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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2004
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM __________ TO __________
COMMISSION FILE NUMBER 0-17771
FRANKLIN CREDIT MANAGEMENT CORPORATION
DELAWARE 75-2243266
(State of incorporation) (I.R.S. ID)
SIX HARRISON STREET
NEW YORK, NEW YORK 10013
(212) 925-8745
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: COMMON STOCK,
$0.01 PAR VALUE PER SHARE.
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Exchange Act of 1934 during the past
12 months (or for such shorter period that the registrant was required to file
such reports), and (2) has been subject to such filing requirements for the past
90 days. Yes X No.
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained in herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. []
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes No X
Number of shares of the registrant's common stock, par value $0.01 per share,
outstanding as of March 23, 2005: 6,082,295
Based upon the closing sale price on the Over-The-Counter Bulletin Board on June
30, 2004, the last business day of the registrant's most recently completed
second fiscal quarter, the aggregate market value of common stock held by
non-affiliates of the registrant as of such date was approximately $6,023,380.
Portions of the registrant's definitive proxy statement, which will be filed
within 120 days of December 31, 2004, are incorporated by reference into Part
III.
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FRANKLIN CREDIT MANAGEMENT CORPORATION
FORM 10-K
DECEMBER 31, 2004
INDEX
PAGE
PART I.
Item 1. Business. 3
Item 2. Properties. 20
Item 3. Legal Proceedings. 21
Item 4. Submission of Matters to a Vote of Security Holders. 21
PART II.
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer 21
Purchases of Equity Securities.
Item 6. Selected Financial Data. 22
Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations. 23
Item 7A. Quantitative and Qualitative Disclosure About Market Risk. 33
Item 8. Financial Statements and Supplementary Data. 35
Item 9. Change in and Disagreements with Accountants on Accounting and Financial
Disclosures. 35
Item 9A. Controls and Procedures. 35
Item 9B. Other Information. 35
PART III.
Item 10. Directors and Executive Officers of the Registrant. 35
Item 11. Executive Compensation. 35
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters. 35
Item 13. Certain Relationships and Related Transactions. 35
Item 14 Principal Accountant Fees and Services. 35
PART IV.
Item 15. Exhibits, Financial Statements Schedules. 37
2
PART I
ITEM 1. BUSINESS.
OVERVIEW
We are a specialty consumer finance company primarily engaged in the
acquisition, origination, sale, servicing and resolution of performing,
sub-performing and non-performing residential mortgage loans. We purchase and
originate loans primarily on the basis of the borrower's ability and willingness
to repay the mortgage loan, the borrower's historical pattern of debt repayment
and the adequacy of the collateral securing the loan. We focus on acquiring and
originating loans made to borrowers who generally do not meet conforming
underwriting guidelines because of higher loan-to-value ratios, the nature or
absence of income documentation, limited credit histories, high levels of
consumer debt or past credit difficulties. We originate non-prime mortgage loans
through our wholly-owned subsidiary, Tribeca Lending Corp. We hold for
investment the loans we acquire and a significant portion of the loans we
originate. From inception through December 31, 2004, we had purchased and
originated in excess of $2.2 billion in mortgage loans, $940 million of which we
held in our portfolio as of December 31, 2004.
PORTFOLIO ACQUISITIONS
Since commencing operations in 1989, we have become a nationally
recognized buyer of non-conforming mortgage loans from a variety of financial
institutions in the United States including mortgage banks, commercial banks and
thrifts, other traditional financial institutions and other specialty finance
companies. As these entities originate, sell and securitize mortgage loans on an
ongoing basis, they inevitably discover a portion of assets that for a wide
range of reasons do not meet the underwriting criteria established by most
buyers in the secondary marketplace, or otherwise do not fit within their own
criteria for holding and servicing through resolution, by which we mean
repayment or foreclosure. In contrast, we have developed a specialized expertise
at risk-based pricing, credit evaluation and loan servicing that allows us to
effectively evaluate and manage the potentially higher risks associated with
this segment of the residential mortgage industry, including the rehabilitation
or resolution of non-performing or sub-performing loans. As a result, we have
the ability to acquire what we call "scratch and dent loans" or "S&D loans" from
a variety of sources that we believe provide us with the opportunity to achieve
an attractive risk-adjusted rate of return. We refer to loans we acquire as
"notes receivable."
We typically acquire S&D loans at a discount relative to the face value of
the mortgage. In 2004, we purchased loans with an aggregate face value of $652
million, including the acquisition of our largest portfolios to date, one of
which was comprised of loans with an aggregate face value of approximately $310
million. From our inception through December 31, 2004, we purchased S&D loans
with a face value in excess of $1.8 billion, $812 million of which we retained
for investment as of December 31, 2004.
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LOAN ORIGINATIONS
We conduct our loan origination business through our wholly owned
subsidiary, Tribeca Lending Corp., or Tribeca, which we formed in 1997 in order
to leverage our experience in evaluating and managing residential mortgage loans
and our loan servicing capabilities. We originate primarily non-prime
residential mortgage loans to individuals whose documentation, credit histories,
income and other factors cause them to be classified as non-prime borrowers and
to whom, as a result, conventional mortgage lenders will often not make loans.
Most lenders in the non-prime market generate a majority of their origination
volume from "Alt-A" borrowers, meaning borrowers with a credit profile in the
level immediately below prime. As a result of the extensive competition in this
subcategory of the non-prime market, the ability for lenders to generate a risk
premium is limited and profitability is more dependent upon an ability to
originate and/or service a high volume of loans. In contrast, fewer lenders
focus on originating loans to borrowers with credit profiles below "Alt-A." We
focus our marketing efforts on this segment given our knowledge of these
borrowers and our ability to service loans to them through the entire credit
cycle.
In 2004, we originated $200 million in non-prime mortgage loans. We
originated approximately 65% of our mortgage loans on a retail basis and the
rest through our wholesale channels. We hold the mortgages we originate for our
portfolio or sell them for cash in the whole loan market, depending on market
conditions and our own portfolio goals. From our inception through December 31,
2004, we originated loans with a face value of $447 million, $127 million of
which we retained for sale or investment as of December 31, 2004.
LOAN SERVICING
In general, after we acquire or originate loans our servicing department
begins the process of servicing each of the loans in our portfolio, seeking to
ensure that it is repaid in accordance with its terms or according to amended
repayment terms negotiated with the borrower. We have developed an extensive
infrastructure that allows us to rehabilitate many loans which become delinquent
or go into default. We also have the capability to follow loans through the
default process into foreclosure and sale of the underlying collateral, when
required.
CORPORATE HISTORY
We were formed in 1989 by, among others, Thomas J. Axon, our Chairman, and
Frank B. Evans, Jr., one of our directors, for the purpose of acquiring consumer
loan portfolios from the Resolution Trust Company, or RTC, and the Federal
Deposit Insurance Corporation, or FDIC. We became a public company in December
1994, when we merged with Miramar Resources, Inc., a publicly traded oil and gas
company that had emerged from bankruptcy proceedings in December 1993. The newly
formed entity was renamed Franklin Credit Management Corporation. At the time of
the merger, we divested substantially all of the remaining oil and gas assets
directly owned by Miramar in order to focus primarily on the non-conforming
sector of the residential mortgage industry. At that time, we decided to
capitalize on our experience and expertise in acquiring and servicing loans from
RTC and the FDIC and began purchasing subprime mortgage loans from additional
financial institutions. In 1997, we formed Tribeca to originate non-conforming
residential mortgage loans to borrowers in the subprime markets.
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LOAN ACQUISITIONS - FRANKLIN
Financial institutions generally sell or securitize the majority of the
loans they originate in the secondary market. The vast majority of these loans
are sold at a premium to face value of the note, creating a profit margin for
the seller. For a variety of reasons, however, a portion of their loan
production is typically sold at a discount to the face value of the note. Our
acquisition business is focused on purchasing these S&D loans for which a highly
liquid secondary market does not exist. We have a variety of opportunities to
purchase S&D loans, both shortly following origination and throughout the
remainder of their lifecycle.
NEWLY ORIGINATED LOANS. When a financial institution cannot sell a
newly-originated mortgage loan through normal secondary market channels, it may
continue to look for ways to sell that mortgage at a discounted price in order
to free up cash or financing capacity so that it may continue to originate and
sell more liquid mortgages. Newly originated loans may be sold multiple times
before they are purchased by a long-term investor. A typical scenario is that a
loan is originated by a local mortgage banker, sold to an intermediary mortgage
banker, and finally either sold to a long term investor or securitized. At any
point in this process, we may have an opportunity to purchase the loan for
various reasons, including:
- Investor Fallout. Mortgages may not meet the requirements of the
secondary market for a number of different reasons, including
noncompliance with program requirements, documentation deficiencies
and valuation variances.
- Loan Repurchases. Once a mortgage is sold, it may be subject to
repurchase by the seller for a number of different reasons,
including a subsequent default by the borrower that occurs within a
specified period of time after the sale.
- Facilitation. Occasionally, financial institutions will originate
loans (frequently second liens) even though a liquid secondary
market does not exist for those loans in order to facilitate the
origination of mortgages that do have a liquid secondary market.
