ITEM 1. BUSINESS
ORGANIZATIONAL CHART (AS OF SEPTEMBER 30, 2001)
[ORG. CHART]
The above chart lists Metropolitan Mortgage & Securities Co., Inc.'s ("Metropolitan") principal operating subsidiaries and their ownership (together with Metropolitan, the "Consolidated Group").
Metropolitan Mortgage & Securities Co., Inc.: Parent organization, invests in Receivables (as defined herein) and other investments, including real estate development, which are principally funded by proceeds from Receivable investments, other investments and securities offerings.
Consumers Group Holding Co., Inc.: A holding company, its sole business activity currently being that of a shareholder of Consumers Insurance Co., Inc.
Consumers Insurance Co., Inc.: Inactive property and casualty insurer, its principal business activity is being a shareholder of Western United Life Assurance Company.
Western United Life Assurance Company ("Western United"): Metropolitan's largest active subsidiary and the largest active company within the Consolidated Group, is engaged in investing in Receivables and other investments principally funded by proceeds from Receivable investments and sales and from annuity contract and life insurance policy sales.
Metwest Mortgage Services, Inc. ("Metwest"): Primarily performs collection and servicing functions for the Consolidated Group and others. It is an Federal Housing Administration ("FHA")/U.S. Department of Housing and Urban Development ("HUD") licensed servicer and lender and is licensed as a Federal National Mortgage Association seller/servicer. - ------------------------------------
* The remaining 3.5% of Consumers Group Holding Co., Inc. is owned by Summit Securities, Inc., an affiliate of Metropolitan.
BUSINESS OVERVIEW
GENERAL
Metropolitan was established in 1953. Through growth and acquisitions it has developed into a diversified institution with assets exceeding $1 billion. Its principal subsidiaries are Western United, an annuity and life insurance company, and Metwest, a Receivable servicer and loan originator. The Consolidated Group had approximately 292 full time equivalent employees at September 30, 2001.
Western United has been assigned an A.M. Best Co. ("Best") rating of "B" (fair), which is the 7th highest rating. Best publishes both a financial strength rating and a financial performance rating on more than 6,000 health, property and casualty insurance companies. Best's financial strength ratings range from A++ (Superior) to F (In Liquidation) and include 15 separate ratings (not including the S rating for "Suspended"). 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.
The Consolidated Group's principal business activity is investing in cash flowing assets, consisting of obligations collateralized by real estate, structured settlements, annuities, lottery prizes and other investments ("Receivables"). The Receivables primarily consist of real estate contracts and promissory notes collateralized by first position liens on real estate. The Consolidated Group invests in Receivables where the borrower or the collateral does not qualify for conventional financing or the seller or the buyer chose to use non-conventional financing. This market is commonly referred to as the non-conventional market. Obligors on the Consolidated Group's real estate Receivables include A-, B and C credit quality obligors. See "RECEIVABLE INVESTMENTS." Additionally, the Consolidated Group expanded the origination of commercial loans during the fiscal year ended September 30, 2001 such that approximately 29% of the face value of the Receivables as of September 30, 2001 are of this type. See "RECEIVABLE INVESTMENTS--Real Estate Receivables--Commercial Loan Originations." Metropolitan and its subsidiaries also acquire other types of Receivables, including, but not limited to, lottery prizes, structured settlements and annuities. See "RECEIVABLE INVESTMENTS--Other Receivables--Non Real Estate Receivable Sources."
All purchased Receivables are purchased at prices calculated to provide a desired yield. Often, in order to obtain the desired yield, a Receivable will be purchased at a discount from its face amount or at a discount from its present value. See "RECEIVABLE INVESTMENTS--Yield and Discount Considerations." The Consolidated Group strives to achieve a positive spread between its investments and its cost of funds.
Metwest performs servicing and collection services for certain of the Receivables for itself, Metropolitan and Western United, as well as other entities. See "RECEIVABLE INVESTMENTS--Servicing, Collection and Delinquency Experience." Also see "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS" under Item 13.
In addition to investing in Receivables originated by others, the Consolidated Group began originating commercial loans collateralized by various types of commercial properties that are evaluated, underwritten and closed by an affiliate, Old Standard Life Insurance Company ("Old Standard"), in accordance with the Consolidated Group's predefined criteria. The Consolidated Group currently expects to expand the origination of commercial loans during 2002. This expectation is due in part to the Consolidated Group's current perception that this market may be inadequately served by current lenders, who management believes are inflexible in their underwriting and pricing policies and who are not able to quickly underwrite and close these loans, particularly in the temporary, bridge and development commercial loan markets.
In addition to the Consolidated Group's Receivable investments, Western United and, to a lesser extent Metropolitan, invest funds in securities which predominantly consist of corporate bonds, U.S. Treasury and government agency obligations, mortgage-backed securities and other securities. These investments also include security hedging investments and subordinate certificates and residual interests created out of
Receivable securitizations. The Consolidated Group also invests in venture capital investments. See "SECURITIES INVESTMENTS" and "RECEIVABLE INVESTMENTS--Receivable Sales."
The Consolidated Group has developed several funding sources. These sources include collateralized lines of credit; the sale of Receivables; Receivable cash flow and investment income; the issuance of annuity and life insurance policies; the issuance of debt and equity securities; the sale of real estate; and securities portfolio earnings. See "METHOD OF FINANCING."
The Consolidated Group also sells and, through the services of Summit Property Development, Inc. ("Summit Property Development"), an affiliate of Metropolitan, develops real estate held generally acquired through the repossession of property securing Receivables or in exchange for property securing Receivables that have been repossessed. See "REAL ESTATE DEVELOPMENT."
The Consolidated Group provides services to certain affiliated entities (the "Affiliated Companies") for a fee and engages in various business transactions with these entities. The Affiliated Companies are National Summit Corp. and its principal subsidiaries which include Summit Securities, Inc. ("Summit"), Old Standard, Old West Life Insurance & Annuity Company ("Old West"), Summit Property Development, Inc. and Metropolitan Investment Securities, Inc. ("MIS"). The Affiliated Companies are affiliated with the Consolidated Group because of the common control of the Consolidated Group and the Affiliated Companies by C. Paul Sandifur, Jr. See "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS" under Item 13.
FACTORS AFFECTING FUTURE OPERATING RESULTS
The Private Securities Litigation Reform Act of 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.
Metropolitan 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.
Metropolitan's future results may be affected by certain risks and uncertainties including, but not limited to, the following:
FALLING INTEREST RATES COULD NEGATIVELY AFFECT THE PROFITABILITY AND THE FAIR VALUE OF EQUITY OF THE CONSOLIDATED GROUP.
If interest rates fall, the profitability and the fair value of equity of the Consolidated Group may decline because of a refinancing of Receivables and a net decrease in interest revenues. When interest rates fall, borrowers have an incentive to refinance their Receivables by taking out new loans at a lower rate of interest and repaying in full existing loans having a higher rate of interest. Because the Receivables with the higher rate of interest may be repaid early, the interest earned by the Consolidated Group may decline. On the other hand, higher interest rates could cause interest expenses to increase faster than interest income increases, because more financial liabilities than assets are scheduled to reprice or mature for the Consolidated Group during the fiscal year that began on October 1, 2001.
FINANCIAL PERFORMANCE AND GROWTH OF THE CONSOLIDATED GROUP COULD BE NEGATIVELY AFFECTED BY THE INABILITY TO SELL RECEIVABLES.
The Consolidated Group has historically sold or securitized pools of Receivables. The Consolidated Group intends to continue selling pools of Receivables but has generally discontinued its securitization of
Receivables. Several factors affect the Consolidated Group's ability to sell pools of Receivables, including conditions in the securities markets generally, conditions in the asset-backed securities markets specifically, the credit quality of the Receivables, compliance of the Consolidated Group's Receivables with the eligibility requirements established by the sale documents and the absence of any material downgrading or withdrawal of ratings given to securities issued in the Consolidated Group's previous securitizations. The Consolidated Group's financial performance and growth prospects may be adversely affected if they cannot favorably sell Receivables, or if they are completely unable to sell Receivables.
IF RESIDUAL AND SUBORDINATE INTERESTS IN SECURITIZATIONS DO NOT PERFORM AS WE ANTICIPATE, THE CONSOLIDATED GROUP COULD HAVE LOWER THAN ANTICIPATED INCOME EARNINGS.
The Consolidated Group owns subordinated and residual interests in several securitized loan pools, which generally are in a "first loss" position relative to the more senior securities sold to third parties and which carry a greater risk if loans in the securitizations are not paid or losses occur. The Consolidated Group values these interests by discounting the expected cash flows using a discount rate commensurate with the risks involved. When determining the expected cash flow, the Consolidated Group must estimate the future rate of prepayments, defaults and losses of the securitized Receivables. If those assumptions are inaccurate, the Consolidated Group will have incorrectly valued these interests on its balance sheet and may earn less income than was anticipated from those assets. In this regard, the Consolidated Group has previously revised certain of the assumptions resulting in losses and may do so in the future depending on the realization of the assumptions. For the Consolidated Group, other comprehensive income consists of net income and unrealized temporary gains and losses, net of income taxes, associated with certain investment securities.
FORECLOSURE ON MORTGAGES COULD DELAY OR REDUCE PAYMENTS ON RECEIVABLES, ADVERSELY AFFECTING THE LIQUIDITY AND PROFITABILITY OF THE CONSOLIDATED GROUP.
Foreclosure, bankruptcy and other similar proceedings used to enforce mortgage loans are generally subject to principles of equity which are designed to relieve the indebted party from the legal effect of that party's default. Statutes may limit the right of the Consolidated Group to obtain a deficiency judgment against the defaulting party after a foreclosure or sale. The application of any such principle may lead to a loss or delay in the payment on a certificate in a securitization in which the Consolidated Group is involved or in loans held by the Consolidated Group.
REAL ESTATE USED AS COLLATERAL TO COVER LOSSES ON RECEIVABLES MAY BE INADEQUATE.
Most of the Receivables purchased by the Consolidated Group are collateralized by real estate to provide security if a borrower defaults on such borrower's mortgage. The real estate used as collateral may be insufficient to cover any loss in the event of foreclosure. Several factors influence whether the value of the real estate will be sufficient to cover the value of the Receivables, including changes in economic conditions, property condition, property values, zoning, land use, environmental laws and other legal restrictions, including changes in and restrictions on the timing and methods of foreclosure.
WE COULD INCUR LOSSES ON RECEIVABLES THAT ARE SECURED ONLY BY A PROMISE TO PAY BECAUSE THERE IS NO COLLATERAL SECURING THE RECEIVABLE.
The Consolidated Group purchases some Receivables that are not collateralized, such as annuities, lottery prizes, structured settlements or other investments. In these cases, the Consolidated Group does not have a security interest in a specific asset. It relies instead on a promise to pay from an insurance company, a state government or other entity. If the payor does not keep its promise to pay and defaults, the Consolidated Group will not have the benefit of a lien on any specific asset on which to foreclose to collect the Receivable.
NET INCOME MAY BE INSUFFICIENT TO COVER FIXED CHARGES.
Net income of the Consolidated Group in 2001, 2000 and 1999 was insufficient to cover fixed charges including preferred stock dividend requirements. In order to have the necessary funds to meet our obligations as they become due, we will be required to generate additional earnings, make additional sales of our preferred stock and debentures, or borrow or obtain funds from other sources. If the insufficiency in earnings continues,
and if we are unable to sell a sufficient amount of preferred stock and debentures or obtain funds from other sources, we may not have sufficient funds to pay the Consolidated Group's obligations when due.
IF EXISTING UNDERWRITING STANDARDS INSUFFICIENTLY EVALUATE THE RISK OF LOSSES ON RECEIVABLES, IT COULD LEAD TO LOSSES.
Metropolitan underwrites many of the Receivables that are purchased by the Consolidated Group other than commercial loan originations. Many of these purchased Receivables were originated by sellers and other non-institutional lenders. Therefore, the underwriting standards used to originate these loans may have been less strict than the standards that are typically used when underwriting conventional mortgage loans. Metropolitan uses a variety of procedures to evaluate Receivables depending on the type of investment. While Metropolitan tries to minimize the risk of default and the risk of losses if there is a default, there is no assurance that these underwriting procedures will be effective. If the underwriting standards incorrectly assess the risk of an investment, actual losses could be higher than anticipated.
IF INSURANCE SUBSIDIARY EARNINGS ARE UNAVAILABLE FOR DIVIDENDS AND FEES, METROPOLITAN COULD BE ADVERSELY AFFECTED.
At September 30, 2001, approximately 83% of the Consolidated Group's assets were held by its insurance subsidiary, Western United. Metropolitan depends, in part, on its subsidiaries to make cash payment to Metropolitan to meet Metropolitan's payment obligations. Regulations in the State of Washington define the way in which an insurance company, such as Western United, can transfer assets and the amount of money that can be paid out in dividends by the insurance company. These regulations restrict the payment of cash dividends to the insurance company's portion of available surplus funds derived from any realized net profits as computed in accordance with statutory accounting principles. Furthermore, the payment of extraordinary dividends, as statutorily defined, is subject to prior notice to and review and approval by the Washington State Insurance Commissioner. The amount of surplus funds available for dividends at September 30, 2001 was approximately $8.0 million. Restrictions on the ability to declare dividends and transfers of assets could have an adverse effect on Metropolitan's financial performance and ability to meet its debt obligations and preferred stock dividend payments.
THE CONSOLIDATED GROUP MAY BE UNABLE TO MEET ITS FINANCIAL OBLIGATIONS AS THEY BECOME DUE.
The Consolidated Group generates cash flow primarily from payments received on Receivables and other investments, the sale of annuities and life insurance, the sale or securitization of Receivables, credit borrowings and the sale of debt and equity securities. Cash flows from existing assets have been adequate during the past five years to satisfy the demand for payment of maturing debentures and to pay preferred stock dividends. However, the Consolidated Group's ability to repay interest and principal on debt securities and preferred stock dividends that become due in the future and other outstanding obligations depends in part on the success of its future public or private offerings of debt and equity securities.
AN INCREASE IN LIFE INSURANCE AND ANNUITY TERMINATION RATES MAY DECREASE EARNINGS.
An increase in the termination rate of annuity contracts and life insurance policies would tend to decrease the earnings of Western United. If terminations increase, costs would increase because the insurance subsidiaries would have to immediately expense the unamortized deferred acquisition costs on those surrendered policies instead of continuing to amortize those costs over time. The rate at which annuity contracts and life insurance policies terminate is affected by several factors, including changes in interest rates, competition and changes in tax and other regulations. Management cannot predict the future rate of termination of life insurance and annuity policies.
ENVIRONMENTAL CONDITIONS AND REGULATION OF PROPERTY ACQUIRED BY THE CONSOLIDATED GROUP MAY LEAD TO LOSSES.
The Consolidated Group acquires properties in the course of its business, some of which may contain hazardous waste or other toxic materials. Various federal, state and local environmental laws, ordinances and regulations hold the owner or the previous owner of the property liable for the costs of removal or remediation of hazardous or toxic substances on, under, in or near the affected property. Historically, the Consolidated
Group has tried to avoid acquiring properties or Receivables collateralized by properties that may be contaminated. The Consolidated Group is currently evaluating whether to acquire or originate commercial loans where the property type or use creates a greater risk of environmental problems or on properties where known environmental problems exist. In those circumstances, the Consolidated Group is evaluating insurance programs to eliminate or minimize the potential environmental costs to the Consolidated Group. However, there is no guarantee that the Consolidated Group can effectively implement an insurance program or that, if implemented, it would be sufficient to cover the losses caused by any of these environmental liabilities. As a result of its current business, the Consolidated Group may sustain significant losses due to such liability.
POTENTIAL LIABILITY FOR ENVIRONMENTAL CLEAN-UP COST ON REAL ESTATE COULD ADVERSELY AFFECT THE CONSOLIDATED GROUP.
The government can place a lien on environmentally contaminated property to guarantee that the clean-up costs for that property are paid. In many states, these liens have priority over the existing mortgage on the property. The Consolidated Group may be directly subject to these liens, or indirectly if they participate in a securitization of property and have a role in the day-to-day management of the facility or property. Environmental assessments to determine whether certain properties are contaminated are rarely performed by the Consolidated Group, and even where they are performed, there is no guarantee that the Consolidated Group will be insulated from liability for an environmental condition.
THE CONSOLIDATED GROUP MAY BE ADVERSELY AFFECTED BY COMPETITION WITH ITS AFFILIATES.
Several companies are affiliated with the Consolidated Group through common control by C. Paul Sandifur, Jr. Certain officers and directors of these affiliated companies are also employees of the Consolidated Group. In addition, the Consolidated Group provides services to affiliated companies, buys and sells Receivables to and from affiliated companies and makes loans to or borrows money from affiliated companies. These factors may lead to conflicts of interests such as which company receives a particular securities sale, how Receivables are distributed among or between separate companies, how fees for services are established and charged, how intercompany sales and purchases of Receivables are priced and the terms of any intercompany loan. Old Standard and Old West may compete with the Consolidated Group in acquiring Receivables and for the sale of annuities. Also, the Consolidated Group may compete with Summit for the acquisition of Receivables and the sale of securities. If these conflicts are not resolved favorably to the Consolidated Group, the performance of the Consolidated Group could be adversely affected.
REAL ESTATE HELD FOR DEVELOPMENT MAY NOT BE ABLE TO BE SOLD, OR MAY NOT BE ABLE TO BE SOLD PROFITABLY.
The Consolidated Group is engaged in the development of various real estate properties, including substantially undeveloped properties. It is possible that this property will not be able to be sold, or will not be able to be sold at a price exceeding the carrying value of the property. Factors such as local and national trends in commercial property values as well as local, state and national economic trends may impact the potential sales price for these properties.
THE INEXPERIENCE OF THE CONSOLIDATED GROUP IN ORIGINATING COMMERCIAL LOANS COULD LEAD TO LOSSES.
The Consolidated Group focuses its loan originations on loans that are collateralized by commercial real estate, including multi-family properties ("Commercial Loans"). The Consolidated Group previously originated and acquired first lien residential mortgage loans. Commercial Loans accounted for approximately $157.1 million, or 60%, of the real estate Receivables purchased or originated by the Consolidated Group in the fiscal year ended September 30, 2001. Management cannot predict whether it will have the ability or the desire to originate commercial loans in the future, whether such loans will achieve desirable yields or whether it will be able to accurately predict commercial loan default rates. It is possible that this shift in resources could prove to be unprofitable and could adversely affect the Consolidated Group.
