount of $203,916 on sales of preferred stock through an in-house trading list. MIS also maintains, on behalf of Summit, certain investor files and information pertaining to investments in Summit's certificates and preferred stock.
MIS, a broker-dealer and former subsidiary of Metropolitan, sells the publicly registered securities of Metropolitan and Summit. Metropolitan paid commissions to MIS for the sale of Metropolitan's securities pursuant to the terms of written Selling Agreements. During the fiscal year ended September 30, 2000, Metropolitan paid commissions to MIS in the amount of $4,131,274, on sales of debt securities in the amount of $96,583,832. During the fiscal year ended September 30, 2000, Metropolitan paid commissions to MIS in the amounts of $365,209, on sales of preferred stock in the amount of $10,904,207. Additionally, in 2000, Metropolitan paid commissions to MIS in the amount of $220,739 on sales of preferred stock through an in-house trading list.
Summit Property Development, Inc. has entered into an agreement with Metropolitan to provide property development services to Metropolitan for a fee. During the year ended September 30, 2000 the fee was approximately $2.0 million. See "PROPERTY DEVELOPMENT SERVICES" under Item 1.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(A) (1). FINANCIAL STATEMENTS
Included in Part II, Item 8 of this report:
Report of Independent Accountants
Consolidated Balance Sheets at September 30, 2000 and 1999
Consolidated Statements of Income for the Years Ended September 30, 2000, 1999 and 1998
Consolidated Statements of Comprehensive Income for the Years Ended September 30, 2000, 1999 and 1998
Consolidated Statements of Stockholders' Equity for the Years Ended September 30, 2000, 1999 and 1998
Consolidated Statements of Cash Flows for the Years Ended September 30, 2000, 1999 and 1998
Notes to Consolidated Financial Statements
(A) (2). FINANCIAL STATEMENTS SCHEDULES
Included in Part IV of this report:
Schedule I--Summary of Investments other than Investments in Related Parties
Schedule II--Valuation and Qualifying Accounts and Reserves
Schedule III--Supplementary Insurance Information
Schedule IV--Mortgage Loans on Real Estate
Other Schedules are omitted because of the absence of conditions under which they are required or because the required information is given in the consolidated financial statements or notes thereto.
(A) (3). EXHIBITS
- ---------
* Filed herewith
(B) REPORTS ON FORM 8-K
Summit did not file any reports on Form 8-K for the fourth quarter of fiscal year 2000.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Date: January 15, 2001
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities and on the dates indicated.
SUMMIT SECURITIES, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2000, 1999 AND 1998
REPORT OF INDEPENDENT ACCOUNTANTS
The Directors and Stockholders Summit Securities, Inc.
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows present fairly, in all material respects, the financial position of Summit Securities, Inc. and its subsidiaries (the "Company") at September 30, 2000 and 1999, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 2000, in conformity with accounting principles generally accepted in the United States of America. 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 of these statements in accordance with auditing standards generally accepted in the United States of America, which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.
As discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting for mortgage-backed securities retained after the securitization of mortgage loans held for sale in fiscal 1999.
/s/ PricewaterhouseCoopers LLP
Spokane, Washington December 28, 2000
SUMMIT SECURITIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2000 AND 1999
The accompanying notes are an integral part of the consolidated financial statements.
SUMMIT SECURITIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED SEPTEMBER 30, 2000, 1999 AND 1998
The accompanying notes are an integral part of the consolidated financial statements.
SUMMIT SECURITIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
FOR THE YEARS ENDED SEPTEMBER 30, 2000, 1999 AND 1998
The accompanying notes are an integral part of the consolidated financial statements.
SUMMIT SECURITIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED SEPTEMBER 30, 2000, 1999 AND 1998
The accompanying notes are an integral part of the consolidated financial statements.
SUMMIT SECURITIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED SEPTEMBER 30, 2000, 1999 AND 1998
The accompanying notes are an integral part of the consolidated financial statements.
SUMMIT SECURITIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
FOR THE YEARS ENDED SEPTEMBER 30, 2000, 1999 AND 1998
The accompanying notes are an integral part of the consolidated financial statements.
SUMMIT SECURITIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED SEPTEMBER 30, 2000, 1999 AND 1998
1. SUMMARY OF ACCOUNTING POLICIES
BUSINESS
Summit Securities, Inc., d/b/a National Summit Securities, Inc. in the states of New York and Ohio (the "Company"), was incorporated on July 25, 1990. The controlling interest in the Company is owned by National Summit Corp., a Delaware corporation which is wholly owned by C. Paul Sandifur, Jr. The Company was formerly a wholly owned subsidiary of Metropolitan Mortgage & Securities Co., Inc. ("Metropolitan"). Metropolitan is controlled by C. Paul Sandifur, Jr. and his immediate family through his common stock ownership and voting control.
The Company engages, nationwide, in the business of acquiring, originating, holding and selling receivables. These receivables include residential real estate contracts and mortgage notes and commercial loans that are collateralized by first position liens on real estate. The Company also invests in receivables consisting of real estate contracts and mortgage notes collateralized by second and lower position liens, structured settlements, annuities, lottery prizes, equipment leases and other investments. The acquired receivables collateralized by real estate are typically non-conventional because they were either financed by the sellers of the properties involved or they were originated by institutional lenders who specialize in borrowers with impaired credit or non-conventional properties. The Company also originates both construction and commercial real estate loans. In addition to receivables, the Company invests in U.S. Treasury obligations, corporate bonds, equity securities and other securities.
In addition to its real estate receivable activities, the Company acts as a securities broker/dealer and provides real estate property development services.
The Company invests in receivables and securities using funds generated from receivable cash flows, the sale of annuities, the sale or securitization of receivables, the sale of investment certificates and preferred stock, secured borrowings and securities portfolio earnings.
Metropolitan and its subsidiaries provide services to the Company for a fee and engage in various business transactions with the Company (see Note 16).
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, Metropolitan Investment Securities, Inc. ("MIS"), a securities broker/dealer; Summit Property Development, Inc., a real estate property development company; Old Standard Life Insurance Company ("OSL"), a life insurance company; and its wholly owned subsidiary, Old West Annuity & Life Insurance Company ("OWAL"), also a life insurance company. All significant intercompany transactions and balances have been eliminated in consolidation.
On May 31, 1995, the Company consummated an agreement with Metropolitan, whereby it acquired OSL effective May 31, 1995, for $2,722,000, which approximated the historical cost basis of OSL at date of purchase, with future contingency payments equal to 20% of statutory income prior to the accrual of income taxes for the fiscal years ending December 31, 1995, 1996 and 1997. Future contingency payments of $135,569 were made during the year ended September 30,1998 and were accounted for as dividends. The initial purchase price plus estimated future contingency payments approximated the appraised valuation of OSL. The acquisition was recorded as a purchase. However, due to the common control of
SUMMIT SECURITIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
Metropolitan and the Company, the historical cost bases of assets and liabilities of OSL were recorded by the Company.