SEASONED LOANS. Seasoned loans may be sold in the secondary market for a
number of reasons, including:
- Mergers and Acquisitions. The acquiror in a merger or acquisition
may find that it has acquired mortgages that do not fit within its
credit parameters.
- Credit or Performance Issues. A portfolio holder of mortgages may
have accumulated mortgages that have credit or performance
characteristics that do not meet its current needs and desires to
sell these mortgages in order to free up capacity.
- Securitization Terminations. When mortgage loans are securitized,
the securitization trust normally sells bonds with maturities that
are shorter than the life of some of the mortgage loans that act as
collateral. Optional call provisions may also provide certain
interested parties with the ability to collapse the trust by selling
or refinancing the remaining mortgage loans in the trust prior to
maturity.
- Insolvency. When a financial institution becomes insolvent, a
trustee may decide to liquidate a mortgage portfolio in order to
satisfy the creditors of the insolvent institution.
It is often more efficient and economical (and sometimes imperative) for
lenders in the situations described above to sell S&D loans at a discount to a
third-party than to expend the resources necessary to rehabilitate these loans
internally, as these lenders generally do not possess the financial capability,
desire or specialized skills and infrastructure necessary to
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effectively value or service these types of assets. In contrast, we have
developed specialized expertise that permits us to effectively value and bid on
S&D loans, as well as to manage the loans in portfolios that we ultimately
acquire, including, in some cases, up to and through the disposition of
foreclosed real estate properties.
Since commencing operations, we have purchased in excess of $1.8 billion
in S&D loans, comprised of approximately 48,800 loans, primarily from financial
institutions. During 2004, we took advantage of market opportunities to
significantly increase our volume of loan acquisitions and purchased over $652
million in S&D loans, compared with approximately $244 million in S&D loans
during 2003 and $212 million in S&D loans during 2002. A substantial portion of
the S&D loans we acquired in 2004 resulted from the purchase of two large
portfolios from Bank One N.A. and Master Financial Inc., which together
represented over $400 million in face loan value at the time of acquisition and
approximately 61% of the total face value of acquired notes receivable in 2004.
Our acquisition department seeks out and identifies opportunities to
purchase portfolios of S&D loans, performs due diligence on the loans included
in a portfolio, prepares a bid for the portfolio in accordance with our price
and yield guidelines based on the results of its due diligence investigation and
assists in the integration of assets that we ultimately acquire into our
existing portfolio.
"BULK" AND "FLOW" ACQUISITIONS
Some lenders sell their S&D loans in the secondary market in small amounts
on a frequent basis, while other institutions tend to accumulate larger pools of
mortgages before selling them. We have established an acquisition group to focus
on each of these two segments of the selling market. Our bulk purchase unit is
responsible for acquisitions of portfolios with a face value of notes receivable
in excess of $1.5 million, while our flow unit is responsible for acquisitions
of portfolios or individual notes with a face value below $1.5 million. We make
the majority of our bulk pool purchases of S&D loans from large conventional
lenders in connection with the various opportunities described above. In
contrast, our flow purchases are generally made on a more regular basis from
smaller, regional mortgage banks that have a need to quickly dispose of one or
more S&D loans. Bulk purchases constituted 84% of our overall purchases in 2004,
71% in 2003 and 71% in 2002, respectively.
DUE DILIGENCE
We have established a proprietary due diligence review process that we use
for all prospective purchases. In connection with our purchases of bulk
portfolios, the due diligence process includes an analysis of a majority of the
loans in a prospective portfolio, except in the case of very large portfolios
where, due to time constraints, we analyze a representative sample of assets in
the portfolio. Our team evaluates, among other things, lien position and the
value of collateral, debt-to-income ratios and the borrower's creditworthiness,
employment stability, number of years of home ownership, credit bureau reports
and mortgage payment history. Where appropriate, our acquisition department
performs an on-site evaluation of the seller's loan servicing department in
addition to reviewing the loan files that comprise the portfolio. This process
provides us with additional information as to the actual quality of the
servicing of the loans in the portfolio, which we believe is critical to our
ability to properly evaluate the portfolio. In the case of flow purchases, we
typically perform due diligence on each loan we acquire, which
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focuses on the same matters described above. In all cases, we tailor our review
as appropriate based on the level of our prior experience with the seller and
other factors relevant to the specific portfolio.
PRICING
For both our bulk and flow purchases, we compare the information derived
from our due diligence review to our historical statistical database and,
coupled with our cumulative knowledge of the non-conforming segment of the
mortgage industry, our acquisition department projects a collection strategy and
estimates the collectability, cost to service and timing of cash flows with
respect to the loans in the portfolio. Based upon this information, the
acquisition department prepares a bid which meets our established pricing and
yield guidelines.
We have accumulated a significant amount of intellectual property,
including proprietary databases and statistical data, over our years of
experience with borrowers of S&D loans, based on our understanding of the entire
credit cycle and our ability to resolve loans. We believe our intellectual
property provides us with a competitive advantage in analyzing, pricing and
bidding on S&D loans.
COMPETITION
We face intense competition in the market for the acquisition of S&D
loans. Many of our competitors have financial resources, acquisition departments
and servicing capacity considerably larger than our own. Among our largest
competitors are Residential Funding Corporation, Bayview Financial Trading
Group, Countrywide Financial Corporation, The Goldman Sachs Group, and Bear
Stearns & Co., Inc. Competition for acquisitions is generally based on price,
reputation of the purchaser, funding capacity and ability to execute within
timing parameters required by the seller.
BORROWERS
Our business model focuses for the most part on holding the mortgage
assets that we acquire through resolution. Our borrowers are a diverse
population and no single borrower represents a significant portion of our S&D
loans. Likewise, our borrowers are located in all fifty states and no single
state represents 10% or more of the aggregate principal balance of loans in our
portfolio.
SELLERS
We acquire S&D loans through a variety of methods, including negotiated
sales, ongoing purchase agreements, joint-bids with other institutions and
private and public auctions. The supply of assets available for purchase by us
is influenced by a number of factors, including knowledge by the seller of our
interest in purchasing assets of the type it is seeking to sell, the general
economic climate, financial industry regulation and new residential mortgage
loan origination volume. During 2004, we purchased an aggregate of 341
portfolios from 153 sellers. Our sources of bulk loan acquisitions have
historically varied from year to year and we expect that this will continue to
be the case. In addition to acquiring loans directly from sellers, we also
acquire loans indirectly through brokers from time to time.
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MARKETING
Members of the sales and marketing group of our acquisitions department
continually seek to identify new opportunities for the purchase of bulk and flow
mortgage assets. They focus on deepening relationships with sellers from whom we
have made acquisitions in the past and on developing relationships with new
sellers, as well as with brokers who have access to sellers of the types of
portfolios that we are interested in purchasing.
LOAN ORIGINATIONS - TRIBECA
We formed Tribeca, our wholly owned subsidiary, in 1997 as an origination
platform for non-prime residential mortgages. Tribeca's mortgage origination
platform provides us with an additional vehicle for growth and reduces the risks
associated with reliance entirely upon the purchase of loans from other
financial institutions for growth. Since commencing operations in 1997, Tribeca
has originated approximately $447 million in non-prime residential mortgage
loans for individuals with credit histories, income and/or other factors that
cause them to be classified as non-prime borrowers.
Through Tribeca, we originate a range of first and second mortgage loans.
While our current strategy is to hold a majority of originated loans in our
portfolio for investment, our strategy has changed in the past and may do so in
the future based on market conditions and our own portfolio needs. We focus on
developing and offering an array of proprietary niche products, including
innovative purchase loans for single family and multi-family residences. We
offer both fixed-rate loans and adjustable rate mortgages. Our products are
offered at various interest rates, depending on credit risk, mortgage history,
collateral and underwriting guidelines. Borrowers may choose to increase or
decrease their interest rate through the payment of different levels of
origination fees. Our maximum loan amount is $2 million and our maximum
loan-to-value ratio is 100%, depending on the specific product.
WHOLESALE AND RETAIL ORIGINATIONS
Tribeca originates loans through both wholesale and retail channels. In
2004, approximately 65% of loans were originated through our retail channels,
with the remainder being originated through wholesale channels, meaning through
mortgage brokers. Of retail loans originated in 2004, approximately 65% were
Liberty loans, which we hold for our portfolio, while the balances were loans
that we originated for sale to investors. All of the wholesale loans we
originated in 2004 were Liberty loans.
The focus of our retail operation is direct-to-consumer loans. Our
marketing efforts consist primarily of Internet-generated leads and
referral-based business from attorneys, accountants, real estate agents and
financial planners. Our wholesale account executives focus on expanding our
mortgage broker network. Our staff's main objective is to identify qualified
mortgage brokers and generate a consistent flow of business. Tribeca maintains
three offices, located in New York, New Jersey and Pennsylvania, but originates
loans from 26 states.
BORROWERS
As with loans we acquire, borrowers of loans we originate are a diverse
population and no single borrower represents a significant portion of our loans.
Our borrowers are located in 26
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states, with approximately 54% of the aggregate face value of loans originated
in 2004 being secured by property in New York and New Jersey.
SECONDARY MARKETING
We sell loans for a cash gain on a whole-loan, servicing-released, basis.