THE CONSOLIDATED GROUP MAY BE NEGATIVELY IMPACTED BY SOME OF ITS EQUITY INVESTMENTS.
The Consolidated Group invests in venture capital, joint ventures and other related equity investments. The market price and valuations of these investments may fluctuate due to market conditions and other conditions over which the Consolidated Group has no control. If these equity investments decline in value, the
Consolidated Group could be negatively affected. Additionally, these investments may not have an active trading market and, as a result, the Consolidated Group may not be able to easily sell these investments and, if they are able to be sold, they may not be sold at favorable prices.
RECEIVABLE INVESTMENTS
INTRODUCTION
Metropolitan has been investing in Receivables for its own account for over 40 years. Metropolitan also provides Receivable acquisition and underwriting services to its subsidiary, Western United, and to Old Standard, Old West and Summit. See "--Management and Receivable Acquisition Services." Also see "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS" under Item 13. The evaluation, underwriting and closing operations are performed at Metropolitan's headquarters in Spokane, Washington. The following information describes the Receivable acquisition and underwriting procedures performed by Metropolitan on behalf of the Consolidated Group as of September 30, 2001. These practices may be amended, supplemented and changed at any time at the discretion of Metropolitan, subject to the investment guidelines of the entity acquiring the Receivable.
The Consolidated Group's Receivable acquisitions include two principal types of Receivables: (1) Receivables collateralized by real estate and (2) alternative cash flows consisting of lottery prizes, structured settlements, annuities and other cash flowing assets. Additionally, the Consolidated Group expanded the origination of commercial loans during the fiscal year ended September 30, 2001. This was due in part to management's current perception that this market may be inadequately served by current lenders, who Metropolitan believes 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 loan markets.
The market for the acquisition of existing real estate Receivables is commonly referred to as the secondary mortgage market. The secondary mortgage market includes individual Receivables that 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 or acquired by a financial institution. The Consolidated Group may acquire both individual and pools of Receivables.
Metropolitan's Receivable acquisition activities (total activities for itself and for others), totaled approximately $654.0 million in fiscal 1999, $651.1 million in fiscal 2000 and $275.4 million in fiscal 2001. The reduction in acquisition activities between 2000 and 2001 was primarily due to a decreased emphasis in acquiring or originating residential mortgage loans (other than jumbo mortgage loans) in favor of a strategy to increase its origination of commercial mortgage loans generally in the $5 million to $15 million range. See "--Real Estate Receivables--Commercial Loan Originations."
REAL ESTATE RECEIVABLES
Metropolitan has developed marketing techniques, sources and underwriting practices for each of its different types of Receivables. In general, the real estate Receivables acquired or originated by the Consolidated Group consist of non-conventional loans. This type of Receivable possesses 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 to use non-conventional financing. In this type of lending, generally the lender will focus on the quality of the collateral as the ultimate recourse in the event of the borrower's default rather than the ability of the borrower to repay.
Individual Real Estate Receivable Acquisition Sources
Historically, the majority of the Consolidated Group's real estate Receivables were acquired as individual Receivable acquisitions. See "--Current Mix of Receivable Investment Holdings." Metropolitan's principal
source for private market Receivables are independent brokers located throughout the United States. These independent brokers typically deal directly with private individuals or organizations that 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 and has implemented 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.
In addition to investing in existing Receivables, the Consolidated Group may originate jumbo residential loans through Metwest. The Consolidated Group may also originate first lien residential loans as a result of re-selling real estate acquired through foreclosure.
Commercial Loan Originations
The Consolidated Group originates commercial loans collateralized by various types of commercial properties including income producing properties, fully developed lots and land held primarily for residential development. These commercial loans are generally small to mid-sized loans that are originated for less than $15 million. The Consolidated Group typically lends at 50-65% loan-to-value ratios, requires guarantors on each loan and may require multiple pieces of collateral to adequately collateralize a particular loan. The Consolidated Group is usually in a first lien position on the primary collateral.
The Consolidated Group obtains leads for such loans through independent mortgage brokers. While these independent mortgage brokers may be involved with the negotiation of terms on behalf of the borrower, all applications, commitments and documentation are drafted by the Consolidated Group's counsel and executed directly with the borrower and guarantor.
Commercial loans originated by the Consolidated Group are underwritten applying criteria which may include, but are not limited to, the following: evaluating the borrower's and guarantor's financials and credit, obtaining a current, satisfactory appraisal of the collateral, making a physical inspection of the property, obtaining title insurance and reviewing other factors that affect collateral valuation such as environmental reports, structural inspections, zoning and entitlement status. The sum of the underwriting evaluation (collateral, borrower and guarantor strength) and the borrower's alternative financing options affect the interest rate and loan-to-value ratios that the Consolidated Group will require. A higher risk evaluation would result in a higher required interest rate and a lower loan-to-value ratio. In the circumstance that the borrower has limited financing options due primarily to time constraints, the Consolidated Group has the opportunity to charge higher rates at lower loan-to-values than the risk might otherwise require. The Consolidated Group's proven ability to be more responsive than the competition to time sensitive opportunities has been key to its ability to capitalize on the latter circumstance, which provides higher returns for lower risk.
The weighted average yields on originated commercial loans were 14.3% on $128.3 million of Receivables at September 30, 2001 and 17.8% on $7.5 million of Receivables at September 30, 2000. The loans closed generally 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 that may be negotiated in future transactions.
OTHER RECEIVABLES
Non Real Estate Receivable Sources
Metropolitan also negotiates the purchase of Receivables which are not collateralized by real estate, such as annuities, lottery prizes and business notes. 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 cashed in directly with the issuing insurance company. Business notes are cashflow instruments that are paid to a seller for the purchase of a business operation. Metropolitan's source for these investments is generally private brokers who specialize in these types of Receivables.
Non Real Estate Receivable Underwriting
In the case of lottery prizes, the underwriting guidelines generally include a review of the documents providing proof of the prize and a review of the credit rating of the insurance company or other entity making the lottery prize payments. Where the lottery prize is from a state run lottery, the underwriting guidelines generally include a confirmation with the respective lottery commission of the prize winner's right to sell the prize and 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.
In the case of all annuity purchases, Metropolitan's underwriting guidelines generally include a review of the annuity policy and review of the seller's credit report. Upon submission of the file the most current credit rating of the annuity issuer will be obtained. Furthermore, Metropolitan will conduct 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.
In the case of business notes, the underwriting guidelines require the review of the note, purchase and sale agreement, closing statement for the purchase of the business, security agreement and any other documents necessary to assist the Underwriters in determining the nature of the business enterprise and the terms of the sale. The borrower's credit will be evaluated and a current UCC search will be obtained to ensure that no prior liens exist on the secured property. Other criteria require that the note be secured by a first priority lien in the security, and if the property is leased, the lease must run to the maturity date of the note.
Other Receivables
Metropolitan continually seeks opportunities to invest in new Receivable markets. These programs account for a minimal amount of Metropolitan's current and projected Receivable acquisition volume. However, Metropolitan always remains open to new opportunities that may arise for the acquisition of new types of Receivables.
YIELD AND DISCOUNT CONSIDERATIONS
Metropolitan negotiates all Receivable acquisitions at prices calculated to provide a desired yield. Often this results in a purchase price less than the Receivable's unpaid balance, or less than its present value (assuming a fixed discount rate). The difference between the unpaid balance and the purchase price is the "discount." The amount of the discount will vary in any given transaction depending upon the Consolidated Group's yield requirements at the time of the purchase. 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.
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.
A greater effective yield can also 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. Acceleration 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 junior liens, primarily on single family residential property and commercial properties. Management believes that the large numbers of relatively small individual Receivables, the geographic dispersion of the collateral and the ratio of collateral value to investment amount requirements dissipate much of the risk in the residential mortgage portion of the portfolio.
During the fiscal year ended September 30, 2001, the Consolidated Group began expanding the origination of commercial loans. The yield earned on the mortgages collateralized by commercial property are higher than the yield on Receivables collateralized by single family residential property because the credit risks are lower for the mortgage collateralized by single family residential property. However, investments in commercial loans are less diversified because, on average, the principal amount of a commercial loan is greater than the principal amount of a residential mortgage or other Receivable.
Management continually monitors economic and demographic conditions throughout the country in an effort to avoid a concentration of its acquired real estate Receivables in those areas experiencing economic decline, which could result in higher than anticipated default rates and subsequent investment losses.
The following charts and map present information regarding type of real estate collateral, geographical distribution and lien priority of the Consolidated Group's portfolio of outstanding real estate Receivables as of September 30, 2001.
DISTRIBUTION OF RECEIVABLES BY COLLATERAL TYPE
(PIE CHART)
DISTRIBUTION OF RECEIVABLES (COLLATERALIZED BY REAL ESTATE) BY SECURITY POSITION
(PIE CHART)
DISTRIBUTION OF ASSETS AS A PERCENTAGE OF TOTAL ASSETS
(PIE CHART)
METROPOLITAN MORTGAGE & SECURITIES CO., INC. PERCENTAGE DISTRIBUTION BY STATE OF THE PRINCIPAL AMOUNT OF RECEIVABLES COLLATERALIZED BY REAL ESTATE AS OF SEPTEMBER 30, 2001
(MAP)
States not showing a percentage have less than 1%.
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES LOANS ON REAL ESTATE SEPTEMBER 30, 2001
At September 30, 2001, the Consolidated Group held first priority liens associated with contracts and mortgage note Receivables with a face value of approximately $439.8 million (99%) and second or lower priority liens of approximately $5.7 million (1%). Approximately 30% of the face value of the Consolidated Group's real estate Receivables are collateralized by properties located in the Pacific Southwest (California, Arizona and Nevada), approximately 23% by properties located in the Pacific Northwest (Washington, Alaska, Idaho, Montana and Oregon), approximately 13% in the Southeast (Florida, Georgia, North Carolina and South Carolina), approximately 13% by properties located in the Southwest (Texas and New Mexico) and approximately 4% in the North Atlantic (New York, Pennsylvania, New Jersey, Connecticut and Maryland). The face value of the real estate Receivables ranges principally from $15,000 to $300,000 with 90 real estate Receivables, aggregating approximately $172.2 million, in excess of this range. No individual contract or note is in excess of 5% of the total carrying value of real estate Receivables and less than 2% of the contracts and notes are subject to variable interest rates. Contractual interest rates principally range from 6% to 13% per annum with approximately 85% of the face value of these Receivables within this range. The weighted average contractual interest rate on these real estate Receivables at September 30, 2001 is approximately 10.5%. Maturity dates range from 2001 to 2031.
The principal amounts of real estate Receivables subject to delinquent principal or interest is defined as being in arrears for more than three months.
The future contractual maturities of the aggregate amounts of Receivables (face amount) are as follows:
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES LOANS ON REAL ESTATE SEPTEMBER 30, 2000
At September 30, 2000, the Consolidated Group held first priority liens associated with contracts and mortgage note Receivables with a face value of approximately $397.8 million (98%) and second or lower priority liens of approximately $6.5 million (2%). Approximately 31% of the face value of the Consolidated Group's real estate Receivables are collateralized by properties located in the Pacific Northwest (Washington, Alaska, Idaho, Montana and Oregon), approximately 26% by properties located in the Pacific Southwest (California, Arizona and Nevada), approximately 11% in the Southeast (Florida, Georgia, North Carolina and South Carolina), approximately 6% in the North Atlantic (New York, Pennsylvania, New Jersey, Connecticut and Maryland) and approximately 12% by properties located in the Southwest (Texas and New Mexico). The face value of the real estate Receivables ranges principally from $15,000 to $300,000 with 98 real estate Receivables, aggregating approximately $73.2 million, in excess of this range. No individual contract or note is in excess of 1.4% of the total carrying value of real estate Receivables and less than 4% of the contracts and notes are subject to variable interest rates. Contractual interest rates principally range from 6% to 13% per annum with approximately 93% of the face value of these Receivables within this range. The weighted average contractual interest rate on these real estate Receivables at September 30, 2000 is approximately 9.5%. Maturity dates range from 2000 to 2030.
The principal amounts of real estate Receivables subject to delinquent principal or interest is defined as being in arrears for more than three months.
The future contractual maturities of the aggregate amounts of Receivables (face amount) are as follows:
SERVICING, COLLECTION AND DELINQUENCY EXPERIENCE
Prior to April 2001, Metwest performed the servicing and collection functions related to the Consolidated Group's Receivable portfolio. Metwest also serviced the Receivables of Summit, Old Standard and Old West, as well as Receivables sold through securitizations. Fees for providing services to Metropolitan and Western United had no impact on the results of operations of the Consolidated Group during fiscal 2001 as they are eliminated in the consolidated financial statements. Fees for providing servicing and collection services to the trusts holding securitized pools and to Summit, Old Standard and Old West were approximately $6.2 million before deducting amortization of servicing rights of approximately $1.2 million during the fiscal year ended September 30, 2001. These charges to parties outside the Consolidated Group provided an additional source of income to the Consolidated Group.
In April 2001, as a result of Metropolitan's decision to stop performing loan servicing operations, the Consolidated Group participated with certain affiliates in a transaction with a wholly-owned subsidiary of Ocwen Financial Corporation ("Ocwen") (NYSE: OCN), where the servicing rights to approximately $721 million of Receivables and foreclosed properties held for sale were transferred to Ocwen. Of the total transferred, the Consolidated Group contributed approximately $597.4 million in Receivables and foreclosed properties. In October 2001, the Consolidated Group entered into a subservicing agreement, whereby Ocwen will provide servicing for the majority of the remaining Receivable portfolio in addition to the Consolidated Group's future acquisitions of new Receivables. As the servicer for the Consolidated Group, Ocwen is responsible for all servicing related functions ranging from payment processing to the liquidation of property acquired as a result of foreclosure. Ocwen carries a level 2 servicer rating from Fitch IBCA, Inc. ("Fitch"). According to Fitch, level 2 servicers have demonstrated high performance in all relevant categories. Standard & Poor's ("S&P") has assigned its Strong Residential Subprime and Residential Special Servicer rankings to Ocwen. S&P has also assigned an Above Average Residential Alternative Servicer ranking to Ocwen for subordinate lien products. Moody's Investor Service, Inc. ("Moody's") does not currently rate mortgage servicers; however, Moody's recognizes Ocwen as a highly qualified subprime and special servicer. According to Ocwen's filings with the SEC, as of June 30, 2001, Ocwen serviced in excess of $15 billion in assets. Ocwen's primary business is the servicing and special servicing of nonconforming and subprime residential and commercial mortgage loans. Ocwen also specializes in the related development of loan servicing technology and software for the mortgage and real estate industries.
When a payment becomes delinquent on a commercial loan, either Ocwen's or the Consolidated Group's collection unit (depending on which entity is acting as servicer) will begin making collection calls immediately. If the defaulted payment is not received by the next payment due date, a notice of default is sent to the borrower and the account is assigned to a Consolidated Group asset manager according to property type, size of loan and complexity of transaction. The asset manager will review the file and all documentation and
attempt to contact the borrower to negotiate with the borrower to cure the default. If, upon the expiration of the notice of default, the default is not cured, foreclosure is begun immediately by counsel. Concurrent with the notice of default period and the foreclosure process, the assigned asset manager will continue to contact and attempt to negotiate a full reinstatement with the borrower. During this same period, the asset manager will also develop a workout program and make recommendations to the Consolidated Group's Problem Loan Review Committee for approval. As a part of formulating this workout plan, the Asset Manager will typically visit the collateral property, talk with local experts and make an assessment of the condition of the collateral and its marketability in the event of a potential foreclosure. The final workout plan is presented to the Problem Loan Review Committee with all relevant information regarding contact with the borrower, condition and marketability of collateral and an assessment of the likelihood of default cure or recovery of the loan balance if the default continues through foreclosure. Any actions undertaken by the asset manager with the borrower that would result in other than full reinstatement are subject to prior approval by the Problem Loan Review Committee.
The Problem Loan Review Committee is composed of the heads of underwriting, risk management and operations, commercial lending, legal and property development. The committee meets bi-weekly and reviews: all newly defaulted loans, continuing defaulted loans, loans in foreclosure, loans in bankruptcy and all repossessed properties for developments and progress on approved workout plans.
The principal amount of the Consolidated Group's originated commercial loans (as a percentage of the total outstanding principal of Receivables collateralized by real estate) that were in arrears for more than ninety days as of the following dates were:
The principal amount of the Consolidated Group's other Receivables collateralized by real estate (as a percentage of the total outstanding principal of Receivables collateralized by real estate) that were in arrears for more than ninety days as of the following dates were:
The real estate Receivables acquired by the Consolidated Group are generally A-, B and C credit Receivables. 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 believes that the economic effects of these higher delinquency rates will be generally offset by the higher yields received on these Receivables than those typically received on the conventional "A" credit lending markets and the value of the underlying collateral. The weighted average yields for the Consolidated Group's Receivables collateralized by real estate were approximately 12.5%, 10.7% and 10.4% at September 30, 2001, 2000 and 1999, respectively. In addition, the Consolidated Group maintains an allowance for losses on delinquent real estate Receivables. As a result, management believes losses from resales of repossessed properties are generally lower than might be expected given the delinquency rates.
ALLOWANCE FOR LOSSES ON REAL ESTATE ASSETS
The Consolidated Group establishes an allowance for expected losses on real estate contracts and mortgage notes receivable held for investment based upon historical experience. The Consolidated Group continually reviews the results of its resales of repossessed real estate to identify any market trends and to document the Consolidated Group's historical experience on such sales. The Consolidated Group adjusts its allowance for losses requirement, as appropriate, based upon such observed trends in delinquencies and losses
on resales. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--Provision for Losses on Real Estate Assets" under Item 7.
The following table outlines the Consolidated Group's changes in the allowance for losses on real estate contracts and mortgage notes receivable held for investment:
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 historical repossession rates 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 that 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. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--Provision for Losses on Real Estate Contracts and Mortgage Notes Receivable" under item 7.