CASH AND CASH EQUIVALENTS
Cash includes all balances on deposit in banks and financial institutions. The Company considers all highly liquid debt instruments purchased with a remaining maturity of three months or less to be cash equivalents. Substantially all cash and cash equivalents are on deposit with one financial institution and balances often exceed the federal insurance limit. The Company periodically evaluates the credit quality of these banks and financial institutions.
INVESTMENTS IN AFFILIATED COMPANIES
Investments in equity securities of affiliated companies are carried at the lower of cost or estimated net realizable value.
INVESTMENTS
The Company has classified its investments in debt and equity securities, other than those of affiliated companies, as "trading," "available-for-sale" or "held-to-maturity". The accounting policies related to these investments are as follows:
TRADING SECURITIES: Trading securities consist of mortgage- and asset-backed securities and are recorded at market value. Trading securities are recorded at fair value based upon independent market quotes. Realized and unrealized gains and losses on these securities are included in the consolidated statements of income.
AVAILABLE-FOR-SALE SECURITIES: Available-for-sale securities, consisting primarily of government-backed securities and mortgage- and asset-backed securities are carried at quoted and estimated market values. Unrealized gains and losses are presented as accumulated other comprehensive income (loss), net of related deferred income taxes. Included in equity securities is restricted equity securities representing the Company's investment in the common stock of the Federal Home Loan Bank of Seattle ("FHLB Seattle"). This stock may only be sold to FHLB Seattle or to another member institution; therefore, it is restricted and is carried at cost. The carrying value of the restricted stock was $617,100 and $404,700 at September 30, 2000 and 1999, respectively.
HELD-TO-MATURITY SECURITIES: Held-to-maturity securities, consisting primarily of government-backed securities and corporate bonds having fixed maturities, are carried at amortized cost. Premiums and discounts on these securities are amortized on a specific-identification basis using the interest method. The Company has the ability and intent to hold these investments until maturity.
The Company initially records residual interests from securitization transactions at their allocated cost based upon the present value of the interest in the cash flows retained by the Company after considering various economic factors, including interest rates, collateral value and estimates of the value of future cash flows using expected loss and prepayment assumptions, discounted at a market yield. The fair value of these securities is determined based on interest rates, actual prepayment rates, collateral value and expanded default rates experienced by the securities.
In October 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 134, "Accounting for Mortgage-Backed Securities Retained after the Securitization of
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Mortgage Loans Held for Sale by a Mortgage Banking Enterprise" which requires that after the securitization of mortgage loans held for sale, an entity engaged in mortgage banking activities classify the resulting mortgage-backed securities or other retained interests based on its ability and intent to sell or hold those investments. This Statement conforms the subsequent accounting for securities retained after the securitization of mortgage loans by a mortgage banking enterprise with the subsequent accounting for securities retained after the securitization of other types of assets by a non-mortgage banking enterprise. This Statement was effective for the first fiscal quarter beginning after December 15, 1998. On January 1, 1999, the Company adopted this new standard and reclassified approximately $16.7 million of securities that were retained after securitizations from trading securities to available-for-sale securities.
Realized gains and losses on investments are calculated on a specific-identification basis and are recognized in the consolidated statements of income in the period in which the investment is sold.
For other than a temporary decline in the value of a common stock, preferred stock or publicly traded bonds below their cost or amortized cost, the investment is reduced to its net realizable value, which becomes the new cost basis of the investment. The amount of the reduction is reported as a loss in the consolidated statements of income. Any recovery of market value in excess of the investment's new cost basis is recognized as a realized gain only upon sale, maturity or other disposition of the investment. Factors which the Company evaluates in determining the existence of an other than temporary decline in value include the length of time and extent to which market value has been less than cost; the financial condition and near-term prospects of the issuers; and the intent and ability of the Company to retain its investment for the anticipated period of recovery in market value.
REAL ESTATE CONTRACTS AND MORTGAGE NOTES RECEIVABLE
Real estate contracts and mortgage notes receivable held for investment purposes are carried at amortized cost. Discounts originating at the time of purchase, net of capitalized acquisition costs, are amortized on an individual contract basis using the level yield (interest) method over the remaining contractual term of the receivable. Origination fees, net of direct origination costs, are deferred and recognized as interest income using the level yield (interest) method over the contractual term of the receivable.
Gains or losses on sales are recognized utilizing the aggregation method for financial reporting and income tax purposes at the time of sale. Interest on these receivables is included in interest income during the period held for sale. Deferred net discounts and capitalized acquisition costs are recognized at the time the related receivables are sold to third-party investors or securitized through transfer to a trust.
Effective January 1, 1997, the Company adopted the provisions of Statement of Financial Accounting Standards No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" ("SFAS No. 125"), as amended by SFAS No. 127, "Deferral of the Effective Date of Certain Provisions of the SFAS No. 125". SFAS No. 125 provides accounting and reporting standards based on a consistent application of a FINANCIAL-COMPONENTS APPROACH that focuses on control. Under this approach, after a transfer of financial assets, an entity recognizes the financial and servicing assets it controls and the liabilities it has incurred, derecognizes financial assets when control has been surrendered and derecognizes liabilities when extinguished. This statement provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. The application of the provisions of SFAS No. 125 did not have a material effect on the Company's financial condition, results of operations or cash flows. On September 29, 2000, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities--A Replacement of FASB Statement No. 125" (SFAS
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140). SFAS 140 is effective for transfers occurring after March 31, 2001 and for disclosures relating to securitization transactions and collateral for fiscal years ending after December 15, 2000. The Company is in the process of evaluating the impact of SFAS 140 on its results of operations and financial condition.
ALLOWANCES FOR LOSSES ON REAL ESTATE CONTRACTS AND MORTGAGE NOTES RECEIVABLE
The established allowances for losses on real estate contracts and mortgage notes receivable include amounts for estimated probable losses on receivables.
The Company establishes allowances, based on prior delinquency, foreclosure and loss experience. Allowances for losses are based on the net carrying values of the receivables, including accrued interest. Accordingly, the Company accrues interest on delinquent receivables until foreclosure, unless the principal and accrued interest on the receivables exceed the fair value of the collateral, net of estimated selling costs. The Company obtains new or updated appraisals on collateral for appropriate delinquent receivables, and adjusts the allowance for losses, as necessary, such that the net carrying value does not exceed net realizable value.