The percentage of originated loans sold varies from year to year, depending on
market conditions and our portfolio needs. We have not historically hedged our
origination pipeline by entering into mandatory delivery commitments; however,
many mortgage originators do so in the ordinary course of business and we may
choose to do so in the future as well, if management deems it to be
advantageous. The purchasers of the whole loans we do sell are typically large
financial institutions. We regularly sell loans meeting specified criteria to
several large financial institutions with whom we have ongoing relationships.
LICENSING
Tribeca is currently licensed as a mortgage banker or exempt from
licensing in 26 states. Tribeca is also a Department of Housing and Urban
Development FHA Title I and Title II approved lender.
PRODUCTS
We vary our product offerings depending on market conditions. In 2004, our
origination volume focused on Liberty loans, which we hold for investment in our
own portfolio, and Gold and Platinum loans, which we originate for sale to
investors as described above.
Liberty Loans. During 2004, a majority of our loan originations were
conducted through our Liberty loan program. The Liberty loan is oriented toward
borrowers who are undergoing a transition in their credit profile due to
unforeseen life events such as divorce, business failure, loss of employment,
health reasons and similar events. We generally expect that Liberty loan
customers will eventually refinance at a lower interest rate once they have
re-established their credit record. Liberty loans are primarily ARMs with
30-year terms. Our loan application and approval process is simple, requiring
little documentation. We believe our Liberty loan product is unique in that we
do not use the borrower's FICO scores to determine eligibility and instead make
our lending decision based solely on the borrower's equity in his or her home.
The maximum loan amount for our Liberty loans is typically $2 million, with a
loan-to-value ratio of up to 75%. Because we emphasize collateral value, we take
extra precautions to confirm the value of the underlying collateral.
Platinum and Gold Loans. The balance of our loan originations in 2004 were
conducted through our Platinum and Gold programs. Borrowers of our Platinum and
Gold loans typically have higher credit ratings than borrowers under loans that
we hold for our portfolio. The maximum loan amount for these loans is generally
$500,000, with a loan-to-value ratio of up to 100%.
COMPETITION
The market for non-prime loan originations is highly competitive. Tribeca
competes with a variety of lenders, including commercial savings banks and
mortgage bankers, for the
9
origination of non-prime mortgages. Among the largest and most well-established
of these competitors are New Century Mortgage, Ameriquest Mortgage, Countrywide
Financial Corporation, and Household Financial Services. Many of our competitors
possess greater financial resources, longer operating histories and lower costs
of capital than we do. Competition for mortgage originations is based upon
marketing efforts, loan processing capabilities, funding capacity, loan product
desirability, interest rates and fees and, to a lesser extent in our case, the
ability to sell loans for a premium in the secondary market.
SERVICING
We hold and service a substantial majority of the loans in our portfolio,
including both purchased and originated loans, until resolution. At December 31,
2004, our servicing department consisted of 68 employees who managed 22,865
loans. Our servicing operations are conducted in the following departments:
LOAN BOARDING AND ADMINISTRATION. The primary objective of the loan
boarding department is to ensure that newly acquired loans are properly
transitioned from the prior servicer and that both newly acquired loans and
originated loans are accurately boarded onto our servicing systems. In the bulk
acquisition context, data is transmitted via a file from the seller which is
loaded directly onto our system, while data for originated loans and flow
acquisitions is boarded directly by us onto our system. Our loan boarding
department audits loan information for accuracy to ensure, in the case of
acquisitions, that the loans conform to the terms provided in the original note
and mortgage. The information boarded onto our systems provides us with a file
that we use to automatically generate introductory letters to borrowers
summarizing the terms of their loan, among other standard industry procedures.
The loan administration department performs typical duties related to the
administration of loans, including incorporating modifications to terms of loans
as well as, in the case of acquisitions, completing and recording the assignment
of collateral documents from the seller into our name, which it does in
conjunction with our acquisition department. The loan administration department
also ensures the proper maintenance and disbursement of funds from escrow
accounts and monitors non-escrow accounts for delinquent taxes and insurance
lapses. For purchased and originated loans with adjustable interest rates, the
loan administration group ensures that adjustments are properly made and timely
identified to the affected borrowers.
CUSTOMER SERVICE. The main objective of our customer service department is
to handle inbound calls from borrowers. In addition, this group is responsible
for processing payoff requests and reconveyances.
COLLECTIONS. The main objective of our collections department is to ensure
loan performance through maintaining customer contact. Our collections group
continuously reviews and monitors the status of collections and individual loan
payments in order to proactively identify and solve potential collection
problems. When a loan becomes seven days past due, our collections group begins
making collection calls and generating past-due letters. Our collections group
attempts to determine whether a past due payment is an aberration or indicative
of a more serious delinquency. If the past due payment appears to be an
aberration, we emphasize a cooperative approach and attempt to assist the
borrower in becoming current or arriving at an alternative repayment
arrangement. Upon a delinquency of 55 days by a borrower, or the earlier
determination by our collections group based on the evidence available that a
serious delinquency is likely, the loan is typically transferred to our legal
department where loss
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mitigation begins. We focus on expediting the loan transfer process as soon as a
borrower is identified as being impaired so that loss mitigation can begin as
promptly as practicable.
LEGAL. Our legal department manages and monitors the progress of seriously
delinquent loans and loans which we believe will develop into serious
delinquencies. In addition to maintaining contact with borrowers through
telephone calls and collection letters, this department utilizes various
strategies in an effort to reinstate an account or revive cash flow on an
account. The legal department analyzes each loan to determine a collection
strategy to maximize the amount and speed of recovery and minimize costs. The
particular strategy is based upon each individual borrower's past payment
history, current credit profile, current ability to pay, collateral lien
position and current collateral value. We employ a range of strategies depending
on the specific situation, including the following:
- Short term repayment plans, or forbearance plans, when a delinquency
can be cured within three months;
- Loan modifications, when a delinquency cannot be cured within three
months but the borrower has the financial ability to abide by the
terms of the loan modification;
- Short sales, when the borrower does not have the ability to repay
and the equity in the property is not sufficient to satisfy the
total amount due under the loan, but we accept the sale price of the
property in full satisfaction of the debt in order to expedite the
process for all parties involved;
- Deed-in-lieu, when the borrower does not have the ability to repay
and the equity in the property is not sufficient to satisfy the
total amount due, but we accept the deed in full satisfaction of the
debt in order to expedite the process for all parties involved;
- Assumption, when the borrower wishes to relinquish responsibility to
a third party and the prospective borrower demonstrates the ability
to repay the loan;
- Subordination, when we have the second lien on a property and the
first lien-holder wishes to refinance its loan, to which we will
agree if the terms of the refinanced loan permit the borrower to
repay our loan; and
- Deferment agreements, when we forgo collection efforts for a period
of time, typically as a result of a hardship incurred by the
borrower, such as a natural disaster or a death or illness in the
family, as a result of which the borrower is temporarily unable to
repay.
Seriously delinquent accounts not resolved through the loss mitigation
activities described above are foreclosed in accordance with state and local
laws, with the objective of maximizing asset recovery in the most expeditious
manner possible. Foreclosure timelines are managed through a timeline report
built into the loan servicing system. The report schedules milestones applicable
for each state throughout the foreclosure process, which enhances our ability to
monitor and manage the process. Properties acquired through foreclosure are
transferred to our real estate department to manage eviction and marketing of
the properties. However, until foreclosure is completed, efforts at loss
mitigation are continued.
In addition, our legal department manages loans the borrower of which has
declared bankruptcy. The primary objective of the bankruptcy group within our
legal department is to proactively monitor bankruptcy assets to ensure
compliance with individual plans and to ensure recovery in the event of
non-compliance.
REAL ESTATE. Our real estate department manages all properties acquired by
us upon foreclosure of a delinquent loan or through purchase as part of a loan
portfolio in order to
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preserve their value and ensure that maximum returns are realized upon sale. We
own real estate, or OREO, in various states that we acquired through
foreclosure, a deed in lieu or acquisition. These properties are 1-4 family
residences, co-ops and condos. We acquire or foreclose on property primarily
with the intent to sell it at a profit. From time to time OREO properties may be
in need of repair or improvements, in order to either increase the value of the
property or reduce the time that the property is on the market. In those cases,
the OREO property is evaluated independently and we make a determination of
whether the additional investment would generate an adequate return.
FINANCING
We require access to credit facilities in order to finance our purchase
and origination of loans. We have historically financed both our acquisitions of
mortgage loan portfolios and our originations, through arrangements with Sky
Bank N. A., with whom we have had a strong relationship since our founding in
1989. In October 2004 we consolidated our arrangements with Sky Bank relating to
the funding of loan acquisitions under a Master Credit and Security Agreement.
Loans to us under the credit agreement are secured by a first priority lien on
the mortgage loans financed by proceeds of loans made under that agreement. In
connection with our continued growth in 2004, and in particular our two large
acquisitions of the Bank One and Master Financial portfolios, respectively, Sky
Bank arranged for two additional financial institutions to participate as
lenders under our arrangements with Sky Bank. Our wholly owned originations
subsidiary, Tribeca, has also entered into a warehousing credit and security
agreement with Sky Bank, in which one of these lenders also participates,
pursuant to which Tribeca finances loans that it originates. From time to time,
amounts borrowed under the warehouse facility are transferred to term loans.