REPOSSESSIONS
In the course of its Receivable investment activity, the Consolidated Group acquires various parcels of real estate as a result of foreclosures and/or voluntary repossessions. It is the Consolidated Group's general policy to attempt to resell such properties at the earliest possible time following its acquisition. Improvements are made to certain properties for the purpose of preservation or restoration to maximize the resale price. The marketing status of all properties is reviewed at least monthly by a committee which includes both sales personnel and management. Generally, repossessed properties are resold within one year from the date of repossession.
The estimated net realizable value of a repossessed property is determined as of the date of repossession of the property. It is based on an appraisal by a licensed independent appraiser at the time the property was repossessed.
The following table presents specific information about the Consolidated Group's repossessed properties with net realizable values of $100,000 or more which were held at September 30, 2001 and/or September 30, 2000.
For information regarding the Consolidated Group's activity in properties held for development, see "REAL ESTATE DEVELOPMENT."
MANAGEMENT AND RECEIVABLE ACQUISITION SERVICES
Metropolitan provides management and Receivable acquisition services to its subsidiaries and to Summit, Old Standard and Old West. The Receivable acquisitions satisfy underwriting and yield requirements established by the purchasing company. The difference between the yield requirement and the yield which Metropolitan actually negotiates is retained by Metropolitan as its compensation for providing acquisition services, except with respect to Western United which on April 1, 1998 began acquiring loans from Metropolitan at Metropolitan's cost in compliance with current insurance regulatory application of statutes regulating transactions within a holding company group.
Additionally, Metropolitan provides Receivable acquisition services to Summit, Old Standard and Old West. The fee is based upon yield requirements established by Summit, Old Standard and Old West. Metropolitan charges, as its Receivable acquisition service fee, the difference between the yield requirement and the yield which Metropolitan actually negotiated when the Receivable is acquired. The fees are recognized as revenues when the related fees are charged to those companies. During 2001, Metropolitan charged Summit, Old Standard and Old West fees of approximately $0.9 million. The service agreements with Western United have no effect upon the consolidated financial results of the Consolidated Group. The service agreements with Summit, Old Standard and Old West provide an additional source of fee income to Metropolitan. See "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS" under Item 13.
RECEIVABLE SALES
The Consolidated Group sells pools of Receivables when it considers it profitable to do so. Such sales generally occur through one of two methods: (1) securitization or (2) direct sales. Historically, the majority of the Consolidated Group's Receivable sales have been through securitizations. The Consolidated Group did not participate in any new securitizations during 2001, and does not anticipate participating in new real estate backed securitizations during 2002. 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, providing liquidity and possibly providing lower cost of funds. The sale of Receivables allows the Consolidated Group to continue to expand its investing activities without increasing its total asset size.
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, which include classes of senior certificates, a class of residual interests certificates, and may also include intermediate classes of subordinated certificates. The rights of the senior certificate holders can be enhanced through several methods which include subordination of the rights of the subordinate and residual interests to receive distributions, or through the establishment of a reserve fund. In connection with securitizations, the senior certificates are sold to investors, which are generally institutional 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 may also receive an interest in any unsold subordinate certificates and an interest in any residual interest. Such interests are generally apportioned based upon the respective companies' contribution of Receivables to the pool of Receivables sold to the trust and may be resecuritized.
Through September 30, 2001, the Consolidated Group (principally Metropolitan and Western United) participated as a co-sponsor in 13 real estate Receivable securitizations, of which five were also participated in by affiliates, Summit, Old Standard and Old West. The affiliates' percentage of each securitization has been less than approximately 10% in each transaction in which they participated.
In the typical securitization structure, the Receivable payments are distributed first to the senior certificates, then 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 due to the failure of the Receivables to pay as scheduled. 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 loss or gain.
In the securitizations in which the Consolidated Group has participated, the rights of the senior certificate holders were enhanced through subordinating the rights of subordinate and residual interests to receive distributions with respect to the mortgage loans. The selling companies initially retained their respective residual interests but in 1999, certain of such residual interests were resecuritized. At September 30, 2001, the value of residual interests held by the Consolidated Group was approximately $31.4 million. 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.
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. During the fiscal year ended September 30, 2001, the Consolidated Group determined that certain residuals had other than temporary declines in value due to a deterioration of future expected cash flows. Accordingly, the Consolidated Group recorded a $4.1 million charge to the statement of operations as a loss on investments, representing the amount permanently impaired. 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.
In addition to sales through securitizations, the Consolidated Group sells 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 the year ended September 30, 2001, the Consolidated Group sold portfolios of real estate Receivables through both direct sales and a securitization pre-funding with proceeds of approximately $113.0 million and gains of $3.2 million. During that same period, the Consolidated Group sold other Receivables through direct sales with proceeds of approximately $6.0 million and losses of $0.3 million.
During the year ended September 30, 2000, the Consolidated Group sold portfolios of real estate Receivables through both direct sales and securitizations with proceeds of approximately $600.0 million and
gains of $24.8 million. During that same period, the Consolidated Group sold other Receivables through both direct sales and securitizations with proceeds of approximately $46.5 million and gains of $2.2 million.
During the year ended September 30, 1999, the Consolidated Group sold portfolios of real estate Receivables through both direct sales and securitizations with proceeds of approximately $592.8 million and gains of $21.8 million. During that same period, the Consolidated Group sold other Receivables through both direct sales and securitizations with proceeds of approximately $50.0 million and gains of $3.0 million.
LIFE INSURANCE AND ANNUITY OPERATIONS
INTRODUCTION
One of the Consolidated Group's principal subsidiaries is Western United. Western United was incorporated in Washington State in 1963. As of September 30, 2001, Western United owned approximately $1.2 billion in assets before any elimination of assets for consolidation purposes.
Western United markets its annuity and life insurance products through over 1,475 independent sales representatives under contract. These representatives may also sell life insurance and/or annuity products for other companies. Western United is licensed as an insurer in the States of Alaska, Arizona, Hawaii, Idaho, Indiana, Montana, Nebraska, Nevada, North Dakota, Oklahoma, Oregon, South Dakota, Texas, Utah, Washington, and Wyoming.
Management intends to expand the operations of Western United into other states as opportunities arise, which may include the acquisition of other existing insurance companies. Western United currently has an insurance license application pending in the State of New Mexico.
During the calendar year ended December 31, 2000, approximately 92% of Western United's deferred annuity business was produced in the states of Idaho, Montana, Oregon, Texas, Utah and Washington. Based on the latest data available, during calendar year 2000, Western United's deferred annuity market share in these six states was 2.8%.
Western United has filed a registration statement with the SEC relating to a public offering of up to $50,000,000 of its Variable Rate Cumulative Preferred Stock, Series B (the "Series B Shares"). The offering is expected to begin promptly after the registration statement is declared effective by the SEC and the other necessary regulatory approvals are received. Western United is unable to predict whether it will be able to sell all or any of the Series B Shares. Offers to sell the Series B Shares will only be made by means of the final prospectus.
Western United is a member of the Insurance Market Standards Association, which is an association established to promote ethical insurance marketing standards among its members. Western United is also a member of the Federal Home Loan Bank of Seattle.
Western United is required by the laws of the State of Washington to limit its investment in real estate assets to 65% of its statutory assets. The balance of Western United's investments are principally invested in government and investment-grade securities, but may be invested in a variety of other areas as permitted by applicable insurance regulations. See "SECURITIES INVESTMENTS" and "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 and instrumentalities, can be acquired. As a result, Western United can acquire qualifying real estate Receivables in amounts which exceed the above referenced 65% limitation. Such acquisitions are also exempt from other state insurance regulations including loan to value and appraisal regulations.
ANNUITIES
Western United has actively marketed single and flexible premium deferred annuities since 1980. During the past three calendar years, approximately 99% of Western United's direct premiums were derived from annuity sales.
Western United's annuities also qualify as investments under several tax advantaged programs.
Western United prices its new annuity products and renewals in order to achieve a positive spread between its annuity costs and available Receivable and other investments while also considering current annuity market rates of interest and competitive pressures. Flexible and single premium annuities are offered with surrender charges for periods varying from one year to ten years.
During the year ended September 30, 2001, Western United introduced Heritage Max, a single premium deferred annuity. The initial interest rate is guaranteed for two policy years, with rates thereafter declared annually and guaranteed for one policy year. The minimum guaranteed interest rate is 3% for all policy years. Bailout provisions exist in policy years three through five that allow policyholders to withdraw their funds without surrender charges if the annual interest rate falls below the initial interest rate. Surrender charges on this product begin at 7% and decline to 4% during the first five years of the policy. However, policyholders may withdraw up to 15% of their account value annually without incurring a surrender penalty. This product is only available to policyholders age 85 or older.
During the year ended September 30, 2001, Western United introduced TD Max+, a single premium deferred annuity. Interest rates are guaranteed for the first five policy years, with rates thereafter declared annually and guaranteed for one policy year. The initial rate applies during the first policy year and increases by .20% in each of the next four policy years. Thereafter, the minimum guaranteed interest rate is 3% for all policy years. Step-down surrender charges ranging from 8% to 5% are in effect for the first five years of the policy. However, policyholders may withdraw up to 10% of their account value annually without incurring a surrender penalty. Minimum premium is $25,000.
At September 30, 2001, deferred policy acquisition costs were approximately 6.9% of life and annuity reserves. Increasing termination rates may have an adverse impact on Western United's earnings through requiring faster amortization of these costs. Management believes that this potentially adverse impact is mitigated by annuity interest spreads. This spread analysis is shown in the following table, which applies to the results of Western United during the past three calendar years, based on insurance regulatory report filings:
During fiscal 2001, 2000 and 1999, amortization of actuarially determined deferred policy acquisition costs was $9.0 million, $12.6 million and $11.0 million, respectively. The amortization of previously capitalized expenses includes an unlocking adjustment of approximately $4.3 million during the fiscal year ended September 30, 2001.
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 calendar years 2000, 1999 and 1998, lapse rates were 27.3%, 16.9%, and 18.9%, respectively. Based upon results for the nine months ended September 30, 2001, lapse rates were 20.18%.
LIFE INSURANCE
During the year ended September 30, 2001, less than 1% of Western United's statutory direct premiums were derived from the sale of interest sensitive whole life insurance and term life insurance policies. As of September 30, 2001, the face amount of life insurance policies written and outstanding totaled approximately $211.0 million, net of amounts ceded to reinsurers. As with annuities, gross profits are determined by the
difference between interest rates credited on outstanding policies and interest earned on investment of premiums. In addition, profitability is affected by mortality experience (i.e. the frequency of claims resulting from deaths of policyholders). Although Western United's mortality rates to date have been lower than expected, higher credited interest rates and higher issuing expenses combined with low volume have resulted in lower profits than those experienced with its annuity products.
The following table sets forth certain key financial information regarding the Consolidated Group's life insurance subsidiary.
REINSURANCE
Reinsurance is the practice whereby an insurance company enters into agreements (called "treaties") with other insurance companies in order to assign some of its insured risk, for which a premium is paid, while retaining 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. Life insurers commonly 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.
Annuity Reinsurance
Western United entered into a reinsurance agreement with Old Standard which became effective July 1, 1998 and remained in effect at September 30, 2001. Although Western United can use this agreement to reinsure risk, the agreement has been inactive since October 31, 2000 because Management determined not to reinsure the risk on policies written after that date. Under this agreement, Western United may reinsure with Old Standard 75% of the risk on 15 different annuity products. The premiums ceded to Old Standard during the fiscal years ended September 30, 2001, 2000 and 1999 were approximately $0.7 million, $27.4 million and $44.7 million, respectively. Western United received ceding allowances equal to actual commission plus 1.5% of premium, which was approximately $0.1 million, $1.5 million and $2.3 million during the fiscal years ended September 30, 2001, 2000 and 1999, respectively. At September 30, 2001, 2000 and 1999, Western United has
recorded a receivable from reinsurer of $109.5 million, $111.2 million and $97.2 million related to this reinsurance agreement.
This agreement allows Western United to continue its market presence and relationship with its insurance agents while moderating its rate of growth. Under its contractual terms, this 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 no premiums will be ceded under this treaty during fiscal 2002. 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.
Life Policy Reinsurance
Western United reinsured approximately $33.7 million of life insurance risk at September 30, 2001 which equaled all risk in excess of $100,000 on each whole life policy and all risk in excess of $50,000 on each term life policy. Life insurance in force at that time was approximately $244.7 million. Western United is a party to 20 separate reinsurance treaties with ten reinsurance companies. The largest treaty is with Optimum Reinsurance Company and provided, at September 30, 2001, approximately $16.7 million of reinsurance coverage. The majority of the remaining coverage is with Business Men's Assurance Company of America and Phoenix Home Life Mutual Insurance Company. Total life policy reinsurance premiums paid by Western United during the fiscal year ended September 30, 2001 were approximately $0.3 million.
RESERVES
Western United's reserves for both annuities and life insurance are actuarially determined and prescribed by its state of domicile and other states in which it does business through laws which are designed to protect annuity contract owners and policy owners. The amount of these reserves required for compliance with state law are reviewed by an actuary. These reserves are amounts which, at certain assumed rates, are calculated to be sufficient to meet Western United's future obligations under annuity contracts and life insurance policies currently in force. At September 30, 2001, such reserves were approximately $971.2 million. Reserves are recalculated each year to reflect amounts of reinsurance in force, issue ages of new policy holders, duration of policies and variations in policy terms. Since such reserves are based on actuarial assumptions, no representation is made that ultimate liability will not exceed these reserves.
INSURANCE ACCOUNTING PRACTICES
Western United is required to file statutory financial statements with its state of domicile, Washington. Accounting principles used to prepare its 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, 2001, 2000 and 1999, respectively, is as follows:
SECURITIES INVESTMENTS
At September 30, 2001, 2000 and 1999, 87.8%, 87.7%, and 84.6%, respectively, of the Consolidated Group's securities investments were held by Western United.
The following table outlines the nature and carrying value of securities investments held by Western United at September 30, 2001:
Investments of Western United are subject to the direction and control of an investment committee appointed by its Board of Directors. All such investments must comply with applicable state insurance laws and regulations. See "REGULATION."
Metropolitan and Western United each are authorized by their respective Board of Directors 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 that 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, 2001, 2000 and 1999, the Consolidated Group had no open hedging positions relative to hedging its securities portfolio, but did have outstanding hedging transactions at September 30, 2000 relating to its loans held for sale. These hedges were closed in October 2000. See "NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Note 1" under Item 8.
The Consolidated Group has retained investments in certain subordinate classes of securities from its securitizations having an estimated fair value of approximately $97.1 million, $105.6 million and $99.6 million at September 30, 2001, 2000 and 1999, respectively.
At September 30, 2001, 2000 an 1999, amounts in the trading portfolio on a consolidated basis, at market value, were approximately $48.8 million, $61.1 million and $45.0 million, respectively. At September 30, 2001, 2000 and 1999, amounts in the available-for-sale portfolio on a consolidated basis were $311.8 million, $204.1 million, and $156.3 million, respectively. The available-for-sale portfolio had net unrealized losses of approximately $6.7 million at September 30, 2001, $17.6 million at September 30, 2000, and $5.1 million at September 30, 1999. In the held-to-maturity portfolio, net unrealized losses were approximately $0.4 million at September 30, 2000 and approximately $1.2 million at September 30, 1999. During the fiscal year ended September 30, 2001, the Consolidated Group reclassified its held-to-maturity securities to available-for-sale securities. See "NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Note 2" under Item 8.
METHOD OF FINANCING
The Consolidated Group finances its business operations and growth through the sale of life insurance, annuity products, debt and equity securities, collateralized lines of credit, proceeds from the sale of Receivables and real estate, Receivable cash flows and securities portfolio earnings. In this regard, Metropolitan engages in a substantially continuous public offering of debt securities and preferred stock while Western United markets annuities and life insurance policies. See "LIFE INSURANCE AND ANNUITY OPERATIONS."
The following table presents information regarding the debentures issued by the Consolidated Group (the "Debentures"):
Substantially all of the Debentures outstanding at September 30, 2001 will mature during the five-year period ending September 30, 2006. Management expects to fund net retirements of Debentures maturing during that period with cash flow generated by Receivable investments, sales of real estate and issuances of securities. During the year ended September 30, 2001, approximately 62% of Metropolitan's Debentures were
reinvested at maturity. Principal payments received from the Consolidated Group's Receivable portfolio and proceeds from sales of real estate and Receivables were as follows for the periods indicated (in millions):
Proceeds of preferred stock issuances less redemptions were approximately ($9.8) million in fiscal 2001, $8.9 million in fiscal 2000 and $3.7 in fiscal 1999. The liquidation preference of outstanding preferred stock at September 30, 2001 was approximately $52.9 million. Preferred shareholders are entitled to monthly distributions at a variable rate based on the rates on various maturities of U.S. Treasury obligations. The average monthly distribution rate during fiscal 2001 was 7.3%. Preferred stock distributions paid by Metropolitan were approximately $4.2 million in fiscal 2001, $4.6 in fiscal 2000 and $3.6 million in fiscal 1999.
The following table summarizes Metropolitan's anticipated annual cash principal and interest obligations on Debentures, credit lines and other debt payable and anticipated annual cash dividend requirements on preferred stock for the indicated periods based on outstanding debt and securities at September 30, 2001, assuming no reinvestments of maturing Debentures:
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(1) Based on an assumed dividend rate per annum of 7.0%
In addition to these contractual cash flow requirements, a certain amount of Western United's annuities may reprice annually which could cause termination of such annuities, some of which may be subject to a surrender charge. In the event of termination of such annuities, the expected cash outlays of Western United will increase. See "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS--Asset/Liability Management" under Item 7. Management believes that cash flows will remain adequate during the next year to satisfy all obligations Metropolitan owes to holders of its securities.
The Consolidated Group also obtains funds through a borrowing facility with the Federal Home Loan Bank of Seattle ("FHLB"). The amount the FHLB will lend depends on the amount of the borrower's stock investment in the FHLB and the type of collateral pledged to secure the borrowings. Under the terms of the line of credit, Western United is authorized to borrow in an aggregate amount not to exceed $90.6 million from time to time for an agreed upon advance rate and pledge of acceptable collateral. The amount advanced at September 30, 2001, was $22.0 million, including accrued interest ranging from 7.27% to 7.48% per annum. At September 30, 2001, the line of credit was collateralized by various securities with a par value of approximately $83.6 million. At September 30, 2000 and 1999, the amount advanced was $23.5 million and $33.0 million, respectively.