OTHER RECEIVABLE INVESTMENTS
Other receivable investments are carried at amortized cost. Discounts originating at the time of purchase, net of capitalized acquisition costs, are amortized using the level yield (interest) method on an individual receivable basis over the remaining contractual term of the receivable.
REAL ESTATE HELD FOR SALE
Real estate held for sale is stated at the lower of cost or fair value less estimated costs to sell. The Company principally acquires real estate through foreclosure, forfeiture or acquisition. Cost is determined by the purchase price of the real estate or, for real estate acquired by foreclosure, at the lower of (a) the fair value of the property at the date of foreclosure less estimated selling costs, or (b) cost (net unpaid receivable carrying value).
The established allowances for losses on real estate held for sale include amounts for estimated losses as a result of an impairment in value of the real property. The Company reviews its real estate properties for impairment in value whenever events or circumstances indicate that the carrying value of the asset may not be recoverable. In performing the review, if expected future undiscounted cash flows from the use of the asset or the fair value, less selling costs, from the disposition of the asset is less than its carrying value, an impairment loss is recognized. As a result of changes in the real estate markets in which these assets are located, it is reasonably possible that the carrying values could be reduced in the near term.
Profit on sales of real estate is recognized when the buyers' initial and continuing investment is adequate to demonstrate that (1) a commitment to fulfill the terms of the transaction exists, (2) collectibility of the remaining sales price is reasonably assured, and (3) the Company maintains no continuing involvement or obligation in relation to the property sold and transfers all the risks and rewards of ownership to the buyer.
DEFERRED COSTS
Deferred annuity acquisition costs, consisting of commissions to agents and other insurance underwriting and annuity policy costs, are deferred. Costs that are estimated not to be recoverable from surrender charges are amortized as a constant percentage of the estimated gross realized and unrealized profits associated with the policies in force.
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Investment certificate issuance costs, including commissions to sales representatives and other issuance costs are deferred. These costs are amortized over the expected term of the related certificate, which ranges from 6 months to 5 years, using the interest method.
Changes in the amount or timing of estimated gross profits on policies in force or expected term of the investment certificates will result in adjustments to the cumulative amortization of the related costs.
ANNUITY RESERVES
Premiums for annuities are recorded as annuity reserves under the deposit method. An obligation is recorded for the premiums assumed under reinsurance transactions with other insurers in annuity reserves.
Reserves for annuities are equal to the sum of the account balances including credited interest and deferred service charges. Based on past experience, consideration is given in actuarial calculations to the number of policyholder and annuitant deaths that might be expected, policy lapses, surrenders and terminations. As a result in changes in the factors included in the actuarial calculations, it is reasonably possible that the reserves for annuities could change in the near term.
RECOGNITION OF ANNUITY REVENUES
Annuity revenues consist of the charges assessed against the annuity account balance for services and surrender charges. Charges for future services are assessed; however, the related revenue is deferred and recognized in income over the period benefited using the same assumptions as are used to amortize deferred policy acquisition costs.
GUARANTY FUND ASSESSMENTS
The Company's life insurance subsidiaries are subject to insurance guaranty laws in the states in which they write premiums. These laws provide for assessments against insurance companies for the benefit of policyholders and claimants of insolvent life insurance companies. A portion of these assessments can be offset against the payment of future premium taxes. However, future changes in state laws could decrease the amount available for offset. At September 30, 2000 and 1999, the Company has accrued a liability for guaranty fund assessments for known insolvencies, net of estimated recoveries through premium tax offsets. As a result of future insolvencies or changes in the assessments of known insolvencies, the guaranty fund liability could change in the near term.
Effective October 1, 1999, the Company adopted the provisions of Statement of Position 97-3, ACCOUNTING BY INSURANCE AND OTHER ENTERPRISES FOR INSURANCE-RELATED ASSESSMENTS ("SOP 97-3"). SOP 97-3 applies to all entities that are subject to guaranty fund and other insurance-related assessments. Assessments covered by this SOP include any charge mandated by statute or regulatory authority that is related directly or indirectly to underwriting activities (including self-insurance), except for income taxes and premium taxes. The application of SOP 97-3 did not have a material effect on the Company's consolidated financial statements.
INCOME TAXES
The Company accounts for income taxes using the liability method, which requires that deferred tax assets and liabilities be determined based on the expected future income tax consequences of events that have been recognized in the financial statements. Deferred tax assets and liabilities are recognized based on the temporary differences between the financial statement carrying amounts and tax bases of assets and
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liabilities using enacted tax rates in effect in the years in which the temporary differences are expected to reverse.
The Company is included in the consolidated income tax return with National Summit Corp., its parent. The Company is allocated a current and deferred tax provision from National Summit Corp. as if the Company filed a separate tax return.
INCOME PER SHARE
Income per share--basic is computed by dividing income applicable to common stockholder by the weighted-average number of common shares outstanding during the period. Income per share--diluted is computed by dividing income applicable to common stockholder by the weighted-average number of common shares outstanding increased by the additional common shares that would have been outstanding if potentially dilutive common shares had been issued. There were no potentially dilutive common shares outstanding during any of the three years in the period ended September 30, 2000.
COMPREHENSIVE INCOME
During the year ended September 30, 1999, the Company adopted Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS No. 130"). SFAS No. 130 establishes standards for reporting and display of comprehensive income and its components (revenues, expenses, gains and losses) in a full set of general-purpose financial statements. This Statement requires an enterprise to classify items of other comprehensive income by their nature in a financial statement and display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of a statement of financial position. Prior years financial statements have been reclassified to conform to this Statement.
Reclassification adjustments, representing the net gains (losses) on available-for-sale securities that were realized during the period, net of related deferred income taxes, were as follows:
HEDGING ACTIVITIES
The Company is authorized by its Board of Directors, subject to certain limitations, to use financial futures instruments for the purpose of hedging interest rate risk relative to the securities portfolio and in anticipation of sales and securitizations of real estate contracts and other receivable investments. The Company participates with Metropolitan and its subsidiaries in futures contracts as a means of managing interest rate risk or to benefit from an anticipated movement in the financial markets.
The Company also purchases collateralized mortgage obligations, mortgage- and other asset-backed securities for its investment portfolio. Such purchases have been limited to tranches that perform in concert with the underlying mortgages or assets; i.e., improving in value with falling interest rates and declining in value with rising interest rates. The Company has not invested in "derivative products" that have been structured to perform in a way that magnifies the normal impact of changes in interest rates or in a way dissimilar to the movement in value of the underlying securities.
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At September 30, 2000, the Company was not a party to any derivative financial instruments.