(For a further description of our financing arrangements, see "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Senior Debt.")
12
PORTFOLIO CHARACTERISTICS
OVERALL PORTFOLIO
At December 31, 2004, our portfolio (excluding REO) consisted of $812
million notes receivable, $110 million loans held for investment and $17 million
loans held for sale. Our total loan portfolio grew 87% to $939 million at
December 31, 2004, from $503 million at December 31, 2003. Not boarded loans
represent loans serviced by the seller on a temporary basis. The following table
sets forth information regarding the types of properties securing our loans.
PERCENTAGE OF TOTAL
PROPERTY TYPES PRINCIPAL BALANCE PRINCIPAL BALANCE
- -------------- ----------------- --------------------
Residential 1-4 family $ 755,307,799 80.44%
Condos, Coops, Pud dwelling 50,622,894 5.39%
Manufactured Homes 16,497,733 1.76%
Multi-family 2,221,894 0.24%
Commercial 2,847,944 0.30%
Unsecured loans 11,754,680 1.25%
Other 4,316,655 0.46%
Not boarded 95,440,903 10.16%
----------------- ------
Total $ 939,010,501 100.00%
================= ======
Geographic Dispersion. The following table sets forth information
regarding the geographic location of properties securing the loans in our
portfolio at December 31, 2004:
PERCENTAGE OF TOTAL
LOCATION PRINCIPAL BALANCE PRINCIPAL BALANCE
- -------------- ----------------- --------------------
Ohio $ 85,252,809 9.08%
New York 70,018,617 7.46%
California 69,624,971 7.41%
Florida 69,404,814 7.39%
Georgia 49,040,644 5.22%
New Jersey 48,469,855 5.16%
Michigan 41,021,623 4.37%
Pennsylvania 40,919,891 4.36%
North Carolina 39,424,071 4.20%
Texas 38,915,010 4.14%
All Others 386,918,196 41.21%
----------------- ------
$ 939,010,501 100.00%
================= ======
13
NOTES RECEIVABLE PORTFOLIO
As of December 31, 2004, our notes receivable portfolio, which consists of
purchased loans, included approximately 22,100 loans with an aggregate face
value of $812 million and a net value of $722 million (after allowance for loan
losses of $89 million), compared with approximately 10,095 loans with an
aggregate face value of $466 million and a net value of $420 million (after
allowance for loan losses of $46 million) as of December 31, 2003. The following
table provides a breakdown of the notes receivable portfolio by year:
2004 2003 2002
-------------- -------------- --------------
Performing loans $ 436,366,894 $ 322,345,537 $ 292,018,333
Allowance for loan losses 19,154,312 15,584,769 11,096,115
-------------- -------------- --------------
Total performing loans,
net of allowance for loan losses $ 417,212,582 $ 306,760,768 $ 280,922,218
============== ============== ==============
Impaired loans $ 280,078,060 $ 126,341,722 $ 119,134,128
Allowance for loan losses 57,889,091 30,111,278 32,809,607
-------------- -------------- --------------
Total impaired loans,
net of allowance for loan losses $ 222,188,969 $ 96,230,444 $ 86,324,521
============== ============== ==============
Not yet boarded onto servicing system $ 95,440,903 $ 16,866,611 $ 24,106,933
Allowance for loan losses 12,584,898 551,183 1,935,929
-------------- -------------- --------------
Not yet boarded onto servicing system,
net of allowance for loan losses $ 82,856,005 $ 16,315,428 $ 22,171,004
============== ============== ==============
Total notes receivable,
net of allowance for loan losses $ 722,257,556 $ 419,306,640 $ 389,417,743
============== ============== ==============
The following table provides a breakdown of the balance of our portfolio
of Notes Receivable by coupon type, net of allowance for loan losses and
excluding loans purchased but not yet boarded onto our servicing operations and
technology system as of December 31, 2004, December 31, 2003 and December 31,
2002 of $82,856,005, $16,315,428 and $22,171,004, respectively:
2004 2003 2002
-------------- -------------- --------------
Total Performing Loans:
Total Fixed Rate Performing Loans $ 300,286,566 $ 199,691,299 $ 213,429,977
============== ============== ==============
Total Adjustable Performing Loans $ 116,926,017 $ 107,069,469 $ 67,492,241
============== ============== ==============
Total Impaired Loans:
Total Fixed Rate Impaired Loans $ 184,312,204 $ 58,752,534 $ 58,873,564
============== ============== ==============
Total Adjustable Impaired Loans $ 37,876,765 $ 37,477,910 $ 27,450,957
============== ============== ==============
Total Notes Receivable, net of
allowance for loan losses,
boarded onto servicing systems $ 639,401,552 $ 402,991,212 $ 367,246,739
============== ============== ==============
14
LOAN ACQUISITIONS
We purchased over $652 million in assets in 2004, compared with
approximately $244 million in assets during 2003 and approximately $212 million
in assets during 2002. A substantial portion of the loans we acquired in 2004
resulted from the purchase of two large portfolios from BankOne N.A. and Master
Financial Corp., which together represented over $400 million in face loan value
at the time of acquisition. The following table sets forth the amounts and
prices of our mortgage loan acquisitions during the previous three years:
YEAR ENDED DECEMBER 31,
2004 2003 2002
-------- -------- -------
($ in millions)
Number of loans 12,914 3,476 4,331
Aggregate unpaid principal
balance at acquisition $ 626 $ 244 $ 212
Purchase price $ 545 $ 214 $ 184
Purchase price percentage 87% 88% 87%
In 2004, we also purchased a pool of $26 million of non-performing credit
card assets in 2004 for an aggregate purchase price of approximately $2 million.
LOAN DISPOSITIONS
In the ordinary course of our loan servicing process, we encounter a small
amount of purchased loans that, for various reasons, we determine to sell. We
typically sell these loans on a whole loan basis, which means that we sell all
right, title and interest in and to a pool of loans for cash. The following
table sets forth our dispositions of both purchased loans during the previous
three years:
2004 2003 2002
----------- ----------- --------
SALE OF PERFORMING
LOANS
Aggregate Face Value $19,845,833 $15,146,598 $900,000
Number of Loans Sold 143 148 4
Gain (Loss) on Sale 2,178,296 2,203,490 114,019
SALE OF NON-PERFORMING
LOANS
Aggregate Face Value 1,154,506 4,220,120 215,000
Number of Loans Sold 65 248 1
Gain (Loss) on Sale (477,182) (1,085,252) 25,500
15
REAL ESTATE OWNED
The following table sets forth our real estate owned, or OREO, portfolio:
2004 2003 2002
Other Real Estate Owned $ 20,626,156 $ 13,981,665 $ 9,353,884
Total Assets 891,510,754 476,733,346 424,419,034
OREO as a percentage of Total Assets 2.32% 2.93% 2.20%
TRIBECA'S LOAN ORIGINATIONS
The following table sets forth Tribeca's origination amounts by year, as
well as dispositions:
YEAR ENDED DECEMBER 31,
2004 2003 2002
------------ ----------- -----------
Number of loans originated 1,159 562 501
Original principal balance $200,301,285 $97,431,553 $70,444,721
Average Loan Amount $ 172,563 $ 172,598 $ 139,721
Originated as Fixed $ 54,128,022 $72,098,058 -
Originated as ARM $146,173,263 $25,045,495 -
Number of loans sold 576 449 235
Aggregate face value $ 89,925,754 $79,105,920 $42,531,689
Gain on sale 3,689,616 3,236,616 2,259,979
Geographic Dispersion of Originated Loans. The following table sets forth
information regarding the geographic location of properties securing the loans
originated by Tribeca in 2004:
PERCENTAGE OF TOTAL
LOCATION PRINCIPAL BALANCE PRINCIPAL BALANCE
New York $ 66,136,591 33.02%
New Jersey 42,943,063 21.44%
California 19,115,350 9.54%
Florida 13,758,554 6.87%
Pennsylvania 11,137,249 5.56%
Virginia 8,905,750 4.45%
Connecticut 7,802,362 3.90%
Maryland 6,765,945 3.38%
North Carolina 6,258,225 3.12%
Missouri 4,903,000 2.45%
All Others 12,575,196 6.28%
------------- ------
$ 200,301,285 100.00%
============= ======
16
GOVERNMENT REGULATION
The mortgage lending industry is highly regulated. Our business is regulated by
federal, state and local government authorities and is subject to federal, state
and local laws, rules and regulations, as well as judicial and administrative
decisions that impose requirements and restrictions on our business. At the
federal level, these laws, rules and regulations include:
- the Equal Credit Opportunity Act and Regulation B;
- the Federal Truth in Lending Act and Regulation Z;
- Home Ownership and Equity Protection Act, or HOEPA;
- the Real Estate Settlement Procedures Act, or RESPA, and Regulation
X;
- the Fair Credit Reporting Act;
- the Fair Debt Collection Practices Act;
- the Home Mortgage Disclosure Act and Regulation C;
- the Fair Housing Act;
- the Telephone Consumer Protection Act;
- the Gramm-Leach-Bliley Act;
- the Fair and Accurate Credit Transactions Act;
- the CAN-SPAM Act; and
- the USA Patriot Act.