REAL ESTATE DEVELOPMENT
The Consolidated Group (principally Metropolitan) is engaged in the development of various properties. These development properties were generally acquired in the ordinary course of business, generally through repossessions. In addition, the Consolidated Group may acquire property for development. Subsequent
acquisitions may include properties adjoining those properties presently owned by the Consolidated Group in order to enhance the value of the original parcel, or may include the acquisition of properties unrelated to existing holdings. The development or improvement of properties is undertaken for the purposes of enhancing values, increasing marketability and to maximize profit potential.
Substantially all of the development activity is performed for the Consolidated Group by Summit Property Development, a subsidiary of Summit. During fiscal 2001, approximately $1.1 million in fees were paid to Summit Property Development for property development activities.
THE LIBERTY LAKE PROPERTIES
Located just east of Spokane, Washington near Liberty Lake, this land was acquired by Metropolitan between 1989 and 1997 primarily utilizing repossessed properties as consideration. At September 30, 2001, the remaining parcel is located within the MeadowWood master-planned community, which includes residential, commercial and industrial properties, including a business park.
Liberty Lake Center (formerly MeadowWood Business Park Phase II): In 1989, Metropolitan acquired an option to purchase a major portion of Liberty Lake Center. Repossessed properties were used as consideration for the acquisition. Another 17.12 acres of industrial-zoned property were acquired by exchange during fiscal 1990. In June 1997, Metropolitan exercised its option to purchase 62.10 acres at $10,500 per acre. An additional 19.26 acres were purchased in December 1996. Also, 6.40 acres of former railroad right-of-way were purchased in 1996. This brought the total land area of Liberty Lake Center (excluding subsequently dedicated road rights-of-way) to 98.41 acres.
During the year ended September 30, 2001, four sales closed for 4.77 acres with proceeds of approximately $1.1 million. At September 30, 2001, the carrying value was approximately $3.0 million on 19.7 remaining acres. The undiscounted cash flow appraised value as of November 23, 1998 was $5.7 million.
THE SUMMIT PROPERTY
This property consists of approximately 76.35 acres in downtown Spokane adjacent to the central business district and is located along the north bank of the Spokane River. It contains several parcels that were purchased between 1982 and 1996. The property is zoned for mixed uses, ranging from medium density residential to office and retail. A final Environmental Impact Statement on the proposed project was published in 1993. The master plan and Shoreline Substantial Development Use Permit were approved by the City of Spokane in 1995. Demolition of several vacant buildings located on the property was completed in 1998. At September 30, 2001, the carrying value of the property was approximately $13.2 million. The appraised value of this property as of September 25, 2001 was $19.4 million. Metropolitan is currently exploring options for the development of the infrastructure of the property. There were no sales of this property for the fiscal year ended September 30, 2001.
AIRWAY BUSINESS CENTRE
Airway Business Centre (the "Center") consists of two phases of commercial/industrial-zoned property. The property is located in the City of Airway Heights, Washington approximately 10 miles west of downtown Spokane. The project is part of a 440-acre parcel originally purchased in 1979.
The first phase of the Center had a final binding site plan consisting of 13 lots with a total area of 43.29 acres (excluding subsequently dedicated road rights-of-way), approved in 1994. The property has approximately one-half mile of frontage on U.S. Highway 2, a regional east/west transportation route. Current improvements to the property include the construction of public streets to serve the various parcels created, extension of private streets within the western portion of the project, a right-turn access off of Highway 2, utility extensions to serve interior parcels and a traffic signal at the project's main intersection. During the year ended September 30, 2001, Metropolitan sold 1.09 acres for approximately $0.2 million.
The second phase of the Center had a final binding site plan approved in 1997. This portion included the extension of two public streets to serve the project. A total of 50.59 acres (excluding subsequently dedicated
road rights-of-way) of the project have an approved binding site plan, while 21.23 acres await city approval of further subdivision.
The carrying value for the entire project as of September 30, 2001 was approximately $3.7 million. The appraised value for the entire project as of September 30, 1998 was $5.7 million.
SPOKANE VALLEY PLAZA
This property is located near the Sullivan Road and Interstate 90 freeway interchange just east of Spokane and consists of 28.15 acres (excluding subsequently dedicated road rights-of-ways) of land zoned for regional commercial use. The property was acquired in 1990 using repossessed property as consideration. County approval for a 348,000 square foot shopping center was received in 1991. Prior to 1999, Metropolitan closed two sales in which a total of 15.60 acres were sold. The following leases have been executed on four buildings constructed on 6.82 acres.
Construction on a fourth building for Eddie Bauer was near completion at September 30, 2001. Occupancy of the building occurred on October 29, 2001.
The carrying value of this property as of September 30, 2001 was approximately $12.4 million which included the cost of buildings built for Michael's, Ross, Eddie Bauer and a building for the Fashion Bug, Corral West Ranchwear, Sally's Beauty Supply and Cigarettes Cheaper. The appraised value of this property as of October 1, 1998 was $10.1 million and did not include values of the constructed buildings. At September 30, 2001, approximately 5.73 acres of this development remained unsold or un-leased.
BROADMOOR PARK (PASCO)
This property, acquired through repossession in 1988, consists of 410 acres of land, at a freeway interchange in Pasco, Washington. The property was zoned in 1994 for mixed residential and commercial use. Water, sewer, gas, electricity and telephone have been extended to the property. Access to the property has been improved by construction of interior roads.
Broadmoor Park Outlet Mall
The Broadmoor Park Outlet Mall is 10.98 acres located on the north side of Interstate 182 freeway. The Mall is approximately 101,000 square feet and over 92% leased as of September 30, 2001. The carrying value of the property as of September 30, 2001 was approximately $8.2 million. The appraised value was $13.3 million as of December 15, 1995. The mall generated approximately $0.3 million of rental income in fiscal 2001, approximately $0.8 million in fiscal 2000 and approximately $0.8 million in fiscal 1999. Lease payments from the initial tenants commenced in August 1995. The Outlet Mall has not developed as anticipated and to retain tenants, leases were converted to percentage rents based upon sales in order to retain occupancy.
Broadmoor Park General
The remaining 378.03 acres (excluding subsequently dedicated road rights-of-way) of Broadmoor Park are zoned for development as hotels, motels, fast food restaurants, gas stations, a variety of stores, and for development of both single and multi-family residential housing. Sales in fiscal 2001 totaled 1.39 acres for approximately $0.1 million. The carrying value as of September 30, 2001 was approximately $9.2 million on the remaining 314.97 acres. The appraised value as of September 13, 2001 was $14.5 million.
EVERETT
This property is a 98-acre parcel of land zoned for industrial use located adjacent to Boeing's Paine Field plant at Everett, Washington. Studies of utility services, access requirements and environmental issues are ongoing, as are discussions with several parties to sell and/or jointly develop the property. At September 30, 2001, the carrying value of the property was approximately $5.4 million. The appraised value was $9.5 million as of July 31, 2001.
RENTON
This property is approximately 35 acres. It is characterized by heavily vegetated terrain and is zoned for residential use. The City of Renton has annexed and rezoned the property increasing its density from just over 100 residential units to over 200 residential units. At September 30, 2001, the carrying value in the property was approximately $3.6 million. The appraised value was $4.2 million as of August 23, 2001.
SUNSET BEACH
This property is 19.1 acres of development property on the North Shore of Oahu, Hawaii acquired in June 2001 for $7.5 million. During fiscal 2002, Metropolitan plans on continuing the development of the property into a 29 lot residential subdivision at an additional cost of approximately $3.0 million. At September 30, 2001, the carrying value in the property was approximately $8.7 million.
CARBONDALE
Metropolitan has entered into a development agreement to acquire a 24-acre parcel of land in Carbondale, Colorado. Carbondale is located approximately 30 miles from Aspen. Metropolitan has hired a developer to obtain the required approvals for development of the property for residential use. Metropolitan anticipates the uses for the property will include 6-acres of single-family residential, 7.5-acres of townhouses, and 10.5-acres of apartments. The acquisition of the property is anticipated to occur in February 2002 when the entitlement process is expected to be completed.
The following table presents additional information about the Consolidated Group's investments in and sales of real estate held for sale and development:
ALLOWANCE FOR LOSSES ON REAL ESTATE HELD FOR SALE
The following table summarizes changes in the Consolidated Group's allowance for losses on real estate held for sale:
Loss provisions for real estate held for sale are calculated as the difference between the estimated net realizable value at the measurement date and the estimated net realizable value at the foreclosure date. At foreclosure, the carrying value of the real estate held for sale is adjusted to the lower of cost or net realizable value. Any subsequent reduction in the estimated net realizable value is charged to operations through provision for losses.
COMPETITION
COMPETITION FOR RECEIVABLE ACQUISITIONS AND ORIGINATIONS
The Consolidated Group competes with other financial institutions including 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 greater name recognition. Management believes the primary competitive factors are the amounts offered and paid to Receivable sellers and the speed in which the processing and funding of the transaction can be completed. Competitive advantages enjoyed by the Consolidated Group include (1) its access to markets throughout the United States; (2) Metropolitan's BrokerNet software; (3) its flexibility in structuring Receivable acquisitions; (4) its long history in the business; and (5) its in-house capabilities for processing and funding transactions. To the extent other competing Receivable investors may develop faster closing procedures, more flexible investment policies, or other attributes that are more desirable to Receivable sellers, they may experience a competitive advantage.
Metropolitan competes with other investors in its lottery, structured settlement and annuity acquisitions. Competitive forces have substantially decreased the yields available on new lottery acquisitions, structured settlements and annuities.
Periodically, Metropolitan and Western United compete in the secondary market as sellers of pools of Receivables. This market is a multi-billion dollar market and includes competitors with access to greater resources, greater volumes and economies of scale, and better name recognition.
Metropolitan's securities products face competition for investors from other securities issuers, many of which are much larger and have greater name recognition.
COMPETITION FOR ANNUITY AND LIFE INSURANCE SALES
The life insurance and annuity business is highly competitive. Western United competes with other financial institutions including ones with greater resources and greater name recognition. Premium rates, annuity yields and commissions to agents are particularly sensitive to competitive forces. Management believes that Western United is in an advantageous position in this regard because of its earnings capability through investments in Receivables compared to that of most other life insurance companies. Additionally, management believes the primary competitive factors among life insurance companies for investment-oriented insurance products, like annuities, include product flexibility, net return after fees, innovation in product design, the claims-paying ability rating and the name recognition of the issuing company, the availability of distribution channels and service rendered to the customer before and after a policy or contract is issued. Other factors affecting the annuity business include the benefits, including before-tax and after tax investment returns, and guarantees provided to the customer and the commissions paid to the agent.
REGULATION
All areas of the Consolidated Group's Receivable acquisition and servicing activities are highly regulated by federal and state laws designed principally to protect the payor. Metwest's lending and servicing activities must comply with, among other regulations, the Truth in Lending Act, the Real Estate Settlement Procedures Act, and Regulation X and Z promulgated by the Board of Governors of the Federal Reserve System. Metwest is licensed as an FHA/HUD servicer/lender and a Fannie Mae seller/servicer. As such, it must comply with applicable FHA, HUD, and Fannie Mae regulations and guidelines.
The Consolidated Group is subject to the Insurance Holding Company Act as administered by the Office of the State Insurance Commissioner of the State of Washington. This act regulates transactions between insurance companies and their affiliates. It requires that Western United provide notification to the Insurance Commissioner of certain transactions between the insurance company and its affiliates. In certain instances, the Commissioner's approval is required before a transaction with an affiliate can be consummated.
Western United is subject to extensive regulation and supervision by the Office of the State Insurance Commissioner of the State of Washington as a Washington domiciled insurer, and to a lesser extent by all of the other states in which it operates. These regulations are directed toward supervision of such things as granting and revoking licenses to transact business on both the insurance company and agency levels, approving policy forms, setting dividend levels, prescribing the nature and amount of permitted investments, establishing solvency standards and conducting extensive periodic examinations of insurance company records. Such regulations are intended to protect annuity contract holders and insurance policy owners rather than investors in an insurance company.
All states in which Western United operates have laws requiring solvent life insurance companies to pay guaranty fund 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.
Dividend restrictions are imposed by regulatory authorities on Western United. These restrictions are limited to the unassigned statutory surplus, reduced by any unrealized capital gains, which netted approximately $8.0 million at September 30, 2001.
For statutory purposes, Western United's capital and surplus and its ratio of capital and surplus to admitted assets were as follows for the dates indicated:
In 1993, Washington State 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 of the insurance company. Western United's capital and surplus levels exceeded the calculated minimum requirements at its statutory reporting period ended December 31, 2000.
ITEM 2.
ITEM 2. PROPERTIES
On November 14, 1997, Metropolitan acquired an office building containing approximately 200,000 square feet located at 601 West First Avenue, Spokane, Washington, approximately three blocks from its previous headquarters. Metropolitan moved its headquarters to this building in fiscal 1998. Approximately 25% of the building is currently leased by other tenants. At September 30, 2001, the mortgage balance on the building was approximately $11.6 million.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Other than ordinary routine litigation incidental to business, there are no material legal proceedings or actions pending or threatened against Metropolitan or to which its property is subject.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
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 Metropolitan's common stock.
(b) Holders: There were three holders of Metropolitan's Common Stock as of September 30, 2001.
(c) Dividends: Metropolitan declared dividends on its Common Stock during the last three fiscal years ended September 30, 2001 as follows:
At the date of this Form 10-K, Metropolitan had made no determination as to the likelihood that it will or will not pay dividends on its Common Stock in the future.
2. Recent Sales of Unregistered Securities: None.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
SELECTED CONSOLIDATED FINANCIAL DATA
The consolidated financial data shown below as of September 30, 2001 and 2000 and for the years ended September 30, 2001, 2000 and 1999 (other than the ratios of earnings to fixed charges and preferred stock dividends) have been derived from, and should be read in conjunction with, Metropolitan's consolidated financial statements, related notes, and Management's Discussion and Analysis of Financial Condition and Results of Operations appearing elsewhere herein. The consolidated financial data shown as of September 30, 1999, 1998 and 1997 and for the years ended September 30, 1998 and 1997 (other than the ratios of earnings to fixed charges and preferred stock dividends) have been derived from audited consolidated financial statements not included herein.
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(1) Earnings were insufficient to meet fixed charges and preferred stock dividends by approximately $40.2 million, $17.4 million and $0.8 million for the years ended September 30, 2001, 2000 and 1999, respectively. The consolidated ratio of earnings to fixed charges and preferred stock dividends was 1.37 and 1.31 for the years ended September 30, 1998 and 1997, respectively.
Assuming no benefit from the earnings of its subsidiaries with the exception of direct dividend payments, earnings were insufficient by approximately $50.5 million and $20.2 million for the years ended September 30, 2001 and 2000, respectively. The ratio of earnings to fixed charges and preferred dividends for Metropolitan alone was 1.10, and 1.01 for the years ended September 30, 1998 and 1997, respectively.
Earnings were insufficient to meet fixed charges excluding preferred stock dividends by approximately $36.1 million and $12.8 million for the years ended September 30, 2001 and 2000, respectively. The consolidated ratio of earnings to fixed charges excluding preferred dividends was 1.12, 1.75 and 1.77 for the years ended September 30, 1999, 1998 and 1997, respectively. The ratio of earnings to fixed charges excluding preferred stock dividends for Metropolitan, assuming no benefit from the earnings of its subsidiaries with the exception of direct dividend payments was insufficient by approximately $46.4 million for the year ended September 30, 2000. The ratio of earnings to fixed charges excluding preferred stock dividends for Metropolitan, assuming no benefit from the earnings of its subsidiaries with the exception of direct dividend payments was 1.13, 1.40 and 1.36 for the years ended September 30, 1999, 1998 and 1997, respectively.
(2) Earnings per common share, basic and diluted, are computed by deducting preferred stock dividends from net income and dividing the result by the weighted average number of shares of common stock outstanding. There were no common stock equivalents or potentially dilutive securities outstanding during any year presented.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following should be read in conjunction with the attached audited consolidated financial statements and the notes attached thereto for the three years ended September 30, 2001.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE THREE FISCAL YEARS ENDED SEPTEMBER 30, 2001
The Consolidated Group's net loss was approximately $8.9 million and $7.6 million for the fiscal year ended September 30, 2001 and 2000 as compared to net income of $16.3 million for the comparable period ended September 30, 1999. The increased loss during the fiscal year ended September 30, 2001 was primarily due to a reduction in gains on sales of Receivables and real estate, and a reduction in net interest income. These reductions in revenues were partially offset by a reduction in loss provisions and increase in income tax provisions. The increased loss in 2000 was primarily due to a reduction in income tax benefits, a writedown of securitization residual values, an increase in loss provisions and valuation adjustments and an increase in other operating expenses including salaries and commissions. The net loss in 2001 and 2000 and the net income in 1999 were insufficient by approximately $40.3 million, $17.4 million and $0.8 million, respectively, to cover fixed charges including preferred stock dividend requirements. Net income in 1998 and 1997 was sufficient to cover fixed charges including preferred stock dividend requirements. See "SELECTED CONSOLIDATED FINANCIAL DATA" under Item 6.
INTEREST SENSITIVE INCOME AND EXPENSE
Interest income and expense are primary revenue and expenses for the Consolidated Group. Net interest sensitive income was $20.9 million, $24.6 million and $27.8 million for the fiscal years ended September 30, 2001, 2000 and 1999 respectively. The net interest spread has decreased over the last three years as the Consolidated Group has reduced the real estate contract and mortgage loan portfolio through securitization and whole loan sales from $539.9 million at September 30, 1999 to $426.4 million at September 30, 2001. During the same period, the Consolidated Group's investment portfolio has increased from $267.7 million at September 30, 1999 to $360.6 million at September 30, 2001. Historically, the yields on the investment portfolio have been lower than yields realized on the real estate contract and mortgage loan portfolio.
Management monitors interest sensitive income and expense as it manages the objectives for the Consolidated Group's results of operations. Interest sensitive income consists of interest on Receivables, earned discount on Receivables, insurance revenues and other investment interest. Interest sensitive expense consists of interest expense on borrowed money and insurance policy and annuity benefits. Insurance policy and annuity benefits primarily consist of interest that is credited on outstanding policies at the rates of return specified therein. Upon the issuance of an annuity or an insurance policy these rates of return are guaranteed for a limited number of years. Thereafter, subject to any guaranteed rate of return specified in the insurance policy or annuity, these rates of return are subject to the discretion of Metropolitan. Additionally, insurance and annuity policy benefits also include payments of death claims on mortality contracts. These mortality contracts account for approximately 2% of Western United's direct premiums with a portion of the life risk offset by certain reinsurance treaties. For additional information on the average credited interest rates and reinsurance treaties see "LIFE INSURANCE AND ANNUITY OPERATIONS" under item 1.