In June 1998, Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133"), was issued. SFAS No. 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. In June 1999 and 2000 Statement of Financial Accounting Standards No. 137, "Accounting for Derivative Instruments and Hedging Activities--Deferral of Effective Date of SFAS 133" ("SFAS No. 137") and Statement of Financial Accounting Standards No. 138 "Accounting for Certain Derivative Instruments and Certain Hedging Activities an amendment of SFAS 133" (SFAS No. 138") were issued. SFAS No. 137 amends SFAS No. 133 to become effective for all quarters of fiscal years beginning after June 15, 2000. The implementation of SFAS No. 133, as amended, will not have a material effect on the Company's consolidated financial statements. As part of implementing SFAS 133 on October 1, 2000, the Company reclassified approximately $4.6 million of investments from held-to-maturity to available-for-sale.
INTEREST RATE RISK
The results of operations of the Company may be materially and adversely affected by changes in prevailing economic conditions, including rapid changes in interest rates. The Company's financial assets (primarily real estate contracts and mortgage notes receivable, other receivables and investment securities) and liabilities (primarily annuity contracts and investment certificates) are subject to interest rate risk. In the year ending September 30, 2001, approximately $168,653,000 of the Company's financial assets will reprice or mature as compared to approximately $159,522,000 of its financial liabilities, resulting in a mismatch of approximately $9,131,000. This structure is beneficial in periods of rising interest rates; however, it may result in declining net interest income during periods of declining interest rates. Of the financial liabilities scheduled to reprice or mature, approximately 84% are annuity contracts which are subject to surrender charges. Management is aware of the sources of interest rate risk and endeavors to actively monitor and manage its interest rate risk, although there can be no assurance regarding the management of interest rate risk in future periods.
OFF-BALANCE-SHEET INSTRUMENTS
The Company has outstanding commitments to extend credit to commercial borrowers. Such financial instruments are recorded in the financial statements when they are funded or related fees are incurred.
ESTIMATES
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
RECLASSIFICATIONS
Certain amounts in the 1999 and 1998 consolidated financial statements have been reclassified to conform with the current year's presentation. These reclassifications had no effect on net income or retained earnings as previously reported.
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RECENT ACCOUNTING PRONOUNCEMENTS
In December, 1999, the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial Statements." SAB 101 summarizes certain of the SEC's views on applying generally accepted accounting principles to revenue recognition in financial statements. On June 26, 2000, the SEC issued SAB 101B to defer the effective date of implementation of SAB 101 until no later than the fourth fiscal quarter of fiscal years beginning after December 31, 1999. The Consolidated Group is required to adopt SAB 101 by July 1, 2001. The Company does not expect the adoption of SAB 101 to have a material impact on the consolidated financial statements.
During the third quarter of 2000, the Emerging Issues Task Force issued EITF 99-20 "Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets" ("EITF 99-20"). This EITF will change the manner in which the Company determines whether a decline in fair value of its investment is other than temporary. The Company must adopt the provisions of EITF 99-20 on April 1, 2001, but has not fully determined the effect of implementing EITF 99-20. As such, there may be declines in fair value of investments, which are currently recorded in equity as other comprehensive losses, which will be considered to be permanent impairments resulting in a charge against earnings upon adoption.
2. INVESTMENTS IN AFFILIATED COMPANIES
At September 30, 2000 and 1999, investments in affiliated companies consisted of:
Class A common stock is the only voting class of Metropolitan's stock. Class A common stock is junior to Class B common stock as to liquidation preference. At September 30, 2000 and 1999, no Class B common stock was outstanding. At September 30, 2000 and 1999, the 9 shares of stock the Company owned represented 9.28% and 7.15%, respectively, of Metropolitan's outstanding Class A common stock. Metropolitan had total consolidated assets of approximately $1.1 billion at September 30, 2000.
The preferred stock of Metropolitan has a par value of $10 per share and has liquidation preferences equal to its issue price. The shares are non-voting and are senior to the common shares as to dividends. Dividends are cumulative at variable rates; however, dividends shall be no less than 6% or greater than 14% per annum. At September 30, 2000, the preferred Series C, D and E-1 had dividend rates of 7.1%. The preferred Series E-4 had a dividend rate of 7.6%. Neither the common or preferred shares are traded
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in a public market. At September 30, 2000 and 1999, the Company owned 3.49% of the outstanding common stock of Consumers Group Holding Co., Inc. The Company acquired the stock investment in April 1996 in a cash purchase from C. Paul Sandifur, Jr. The remaining outstanding shares of common stock of Consumers Group Holding Co., Inc. are owned by Metropolitan. Consumers Group Holding Co., Inc. owns approximately 75.5% of Western United Life Insurance Company ("Western"), a life insurer domiciled in the state of Washington. Western had total assets of approximately $919 million at September 30, 2000.
3. INVESTMENTS
A summary of carrying and estimated market values of investments at September 30, 2000 and 1999 is as follows:
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The principal amount of mortgage- and asset-backed securities with required principal or interest payments being in arrears for more than three months was approximately $2,000,000 at September 30, 2000.
Proceeds from sales of available-for-sale securities during the year ended September 30, 2000 were $14,612,748, which resulted in gross realized losses of $530,806. Proceeds from sales of available-for-sale securities during the year ended September 30, 1999 were $12,030,278, which resulted in gross gains and losses of $71,624 and $62,790, respectively.
The change in net unrealized gains (losses) on trading securities, recorded in the statements of income, were $4,234,388, $(600,029) and $372,225 during the years ended September 30, 2000, 1999 and 1998, respectively.
The activity related to certain mortgage-backed securities, which represent the Company's residual interests from securitization transactions, for the years ended September 30, 2000, 1999 and 1998 is as follows:
The Company is not aware of an active market for the purchase or sale of residuals and, accordingly, the Company determines the estimated fair value of the residuals by discounting the expected cash flows using a discount rate commensurate with the risks involved. When determining the expected cash flow, the Company must estimate the future rates of prepayments, defaults, and default loss severity (the loss realized upon liquidation of collateral from repossessed loans) as they affect the amount and timing of the estimated cash flows. During the year ended September 30, 2000, the Company adjusted its assumptions based on the actual historical performance and expectations of future performance of the loan pools. The assumptions used for valuing the residual certificates as of September 30, 2000 were as follows:
The Company may experience changes in the fair value of its residuals, which are recorded at estimated fair value and accounted for as "available-for-sale" securities. Changes in the fair value of residuals are excluded from earnings and reported as a separate component of stockholders' equity. Other than temporary declines in the fair value of residuals are charged to operations. During the
SUMMIT SECURITIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
year ended September 30, 2000, the Company recorded pre-tax valuation adjustments of $1.4 million. The Company will continue to periodically assess the assumptions used in valuing the cash flows and the related carrying value of its residuals and subordinated securities.