These laws, rules and regulations, among other things:
- impose licensing obligations and financial requirements on us;
- limit the interest rates, finance charges, and other fees that we
may charge;
- prohibit discrimination both in the extension of credit and in the
terms and conditions on which credit is extended;
- prohibit the payment of kickbacks for the referral of business
incident to a real estate settlement service;
- impose underwriting requirements;
- mandate various disclosures and notices to consumers, as well as
disclosures to governmental entities;
- mandate the collection and reporting of statistical data regarding
our customers;
- require us to safeguard non-public information about our customers
and prohibit or limit sharing of that information;
- regulate our collection practices;
17
- require us to combat money-laundering and avoid doing business with
suspected terrorists;
- restrict the marketing practices we may use to find customers,
including restrictions on outbound telemarketing; and
- in some cases, impose assignee liability on us as purchaser of
mortgage loans as well as the entities that purchase our mortgage
loans.
Our failure to comply with these laws can lead to:
- civil and criminal liability, including potential monetary
penalties;
- loss of lending licenses or approved status required for continued
lending and servicing operations;
- demands for indemnification or loan repurchases from purchasers of
our loans;
- legal defenses causing delay and expense;
- adverse effects on the servicer's ability to enforce loans;
- the borrower having the right to rescind or cancel the loan
transaction;
- adverse publicity;
- individual and class action lawsuits;
- administrative enforcement actions;
- damage to our reputation in the industry;
- inability to sell or securitize our loans;
- loss of the ability to obtain ratings on our securitizations by
rating agencies; or
- inability to obtain credit to fund our operations.
These applicable laws and regulations are subject to administrative or judicial
interpretation, but some of these laws and regulations have been enacted only
recently or may be interpreted infrequently. As a result of infrequent or sparse
interpretations, ambiguities in these laws and regulations may leave uncertainty
with respect to permitted or restricted conduct under them. Any ambiguity under
a law to which we are subject may lead to non-compliance with applicable
regulatory laws and regulations. We actively analyze and monitor the laws, rules
and regulations that apply to our business, as well as the changes to such laws,
rules and regulations.
In 2002, the Federal Reserve Board adopted changes to Regulation C promulgated
under the Home Mortgage Disclosure Act. Among other things, the new regulations
require lenders to report pricing data on loans with annual percentage rates
that exceed the yield on treasury bills with comparable maturities by three
percent. The expanded reporting takes effect in 2004 for reports filed in 2005.
We anticipate that a majority of our loans will be subject to the expanded
reporting requirements. The expanded reporting does not provide for additional
loan information such as credit risk, debt-to-income ratio, LTV ratio,
documentation level or other salient loan features. As a result, lenders like us
are concerned that the reported information may lead to increased litigation as
the information could be misinterpreted by third parties.
Local, state and federal legislatures, state and federal banking regulatory
agencies, state attorneys general offices, the FTC, the Department of Justice,
the Department of Housing and Urban Development and state and local governmental
authorities have increased their focus on lending practices by some companies,
primarily in the
18
subprime lending industry, sometimes referred to as "predatory lending"
practices. Sanctions have been imposed by various agencies for practices such as
charging excessive fees, imposing higher interest rates than the credit risk of
some borrowers warrant, failing to disclose adequately the material terms of
loans to borrowers and abrasive servicing and collections practices.
HOEPA identifies a category of mortgage loans and subjects such loans to
restrictions not applicable to other mortgage loans. Loans subject to HOEPA
consist of loans on which certain points and fees or the annual percentage rate,
known as the APR, exceed specified levels. Liability for violations of
applicable law with regard to loans subject to HOEPA would extend not only to us
as the originator, but to the institutional loan purchasers of our loans or to
our purchase of loans as well. It is our policy to seek not to originate or
purchase loans that violate HOEPA or state and local laws discussed in the
following paragraph. Non-compliance with HOEPA and other applicable laws may
lead to demands for indemnification or loan repurchases from our warehouse
lenders and institutional loan purchasers, class action lawsuits and
administrative enforcement actions.
Laws, rules and regulations have been adopted, or are under consideration, at
the state and local levels that are similar to HOEPA in that they impose certain
restrictions on loans on which certain points and fees or the APR exceeds
specified thresholds, which generally are lower than under federal law. These
restrictions include prohibitions on steering borrowers into loans with high
interest rates and away from more affordable products, selling unnecessary
insurance to borrowers, flipping or repeatedly refinancing loans and making
loans without a reasonable expectation that the borrowers will be able to repay
the loans. Compliance with some of these restrictions requires lenders to make
subjective judgments, such as whether a loan will provide a "net tangible
benefit" to the borrower. These restrictions expose a lender to risks of
litigation and regulatory sanction no matter how carefully a loan is
underwritten. The remedies for violations of these laws are not based on actual
harm to the consumer and can result in damages that exceed the loan balance. In
addition, an increasing number of these laws, rules and regulations seek to
impose liability for violations on assignees, which may include our warehouse
lenders and whole-loan buyers, regardless of whether such assignee knew of or
participated in the violation.
The continued enactment of these laws, rules and regulations may prevent us from
originating certain loans and may cause us to reduce the interest rate or the
points and fees on loans that we do originate. These thresholds below which we
try to originate or purchase loans create artificial barriers to production and
limit the price at which we can offer loans to borrowers and our ability to
underwrite, originate, sell and finance mortgage loans. We may decide to
originate or purchase a loan that is covered by one of these laws, rules or
regulations only if, in our judgment, the loan is made in accordance with our
strict legal compliance standards and without undue risk relative to litigation
or to the enforcement of the loan according to its terms. If we decide to relax
our self-imposed restrictions on originating loans subject to these laws, rules
and regulations, we will be subject to greater risks for actual or perceived
non-compliance with the laws, rules and regulations, including demands for
indemnification or loan repurchases from the parties to whom we broker or sell
loans, class action lawsuits, increased defenses to foreclosure of individual
loans in default, individual claims for significant monetary damages, and
administrative enforcement actions. In addition, the difficulty of managing the
risks presented by these laws, rules and regulations may decrease the
availability of warehouse financing and the overall demand for subprime loans,
making it difficult to fund or sell any of our loans. If nothing else, the
growing number of these laws, rules and regulations will increase our cost of
doing business as we are required to develop systems and procedures to ensure
that we do not violate any aspect of these new requirements.
A portion of our mortgage loans are originated through independent mortgage
brokers. Mortgage brokers provide valuable services in the loan origination
process and are compensated for their services by receiving fees on loans.
Brokers may be paid by the borrower, the lender or both. If a borrower cannot or
does not want to pay the mortgage broker's fees directly, the loan can be
structured so that the mortgage broker's fees are paid from the proceeds of the
loan, or the loan can provide for a higher interest rate or higher fees to the
lender. Regardless of manner in which the broker is compensated, the payment is
intended to only compensate the broker for the services actually performed and
the facilities actually provided. RESPA prohibits the payment of fees for the
mere referral of real estate settlement service business. This law does permit
the payment of reasonable value for services actually performed and facilities
actually provided unrelated to the referral. Although we believe that our broker
compensation programs comply with all applicable laws and are consistent with
long-standing industry practice and regulatory interpretations, in the future
new regulatory interpretations or judicial decisions may require us to change
our broker compensation practices. Such a change may have a material adverse
effect on us and the entire mortgage lending industry.
19
COMPLIANCE, QUALITY CONTROL AND QUALITY ASSURANCE
We maintain a variety of quality control procedures designed to detect
compliance errors prior to funding. We have a stated anti-predatory lending
policy which is communicated to all employees at regular training sessions. In
addition, we subject a statistical sampling of our loans to post-funding quality
assurance reviews and analysis. We track the results of the quality assurance
reviews and report them back to the responsible origination units. Our loans and
practices are reviewed regularly in connection with the due diligence that our
loan buyers and lenders perform. State regulators also review our practices and
loan files and report the results back to us.
ENVIRONMENTAL MATTERS
In the ordinary course of our business we have from time to time acquired, and
we may continue to acquire in the future, properties securing loans that are in
default. In addition, loans that we purchase that are initially not in default
may subsequently be defaulted on by the borrower. In either case, it is possible
that hazardous substances or waste, contamination, pollutants or sources thereof
could be discovered on those properties after we acquire them. To date, we have
not incurred any environmental liabilities in connection with our OREO, although
there can be no guarantee that we will not incur any such liabilities in the
future.
EMPLOYEES
We recruit, hire, and retain individuals with the specific skills that
complement our corporate growth and business strategies. As of December 31,
2004, we had 186 full time employees. Of these, 66 were employed by Tribeca, our
origination subsidiary.
None of our employees are represented by a union or covered by a collective
bargaining agreement. We believe our relations with our employees are good.
ITEM 2. PROPERTIES.
We currently maintain our corporate headquarters on the sixth floor at 6
Harrison Street, New York, New York, where we own a 6,600 square foot
condominium unit. In the same building, we have also entered into two subleases
for additional space, one of approximately 2,500 square feet of space on the
fifth floor, which we sublease from RMTS Associates, LLC, a company that is 80%
owned by our Chairman, and one of approximately 2,200 square feet of space on
the fourth floor, which we sublease from a third party. These subleases
terminate in 2008 and 2005, respectively.