The Consolidated Group is in a "liability sensitive" position in that its interest sensitive liabilities reprice or mature more quickly than do its interest sensitive assets. Consequently, in a rising interest rate environment, the net return from interest sensitive assets and liabilities will tend to decrease. Conversely, in a falling interest rate environment, the net return from interest sensitive assets and liabilities will tend to improve. 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 income and NPV of its financial assets and liabilities 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 redemptions of debentures, and should not be relied upon as indicative of actual future results.
The following table presents, as of September 30, 2001, the Consolidated Group's estimate of the change in the NPV of the financial assets and liabilities of the Consolidated Group if interest rate levels generally were to increase or decrease by 1% and 2%, respectively. The loan prepayment assumptions used in computing the fair value did not change with the change in interest rates. 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 debentures, 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 assume 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 following table presents the average yields realized by the Consolidated Group on interest sensitive assets and liabilities during the three year periods ending September 30, 2001, 2000 and 1999:
REDUCTION IN VALUE OF MORTGAGE SERVICING RIGHTS
During the fiscal year ended September 30, 2000, the prepayment and default rates increased over historical rates which had previously been used to estimate the fair value of mortgage servicing rights. Therefore, the Consolidated Group reduced the carrying value of its servicing rights created by past securitizations. The value of mortgage servicing rights are dependent upon the timing and amount of cash flows from the payments on the related securitized assets. By adjusting the Consolidated Group's prior assumption based on the recent historical performance and expectations of future performance of the loan pools, the Consolidated Group lowered the estimated fair values of the mortgage servicing rights by approximately $1.3 million through a charge to operations.
In April 2001, Metropolitan sold its mortgage servicing rights. The transfer of servicing on three securitization pools were still pending certificate holder approval as of September 30, 2001. Metropolitan received final certificate holder approval on two of the remaining securitization pools in November 2001. In the interim period, Metropolitan has entered into an agreement with the purchaser where the purchaser will act as a subservicer on the securitization pools pending final certificate holder approval. Accordingly, the related servicing rights have not been removed from the balance sheet. The proceeds that Metropolitan received on the sales pending certificate holder approval have been recorded as a servicing liability under accounts payable and accrued expenses in the balance sheet. Additionally, as part of the sale, the Company entered into an agreement with the purchaser whereby the prepayment penalties collected by the purchaser will continue to be paid to the Company. This retained cashflow has been reclassified to other assets on the balance sheet.
NET GAINS ON REAL ESTATE SALES
The Consolidated Group is in the real estate market due primarily to its repossession of properties following Receivable defaults. At September 30, 2001, approximately 76% of real estate owned by the Consolidated Group is located in the Pacific Northwest (Alaska, Washington, Oregon, Idaho, Montana), which has experienced a more stable economy than many areas of the nation in the past several years. Consequently, management believes that the sale of these assets will be largely dependent on the attractiveness of the Pacific Northwest marketplace. Of the property owned in the Pacific Northwest, approximately $17.7 million is invested in commercial developments with approximately $44.4 million invested in undeveloped or partially developed commercial land. The net gains on sale of real estate recorded during 2001, 2000 and 1999 were approximately $0.3 million, $4.1 million and $2.8 million, respectively.
The Consolidated Group is also engaged in the development of various properties acquired in the course of its business through repossession or as investment property. The development or improvement of properties is undertaken for the purpose of enhancing values to increase salability and to maximize profit potential. Gains on the sale of development properties were approximately $0.3 million on sales of approximately $1.3 million during the fiscal year ended September 30, 2001, compared to gains of $3.1 million on sales of $14.3 million during the fiscal year ended September 30, 2000 and gains of $0.9 million on sales of $16.1 million during the fiscal year ended September 30, 1999. For additional information see "REAL ESTATE DEVELOPMENT" under Item 1.
PROVISION FOR LOSSES ON REAL ESTATE CONTRACTS AND MORTGAGE NOTES RECEIVABLE
The following table summarizes changes in the Consolidated Group's allowance for losses on real estate contracts and mortgage notes receivable:
These allowances are in addition to unamortized acquisition discounts of approximately $15.4 million at September 30, 2001, $13.9 million at September 30, 2000 and $13.4 million at September 30, 1999.
The Consolidated Group uses historical repossession and loss severity rates to determine an adequate allowance for probable losses. During the fiscal year ended September 30, 1999, the Consolidated Group's expected future loss rates inherent in the portfolio as of the balance sheet dates were based on the historical performance of the Company's Receivable portfolio, which were primarily seller-financed Receivables. The Consolidated Group used the seller-financed based assumptions because they anticipated that the sub-prime loans that were also being originated would perform the same as the seller-financed loans. When the Consolidated Group determined that the expected performance of the sub-prime loans differed from the assumptions, and such actual performance is not generally known until 12-24 months after origination, it revised the expected future loss rate accordingly. Additionally, not all pools will experience the same rate of loss over their respective remaining lives. Pools that have seasoned beyond the four year mark generally experience lower future losses than pools that are less seasoned. During the fiscal year ended September 30, 2000, the Consolidated Group identified actual delinquency and foreclosure experience by individual pool years and type of loan origination. Identifying actual delinquency, foreclosure experience and seasoning by individual pool years has allowed Metropolitan to further refine its methodology for determining an adequate allowance for probable losses. See "NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Note 3" under Item 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements and related financial information required to be filed are attached to 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
Information called for by Item 304(a) of regulation S-K was previously reported by Metropolitan in its current report on Form 8-K dated June 12, 2001.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
MANAGEMENT
DIRECTORS, EXECUTIVE OFFICERS AND CERTAIN EMPLOYEES (AGE INFORMATION CURRENT AS OF SEPTEMBER 30, 2001)
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.
C. Paul Sandifur, Jr., President, CEO and Chairman of the Board. Mr. Sandifur became Executive Vice President in 1980, was elected President in 1981, succeeded his father as Chief Executive Officer in 1991 and became Chairman of the Board in 1995. He has been a Director since 1975. Mr. Sandifur was a real estate salesman with Diversified Properties in Kennewick, Washington during 1977 and 1978 and then with Century 21 Real Estate in Kennewick. In June 1979, he became an associate broker with Red Carpet Realty in
Kennewick before rejoining Metropolitan in 1980. He is a Director and Officer of most of the subsidiary companies. He is the sole shareholder of National Summit Corp., which in turn is the sole shareholder of former subsidiaries of Metropolitan, Summit and Old Standard. Mr. Sandifur was born in Spokane, Washington, and received his baccalaureate degree in Psychology from Whitman College in Walla Walla, Washington. He pursued graduate studies at the University of California, Berkeley, San Jose State University and San Francisco State University.
Sterling Gallagher, Chief Financial Officer. Mr. Gallagher joined Metropolitan in August of 2001 as Chief Financial Officer. From 1990 until joining Metropolitan in 2001, Mr. Gallagher had his own consulting firm, Sterling, Limited, where he served as financial advisor to municipalities for energy projects and educational institutions. During this period he began working with Plasma, Inc., a developer of technology based on the Department of Energy's Clean Coal program, as their Chief Financial Officer. From 1979 to 1990 he was Vice President and Regional Manager for Nuveen and Co., where Nuveen was positioned as either the lead underwriter or financial advisor for $3.5 billion of Alaska bonds providing financing for various hydroelectric projects for various utilities. From 1974 to 1979, Mr. Gallagher was appointed by Governor Jay Hammond to the Commission of Revenue, as a member of the Governor's cabinet, where he was responsible for tax, treasury, and debt management functions for the State of Alaska. During his four year term as Commissioner of Revenue, he served as Vice Chairman of the Multi-state Tax Commission, developed the Oil and Gas Tax structure for the state, handled all matters before Congress on Prudhoe Bay oil pricing, as well as all matters relating to the Alaska Gas Pipeline. Mr. Gallagher holds a Bachelor of Science in Finance from the University of Southern California.
B. Elaine Hoskin, Vice President. Ms. Hoskin joined Metropolitan in December 1999 as Chief Risk Management Officer. She was elected Assistant Vice President of Metropolitan in March of 2000 and Vice President February 2001. From 1993 until joining Metropolitan, she worked for GE Capital as its Vice President of Portfolio Management and Underwriting. Prior to working for GE, she held various positions with the Bank of America starting in 1978, including Vice President and Senior Credit Team Manager; First Vice President & Senior Regional Credit Officer; Vice President and Manager; Vice President, Corporate Banking; Assistant Vice President, Corporate Banking; and Account Officer, Corporate Banking. Ms. Hoskin holds a Bachelor of Arts in German and Psychology from Wellesley College and a Masters of Business Administration in Finance and Accounting from Stanford Graduate School of Business in 1978.
Reuel Swanson, Secretary and Director. Mr. Swanson has worked for Metropolitan since 1960 and has been a Director since 1969. From 1973 to 1993, Mr. Swanson was Metropolitan's Treasurer. In 1976, he was elected Corporate Secretary. He is also a Director and Secretary of most of the subsidiary companies. In 1962, he received a Masters of Accounts from Kinman Business University. Mr. Swanson also holds a Bachelor of Science in Business Administration and a Masters of Business Administration from City University.
John Van Engelen, President, Western United Life Assurance Company. Mr. Van Engelen joined Metropolitan's insurance subsidiary, Western United, in 1984 as its underwriting manager, and shortly thereafter he was appointed Vice President-Underwriting. From 1987 to 1994, he was Vice President-Sales and a Regional Sales Manager. During 1994, he was appointed President of Western United. Prior to joining Western United, Mr. Van Engelen had worked in the insurance industry and in corporate and public accounting. He holds the following certifications: CPA, CFP, CLU, CHFC, and FLMI. He is also a member of the American Institute of Certified Public Accountants, Society of Financial Service Professionals, National Association of Insurance and Financial Advisors, and a board member of the New Mexico Life and Health Guaranty Fund. Mr. Van Engelen holds a Bachelor of Business Administration in Accounting from Boise State University.
Gary Brajcich, Director. Mr. Brajcich was elected as a Director in 2000. Mr. Brajcich is an attorney admitted to practice law in the State of Washington. He is a member of Workland, Witherspoon, PLLC, where he has been practicing since 1992.
Harold Erfurth, Director. Mr. Erfurth, currently retired, was a stockbroker, and an independent contractor selling the securities issued and offered by Metropolitan, from 1972 to 1983. He served as a Director from 1979 to 1994, and was elected as a Director again in 1996.
Irv Marcus, Director. Mr. Marcus had been an Officer of Metropolitan from 1974 until his retirement in 1995. At retirement, he was Senior Vice President, a title which he had held since 1990, and during which time he supervised Metropolitan's Receivable investing operations. He had previously been a loan officer with Metropolitan and has over 25 years' experience in the consumer finance business. He continues as a Director following his retirement.
Samuel Smith, Ph.D., Director. Dr. Smith was elected as a Director in 2000. Dr. Smith served as President of Washington State University from 1985-2000 and is currently President Emeritus. Dr. Smith was Dean of the College of Agriculture at Penn State University prior to his association with Washington State University.
William D. Snider, Director. Mr. Snider was elected as Director for Metropolitan in June 2001. He held the position as Metropolitan's Chief Financial Officer from May 1999 until August 2001. He still maintains his status as Director. Mr. Snider was the Chairman of Snider Financial Partners from June of 1997 through December of 1998. From March 1992 until June of 1997, he was the Executive Vice President and Chief Financial Officer of Finance and Operations of CoBank in Denver, Colorado. Prior to that, Mr. Snider was Senior Vice President and Treasury Group Head for Continental Bank Corporation in Chicago, Illinois. Currently, Mr. Snider is President of Snider Financial Partners. Mr. Snider received his Bachelor of Science and his Masters of Business Administration from the University of Illinois.
John Trimble, Director. Mr. Trimble had been employed by Metropolitan from 1980 until his retirement in 1995. His principal area of responsibility was Receivables underwriting. At retirement he was Vice President. He became a Director in February 1996.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
EXECUTIVE COMPENSATION
The following table sets forth the aggregate compensation awarded to, earned by, or paid to (1) Metropolitan's Chief Executive Officer, and (2) Metropolitan's other four most highly compensated executive officers during 2001 whose total annual compensation exceeded $100,000 in 2001 (the "Named Executive Officers"), all during the fiscal years specified. In addition, the following table sets forth the aggregate compensation for two individuals who would have been Named Executive Officers but for the fact that the individuals were not serving as executive officers of Metropolitan at the end of fiscal 2001. No executive officer is a party to, or a participant in, any pension plan, contract or other arrangement providing for cash or non-cash forms of remuneration except Metropolitan's 401(k) qualified retirement plan adopted as of January 1, 1992, which is available generally to all employees of Metropolitan, except as described below. See "EMPLOYMENT CONTRACTS AND TERMINATION OF EMPLOYMENT AND CHANGE IN CONTROL ARRANGEMENTS." The 401(k) Plan provides for maximum annual company matching contributions equal to 3% of each participant's salary. As of September 30, 2001, Metropolitan had no stock option plans in effect.
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(1) Mr. Snider resigned from Metropolitan in February of 2001 and is now a member of Metropolitan's Board of Directors.
(2) Represents amounts paid to Mr. Snider in connection with termination of his employment agreement in February of 2001.
(3) Ms. Yoshioka resigned from Metropolitan in February of 2001.
The foregoing compensation table does not include certain fringe benefits made available on a nondiscriminatory basis to all Metropolitan employees like group health insurance, dental insurance, long-term disability insurance, vacation and sick-leave. In addition, Metropolitan makes available certain non- monetary benefits to certain of its executive officers, with the aggregate value of these benefits in the case of each executive officer listed in the above table being less than the lesser of (1) ten percent of the cash compensation paid to each such executive officer, or (2) $50,000, and is not included in the above table.
COMPENSATION OF DIRECTORS
All directors (including honorary Directors) of Metropolitan are paid $500 per meeting. There were six such meetings during fiscal 2001. In addition, non-employee directors are reimbursed for travel expenses.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Metropolitan does not have a formal compensation committee of the Board of Directors. Executive Officer compensation is determined by C. Paul Sandifur, Jr. and/or the Human Resources Manager. Mr. Sandifur is the sole shareholder of National Summit Corporation, which in turn owns Summit, Old Standard and Old West. Mr. Sandifur determines the compensation of the executive officers of Summit, but is not an officer or director of Summit. The Consolidated Group engages in various transactions with these companies. See "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS" under Item 13.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
SHARE OWNERSHIP INFORMATION
The following table sets forth information as to each class of equity securities of Metropolitan beneficially owned by (1) each director of Metropolitan, (2) Metropolitan's Chief Executive Officer and the Named Executive Officers, (3) all directors and executive officers of Metropolitan as a group, and (4) all persons known to Metropolitan to be the beneficial owner of 5% or more of the outstanding shares of voting securities of Metropolitan as of December 15, 2001. The officers and directors of Metropolitan not listed on the table do not own any equity securities of Metropolitan.
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* Less than 1%.
(1) C. Paul Sandifur, Jr. is trustee of the C. Paul Sandifur and J. Evelyn Sandifur irrevocable trust and has sole voting and sole investment control over the shares of stock held by the trust. The trust beneficiaries are C. Paul Sandifur, Jr., Sara E. Quinn and William F. Sandifur. Mr. Sandifur also directly owns 347 shares of preferred stock and 35.6925 shares of common stock.
(2) Summit Securities, Inc. is a wholly owned subsidiary of National Summit Corp., a Delaware corporation, which is majority owned by C. Paul Sandifur, Jr. As a result, Mr. Sandifur effectively has sole voting and investment control over the shares owned by Summit, and may be deemed the beneficial owner of the shares under the rules of the SEC.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
TRANSACTIONS WITH AND BETWEEN METROPOLITAN AND SUBSIDIARIES
In the normal course of business, Metropolitan and its subsidiaries engage in intercompany transactions. All subsidiaries are wholly owned by Metropolitan except Western United, in which Metropolitan owns approximately 36.7% directly and 61.1% indirectly. See "ORGANIZATIONAL CHART" under Item 1.
During the last year ended September 30, 2001, Western United purchased approximately $8.1 million of Receivables from Metropolitan at Metropolitan's cost while Metropolitan purchased approximately $13.2 million of Receivables from Western at Western's cost.
In addition, Metropolitan charges Western United for real estate contract acquisition and management services. These charges have no effect on the Consolidated Financial Statements, but create fee income for Metropolitan when presented alone.
Metwest provides Receivable servicing and collection for Metropolitan and Western United. See "RECEIVABLE INVESTMENTS--Servicing and Collection Procedures, and Delinquency Experience" under Item 1.
At September 30, 2001, Metropolitan had two notes payable to Western United totaling approximately $19.9 million that were secured by certain property held for development. Such loans within the Consolidated Group have no effect on the consolidated financial statements.
From time to time, since December of 1979, Metropolitan has made loans to Consumers Group Holding Co. for purposes of increasing the capital and surplus of Consumers and Western United. As of September 30, 2001, these loans outstanding totaled $3,710,000 and currently bear no interest. Additionally, at September 30, 2001, Metropolitan had $35.1 million invested in Western United preferred stock. These investments have no effect on the Consolidated Group's financial statements.
TRANSACTIONS WITH AFFILIATES
In the normal course of business, Metropolitan engages in transactions with companies which were former subsidiaries and which are currently affiliated through the common control of C. Paul Sandifur, Jr.
Metropolitan Investment Securities ("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. 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. During the fiscal year ended September 30, 2001, Metropolitan paid commissions to MIS in the amount of $3.0 million. See "NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Note 20" under Item 8.
Metropolitan provides management and Receivable acquisition services for a fee to Summit, Old Standard and Old West. During the fiscal year ended September 30, 2001, such fees were approximately $0.9 million. See "RECEIVABLE INVESTMENTS--Management and Receivable Acquisition Services" under Item 1.