Although the Company believes it has made reasonable estimates of the fair value of the residuals likely to be realized, the rate of prepayments and the amount of defaults utilized by the Company are estimates and actual experience may vary. Higher than anticipated rates of loan prepayments or losses would require the Company to reduce the fair value of the residual interests.
During the year ended September 30, 1999, the Company participated in a resecuritization of certain of its residual interests with Metropolitan. The carrying value of the residual interests that were contributed by the Company was $1,312,258. The residual interests were restructured and a class was created and assigned a credit rating. This class was sold to Western at estimated fair value.
During the year ended September 30, 1999, in accordance with Statement of Financial Accounting Standards No. 134, the Company reclassified trading securities with a carrying value of approximately $16.7 million to the available-for-sale classification. The reclassified securities were consistently carried at estimated fair value. However, subsequent changes in estimated fair value are recorded as a component of other comprehensive income (loss) rather than being recognized in operations.
The following aggregate investments with individual issuers (excluding U.S. government bonds) held by the Company at September 30, 2000 and 1999 were in excess of ten percent of stockholders' equity:
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The amortized costs and estimated market values of available-for-sale and held-to-maturity debt securities at September 30, 2000, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.
The Company intends to maintain an available-for-sale portfolio which may be shifted between investments of differing types and maturities to attempt to maximize market returns without assuming unacceptable levels of credit risk. Future purchases assigned to the held-to-maturity portfolio will be to replace maturing investments, or increase the overall size of the portfolio while maintaining its overall composition.
4. REAL ESTATE CONTRACTS AND MORTGAGE NOTES RECEIVABLE
The following is a reconciliation of the face value of the real estate contracts and mortgage notes receivable to the Company's carrying value at September 30, 2000 and 1999.
At September 30, 2000, the Company held first position liens associated with real estate contracts and mortgage notes receivable with a face value of approximately $182,000,000 (98%) and second position or lower liens of approximately $3,900,000 (2%).
The originated receivables are collateralized primarily by first position liens and result from loans originated by the Company on commercial real estate and loans to facilitate the sale of its repossessed property.
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Real estate contracts and mortgage notes receivable include receivables collateralized by property located throughout the United States. The Company's real estate contracts and mortgage notes receivable at September 30, 2000 and 1999 are collateralized by property concentrated in the following geographic regions:
The value of real estate properties in these geographic regions will be affected by changes in the economic environment of that region. It is reasonably possible that these values could change in the near term, which would affect the Company's estimate of its allowance for losses associated with these receivables.
The face value of the Company's real estate contracts and mortgage notes receivable as of September 30, 2000 and 1999 are grouped by the following dollar ranges:
Contractual interest rates on the face value of the Company's real estate contracts and mortgage notes receivable as of September 30, 2000 and 1999 are as follows:
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The weighted-average contractual interest rate on these receivables at September 30, 2000 and 1999 is approximately 12.4% and 11.8%, respectively. Maturity dates range from 2000 to 2030.
The following is an analysis of the allowance for losses on real estate contracts and mortgage notes receivable.
The Company establishes an allowance for expected losses on real estate assets and periodically evaluates its reserves to determine their adequacy. During the year ended September 30, 2000, the Company adjusted its loss reserve assumptions based on historical experience. The increase in loss provisions reflects the changes in reserve assumptions.
The principal amount of receivables with required principal or interest payments being in arrears for more than three months was approximately $12,218,000 and $7,747,000 at September 30, 2000 and 1999, respectively.
Aggregate amounts of receivable, by maturity date, at their face value are as follows:
Actual repayments of receivables will likely differ from contractual amounts due to prepayments.
The Company entered into securitization transactions during the years ended September 30, 1999 and 1998. The Company participates in these securitization transactions with its subsidiaries, Metropolitan and Metropolitan's subsidiaries. These receivables are structured in classes by credit rating and transferred to a trust, which sells mortgage-backed securities to third parties. These securitizations are recorded as sales of receivables, and gains, net of transaction expenses, are recognized in the consolidated statements of income as each class is sold. The Company did not participate in any securitizations during the year ended September 30, 2000.
During the years ended September 30, 1999 and 1998, proceeds from securitization transactions were approximately $12,331,000 and $22,707,000 and resulted in gains of approximately $934,500 and $1,400,500, respectively. The gains realized during the years ended September 30, 1999 and 1998 included approximately $77,800 and $150,100, respectively, associated with the estimated fair value of the mortgage servicing rights retained on the pools. The fair value of these rights was determined based on the estimated
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present value of future net servicing cash flows, including float interest and late fees, adjusted for anticipated prepayments. The servicing rights associated with the securitization transactions were subsequently sold to an affiliated entity at the Company's carrying value.
The Company has retained, or purchased from Metropolitan, an interest in certain subordinate and residual classes of the securitized receivables which had a fair value of $43,824,506 and $31,825,639 at September 30, 2000 and 1999, respectively.
5. OTHER RECEIVABLE INVESTMENTS
Other receivable investments include various cash flow investments, primarily annuities and lottery prizes. Annuities are general obligations of the payor, which is generally an insurance company. Lottery prizes are general obligations of the insurance company or other entity making the lottery prize payments. Additionally, when the lottery prizes are from a state-run lottery, the lottery prizes are often backed by the general credit of the state.
These investments normally are non-interest bearing and are purchased at a discount sufficient to meet the Company's investment yield requirements. The weighted average constant effective yield on these receivables at September 30, 2000 and 1999 was approximately 10.05% and 9.8%, respectively. Contractual maturities range from 2001 to 2035.
The following is a reconciliation of the face value of the other receivable investments to the Company's carrying value at September 30, 2000 and 1999.
During the year ended September 30, 2000, the Company established a loss reserve on its investments in annuity and structured settlement cashflows as the industry has recently focused on State and Federal collection laws and their applicability to delinquent annuity and structured settlement payments. Additionally, during the year ended September 2000, the Company established a reserve against a participation in finance leases purchased from an affiliate.
The following is an analysis of the allowance for losses on other receivable investments for the year ended September 30, 2000.
The carrying value of other receivable investments that were more than 90 days delinquent as of September 30, 2000 and September 30, 1999 were $2,738,993 and $2,140,202 respectively.
During the years ended September 30, 2000, 1999 and 1998, the Company sold or securitized otherreceivables with a carrying value of approximately $1,644,680, $16,153,000 and $10,879,000,
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respectively, without recourse and recognized gains of approximately $56,164, $549,000 and $702,000, respectively.
The following other receivable investments, by issuer, were in excess of ten percent of stockholders' equity at September 30, 2000 and 1999.