We also have two other office locations in the same general vicinity. One is
located at 99 Hudson Street, New York, New York where we lease approximately
6,400 square feet of office space under a lease agreement with a term expiring
in December 2008. We have also leased approximately 7400 square feet of office
space at 185 Franklin Street, New York, New York, which is owned by 185 Franklin
Street Development Associates, a limited partnership of which 185 Franklin
Street Development Corporation, which is wholly owned by our Chairman, is the
general partner. These leases expire in November 2008 and March 2008,
respectively.
We have also leased two offices for Tribeca in Marlton, New Jersey
(approximately 1,400 square feet) and Trivos, Pennsylvania (approximately 1,000
square feet). These leases expire in 2006.
On March 4, 2005, we entered into a sublease agreement with Lehman Brothers
Holdings Inc. to sublease approximately 33,866 square feet of space at 101
Hudson Street, Jersey City, New Jersey for use as executive and administrative
offices. We currently expect the term of the sublease, which is subject to
certain conditions, to commence by April 1, 2005. The term of the sublease is
through December 30, 2010.
20
We are negotiating with certain of our landlords regarding the cost of
terminating certain of our current leases in New York.
In addition to the properties described above that we use for the conduct of our
business, we own REO in various states that we acquired through acquisition,
foreclosure or a deed in lieu. These properties are 1-4 family residences,
co-ops, condos or commercial property. We acquire or foreclose on property
primarily with the intent to sell it at a profit, or to rent the property until
an economically beneficial sale can be made.
ITEM 3. LEGAL PROCEEDINGS.
We are involved in routine litigation matters incidental to our business related
to the enforcement of our rights under mortgage loans we hold, none of which is
individually material. In addition, because we originate and service mortgage
loans throughout the country, we must comply with various state and federal
lending laws and we are routinely subject to investigation and inquiry by
regulatory agencies, some of which arise from complaints filed by borrowers,
none of which is individually material.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On December 29, 2004, the holders of 4,031,044 shares of common stock of the
Company, or approximately 66% of the outstanding shares of common stock of the
Company, acting by written consent in lieu of a special meeting, pursuant to
Section 228 of the General Corporation Law of the State of Delaware, authorized,
approved and adopted the Company's fifth amended and restated certificate of
incorporation.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
Market Information. The Company's common stock is quoted on the Over-The-Counter
Bulletin Board ("OTCBB") under the symbol "FCSC".
The following table sets forth the bid prices for the common stock on the OTCBB,
for the periods indicated. Trading during these periods was limited and
sporadic; therefore, the following quotes may not accurately reflect the true
market value of the securities. Such prices reflect inter-dealer prices without
retail markup or markdown or commissions and may not represent actual
transactions.
Information for 2004 and 2003 was compiled from information representing the
daily inter-dealer bid activity during the period.
2004 Bid 2003 Bid
--------------- --------------
High Low High Low
------ ----- ----- -----
First Quarter $ 4.10 $2.97 $1.75 $1.07
Second Quarter $ 4.10 $3.35 $5.25 $1.15
Third Quarter $ 6.50 $3.33 $3.25 $2.75
Fourth Quarter $13.00 $6.41 $3.20 $2.96
As of December 31, 2004, there were approximately 468 record holders of the
Company's common stock.
Dividend Policy. The Company intends to retain all future earnings that may be
generated from operations to help finance the operations and expansion of the
Company and accordingly does not plan to pay cash dividends to holders of the
common stock during the reasonably foreseeable future. Any
21
decisions as to the future payment of dividends will depend on the earnings and
financial position of the company and such factors, as the Company's Management
and Board of Directors deem relevant.
See Item 12 for certain equity compensation information with respect to equity
compensation plans of the Company.
RECENT SALES OF UNREGISTERED SECURITIES
In October 2004, our new CEO purchased 20,000 shares of common stock at a price
of $5.52 per share. In addition, the new CEO received 100,000 restricted shares
of our common stock as compensation.
The above transaction was a private transaction not involving a public offering
and was exempt from registration provisions of the Securities Act of 1933, as
amended, or the "Act", pursuant to Section 4(2) thereof. The sale of the
securities was without the use of an underwriter, and the certificates
representing the shares of common stock bear a restrictive legend permitting
transfer thereof only upon registration or under an exemption from registration
under the Act.
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data set forth below as of and for the years ended
December 31, 2004, 2003, 2002, 2001 and 2000 have been derived from the
Company's audited consolidated financial statements. This information should be
read in conjunction with "Item 1. Business" and "Item 7. Management Discussion
and Analysis of Financial Condition and Results of Operations", as well as the
audited financial statements and notes thereto included in "Item 8. Financial
Statements."
2004 2003 2002 2001 2000
------------- ------------- ------------- ------------- -------------
STATEMENT ON INCOME DATA
Revenues $ 80,485,015 $ 57,566,559 $ 46,842,437 $ 37,963,358 $ 29,047,390
Expenses 63,078,705 45,186,102 34,664,987 34,637,210 28,476,727
------------- ------------- ------------- ------------- -------------
Income before provision for income taxes 17,406,310 12,380,457 12,177,450 3,326,148 570,663
Provision for income taxes 7,900,000 5,695,000 5,514,000 444,000 -
------------- ------------- ------------- ------------- -------------
Net Income $ 9,506,310 $ 6,685,457 $ 6,663,450 $ 2,882,148 $ 570,663
============= ============= ============= ============= =============
Earnings per share basic $ 1.60 $ 1.13 $ 1.13 $ 0.49 $ 0.10
Earnings per share diluted $ 1.43 $ 1.05 $ 1.07 $ 0.49 $ 0.10
BALANCE SHEET DATA
Total Assets $ 891,510,754 $ 476,733,346 $ 424,419,034 $ 334,162,501 $ 243,235,288
Total Liabilities 861,954,872 457,054,040 411,425,185 327,832,102 239,787,037
------------- ------------- ------------- ------------- -------------
Total Stockholders' Equity $ 29,555,882 $ 19,679,306 $ 12,993,849 $ 6,330,399 $ 3,448,251
============= ============= ============= ============= =============
Principal $ 811,885,856 $ 465,553,870 $ 435,259,394 $ 331,643,076 $ 255,055,677
Purchase discount (32,293,669) (25,678,165) (22,974,310) (22,248,344) (23,392,400)
Allowance for loan losses (89,628,299) (46,247,230) (45,841,651) (33,490,456) (24,086,322)
------------- ------------- ------------- ------------- -------------
Net Notes $ 689,963,888 $ 393,628,475 $ 366,443,433 $ 275,904,276 $ 207,576,955
============= ============= ============= ============= =============
Allowance for loan losses as a percentage of principal 11.0% 9.9% 10.5% 10.1% 9.4%
Purchase discount as a percentage of principal 4.0% 5.5% 5.3% 6.7% 9.2%
Loans held for Investment $ 110,496,274 $ 9,536,669 $ - $ - $ -
Loans held for sale 16,851,041 27,372,779 22,869,947 28,203,047 8,670,691
Other real estate owed 20,626,156 13,981,665 9,353,669 3,819,673 5,290,053
22
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
The following discussion of our operations and financial condition should be
read in conjunction with our financial statements and notes thereto included
elsewhere in this Form 10-K. In these discussions, most percentages and dollar
amounts have been rounded to aid presentation. As a result, all such figures are
approximations.
OVERVIEW
The following management's discussion and analysis of financial condition and
results of operations is based on the amounts reported in the Company's
consolidated financial statements. These financial statements are prepared in
accordance with accounting principles generally accepted in the United States of
America. In preparing the financial statements, management is required to make
various judgments, estimates and assumptions that affect the reported amounts.
Changes in these estimates and assumptions could have a material effect on the
Company's consolidated financial statements.
EXECUTIVE LEVEL SUMMARY
Net income totaled $9.5 million for 2004, $6.7 million for 2003 and $6.7 million
for 2002. Earnings per common share for 2004 were $1.43 on a diluted basis and
$1.60 on a basic basis, compared to $1.02 and $1.13 for 2003 and $1.07 and $1.13
for 2002. Our revenues for 2004 increased by 39.8% to $80.5 million, from 2003
revenues of $57.6 million. Net income increased 42.2% to $9.5 million in 2004,
from net income of $6.7 million in 2003. During 2004, we closed acquisitions of
S&D assets with an aggregate face amount of $652 million, comprised of
approximately $548 million of bulk acquisitions, including acquisitions of $310
million from Bank One and $100 million from Master Financial, which were the two
largest bulk acquisitions in our history, and $104 million of flow acquisitions.
We originated over $200 million of sub prime loans through Tribeca. We grew the
size of our total portfolio aggregate net notes receivable, loans held for sale,
loans held for investment and REO at the end of 2004 to $838 million from $446
million at the end of 2003. Our total debt outstanding, including senior debt
and financing agreements grew to $847 million at the end of 2004 from $450
million at the end of 2003. Our weighted average cost of funds during 2004
increased to 5.0% from 4.8% during 2003.