Metwest provides Receivable collection services for a fee to Summit, Old Standard and Old West. Additionally, Metropolitan provides accounting, data processing, contract servicing and other administrative services to Summit, Old Standard and Old West. During the year ended September 30, 2001, the Company entered into an agreement with Summit, Old Standard and Old West to change the allocation of the service fee and administrative charges to a cost sharing arrangement from a fixed and calculated fee arrangement. Management believes that these charges are reasonable and result in the reimbursement to Metropolitan of all significant direct expenses incurred on behalf of its affiliates and its subsidiaries. During the fiscal year ended September 30, 2001, total fees charged to Summit, Old Standard and Old West for servicing, collection and
administrative services were approximately $5.8 million. See "NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Note 20" under Item 8.
In the ordinary course of business the Consolidated Group may purchase or sell Receivables from or to affiliated companies or borrow or lend money from or to affiliated companies. See "NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Note 20" under Item 8.
At September 30, 2001, Metropolitan had a note payable to Old Standard that was secured by certain property held for development in the amount of approximately $4.4 million.
At September 30, 2001, Metropolitan had a note receivable from Summit in the amount of approximately $10.9 million that was secured by a participation interest in certain structured settlements and lease Receivables, See "NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Note 20" under Item 8.
Management believes that the terms of the service agreements are at least as favorable as could have been obtained from non-affiliated parties.
Western United has entered into a reinsurance agreement with Old Standard, which became effective July 1, 1998 and remained in effect at September 30, 2001. Although Western United has the ability to use this agreement, the agreement has been inactive since October 31, 2000. Under this agreement, Western United reinsured with Old Standard 75% of the risk on certain annuity products. The reinsurance agreement is an ongoing arrangement with no stated expiration or termination date, although each may stop and restart at their discretion upon providing a 30-day advance written notice. Western United receives an annual fee of 40 basis points on the cash value of the reinsured policies from Old Standard for servicing the reinsured policies. See "NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Note 20" under Item 8.
Metropolitan's and Western United's property development activities are provided by Summit Property Development. The Consolidated Group paid Summit Property Development $1.1 million in development fees during the fiscal year ended September 30, 2001. See "REAL ESTATE DEVELOPMENT" under Item 1.
During the year ended September 30, 2000, Summit purchased an $18 million non-interest bearing contract receivable collateralized by timber rights in Hawaii from Metropolitan at an estimated fair value of approximately $13.1 million using a discount rate of 12%.
In February 2001, Metropolitan and William D. Snider, Metropolitan's former Chief Financial Officer, entered into an agreement where Metropolitan agreed to pay Mr. Snider $340,000 and certain COBRA benefit payments in connection with the termination of Mr. Snider's employment agreement with Metropolitan.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) The following documents are filed as part of this Report:
1. FINANCIAL STATEMENTS.
Included in Part II, Item 8 of this report:
2. FINANCIAL STATEMENT SCHEDULES.
Included in Part IV of this report:
Schedules Required by Article 7
Schedule I--Summary of Investments other than Investments in Related Parties Schedule III--Supplementary Insurance Information Schedule IV--Supplementary Reinsurance Information
Schedules Required by Article 5
Schedule II--Valuation and Qualifying Accounts and Reserves Schedule IV--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 financial statements or notes thereto.
3. EXHIBITS.
The following is a complete list of exhibits filed as part of this Form 10-K.
(B) REPORTS ON FORM 8-K.
Metropolitan did not file any reports on Form 8-K during the fourth quarter of 2001.
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.
METROPOLITAN MORTGAGE & SECURITIES CO., INC.
By /s/ C. PAUL SANDIFUR, JR. ------------------------------------ C. Paul Sandifur, Jr., Chief Executive Officer
Date: December 26, 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 and in the capacities and on the dates indicated.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2001, 2000, AND 1999
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
Board of Directors and Stockholders Metropolitan Mortgage and Securities Co, Inc.
We have audited the consolidated balance sheet of Metropolitan Mortgage and Securities Co, Inc. and subsidiaries as of September 30, 2001, and the related consolidated statements of operations, comprehensive income, stockholders' equity, and cash flows for the year then ended. Our audit also included the financial statement schedules as of September 30, 2001 and for the year then ended, listed in the Index at Item 14(a). These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Metropolitan Mortgage and Securities Co, Inc. and subsidiaries at September 30, 2001, and the consolidated results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedules referred to above, when considered in relation to the basic 2001 financial statements taken as a whole, present fairly in all material respects the information set forth therein.
/s/ Ernst & Young LLP
Seattle, Washington December 14, 2001
[PRICEWATERHOUSECOOPER LOGO]
REPORT OF INDEPENDENT ACCOUNTANTS
The Directors and Stockholders Metropolitan Mortgage & Securities Co., Inc.
In our opinion, the consolidated balance sheet as of September 30, 2000 and the related consolidated statements of operations, of comprehensive income, of stockholders' equity and of cash flows for each of the two years in the period ended September 30, 2000 (appearing on pages through of this Annual Report on Form 10-K of Metropolitan Mortgage & Securities Co., Inc. and its subsidiaries) present fairly, in all material respects, the financial position, results of operations and cash flows of Metropolitan Mortgage & Securities Co., Inc. and its subsidiaries at September 30, 2000 and for each of the two years in the period ended September 30, 2000, in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statements schedules, II, IV and V, listed in the index appearing under Item 14(a)(2) on pages S-2, S-5, S-6, S-7 and S-8, present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedules are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and financial statement schedules 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 our opinion. We have not audited the consolidated financial statements or financial statement schedules of Metropolitan Mortgage & Securities Co., Inc. and its subsidiaries for any period subsequent to September 30, 2000.
/s/ PricewaterhouseCoopers LLP PricewaterhouseCoopers LLP
Spokane, Washington December 28, 2000
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS SEPTEMBER 30, 2001 AND 2000
The accompanying notes are an integral part of the consolidated financial statements.
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED SEPTEMBER 30, 2001, 2000 AND 1999
The accompanying notes are an integral part of the consolidated financial statements.
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) FOR THE YEARS ENDED SEPTEMBER 30, 2001, 2000 AND 1999
The accompanying notes are an integral part of the consolidated financial statements.
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED SEPTEMBER 30, 2001, 2000 AND 1999
The accompanying notes are an integral part of the consolidated financial statements.
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED SEPTEMBER 30, 2001, 2000 AND 1999
See Note 18 for supplemental cash flow information. The accompanying notes are an integral part of the consolidated financial statements.
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED SEPTEMBER 30, 2001, 2000 AND 1999
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
BUSINESS AND ORGANIZATION
Metropolitan Mortgage & Securities Co., Inc. (the "Company" and "Metropolitan") was incorporated in the state of Washington in 1953.
Metropolitan engages, nationwide, in the business of acquiring, holding and selling receivables. These receivables include real estate contracts and mortgage notes collateralized by first position liens on real estate. Metropolitan also invests in receivables consisting of real estate contracts and mortgage notes collateralized by junior position liens, structured settlements, annuities, lottery prizes and other investments. The receivables collateralized by real estate are typically non-conventional because they are originated as the result of seller financing or they are originated by lenders who specialize in borrowers with impaired credit histories or non-conventional properties. Beginning in 2000, the Company began originating commercial loans collateralized by various types of commercial properties. In addition to receivables, the Company invests in U.S. Treasury obligations, mortgage- and asset-backed securities, corporate bonds, equity securities, venture capital and other securities.
The Company invests in receivables and securities using funds generated from the sale of annuities, debentures and preferred stock, the sale of receivables and real estate, secured borrowings, receivable cash flows and securities portfolio earnings.
The funds from the sale of annuities are generated by Western United Life Assurance Company ("Western"), a life insurance subsidiary substantially owned by Metropolitan Mortgage & Securities Co., Inc. Western is engaged in the offering, issuance and sale of annuity and life insurance policies. Western is licensed to sell insurance in fifteen states, but its business is primarily concentrated in the states of Idaho, Montana, Oregon, Texas, Utah and Washington.
Metropolitan provides receivable acquisition, management and collection services, for a fee, to its subsidiaries and affiliates (see Note 20).
Metropolitan owns various properties acquired through foreclosure and other sources. These properties are held for sale or development.
Metropolitan is effectively controlled by C. Paul Sandifur, Jr. through common stock ownership and voting control.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Metropolitan Mortgage & Securities Co., Inc. and its majority-owned subsidiaries. Metropolitan's significant subsidiaries include Western, Consumers Group Holding Co., Inc., a holding company and shareholder of Consumers Insurance Co., Inc., an inactive property and casualty insurer, and Metwest Mortgage Services, Inc., a mortgage loan originator and servicer. Minority interest represents minority stockholders' proportionate share of the equity in the Company's consolidated subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation.
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
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
balances often exceed the federal insurance limit. The Company periodically evaluates the credit quality of these banks and financial institutions.
INVESTMENTS
The Company classifies its investments in debt and equity securities as "trading," "available-for-sale," or "held-to-maturity". The accounting policies related to these investment classifications are as follows:
Trading Securities: Trading securities consist primarily of mortgage- and asset-backed securities and are recorded, at fair value based on quoted market value. Realized and unrealized gains and losses on these securities are included in the consolidated statements of operations.
Available-for-Sale Securities: Available-for-sale securities, consisting primarily of mortgage- and asset-backed securities, are carried at quoted and estimated market values. Other available-for-sale securities include government-backed bonds, corporate bonds, equity securities and venture capital investments. Unrealized gains and losses on available-for-sale securities are excluded from earnings and presented as accumulated other comprehensive income or loss, net of related deferred income taxes.
For other than a temporary decline in value below cost or amortized cost, the investment is reduced to its fair value, which becomes the new cost basis of the investment. The amount of the reduction is reported as a realized loss in the statements of operations. Any recovery of fair 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 that the Company evaluates in determining the existence of an other than temporary decline in value include the length of time and extent to which fair value has been less than cost; the financial condition and near-term prospects of the issuer; and the intent and ability of the Company to retain its investment for the anticipated period of recovery in fair value.
During the third quarter of 2000, the Emerging Issues Task Force released issue No. 99-20, Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets ("EITF 99-20"). This EITF changed the manner in which the Company determines whether a decline in fair value of certain investments is other than temporary. In accordance with this new methodology, if (1) the fair value of an investment is less than the amortized cost and (2) the present value of the estimated cash flows have decreased since the last estimate was made, then an other than temporary impairment is deemed to have occurred. The implementation of EITF 99-20 on April 1, 2001 did not have a material impact on the Company's financial statements. Financial statements for periods prior to the implementation of EITF 99-20 are not to be restated.
Equity securities include 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 approximately $2.7 million and $2.9 million at September 30, 2001 and 2000, respectively.
Held-to-Maturity Securities: Held-to-maturity securities 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 by estimating the remaining value of future cash flows using future expected loss rates and prepayment assumptions, discounted at a market yield.
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Realized gains and losses on investments are calculated on the specific-identification method and are recognized in the consolidated statements of operations in the period in which the investment is sold.
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 receivables. 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.
REAL ESTATE CONTRACTS AND MORTGAGE NOTES RECEIVABLE HELD FOR SALE
Real estate contracts and mortgage notes receivable held for sale are carried at the lower of cost (outstanding principal adjusted for net discounts and capitalized acquisition costs) or fair value, determined on an aggregate basis by major type of receivable. Gains or losses on such 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.
In September 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). The implementation of SFAS 140 on April 1, 2001 did not have a material impact on the Company's financial statements.
REAL ESTATE HELD FOR SALE AND DEVELOPMENT
Real estate held for sale and development is stated at the lower of cost or fair value less estimated costs to sell. The Company principally acquires real estate through acquisition and foreclosure. 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) carrying value (net unpaid receivable carrying value) at the date of foreclosure.
Project costs, including interest, associated with the development of real estate are capitalized and included in the cost basis of the real estate. During the years ended September 30, 2001, 2000, and 1999, the Company capitalized interest of approximately $1.6 million, $1.1 million and $0.9 million, respectively.
Occasionally, real estate properties are rented, with the revenue being included in other income and related costs being charged to expense.
Profit on sales of real estate is recognized when the buyers' initial and continuing investment is adequate to demonstrate (1) a commitment to fulfill the terms of the transaction, (2) that collectibility of the remaining sales price due is reasonably assured, and (3) the Company maintains no continuing involvement or obligation in relation to the property sold and has transferred all the risks and rewards of ownership to the buyer.
ALLOWANCE FOR LOSSES ON REAL ESTATE ASSETS
The Company establishes allowances for losses on real estate contracts and mortgage notes receivable, including accrued interest, inherent in the portfolio at the balance sheet date based on historical foreclosure and loss experience.
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The established allowance for losses on real estate held for sale and development includes 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. The carrying value of a repossessed property is determined as of the date of repossession of the property. It is based on the lower of fair value or carrying value at the time the property was repossessed. The fair value is based on an appraisal by a licensed independent appraiser at the time of repossession. 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.
OTHER RECEIVABLE INVESTMENTS
Other receivable investments (primarily lottery prizes, annuities and structured settlements) are carried at the lower of amortized cost or net realizable value. 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.
REINSURANCE RECEIVABLE
The Company's life insurance subsidiary has ceded a portion of certain life insurance annuity reserves and the related premiums to other companies, including Old Standard Life Insurance Company ("OSL"), an affiliate. Such reinsurance permits recovery of losses from reinsurers, although it does not discharge the primary liability of the Company as direct insurer of the risk reinsured. Accordingly, the Company has not removed the related assets and liabilities from the consolidated balance sheets.
DEFERRED COSTS
Deferred acquisition costs, consisting of commissions to agents and other insurance underwriting and annuity policy costs, are deferred. Cost for annuity contracts and life insurance policies are amortized over the lives of the contracts or policies in proportion to the present value of estimated future gross profits. To the extent actual experience differs from assumptions, and to the extent estimates of future gross profits require revision, the unamortized balance of deferred acquisition costs is adjusted accordingly; such adjustments would be included in current operations. During the year ended September 30, 2001, the Company revised its gross profit estimate, which resulted in approximately $4.3 million increase in deferred acquisition costs with a corresponding decrease in the amortization of deferred acquisition costs. There were no significant adjustments to the gross profit estimates in 2000 or 1999.
The amortization of deferred acquisition costs, which is based on the estimated gross profits of the underlying life and 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.
Debenture issuance costs, including commissions to sales representatives and other issuance costs, are deferred. Commission costs are amortized over the expected average term of the related debenture bond, which ranges from 6 months to 5 years, using the interest method. Other debenture issuance costs are amortized over an average four year average term of the related debenture bond using a straight-line method.
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
LAND, BUILDINGS AND EQUIPMENT
Land, buildings and equipment are stated at cost. Buildings, improvements, furniture and equipment are depreciated using both straight-line and accelerated methods over their estimated useful lives which, for buildings and improvements, range from 5 to 40 years, and for furniture and equipment, range from 3 to 10 years. Repairs, maintenance and minor renewals are expensed as incurred. Upon sale or retirement, the costs and related accumulated depreciation are eliminated from the accounts and any resulting gain or loss is reflected in operations. Depreciation expense for the fiscal years ended September 30, 2001, 2000 and 1999 was approximately $4.1 million, $4.0 million and $4.3 million, respectively.
COMPUTER SOFTWARE COSTS
The Company capitalizes direct costs of enhancements to computer software operating systems acquired and modified for internal use to the extent that the functionality of the software is improved. Total capitalized enhancement costs net of related amortization were approximately $1.9 million and $3.0 million at September 30, 2001 and 2000, respectively. These costs are being amortized over 3- and 10-year periods, depending on the estimated useful life of the enhancement, using the straight-line method. Due to technological advancements, it is reasonably possible that the remaining estimated useful lives could change in the near term.
MORTGAGE SERVICING RIGHTS
At the closing of each securitization, the Company measures the servicing asset retained at the allocated previous carrying amount based on relative fair values. Subsequent valuations of the servicing rights are performed to determine if there has been any impairment to the asset. The amount of any impairment recognized is the amount by which the carrying amount of the servicing rights exceed their fair value. The Company calculates the fair value of the servicing rights by discounting the expected net cash flow from its servicing activity. The net cash flow is measured as the amount by which the expected revenues from contractually specified servicing fees, late charges, and other ancillary sources, including "float", exceeds the estimated cost of servicing the assets. When determining the expected cash flow, the Company estimates (i) the future rates of prepayments (ii) ancillary income and (iii) net cost of servicing. In April 2001, the Company sold its mortgage servicing rights. The transfer of servicing on three securitization pools were still pending certificate holder approval as of September 30, 2001. Accordingly, the related servicing rights have not been removed from the balance sheet.
POLICY LOANS
Policy loans are carried at the unpaid principal balance of the loans, and represent borrowings against the cash surrender value of in-force life insurance policies and annuity contracts. Policy loans bear interest at rates ranging from 6.00% to 8.00%. Life insurance policy loans may remain outstanding until the policy is surrendered. Annuity policy loans are generally due over terms ranging from five to fifteen years.
LIFE INSURANCE AND ANNUITY RESERVES
Premiums for universal life insurance contracts and annuities are reported as life insurance and annuity reserves under the deposit method. Reserves for universal life insurance and 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 of changes in the factors considered in the
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
actuarial calculations, it is reasonably possible that the reserves for insurance and annuities could change in the near term.
RECOGNITION OF INSURANCE PREMIUMS
Revenues for universal life contracts are recognized upon assessment. These revenues consist of charges to policyholders, primarily for mortality expenses and surrender charges. Revenues related to annuity contracts are recognized over the estimated policy term. 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 subsidiary is subject to insurance guaranty laws in the states in which it writes 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, 2001, the Company had accrued an estimated liability of approximately $2.1 million 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 assessment of known insolvencies, the guaranty fund liability could change in the near term.
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 liabilities using enacted tax rates in effect in the years in which the temporary differences are expected to reverse.
The Company is included in a consolidated federal income tax return with certain of its affiliates. The consolidating companies have executed a tax allocation agreement. Under the agreement, the Companies' income tax provisions are computed on a separate return basis and consolidated affiliates receive a reimbursement to the extent that their losses and other credits result in a reduction of the consolidated tax liability.