Aggregate amounts of contractual maturities of other receivables at their face amounts are as follows:
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6. DEFERRED COSTS
An analysis of deferred costs related to annuity acquisition and investment certificate issuance for the years ended September 30, 2000, 1999 and 1998 is as follows:
The amortization of deferred annuity acquisition costs, which is based on the estimated gross profits of the underlying annuity products, could be changed significantly in the near term due to changes in the interest rate environment. As a result, the recoverability of these costs may be adversely affected in the near term.
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Annuity reserves are based upon contractual amounts due the annuity holder including credited interest. Annuity contract interest rates ranged from 4.7% to 7.9% during the year ended September 30, 2000, 4.7% to 7.9% during the year ended September 30, 1999 and 4.7% to 8.1% during the year ended September 30, 1998.
OSL reinsures certain single premium deferred annuity contracts underwritten by Western. The following is a summary of reinsurance transactions assumed from Western as of and for the years ended September 30, 2000, 1999 and 1998:
8. GUARANTY FUND ASSESSMENTS
All states in which the Company's life insurance subsidiaries operate have laws requiring solvent life insurance companies to pay assessments to protect the interests of policyholders of insolvent life insurance companies. Assessments are levied on all member insurers in each state based on a proportionate share of premiums written by member insurers in the lines of business in which the insolvent insurers engaged. A portion of these assessments can be offset against the payment of future premium taxes. However, future changes in state laws could decrease the amount available for offset.
The net amount expensed (recaptured) by the Company's life insurance subsidiaries for guaranty fund assessments and amounts estimated to be assessed for the years ended September 30, 2000, 1999 and 1998 were ($263,000), $270,000 and $119,000, respectively. The Company's estimate of these liabilities is based upon updated information from the National Organization of Life and Health Insurance Guaranty Associations regarding insolvencies occurring during the years 1990 through 1998. These estimates are subject to future revisions based upon the ultimate resolution of the insolvencies and resultant losses. As a result of these uncertainties, the Company's estimate of future assessments could change in the near term. The Company does not believe that the amount of future assessments associated with known insolvencies after 1998 will be material to its financial condition or results of operations. At September 30, 2000 and 1999, an estimated future guaranty fund assessment of approximately $387,000 and $650,000, respectively, has been recorded.
SUMMIT SECURITIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
9. INVESTMENT CERTIFICATES
The Company has registered $50,000,000 of Investment Certificates, Series B, of which a face amount of approximately $44,561,000 was unissued at September 30, 2000. This current registration expires on January 31, 2001. At September 30, 2000 and 1999, investment certificates consist of:
The weighted average interest rate on outstanding investment certificates was approximately 8.4% at September 30, 2000 and 1999.
Investment certificates (including principal and compound and accrued interest) mature as follows:
SUMMIT SECURITIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
10. DEBT PAYABLE
At September 30, 2000 and 1999, debt payable consists of:
Aggregate amounts of principal and accrued interest due on debt payable are as follows:
The Company has secured a line of credit agreement with the FHLB through its subsidiary, OSL. When an institution becomes a stockholder in the FHLB, it can borrow from the FHLB at a stock to borrowing ratio of 1 to 20. At September 30, 2000, OSL had a stock investment in the FHLB of $617,000, which resulted in a borrowing capacity of $12.3 million. The collateral eligible to be used to secure the borrowing is predefined by the FHLB and generally consists of eligible securities and mortgage loans. Additionally, each type of collateral has a minimum pledge requirement that ranges from 100% to 150%. At September 30, 2000, OSL had pledged $26.8 million in eligible collateral with a market value of $25.9 million and a borrowing potential of $12.3 million. At September 30, 2000, OSL had borrowed $7 million leaving an unused borrowing potential of $5.3 million. In the event the Company wanted to increase the borrowing capacity of the FHLB line of credit, it could purchase additional stock and or pledge additional eligible collateral.
SUMMIT SECURITIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
In October, 2000, the Company successfully completed a $22.5 million publicly traded note offering listed with the Pacific Exchange. The notes bear interest at 9.5% and mature on September 15, 2005.
11. INCOME TAXES
The tax effect of the temporary differences giving rise to the Company's deferred tax assets and liabilities as of September 30, 2000 and 1999 is as follows:
SUMMIT SECURITIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
No valuation allowance has been established to reduce the deferred tax assets, as it is more likely than not that these assets will be realized due to the future reversals of existing taxable temporary differences and the probability of the generation of future taxable income. Realization is dependent on the generation of sufficient taxable income prior to expiration of the net operating loss carryforwards. The amount of the deferred tax asset considered realizable, however, could be reduced in the near term if estimates of future taxable income during the carryforward period are reduced.
At September 30, 2000, the Company's remaining net operating loss carryforwards of approximately $5,180,000 expire in years 2006 through 2019.
The components of the provision (benefit) for income taxes for the years ended September 30, 2000, 1999 and 1998 are as follows:
The following is a reconciliation of the provision for income taxes to an amount computed by applying the statutory federal income tax rate to income before income taxes for the years ended September 30, 2000, 1999 and 1998.
SUMMIT SECURITIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
12. STOCKHOLDERS' EQUITY
A summary of preferred and common stock at September 30, 2000 and 1999 is as follows:
The Company has authorized 10,000,000 total shares of Series S preferred stock. The Company has the right, without further stockholder approval, to establish additional series of preferred stock with provisions different than those described below for the Series S-1, S-2, S-3 and S-RP preferred stock.
Series S-1, S-2, S-3 and S-RP preferred stock is cumulative and the holders thereof are entitled to receive monthly dividends at an annual rate equal to the highest of the "Treasury Bill Rate," the "Ten Year Constant Maturity Rate" or the "Twenty Year Constant Maturity Rate" as defined in the offering prospectus determined immediately prior to declaration date. The board of directors may, at its sole option, declare a higher dividend rate; however, dividends shall be no less than 6% or greater than 14% per annum.
Series S-1, S-2, S-3 and S-RP preferred stock have a par value of $10 per share and were or will be sold to the public at $100 per share. Series S-1, S-2, S-3 and S-RP shares are callable at the sole option of the board of directors at $100 per share.
All preferred shares have liquidation preferences equal to their issue price, are non-voting and are senior to the common shares as to dividends. All preferred stock dividends are based upon the original issue price.
The payment of dividends by the Company's wholly owned life insurance subsidiaries is subject to certain restrictions imposed by statute by the respective state of domicile (see Note 13). Dividends can only be paid out of earned surplus. Earned surplus includes accumulated statutory basis earnings of the Company and surplus arising from unrealized capital gains or the revaluation of assets.