APPLICATION OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES
In December 2001, the Securities and Exchange Commission ("SEC") requested
that all registrants discuss their most "critical accounting policies" in
management's discussion and analysis of financial condition and results of
operations. The SEC indicated that a "critical accounting policy" is one which
is both important to the portrayal of the company's financial condition and
results and requires management's most difficult, subjective or complex
judgments, often as a result of the need to make estimates about the effect of
matters that are inherently uncertain. While The Company's significant
accounting policies are more fully described in Note 1 to the Consolidated
Financial Statements, the following is a summary of the accounting policies
believed by management to be most critical in their potential effect on the
Company's financial position or results of operations:
ALLOWANCE FOR LOAN LOSSES - The Company performs reviews of its loan portfolio
upon purchase, at loan boarding, and on a frequent basis thereafter to segment
impaired loans under Statement of Financial Accounting Standards ("SFAS") No.
114. A loan is considered impaired when it is probable the Company will be
unable to collect all contractual principal and interest payments due in
accordance with the terms of the note agreement. An allowance for loan losses is
estimated based on the Company's impairment analysis. Management's judgment in
determining the adequacy of the allowance for loan losses is based on the
evaluation of individual loans within the portfolios, the known and inherent
risk
23
characteristics and size of the portfolio, the assessment of current economic
and real estate market conditions, estimates of the current value of underlying
collateral, past loan loss experience and other relevant factors. In connection
with the determination of the allowance for loan losses, management obtains
independent appraisals for the underlying collateral when considered necessary.
The allowance for loan losses is a material estimate which could change
significantly in the near term.
PURCHASE DISCOUNT - The Company frequently purchases S&D assets at discounts to
unpaid principal balance. The Company accounts for its acquisitions of S&D
assets using the guidance provided by the AICPA Practice Bulletin 6,
"Amortization of Discounts on Certain Acquired Loans" and, effective January
2005 for acquisitions that are subject to it, the guidance provided by the AICPA
Statement of Position 03-03 ("SOP 03-03"), "Accounting for Certain Debt
Securities Acquired in a Transfer." The Company purchases portfolios of
relatively homogenous S&D assets, pools them with similar, recently originated
S&D assets, and records each pool ("Static Pool") at its acquisition cost. Each
Static Pool is accounted for as a single unit for recognition of revenue,
principal payments and impairment purposes.
The difference between the initial allowance for loan losses and the initial
discount of a Static Pool is accreted into income as purchase discount based on
the level yield method. The amount of purchase discount to be accreted under the
level yield method is based on the internal rate of return ("IRR") of the
cashflow, or the rate of return that each Static Pool requires to amortize the
outstanding purchase discount of such Static Pool to zero over its estimated
life. Each Static Pool's IRR is determined by estimating future cash flows no
less frequently than on a quarterly basis. The projection of cash flows for
purposes of amortizing purchase loan discount is a material estimate, which
could change significantly, in the near term.
To the extent that the allowance for loan losses decreases, the change is added
to purchase discount and accreted into income under the level yield method or
taken directly into income to the extent there is no outstanding purchase
discount balance. To the extent that the allowance for loan losses increases,
the change was historically netted against the outstanding balance of purchase
discount (or directly against income if no purchase discount existed). Beginning
in January 2005, for acquisitions that are subject to SOP 03-3, if the allowance
for loan losses on a Static Pool increases, the outstanding purchase discount of
such Static Pool will remain unchanged and an immediate provision for loan
losses will be taken against income.
NOTES RECEIVABLE - The Company purchases mortgage loans, notes receivable, to be
held as long-term investments. Loan purchase discounts are established at the
acquisition date. Management must periodically evaluate each of the purchase
discounts to determine whether the projection of cash flows for purposes of
amortizing the purchase loan discount has changed significantly. Changes in the
projected payments are accounted for as a change in estimate and the periodic
amortization is prospectively adjusted over the remaining life of the loans.
Should projected payments not exceed the carrying value of the loan, the
periodic amortization is suspended and either the loan is written down or an
allowance for uncollectibility is recognized. The allowance for loan losses is
initially established by an allocation of the purchase loan discount based on
management's assessment of the portion of purchase discount that represents
uncollectable principal. Subsequently, increases to the allowance are made
through a provision for loan losses charged to expense. Given the nature of the
Company's loan portfolio and the underlying real estate collateral, significant
judgment is required in determining periodic amortization of purchase discount,
and allowance for loan losses. The allowance is maintained at a level that
management considers adequate to absorb potential losses in the loan portfolio.
LOANS HELD FOR SALE - The loans held for sale consist primarily of secured real
estate first and second mortgages originated by the Company. Such loans held for
sale are performing and are carried at lower of cost or market.
24
OTHER REAL ESTATE OWNED - Other real estate owned ("OREO") consists of
properties acquired through, or in lieu of, foreclosure or other proceedings and
are held for sale and carried at the lower of cost or fair value less estimated
costs to sell. Any write-down to fair value, less cost to sell, at the time of
acquisition is charged to purchase discount. Subsequent write-downs are charged
to operations based upon management's judgment and continuing assessment of the
fair value of the underlying collateral. Property is evaluated periodically to
ensure that the recorded amount is supported by current fair values and
valuation allowances are recorded as necessary to reduce the carrying amount to
fair value less estimated cost to sell. Revenue and expenses from the operation
of OREO and changes in the valuation allowance are included in operations.
Direct costs relating to the development and improvement of the property are
capitalized, subject to the limit of fair value of the collateral, while costs
related to holding the property are expensed. Gains or losses are included in
operations upon disposal.
INCOME TAXES - Income taxes are accounted for under Financial Accounting
Standards Board Statement No. 109 "Accounting for Income Taxes". This method
provides for deferred income tax assets or liabilities based on the temporary
difference between the income tax basis of assets and liabilities and their
carrying amount in the consolidated financial statements. Deferred tax assets
and liabilities are measured using enacted tax rates expected to apply to
taxable income in the years in which those temporary differences are expected to
be recovered or settled. Deferred tax assets are reduced by a valuation
allowance if management determines that it is more likely than not that some
portion or all of the deferred tax assets will not be realized.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2004 COMPARED TO YEAR ENDED DECEMBER 31, 2003
Revenues increased by $22.9 million or 40%, to $80.5 million during 2004, from
$57.6 million during 2003. Revenues includes interest income, purchase discount
earned, gains on sale of notes receivable, gain on sale of loans held for sale,
gain on sale of REO, gain on holding securities, rental income and other income.
Revenue, as a percentage of average assets, was for the fiscal year 11.8% for
2004 as compared with 12.8% for 2003. The difference represented principally our
closings towards the latter half of 2004 of the two largest bulk acquisitions in
our history.
Interest income increased by $16.8 million or 39%, to $59.5 million during 2004
from $42.7 million during 2003. The Company recognizes interest income on notes
receivable and loans held for investment, including: (i) interest on performing
notes, (ii) interest received with settlement payments on non-performing notes
and (iii) the balance of settlements in excess of the carried principal amount.
The increase in interest income reflected a 36% increase in the average of the
balances of gross notes receivable and loans held for investment and sale at the
end of 2004 compared to the end of 2003.
Purchase discount earned increased by $4.0 million or 77%, to $9.2 million
during 2004 from $5.2 million during 2003. This increase resulted primarily from
a 74% increase in gross notes receivable, and the increased prepayments during
2004, which accelerate recognition of the associated purchase discount. The
Company received $231 million of principal in 2004 compared with $157 million of
principal in 2003. These two contributing factors outweighed the reduction over
the past several years, of purchase discount available to be earned as a
percentage of our portfolio of purchased notes receivable.
Gains on sale of notes receivable increased by $0.6 million or 52%, to $1.7
million during 2004 from $1.1 million during 2003. The Company sold a total of
$21.0 million in principal amount of notes receivable during 2004, of which
$19.8 million was performing, as compared to $19.4 million during 2003, of which
only $11.2 million was performing.
25
Gain on sale of originated loans increased by $0.5 million or 16%, to $3.7
million during 2004 from $3.2 million during 2003. This increase reflected a 14%
increase in the principal amount of such loans sold during 2004 to $89.9 million
from $79.1 million during 2003. The weighted average margin on sold loans
remained constant at 410 basis points during both 2004 and 2003. During 2003,
Tribeca's policy was to realize the gains associated with its origination by
selling all of its originated loans for margin. In July, 2004, the Company
determined for the foreseeable future to retain most of the liberty loans
originated by Tribeca, subject to sales from time to time for the same reasons
we periodically sell notes receivable in our portfolio.
Gain on sale of OREO decreased by $0.5 million or 47% to $0.5 million during
2004 from $1.0 million during 2003. The Company sold 290 OREO properties at a
sales price of $23.5 million during 2004 as compared to 231 OREO properties at a
sales price of $18.1 million during 2003. This decrease was due to increased
costs associated with maintaining the properties and restoring them to
appropriate condition for marketing and sales, and the increasing number of the
properties that are carried at market value, which are generally lower than the
cost at which we acquired the notes or claims resolution of which resulted in
our ownership of the OREO.
Prepayment penalties and other income increased by $1.6 million or 38%, to $5.8
million during 2004 from $4.2 million during 2003. The increase reflected
increases in prepayments during 2004 resulting from the low interest rate
environment and the growth in the size of the portfolio, increases in late
charges resulting primarily from the growth in the size of the portfolio, and
increases in loan application fees due to the growth in the volume of our
non-prime loan originations.