HEDGING ACTIVITIES
The Company is authorized by its Board of Directors to use financial futures instruments for the purpose of hedging interest rate risk relative to the securities portfolio, potential trading situations and in anticipation of sales and securitizations of real estate contracts and other receivable investments. Futures transactions are intended to reduce the risk associated with price movements for a balance sheet asset. Securities may be sold "short" (the sale of securities that 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. At September 30, 2000, the Company had open hedge positions on 275 futures contracts on U.S. Treasury notes with a notional value of approximately $55 million, resulting in deferred losses of approximately $0.2 million, which were used to hedge interest rate risk on real estate contracts and mortgage notes receivable that were held for sale. These hedges were closed in October 2000.
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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. As part of implementing SFAS No. 133, as amended, on October 1, 2000, the Company reclassified approximately $59.4 million of investments, with a fair value of $59.0 million, from held-to-maturity to available-for-sale.
INTEREST RATE RISK
The Company is subject to interest rate risk because most of its assets and liabilities are financial in nature. During the year ending September 30, 2002, approximately $28.6 million more of the Company's financial liabilities (primarily debentures and annuities) are expected to reprice than the Company's financial assets (primarily cash and cash equivalents, Receivables and fixed income investments). In an declining interest rate environment, this factor will tend to increase earnings as liabilities will generally be repriced at lower rates of interest while financial assets maintain their existing rates of interest. Conversely, in a rising interest rate environment, this factor will tend to decrease earnings.
Of the life insurance and annuity contracts scheduled to reprice or mature, approximately 31% are subject to surrender charges. These contracts have surrender charges that apply for as long as nine years, but with decreasing amounts during such term. At the option of the Consolidated Group, these contracts are subject to annual repricing. In periods of declining interest rates, this feature is beneficial as it allows the Company to reprice its liabilities at lower market rates of interest. Depending on the remaining surrender charges, the Company has 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 Company may respond more slowly to increases in market interest rate levels thereby diminishing the impact of the current mismatch in the interest sensitivity ratio.
The Company utilizes static gap analysis at the end of each quarter to measure the amount of interest rate risk embedded in the balance sheet as of a point in time. It does this by comparing the differences in the repricing characteristics of interest-earning assets and interest-bearing liabilities. A gap is defined as the difference between the principal amount of interest-earning assets and interest-bearing liabilities that reprice within a specified time period. This gap provides a general indication of the sensitivity of the Company's net interest income to interest rate changes. Consequently, if more assets than liabilities reprice or mature in a given period, resulting in an asset sensitive position or positive gap, increases in market interest rates will generally benefit net interest income because earning asset rates will reflect the changes more quickly. Alternatively, where interest-bearing liabilities reprice more quickly than interest-earning assets, resulting in a liability sensitive position or negative gap, increases in market interest rates will generally have an adverse impact on net interest income.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
ESTIMATES
The preparation of financial statements in conformity with accounting principles generally accepted in the United States 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 2000 and 1999 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.
The 2000 and 1999 Consolidated Statements of Cash Flows have been reclassified to eliminate the non-cash effect of the receipt of certificates from previous securitizations. These non-cash transactions, which had previously been presented as cash transactions, have been reclassified to the Supplemental Disclosures for Statements of Cash Flows -- Note 18.
Additionally, the 2000 and 1999 Parent Only Statement of Cash Flows have been reclassified to (1) eliminate the non-cash effect of the receipt of certificates from previous securitizations and (2) present equity in undistributed income of subsidiaries as cash flow from operating activities rather than cash flow from investing activities. The non-cash proceeds from securitization transactions, which had previously been presented as cash transactions, have been reclassified to the supplemental non-cash activities included in Parent Only Financial Statements -- Note 23.
OTHER 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. The implementation of SAB 101 on July 1, 2001 did not have a material impact on the consolidated financial statements.
In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No. 141, Business Combinations. The statement discontinues the use of the pooling of interests method of accounting for business combinations. The statement is effective for all business combinations after June 30, 2001. The Company has completed an evaluation of the effects of this statement and does not believe it will have a material impact on the Company's consolidated financial statements.
In July 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible Assets. The statement will require discontinuing the amortization of goodwill and other intangible assets with indefinite useful lives. Instead, these assets will be tested periodically for impairment and written down to their fair market values as necessary. This statement is effective for fiscal years beginning after December 15, 2001. The Company is currently evaluating the impact of this statement on the Company's consolidated financial statements.
In October 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which is effective for fiscal years beginning after December 15, 2001. SFAS No. 144 addresses accounting and reporting of ling-lived assets, except goodwill, that are either held and used or disposed of through sale or other means. The Company is currently evaluating the impact of this statement on the Company's consolidated financial statements.
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2. INVESTMENTS:
A summary of cost and estimated fair values of investments at September 30, 2001 and 2000 is as follows:
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2. INVESTMENTS (CONTINUED)
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 $3.2 million at September 30, 2001 and 2000.
Proceeds from sales of available-for-sale securities during the years ended September 30, 2001, 2000 and 1999 were approximately $181.3 million, $18.3 million and $11.3 million, respectively, which resulted in gross realized gains of approximately $6.4 million, $1.4 million and $75,000 and gross realized losses of approximately $4.0 million, $0.2 million and $0 during each respective year.
The net change in unrealized gains (losses) on trading securities, recorded in the statements of operations were approximately $0.8 million, $0.3 million and $($7.4) million during the years ended September 30, 2001, 2000 and 1999, respectively.
During the years ended September 30, 2001 and 2000, the Company determined that certain "available-for-sale" securities, including residual interests from securitization transactions, had other than temporary impairments in value. Accordingly, the carrying values of the securities were decreased by approximately $8.7 million and $7.5 million through a charge to operations.
The Company did not have any other than temporary adjustments during the year ended September 30, 1999.
The carrying values of the following individual investments (excluding U.S. government bonds) held by the Company at September 30, 2001 and 2000, were in excess of ten percent of stockholders' equity.
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2. INVESTMENTS (CONTINUED)
The amortized cost and estimated fair values of available-for-sale securities with fixed maturities at September 30, 2001, 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.
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2. INVESTMENTS (CONTINUED)
RESIDUALS
The activity related to certain mortgage-backed securities, which represent the Company's residual interests from securitization transactions, for the years ended September 30, 2001, 2000 and 1999 are as follows:
During the year ended September 30, 1999, the Company participated in a resecuritization of certain of its residual interests. The carrying value of the residual interests that were contributed by the Company was approximately $17.8 million. The residual interests were restructured and a class was created, which was assigned a credit rating.
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.
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. During the year ended September 30, 2001 and 2000, the Company determined that certain "available-for-sale" residuals had other than temporary declines in value. Accordingly, the carrying value of the securities were decreased by approximately $4.1 million and $7.5 million, respectively, representing the amount permanently impaired. These amounts have been recorded in the statements of operations as gains (losses) on investments, net. The Company will continue to periodically assess the assumptions used in valuing the cash flows and the related carrying value of its residuals and subordinated securities.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2. INVESTMENTS (CONTINUED)
At September 30, 2001, key economic assumptions and the sensitivity of the current fair value of residual cash flows to immediate 10 percent and 20 percent adverse changes in those assumptions are as follows ($ in millions):
These sensitivities are hypothetical and should be used with caution. As the figures indicate, changes in fair value based on a 10 percent variation in assumptions generally cannot be extrapolated because of the relationship of the change in assumption to the change in fair value may not be linear. Also, in this table, the effect of a variation in a particular assumption on the fair value of the residual is calculated without changing any other assumptions; in reality, changes in one factor may result in changes in another (for example, increases in market interest rates may result in lower prepayments and higher foreclosure rates), which might magnify or counteract the sensitivities.
Static pool losses are calculated by summing the actual and projected future credit losses and dividing them by the original balance of each pool of assets. The following table summarizes the actual and projected future losses as of September 30, 2001 for securitizations by year.
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. REAL ESTATE CONTRACTS AND MORTGAGE NOTES RECEIVABLE:
The following is a reconciliation of the face value of real estate contracts and mortgage notes receivable (including those held for resale) to the Company's carrying value at September 30, 2001 and 2000.
At September 30, 2001, the Company held first position liens associated with real estate contracts and mortgage notes receivable with a face value of approximately $439.8 million (99% of its total portfolio) and junior position liens of approximately $5.7 million (1% of its total portfolio).
Real estate contracts and mortgage notes receivable include mortgages collateralized by property located throughout the United States. The Company's real estate contracts and mortgage notes receivable at September 30, 2001 and 2000 are collateralized by property concentrated in the following geographic areas:
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. REAL ESTATE CONTRACTS AND MORTGAGE NOTES RECEIVABLE (CONTINUED)
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 real estate contracts and mortgage notes receivable 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, 2001 and 2000 are as follows:
Less than 2% of the receivables are subject to variable interest rates. The principal amount of delinquent receivables are receivables with required principal or interest payments being in arrears for more than three months.
Whole loans sales of receivables with net carrying values of approximately $42.0 million, $29.0 million and $55.7 million were sold without recourse to various financial institutions resulting in a loss of approximately $0.7 million during the year ended September 30, 2000 and gains of approximately $0.4 million and $60,000 during the years ended September 30, 2001 and 1999, respectively.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. REAL ESTATE CONTRACTS AND MORTGAGE NOTES RECEIVABLE (CONTINUED)
Aggregate amounts of contractual maturities of receivables at their face value are as follows:
Maturity dates range from 2001 to 2031. Actual maturities of receivables will likely differ from contractual maturities due to prepayments and defaults.
The carrying values of receivables that were in excess of ten percent of stockholders' equity as of September 30, 2001 are as follows:
As of September 30, 2000 there were no receivables in excess of 10 percent of stockholders' equity.
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. REAL ESTATE CONTRACTS AND MORTGAGE NOTES RECEIVABLE (CONTINUED)
The following is a summary of the changes in the allowance for losses on real estate contracts and mortgage notes receivable for the years ended September 30, 2001, 2000 and 1999.
The Company establishes allowances for losses on real estate contracts and mortgage notes receivable, including accrued interest, inherent in the portfolio at the balance sheet date based on historical foreclosure and loss experience. 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.
4. REAL ESTATE CONTRACTS AND MORTGAGE NOTES RECEIVABLE, HELD FOR SALE:
The Company acquires certain real estate contracts and mortgage notes receivable which may ultimately be sold or securitized.
The Company entered into securitization transactions during the fiscal years ended September 30, 2000 and 1999 and completed a securitization prefunding during the fiscal year ended September 30, 2001. The Company participated in these securitization transactions with its subsidiaries and affiliates. These receivables were structured in classes by credit rating and transferred to a trust, which sold mortgage-backed securities to third parties. These securitizations were recorded as sales of receivables and gains, net of transaction expenses, and were recognized in the consolidated statements of operations as each class is sold.
During the years ended September 30, 2001, 2000 and 1999, proceeds from securitization transactions were approximately $70.6 million, $592.3 million and $530.0 million, respectively, and resulted in gains of approximately $2.8 million, $14.6 million and $21.5 million, respectively. The gains realized during the years ended September 30, 2001, 2000 and 1999 included approximately $1.0 million, $8.7 million and $6.6 million, respectively, associated with the estimated fair value of the mortgage servicing rights retained on the pool.
Of the receivables securitized, the Company has retained an investment in certain subordinate classes of the securities having an estimated fair value of approximately $97.1 million and $105.6 million at September 30, 2001 and 2000, respectively.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
5. REAL ESTATE HELD FOR SALE AND DEVELOPMENT:
A detail of the Company's real estate held for sale and development by region as of September 30, 2001 is as follows:
At September 30, 2001, the Company had approximately $67.5 million invested in real estate development projects and approximately $0.8 million in commitments for construction associated with these projects.
The following is a summary of the changes in the allowance for losses on real estate held for sale for the years ended September 30, 2001, 2000 and 1999.
Loss provisions for real estate held for sale are calculated as the difference between the estimated fair value at the measurement date and the estimated net realizable value at the foreclosure date. At foreclosure, the carrying value of the real estate held for sale is adjusted to the lower of cost or net realizable value. Any subsequent reduction in the estimated net realizable value is charged to operations through provision for losses. The Company periodically evaluates its reserves to determine their adequacy.
6. 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 respective 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 yield on these receivables at
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
6. OTHER RECEIVABLE INVESTMENTS (CONTINUED)
September 30, 2001 and 2000 was approximately 9.5% and 9.4%, respectively. Maturity dates range from 2001 to 2029.
The following is a reconciliation of the face value of the other receivable investments to the Company's carrying value at September 30, 2001 and 2000.
The carrying value of other receivable investments that were more than 90 days delinquent as of September 30, 2001 and September 30, 2000 was $6.8 million and $5.0 million respectively.
During the years ended September 30, 2001, 2000 and 1999, the Company sold or securitized approximately $4.1 million, $44.3 million and $47.1 million, respectively, of these receivables without recourse and recognized gains of approximately $0.3 million, $2.2 million and $3.0, respectively.
The following other receivable investments, by issuer, were in excess of ten percent of stockholders' equity at September 30, 2001 and 2000.
Aggregate amounts of contractual maturities of other receivable investments to be received at their face values are approximately as follows:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
6. OTHER RECEIVABLE INVESTMENTS (CONTINUED)
The following is an analysis of the allowance for losses on other receivable investments for the year ended September 30, 2001 and 2000.
During the year ended September 30, 2000, a loss allowance for other receivable investments was established as the Company began to originate finance leases. Additionally, 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.
7. DEFERRED COSTS:
An analysis of deferred costs related to policy acquisition and debenture issuance for the years ended September 30, 2001, 2000 and 1999 is as follows:
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
8. LAND, BUILDINGS AND EQUIPMENT:
Land, buildings, equipment and related accumulated depreciation at September 30, 2001 and 2000 consisted of the following:
9. MORTGAGE SERVICING RIGHTS:
The following is an analysis of the mortgage servicing rights activity for the years ended September 30, 2001, 2000 and 1999:
The servicing of securitized pools of receivables are subject to "Pooling and Servicing Agreements." In accordance with the terms of the various agreements, the Company collects payments from the individual borrowers and remits such payments to the trustee of the pool. The Company is obligated to make cash advances with respect to delinquent principal and interest payments on any receivable to the extent that the Company determines the advances to be recoverable. Subject to certain conditions, the Company has the option to purchase from the mortgage pool any receivable which is 90 days or more delinquent or to sell any receivable in a commercially reasonable manner if such a sale would produce a greater recovery than the liquidation of the mortgaged property.
As compensation for its services, the Company is entitled to retain, from amounts collected on the receivables, service fees that range from .50% to .75% per annum of the scheduled principal balance of the receivable pool as of the first day of the month. The agreements also entitle the Company to receive all late payment fees, prepayment penalties, assumption fees and other similar charges and all investment income earned on amounts collected prior to their remittance to the trustee or other third party.
During the year ended September 30, 2000, the Company recorded a $1.3 million charge to operations to reflect a reduction in the fair value of mortgage servicing rights.
In April 2001, the Company sold its mortgage servicing rights. The transfer of servicing on three securitization pools were still pending certificate holder approval as of September 30, 2001. The Company received final certificate holder approval on two of the remaining securitization pools in November 2001. In
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
9. MORTGAGE SERVICING RIGHTS (CONTINUED)
the interim period, the Company has entered into an agreement with the purchaser where the purchaser will act as a subservicer on the securitization pools pending final certificate holder approval. Accordingly, the related servicing rights have not been removed from the balance sheet. The proceeds that the Company received on the sales pending certificate holder approval have been recorded as a servicing liability under accounts payable and accrued expenses in the balance sheet. Additionally, as part of the sale, the Company entered into an agreement with the purchaser whereby the prepayment penalties collected by the purchaser will continue to be paid to the Company. This retained cashflow has been reclassified to other assets on the balance sheet.
10. LIFE INSURANCE AND ANNUITY RESERVES:
Life insurance and annuity reserves are based upon contractual amounts due to the policyholder, including credited interest. Annuity contract interest rates ranged from 3.75% to 9.95%, 4.65% to 10.25% and 4.45% to 9.85% during the years ended September 30, 2001, 2000 and 1999, respectively. Interest assumptions used to compute life insurance reserves ranged from 4.5% to 6.5% during each of the years ended September 30, 2001, 2000 and 1999.
The Company's life insurance subsidiary has ceded a portion of certain life insurance risks, annuity reserves and the related premiums to other companies, including OSL, an affiliate. Such reinsurance permits recovery of losses from reinsurers although it does not discharge the primary liability of the Company as direct insurer of the risk reinsured.
The following is a summary of reinsurance transactions ceded to OSL and other reinsurers as of and for the years ended September 30, 2001, 2000 and 1999:
The Company is contingently liable for claims on ceded life insurance business in the event the reinsuring companies do not meet their obligations under those reinsurance agreements. The Company evaluates the
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
10. LIFE INSURANCE AND ANNUITY RESERVES (CONTINUED)
financial condition of its reinsurers and monitors concentrations of credit risk to minimize its exposure to significant losses from reinsurer insolvencies.
11. DEBENTURE BONDS:
The Company has registered $100.0 million of Series III and Series III-A Debenture Bonds, of which a face amount of approximately $61.4 million was unissued at September 30, 2001. This current registration expires on April 30, 2002. Additionally, in December 1999, the Company successfully completed a $25 million publicly traded note offering listed with the Pacific Exchange.
At September 30, 2001 and 2000, debenture bonds consisted of the following:
The weighted-average interest rate on outstanding debentures was approximately 8.3% and 8.2% at September 30, 2001 and 2000.
Debenture bonds (including principal and compound and accrued interest) mature as follows:
12. ADVANCES UNDER LINE OF CREDIT:
The Company had a nonrecourse committed facility with Banc of America Securities LLC in the authorized amount of $50,000,000, with interest at the London Interbank Offered Rate plus 1%, which matured on November 2, 2000. The amount advanced at September 30, 2000 of $7,805,520, including accrued interest at 8.62%, was collateralized by real estate contracts and mortgage notes receivable held for sale with a carrying value of approximately $8,215,000. The line-of-credit agreement contained certain financial tests, including a minimum net worth and a maximum debt to net worth ratio. Violation of these tests is an event of default under the agreement. As of September 30, 2000, the Company failed to maintain the required levels. The Company paid off the remaining line-of-credit balance at maturity.
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
13. DEBT PAYABLE:
At September 30, 2001 and 2000, debt payable consisted of the following:
Aggregate amounts of principal and accrued interest payments due on debt payable are as follows:
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
14. INCOME TAXES:
The Company files a consolidated federal income tax return with all of its subsidiaries.