SUMMIT SECURITIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
13. STATUTORY ACCOUNTING
The life insurance subsidiaries of the Company are required to file statutory financial statements with state insurance regulatory authorities in their states of domicile. Accounting principles used to prepare these statutory financial statements differ from generally accepted accounting principles ("GAAP"). Selected differences between the statutory and the GAAP financial statements (after eliminating Old Standards investment in subsidiary earnings of Old West) for the insurance subsidiaries as of and for the years ended September 30, 2000, 1999 and 1998, respectively, are as follows:
The Idaho Insurance Code presently requires the life insurance subsidiary domiciled in the state of Idaho to maintain $1 million in common stock and $1 million in contributed surplus. The life insurance subsidiary domiciled in this state had an unassigned statutory deficit of approximately $361,000 at September 30, 2000, and thus, is currently restricted from paying dividends.
The Arizona Insurance Code presently requires the life insurance subsidiary domiciled in the state of Arizona to maintain $450,000 in common stock and contributed surplus. This life insurance subsidiary domiciled in this state had an unassigned statutory deficit of approximately $3,082,000 at September 30, 2000 and thus, is currently restricted from paying dividends.
The National Association of Insurance Commissioners (the "NAIC") adopted the Codification of Statutory Accounting Principles guidance, which will replace the current Accounting Practices and Procedures manual as the NAIC's primary guidance on statutory accounting. The NAIC has recommended an effective date of January 1, 2001. The Codification provides guidance for areas where statutory accounting has been silent and changes current statutory accounting in some areas. The Company has not estimated the potential effect of the Codification guidance.
The regulatory authorities impose minimum risk-based capital requirements on insurance enterprises that were developed by the NAIC. The formulas for determining the amount of risk-based capital
SUMMIT SECURITIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
("RBC") specify various weighting factors that are applied to financial balances or various levels of activity based on perceived degree of risk. Regulatory compliance is determined by a ratio of the enterprise's regulatory total adjusted capital, as defined by the NAIC, to its authorized control level RBC, as defined by the NAIC. Enterprises below specific trigger points or ratios are classified within certain levels, each of which requires specified corrective action. The RBC measure of the life insurance subsidiaries at September 30, 2000 was above the minimum standards.
14. SUPPLEMENTAL DISCLOSURES FOR STATEMENTS OF CASH FLOWS
Supplemental information on interest and income taxes paid during the years ended September 30, 2000, 1999 and 1998 is as follows:
Non-cash investing and financing activities of the Company during the years ended September 30, 2000, 1999 and 1998 are as follows:
15. BUSINESS SEGMENT REPORTING
The Company principally operates in three industry segments which encompasses: (1) the investing in real estate contracts and mortgage notes receivable, other receivables and1 investment securities with funds generated from the issuance of investment certificates and preferred stock; (2) annuity operations; and (3) a property development division, which provides services related to the selling, marketing, designing, subdividing and coordinating activities of real estate development properties.
SUMMIT SECURITIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
Information about the Company's separate business segments and in total as of and for the years ended September 30, 2000, 1999 and 1998 is as follows:
SUMMIT SECURITIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
16. RELATED-PARTY TRANSACTIONS
The Company had the following related-party transactions with Metropolitan and its affiliates during the years ended September 30, 2000, 1999 and 1998:
SUMMIT SECURITIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
At September 30, 2000 and 1999, the Company had net receivables due from affiliates of $367,000 and net payables to affiliates of $151,000, respectively. At September 30, 2000, the outstanding note payable to Metropolitan was $10,900,800. At September 30, 2000 and 1999, the outstanding note receivable balance from Metropolitan was $4,500,000 and $12,507,289, respectively.
During the year ended September 30, 1999, the Company sold pools of real estate contracts and mortgage notes receivable to Metropolitan or its affiliates, which were subsequently securitized by Metropolitan or its affiliates. To the extent these sales were consummated just prior to the securitization transaction, the Company was allocated a gain as if they had participated in the securitization transaction. If the sales were made in advance of the securitization transaction, then such sales were made at fair value on the date of the sale, and Metropolitan or its affiliates assumed all credit and market risk associated with the real estate contracts and mortgage notes receivable from the date of the sale through the securitization.
The Company receives management, receivable acquisition and receivable collections services from Metropolitan for a fee pursuant to the terms of the Management, Receivable Acquisition and Servicing Agreement. The receivable acquisition fees are based upon yield requirements established by the Company. The Company pays, as its receivable acquisition service fee, the difference between the yield requirement and the yield which Metropolitan actually negotiates when the receivable is acquired. During the years ended September 30, 2000, 1999 and 1998, the Company incurred service fees for receivable acquisition from Metropolitan of approximately $111,000, $396,000 and $900,000, respectively. The agreements are non-exclusive and may be terminated in whole or part by either party upon notice to the other party.
The Company receives accounting, data processing, contract servicing and other administrative services from Metropolitan. Charges for these services were approximately $884,000, $1,153,000 and $891,000 in the years ended September 30, 2000, 1999 and 1998, respectively. During the year ended September 30, 2000, the Company entered into an agreement with Metropolitan to change from a calculated service fee to a cost sharing arrangement. Other indirect services provided by Metropolitan to the Company, such as management and regulatory compliance, were not directly charged to the Company.
Management believes that these charges are reasonable and result in the reimbursement to Metropolitan of all significant direct expenses incurred on behalf of the Company and its subsidiaries. Currently, management anticipates that Metropolitan will continue to supply these services in the future.
MIS is a securities broker/dealer and member of the National Association of Securities Dealers. It markets the securities products of Summit and of Metropolitan. MIS charges commissions ranging from .6% to 6% of the face value of the security sold. The commission rate depends on the type of security sold, its stated term and whether the security sale involved a reinvestment by a prior investor or a new investment. Commissions and service fees charged to Metropolitan during the years ended September 30, 2000, 1999 and 1998 were approximately $4,717,000, $1,786,000 and $2,448,000, respectively.
Summit Property Development, Inc., a wholly owned subsidiary of Summit, provides real estate development services for a fee. Currently its principal client is Metropolitan. Such services may include, but are not limited to the following: sales, marketing, market analysis, architectural services, design services, subdividing properties and coordination with regulatory groups to obtain the approvals which are necessary to develop a particular property. The fees charged to Metropolitan for these services were approximately $1,975,000, $1,911,000 and $1,844,000 during the years ended September 30, 2000, 1999 and 1998, respectively.
During the year ended September 30, 2000, the Company purchased a participation in certain structured settlements from Metropolitan and a participation in certain lease equipment receivables from
SUMMIT SECURITIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
a subsidiary of Metropolitan at estimated fair value. The purchase price for the structured settlements of $8,068,000 and the lease equipment receivables of $5,542,000 were financed in part by a $10,900,800 note payable with the participated receivables pledged as collateral.
Additionally, during the year ended September 30, 2000, the Company purchased an $18 million non-interest bearing contract receivable, collateralized by timber rights in Hawaii from Metropolitan at an estimated fair value of approximately $13,100,000 using a discount rate of 12%.