The income tax effects of the temporary differences giving rise to the Company's deferred tax assets and liabilities as of September 30, 2001 and 2000 are as follows:
During the year ended September 30, 2000, the Company had provided a valuation allowance for certain of its deferred tax assets due to uncertainty of recoverability. During the year ended September 30, 2001, circumstances surrounding the deferred tax assets changed such that the allowance was no longer deemed necessary; consequently the allowances was eliminated.
Following is a reconciliation of the provision for income taxes to an amount as computed by applying the statutory federal income tax rate to income before income taxes for the years ended September 30, 2001, 2000 and 1999:
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
14. INCOME TAXES (CONTINUED)
The components of the income tax provision (benefit) for the years ended September 30, 2001, 2000 and 1999 are as follows:
At September 30, 2001, the Company and its subsidiaries had unused net operating loss carryforwards, for income tax purposes, as follows:
15. COMMITMENTS AND CONTINGENCIES:
The company leases equipment under operating leases with remaining lives on most leases ranging from six months to 4 years. Aggregate rental expense paid for all operating leases for the three years ended September 30, 2001, 2000 and 1999 was approximately $1.2 million, $1.1 million and $0.7 million, respectively. As of September 30, 2001, future minimum rental payments under noncancelable operating leases for equipment consisted of the following:
During the fiscal year ended September 30, 2000, the Company began self-insuring for certain losses relating to employee medical benefits. The Company has purchased stop-loss coverage that limits its exposure on individual claims to $75,000. Accrual of self-insured losses are based upon the Company's historical experience.
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
16. STOCKHOLDERS' EQUITY:
A summary of preferred and common shares at September 30, 2001 and 2000 is as follows:
The Series E preferred stock has been issued in the following sub-series:
PREFERRED STOCK
Series A preferred stock has a par value of $1 per share, is cumulative and the holders thereof are entitled to receive dividends at the annual rate of 8.5%. Series B preferred stock is cumulative and the holders thereof are entitled to receive monthly dividends at the annual rate of two percentage points over the rate payable on six-month U.S. Treasury Bills as determined by the Treasury Bill auction last preceding the monthly dividend declaration. Series C, D and E-1 preferred stock are also 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" determined immediately prior to the declaration date. The Board of Directors may, at its sole option, declare a higher dividend rate; however,
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
16. STOCKHOLDERS' EQUITY (CONTINUED)
dividends shall be no less than 6% or greater than 14% per annum. Series E-2, E-3, E-4, E-5, E-6 and E-7 preferred stock are also cumulative and the holders thereof are entitled to receive monthly dividends at an annual rate of one-half of one percent more than the rate in effect for the E-1 series; however, dividends shall be no less than 6% or greater than 14% per annum.
Series B, C, D and E-1 preferred stock have a par value of $10, were sold to the public for $10 and are callable at the sole option of the Board of Directors at $10.50 per share reduced proratably to $10.20 per share as of the date five years from the date of issuance. Series E-2, E-3, E-4, E-5, E-6 and E-7 preferred stock have a par value of $10 per share, were sold to the public at $100 per share and are callable at the sole option of the Board of Directors at $100 per share.
All preferred stock series 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.
SUBORDINATE PREFERRED STOCK
Subordinate preferred shares, no par value, shall be entitled to receive dividends as authorized by the Board of Directors, provided that such dividend rights are subordinate and junior to all series of preferred stock. Subordinate preferred shares shall be entitled to distributions in liquidation in such priority as established by the Board of Directors prior to the issuance of any such shares. These liquidation rights shall at all times be subordinate and junior to all series of preferred stock. At September 30, 2001, 2000 and 1999, no subordinate preferred stock had been issued.
COMMON STOCK
Class A and B common stock have a par value of $2,250 per share. Class B is senior to Class A common stock as to liquidation up to the amount of the original investment. Any remaining amounts are then distributed pro rata to Class A and Class B common stockholders. Class B common stock has no voting rights. All series of common stock are subordinate in liquidation to all series of preferred stock.
In April 1998, the Company's Board of Directors authorized the payment of dividends on the outstanding Class A common stock. Dividends of $200 per share have been declared and paid in each subsequent month and will continue until further action by the Board.
Dividend restrictions are imposed by regulatory authorities on the insurance subsidiary in which the Company has a 97.8% stock ownership interest. Dividends can only be paid out of earned surplus. Earned surplus includes accumulated statutory basis earnings of the Company, but excludes surplus arising from unrealized capital gains or a revaluation of assets.
17. STATUTORY ACCOUNTING:
The Company's life insurance subsidiary is required to file statutory financial statements with state insurance regulatory authorities. Accounting principles used to prepare these statutory financial statements differ from generally accepted accounting principles ("GAAP"). Selected statutory and GAAP financial
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
17. STATUTORY ACCOUNTING (CONTINUED)
statement balances for the life insurance subsidiary as of and for the years ended September 30, 2001, 2000 and 1999 are as follows:
The National Association of Insurance Commissioners (the "NAIC") adopted the Codification of Statutory Accounting Principles guidance, which replaced the current Accounting Practices and Procedures manual as the NAIC's primary guidance on statutory accounting. The adoption of the Codification guidance on January 1, 2001 resulted in a $1.6 million charge to the Company's statutory basis capital and surplus. State regulatory authorities also 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 ("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. At September 30, 2001, the Company's statutory-basis surplus exceeded the RBC requirements.
Statutory Statements of Accounting Principles No. 37, Mortgage Loans, requires that all costs incurred in connection with originating a loan, acquiring purchased loans or committing to purchase loans be charged to expense as incurred. The Washington State Insurance Department has granted the Company a permitted accounting practice that differs from NAIC statutory accounting practices. The permitted practice allows the Company to capitalize and amortize certain costs, including underwriting fee charges paid to its parent, incurred in connection with acquiring purchased loans through March 31, 1998, except that all such costs shall be amortized into investment income no later than December 31, 2004. At September 30, 2001, the permitted practice has resulted in an increase in statutory surplus of approximately $5.7 million.
18. SUPPLEMENTAL DISCLOSURES FOR STATEMENTS OF CASH FLOWS:
The following table summarizes interest costs, net of amounts capitalized and income taxes paid (refunded) during the years ended September 30, 2001, 2000 and 1999:
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
18. SUPPLEMENTAL DISCLOSURES FOR STATEMENTS OF CASH FLOWS (CONTINUED)
Non-cash investing and financing activities of the Company during the years ended September 30, 2001, 2000 and 1999 are as follows:
19. BUSINESS SEGMENT REPORTING:
The Company principally operates in the three industry segments which encompass: (1) the investing in real estate contracts and mortgage notes receivables, other receivables and investment securities, (2) insurance and annuity operations, and (3) property development activities. The insurance segment also invests a substantial portion of the proceeds from insurance and annuity operations in real estate contracts and mortgage notes receivables, other receivables and investment securities.
The accounting policies of the Company's business segments are the same as those described in Note 1. All transactions between segments are eliminated. The Company allocates certain overhead and operating expenses amongst its segments.
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
19. BUSINESS SEGMENT REPORTING (CONTINUED)
Information about the Company's separate business segments and in total as of and for the years ended September 30, 2001, 2000 and 1999 are as follows:
20. RELATED-PARTY TRANSACTIONS:
During the years ended September 30, 2001, 2000 and 1999, the Company had the following related-party transactions with Summit Securities, Inc. ("Summit") and other affiliates due to common control of C. Paul Sandifur, Jr.
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
20. RELATED-PARTY TRANSACTIONS (CONTINUED)
At September 30, 2001 and 2000, the Company had net receivables due from affiliates of $3.5 million and $50,229, respectively. At September 30, 2001, the outstanding note receivable from Summit was approximately $10.9 million. At September 30, 2001 and 2000, the outstanding note payable balance to OSL was approximately $4.4 million and $4.5 million, respectively.
The Company provides management, receivable acquisition and receivable collections services to Summit OSL and OWAL for a fee pursuant to the terms of the Management, Receivable Acquisition and Servicing Agreement. The receivable acquisition fees for Summit and OSL are based upon yield requirements established by management of Summit and OSL. The Company charges, as its receivable acquisition service fee, the difference between the yield requirement and the yield which Summit and OSL actually negotiated when the receivable is acquired. The agreements are non-exclusive and may be terminated in whole or part by either party upon notice.
During the year ended September 30, 1999, the Company acquired pools of real estate contracts and mortgage notes receivable from Summit or its affiliates which were subsequently securitized. To the extent these sales were consummated just prior to the securitization transaction, Summit or its affiliates were allocated a gain as if they had participated in the securitization transaction. This allocation represented the fair value of the pool of real estate contract and mortgage notes receivable sold. If the sales were made in advance of the securitization transaction, then such sales were made at estimated fair value on the date of the sale.
The Company provides accounting, data processing, contract servicing and other administrative services to Summit, OSL and OWAL. During the year ended September 30, 2001, the Company entered into an agreement with Summit, OSL and OWAL to change the allocation of the service fee and administrative charges to a cost sharing arrangement from a fixed and calculated fee arrangement. Management believes that these charges are reasonable and result in the reimbursement to Metropolitan of all significant direct expenses incurred on behalf of its affiliates and its subsidiaries.
Summit Property Development, Inc., a wholly owned subsidiary of Summit, provides real estate development services to the Company for a fee. 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.
MIS is a securities broker/dealer and member of the National Association of Securities Dealers. It markets the securities products of Metropolitan and of Summit. The commission rate charged by MIS
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
20. RELATED-PARTY TRANSACTIONS (CONTINUED)
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.
Western has entered into a reinsurance agreement with OSL, which became effective July 1, 1998 and remained in effect at September 30, 2001. Under this agreement, Western may reinsure with Old Standard 75% of the risk on certain annuity products. The reinsurance agreement is an ongoing arrangement with no stated expiration or termination date, although each may stop and restart at their discretion upon providing a 30-day advance written notice. Western receives an annual fee of 40 basis points on the cash value of the reinsured policies from OSL for servicing the reinsured policies.
During the year ended September 30, 2000, the Company sold a participation in certain structured settlement and lease equipment receivables to Summit at estimated fair value. Proceeds from the structured settlement sale of $8.1 million resulted in a gain of approximately $1.6 million while proceeds from the lease equipment receivable sale of approximately $5.5 million resulted in a gain of approximately $0.4 million. The proceeds were financed in part by a $10.9 million note receivable with the participated receivables pledged as collateral.
Additionally, during the year ended September 30, 2000, the Company sold an $18 million non-interest bearing contract receivable, collateralized by timber rights in Hawaii to Summit at estimated fair value using a discount rate of 12%. The proceeds of $13.2 million resulted in a gain of $10.7 million.
21. 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.
Publicly Traded Investment Securities -- Fair value is determined by quoted market prices.
Non-Publicly Traded Investment Securities -- Fair value is derived from quoted market prices for securities with similar characteristics and risks or is estimated based upon expected discounted future cash flows. When determining expected future cash flows, the Company considers interest rates, estimated prepayment rates, collateral value and historical default rates experienced by the securities.
Real Estate Contracts and Mortgage Notes Receivable -- For receivables (excluding accrued interest receivable), fair value is estimated by discounting contractual cash flows adjusted for prepayment estimates. The prepayment estimates are based upon internal historical data. 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 loan.
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.
Reinsurance Receivables -- The fair value of reinsurance receivables approximates the carrying value because the majority of the life insurance and annuity policies reinsured provide for variable rates of interest.
Mortgage Servicing Rights -- The fair value of mortgage servicing rights is based on the discounted value of contractual servicing income using estimated prepayment rates of the related serviced receivables.
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
21. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
Life Insurance and Annuity Reserves -- The fair value of annuity reserves approximates the carrying value because the majority of the life insurance and annuity policies provide for variable rates of interest.
Debenture Bonds and Debt Payable -- The fair value of debenture bonds 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.
Debt Payable -- The fair value of 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.
Advances Under Line of Credit -- The fair value approximates the carrying value because the advances have variable rates of interest.
The estimated fair values of the following financial instruments as of September 30, 2001 and 2000 are as follows:
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.
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
22. EMPLOYEE BENEFIT PLANS:
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 Employer 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 Employer may also make an additional discretionary contribution during any plan year. The Company's contributions to the Plan were approximately $0, $450,000 and $354,000 during the years ended September 30, 2001, 2000 and 1999, respectively.
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
23. PARENT COMPANY ONLY FINANCIAL STATEMENTS:
The condensed balance sheets of Metropolitan Mortgage & Securities Co., Inc. ("Metropolitan" or the "parent company") at September 30, 2001 and 2000 are as follows:
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
23. PARENT COMPANY ONLY FINANCIAL STATEMENTS (CONTINUED)
Metropolitan's condensed statements of operations for the years ended September 30, 2001, 2000 and 1999 are as follows:
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
23. PARENT COMPANY ONLY FINANCIAL STATEMENTS (CONTINUED)
Metropolitan's condensed statements of cash flows for the years ended September 30, 2001, 2000 and 1999 are as follows:
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
23. PARENT COMPANY ONLY FINANCIAL STATEMENTS (CONTINUED)
Non-cash investing and financing activities not included in Metropolitan's condensed statements of cash flows for the years ended September 30, 2001, 2000 and 1999 are as follows:
Accounting policies followed in the preparation of the preceding condensed financial statements of Metropolitan (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.
Metropolitan had a nonrecourse committed facility with Banc of America Securities LLC in the authorized amount of $50.0 million, with interest at the London Interbank Offered Rate plus 1%, which matured on November 2, 2000. The amount advanced at September 30, 2000 of approximately $7.8 million, including accrued interest at 8.62%, is collateralized by real estate contracts and mortgage notes receivable held for sale with a carrying value of approximately $8.2 million. The line-of-credit agreement contained certain financial tests, including a minimum net worth and a maximum debt to net worth ratio. Violation of these tests is an event of default under the agreement. As of September 30, 2000, the Company failed to maintain the required levels. The Company paid off the remaining line-of-credit balance at maturity.
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
23. PARENT COMPANY ONLY FINANCIAL STATEMENTS (CONTINUED)
At September 30, 2001 and 2000, Metropolitan's debt payable consists of the following:
Aggregate amounts of principal payments due on the parent company's debt payable are expected to be as follows:
At September 30, 2001 and 2000, Metropolitan's debenture bonds payable consisted of the following:
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
23. PARENT COMPANY ONLY FINANCIAL STATEMENTS (CONTINUED)
Maturities of the parent company's debenture bonds are as follows:
Metropolitan had the following related-party transactions with its various subsidiaries and affiliated entities:
Historically, Metropolitan has charged various subsidiaries and affiliated entities for underwriting fees related to contracts sold to these entities. Amounts charged to subsidiaries are deferred and recognized as income over the estimated life of the contracts. Amounts amortized into service fee income were approximately $1.2 million, $2.4 million and $6.5 million for the years ended September 30, 2001, 2000 and 1999, respectively.
The underwriting fees are based upon a yield requirement established by the purchasing entity. In the case of Western, one of Metropolitan's subsidiaries, beginning in 1994 and ending March 31, 1998, the yield requirement established by Western had been guaranteed by Metropolitan and an intercompany reserve was established to support the guarantee. Metropolitan remains liable to Western for any losses in excess of the reserve. In connection with its guarantee, Metropolitan has holdbacks of $2.7 million, $1.4 million and $3.7 million at September 30, 2001, 2000 and 1999, respectively. The guarantee by Metropolitan has been eliminated with respect to all receivables sold to Western after March 31, 1998.
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
24. SUPPLEMENTARY FINANCIAL INFORMATION:
Supplementary financial information of the Company for each three month period (September 30, June 30, March 31 and December 31) of the fiscal years ended September 30, 2001 and 2000 are as follows:
SCHEDULE I
METROPOLITAN MORTGAGE & SECURITIES CO., INC. SUMMARY OF INVESTMENTS OTHER THAN INVESTMENTS IN RELATED PARTIES
SEPTEMBER 30, 2001
S-1
SCHEDULE II
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
YEARS ENDED SEPTEMBER 30, 2001, 2000 AND 1999
S-2
SCHEDULE III PAGE 1 OF 2
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES SUPPLEMENTARY INSURANCE INFORMATION
S-3
SCHEDULE III PAGE 2 OF 2
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES SUPPLEMENTARY INSURANCE INFORMATION
S-4
SCHEDULE IV PAGE 1 OF 3
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES LOANS ON REAL ESTATE
SEPTEMBER 30, 2001
At September 30, 2001, the Consolidated Group held first priority liens associated with contracts and mortgage note receivables with a face value of approximately $439.8 million (99%) and second or lower priority liens of approximately $5.7 million (1%). Approximately 23% of the face value of the Consolidated Group's real estate Receivables are collateralized by properties located in the Pacific Northwest (Washington, Alaska, Idaho, Montana and Oregon), approximately 30% by properties located in the Pacific Southwest (California, Arizona and Nevada), approximately 13% in the Southeast (Florida, Georgia, North Carolina and South Carolina), approximately 4% in the North Atlantic (New York, Pennsylvania, New Jersey, Connecticut and Maryland) and approximately 13% by properties located in the Southwest (Texas and New Mexico). The face value of the real estate Receivables ranges principally from $15,000 to $300,000 with 90 real estate Receivables, aggregating approximately $172.2 million, in excess of this range. No individual contract or note is in excess of 5% of the total carrying value of real estate Receivables and less than 2% of the contracts and notes are subject to variable interest rates. Contractual interest rates principally range from 6% to 13% per annum with approximately 85% of the face value of these Receivables within this range. The weighted average contractual interest rate on these real estate Receivables at September 30, 2001 is approximately 10.5%. Maturity dates range from 2001 to 2031.
The principal amounts of Receivables subject to delinquent principal or interest are defined as being in arrears for more than three months.
S-5
SCHEDULE IV PAGE 2 OF 3
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES LOANS ON REAL ESTATE
SEPTEMBER 30, 2001
The future contractual maturities of the aggregate amounts of Receivables (face amount) are as follows:
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SCHEDULE IV PAGE 3 OF 3
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES LOANS ON REAL ESTATE
SEPTEMBER 30, 2001
S-7
SCHEDULE V
METROPOLITAN MORTGAGE & SECURITIES CO., INC. AND SUBSIDIARIES SUPPLEMENTARY REINSURANCE INFORMATION
S-8
EXHIBIT INDEX