The Company sponsors a Retirement Savings Plan (the "Plan"), authorized under Section 401(k) of the Tax Reform Act of 1986, as amended. This Plan is available to all employees over the age of 18 upon completion of six months of service in which he or she has completed 500 hours of service. Employees may defer from 1% to 15% of their compensation in multiples of whole percentages.
Prior to January 1, 1999, if the Company had a net profit for the fiscal year ending within a calendar year, a match equal to 50% of pre-tax contributions up to 6% of the participant's compensation, was credited to the account of each active participant on December 31. Effective January 1, 1999, the plan was amended to modify the employer match to a discretionary matching contribution equal to a uniform percentage of the amount of the participant contribution, up to 6% of the participant's annual compensation. The uniform percentage is to be determined annually by the Company. The Company may also make an additional discretionary contribution during any plan year. For services performed, the contribution relating to the Company's employees was made by Metropolitan during the years ended September 30, 2000, 1999 and 1998.
17. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value. Potential income tax ramifications related to the realization of unrealized gains and losses that would be incurred in an actual sale and/or settlement have not been taken into consideration.
INVESTMENTS IN AFFILIATED COMPANIES--Fair value is estimated by management to equal carrying amounts. The preferred shares are not publicly traded; however, preferred share dividends are paid at variable rates.
PUBLICLY TRADED INVESTMENT SECURITIES--Fair value is determined by quoted market prices.
NON-PUBLICLY TRADED INVESTMENT SECURITIES--Fair value is determined based upon quoted market prices for securities with similar characteristics and risks or is estimated based upon expected discounted future cash flows.
REAL ESTATE CONTRACTS AND MORTGAGE NOTES RECEIVABLE--For receivables, the discount rate is estimated using rates currently offered for receivables of similar characteristics that reflect the credit and interest rate risk inherent in the receivable. For residential mortgage notes receivable, fair value is estimated by discounting contractual cash flows adjusted for prepayment estimates. The prepayment estimates are based upon internal historical data.
OTHER RECEIVABLE INVESTMENTS--The fair value of other receivable investments is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for investments with similar credit ratings and similar remaining maturities.
ANNUITY RESERVES--The fair value of annuity reserves approximates the carrying value because the majority of the annuity policies provide for variable rates of interest.
SUMMIT SECURITIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
INVESTMENT CERTIFICATES AND DEBT PAYABLE--The fair value of investment certificates and debt payable is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for debt with similar remaining maturities.
OFF-BALANCE-SHEET FINANCIAL INSTRUMENTS--Fair value approximates the notional amount of commitments to extend credit because advances bear current interest rates and are made contingent to the borrowers compliance with the existing loan agreement.
The estimated fair values of the following financial instruments as of September 30, 2000 and 1999 are as follows:
SUMMIT SECURITIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
LIMITATIONS--The fair value estimates are made at a discrete point in time based on relevant market information and information about the financial instruments. Because no market exists for a significant portion of these financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates. Accordingly, the estimates presented herein are not necessarily indicative of what the Company could realize in a current market exchange.
SUMMIT SECURITIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
18. PARENT COMPANY ONLY FINANCIAL STATEMENTS
The condensed balance sheets of Summit Securities, Inc. ("Summit" or the "parent company") at September 30, 2000 and 1999 are as follows:
SUMMIT SECURITIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
Summit's condensed statements of income for the years ended September 30, 2000, 1999 and 1998 are as follows:
Summit's condensed statements of cash flows for the years ended September 30, 2000, 1999 and 1998 are as follows:
SUMMIT SECURITIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
Non-cash investing and financing activities not included in Summit's condensed statements of cash flows for the years ended September 30, 2000, 1999 and 1998 are as follows:
Accounting policies followed in the preparation of the preceding condensed financial statements of Summit (parent company only) are the same as those policies described in the consolidated financial statements except that the equity method was used in accounting for the investments in and net income from subsidiaries.
SUMMIT SECURITIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
At September 30, 2000 and 1999, Summit's debt payable consists of the following:
At September 30, 2000 and 1999, Summit's investment certificates consisted of the following:
Maturities of the parent company's investment certificates are as follows:
SUMMIT SECURITIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --(CONTINUED)
Summit had the following related-party transactions with its various subsidiaries and affiliated entities:
During the year ended September 30, 2000, the Company purchased a participation in certain structured settlements from Metropolitan and a participation in certain lease equipment receivables from a subsidiary of Metropolitan at estimated fair value. The purchase price for the structured settlements of $8,068,000 and the lease equipment receivables of $5,542,000 were financed in part by a $10,900,800 note payable with the participated receivables pledged as collateral. The outstanding balance on the note receivable at September 30, 2000 was $10,900,800.
Additionally, during the year ended September 30, 2000, the Company purchased an $18 million non-interest bearing contract receivable, collateralized by timber rights in Hawaii from Metropolitan at an estimated fair value of $13,194,396 using a discount rate of 12%.
SCHEDULE I
SUMMIT SECURITIES, INC. SUMMARY OF INVESTMENTS OTHER THAN INVESTMENTS IN RELATED PARTIES SEPTEMBER 30, 2000
S-1
SCHEDULE II
SUMMIT SECURITIES, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
YEARS ENDED SEPTEMBER 30, 2000, 1999, AND 1998
S-2
SCHEDULE III
PAGE 1 OF 2
SUMMIT SECURITIES, INC. AND SUBSIDIARIES
SUPPLEMENTARY INSURANCE INFORMATION
S-3
SCHEDULE III
PAGE 2 OF 2
SUMMIT SECURITIES, INC. AND SUBSIDIARIES
SUPPLEMENTARY INSURANCE INFORMATION
S-4
SCHEDULE IV
PAGE 1 OF 3
SUMMIT SECURITIES, INC. MORTGAGE LOANS ON REAL ESTATE SEPTEMBER 30, 2000
Less than 1% of the Receivables are subject to variable interest rates. Interest rates range principally from 6% to 14% with approximately 92% of the face value of the Receivables within this range. The following table segregates the Consolidated Group's Receivable portfolio by type, size, and lien position.
The principal amount of Receivables subject to delinquent principal or interest is defined as being in arrears for more than three months but which are still accruing interest.
S-5
SCHEDULE IV
PAGE 2 OF 3
SUMMIT SECURITIES, INC. MORTGAGE LOANS ON REAL ESTATE SEPTEMBER 30, 2000
The future maturities of the aggregate amounts of Receivables (face amount) are as follows:
S-6
SCHEDULE IV
PAGE 3 OF 3
SUMMIT SECURITIES, INC. MORTGAGE LOANS ON REAL ESTATE SEPTEMBER 30, 2000
S-7