Operating expenses increased by $17.9 million or 40% to $63.1 million during
2004 from $45.2 million during 2003. Total operating expenses include interest
expense, collection, general and administrative expenses, provisions for loan
losses, amortization of loan commitment fees and depreciation expense.
Interest expense increased by $11.1 million or 51%, to $32.8 million during 2004
from $21.7 million during 2003. This increase reflected an increase in the
balance of total debt, including Senior Debt and financing agreements and
increases in the costs of funds during 2004, resulting from increases in the
index rates. Senior Debt and financing agreements increased by 88% or $397
million to $847 million as of the end of 2004 compared with $450 million as of
the end of 2003. The weighted average cost of funds was 5.0% during 2004 and
4.9% during 2003.
Collection, general and administrative expenses increased by $5.4 million or 30%
to $23.3 million during 2004 from $17.9 million during 2003. The increased costs
occurred primarily related to the growth in the level of acquisitions and the
size of the portfolio. Increased costs also resulted from a restricted stock
grant to our new Chief Executive Officer, a settlement entered into with our
former Chief Executive Officer, a settlement in respect of options owing to
members of our board of directors for services rendered in previous years that
were not issued in such years, and professional fees relating to increased tax
and audit fees.
Provisions for loan losses, which relate to our purchased loans, increased by
$0.5 million or 16%, to $3.7 million during 2004 from $3.2 million during 2003.
This increase was primarily due to increased provision for loan losses with
respect to certain portfolios, which did not have additional purchase discount
that might be moved into provision for loan losses. Provisions for loan losses
are incurred as soon as the valuation of the asset diminishes and there is no
unamortized discount remaining associated with that asset. Provision for loan
losses, expressed as a percentage of principal amounts of notes receivable held
at the end of the year, were approximately 0.46% and 0.63% for 2004 and 2003,
respectively.
Amortization of deferred financing costs increased by $0.8 million or 40%, to
$2.8 million during 2004 from $2.0 million during 2003. This increase resulted
primarily from the growth in the portfolio and the
26
increased pace of prepayments during 2004, which caused a corresponding increase
in the pay down of Senior Debt.
Our operating income increased by $5.0 million or 40% to $17.4 million during
2004 from $12.4 million during 2003 for the reasons set forth above.
During 2004, the Company had a provision for income taxes of $7.9 million as
compared to a provision of $5.7 million in 2003. Our effective tax rates for
2004 and 2003 were 45% and 46%, respectively.
YEAR ENDED DECEMBER 31, 2003 COMPARED TO YEAR ENDED DECEMBER 31, 2002
Revenues increased by $10.8 million or 23%, to $57.6 million during 2003, from
$46.8 million during 2002.
Revenue, as a percentage of average assets was 12.8% for 2003 as compared with
12.4% for 2002.
Interest income increased by $6.0 million or 16%, to $42.7 million during 2003
from $36.7 million during 2002. The increase reflected a 17.5% increase in the
average of the balances of the gross notes receivable and loans held for
investment and sale, at the end of the four fiscal quarters of 2004.
Purchase discount earned increased by $1.4 million or 37%, to $5.2 million
during 2003 from $3.8 million during 2002. This increase reflected primarily the
increase in prepayments received in 2003. The Company received $144 million of
principal in 2003 compared with $106 million of principal in 2002.
Gains on sale of notes receivable increased by $1.0 to $1.1 million during 2003
from $0.1 million during 2002. The Company sold a total of $19.4 million in
principal amount of notes receivable during 2003, of which $11.2 million was
performing, as compared to $1.1 million in performing notes during 2002. The
increase in loan sales reflected our initiating during 2003 a policy of
liquidating loans we suspect might be likely to refinance or decline in value
often due to interest rate changes in anticipation of such changes.
Gain on sale of originated loans increased by $0.9 million or 39%, to $3.2
million during 2003 from $2.3 million during 2002. This increase reflected an
86% increase in the principal amount of such loans sold during 2003 to $79.1
million from $42.5 million during 2002.
Gain on sale of OREO increased by $0.2 million or 25% to $1.0 million during
2003 from $0.8 million during 2002. The Company sold 231 OREO properties at a
sales price of $18.1 million during 2003 as compared to 105 OREO properties at a
sales price of $4.9 million during 2002. The increase in the number of
properties sold reflected growth in our OREO inventory due to both an increase
in foreclosures and the purchase of a few pools during the year that already had
loans in the foreclosure process.
Prepayment penalties and other income increased by $1.3 million or 45%, to $4.2
million during 2003 from $2.9 million during 2002. The increase reflected
increases in prepayment penalties associated with the increased volume of
prepayments during 2003, increases in late charges resulting primarily from the
growth in the size of the portfolio, and increase in loan application fees due
to the growth in the volume of our non-prime loan originations.
Operating expenses increased by $8.9 million or 24% to $45.2 million during 2003
from $36.3 million during 2002, excluding the effects of a special recovery
during 2002.
Interest expense increased by $2.6 million or 14%, to $21.7 million during 2003
from $19.1 million during 2002. This increase reflected an increase in the
balance of total debt, including Senior Debt and financing agreements at the end
of 2003. Senior debt and financing agreements increased by 11% or $44
27
million to $451 million at the end of 2003 as compared to $407 million at the
end of 2002. The weighted average cost of funds during 2003 was 4.9% and 5.4%
during 2002.
Collection, general and administrative expenses increased by $5.0 million or 39%
to $17.9 million during 2003 from $12.9 million during 2002. The increase in
expenses resulted from a variety of different initiatives, including ramping up
our Tribeca, our origination subsidiary, upgrading our servicing system,
changing and upgrading our property insurance policies, as well as a result of
the acquisition and servicing of a greater number of loans.
Provisions for loan losses, which related to our purchased loans, increased by
$0.5 or 18%, to $3.2 million during 2003 from $2.7 million during 2002. This
increase was primarily due to increased provision for loan losses with respect
to certain portfolios which did not have additional purchase discount that might
be moved into provision for loan losses and the increase in the size of the
nonperforming portfolio. Provision for loan losses, expressed as a percentage of
principal amount of notes receivable held at the end of the year, were
approximately 0.63% and 0.58% for 2003 and 2002, respectively.
Amortization of deferred financing costs increased by $0.7 million or 54%, to
$2.0 million during 2003 from $1.3 million during 2002. This increase resulted
primarily from the increased pace of prepayments in 2003 and the growth in the
portfolio which caused a corresponding increase in the pay down of Senior Debt.
Our operating income increased by $0.2 million or 2% to $12.4 million during
2003 from $12.2 million during 2002 for the reasons set forth above.
During 2003, we had a provision for income taxes of $5.7 million as compared to
a provision of $5.5 million in 2002. The effective tax rate for 2003 and 2002
was 46% and 45% respectively.
COST OF FUNDS. As of December 31, 2004, the Company owed an aggregate of $808
million ("Senior Debt") to a bank (the "Senior Debt Lender"), which was incurred
in connection with the purchase of, and is secured by, the Company's loan
portfolios and OREO portfolios. The Company's Senior Debt incurred after March
1, 2001, accrues interest at the Federal Home Loan Bank of Cincinnati ("FHLB")
thirty-day advance rate (the "Index") plus a spread of 3.25% (the "Spread").
Senior Debt incurred before March 1, 2001 accrues interest at prime rate plus a
margin of between 0% and 1.75%. At December 31, 2004, approximately $21 million
of the Senior Debt incurred before March 1, 2001 remained outstanding and will
continue to accrue interest at the prime rate plus a margin of between 0% and
1.75%. At December 31, 2004, the weighted average interest rate on Senior Debt
was 5.73%.
LIQUIDITY AND CAPITAL RESOURCES
GENERAL
During the year ended December 31, 2004 the Company purchased 12,914 loans,
consisting primarily of first and second mortgages, with an aggregate face value
of $626 million at an aggregate purchase price of $545 million, or 87% of the
face value. These acquisitions were fully funded through Senior Debt in the
amount equal to the purchase price plus a 1% loan origination fee.
The Company's portfolio of purchased notes receivable at December 31, 2004, had
a face amount of $812 million and included net notes receivable of approximately
$690 million. Net notes receivable are stated at the amount of unpaid principal,
reduced by purchase discount and allowance for loan losses. The Company has the
ability and intent to hold its notes until maturity, payoff or liquidation of
collateral or may sell certain notes, if it is economically advantageous to do
so.
28
At December 31, 2004, the Company held OREO recorded in its consolidated
financial statements at $21 million. OREO is recorded at the lower of cost or
fair market value less estimated costs of disposal. The Company believes that
the OREO inventory held at December 31, 2004 has a net realizable value of
approximately $22 million based on market analyses of the individual properties
less estimated closing costs.
At December 31, 2004, the Company held originated loans for investment of $110
million, which are carried at the amortized cost of the loans, and held
originated loans for sale of $17 million, which are carried at the lower of cost
or fair market value.
CASH FLOW FROM OPERATING, INVESTING AND FINANCING ACTIVITIES
As of December 31, 2004, we had cash and cash equivalents of approximately $19
million compared to approximately $14 million at December 31, 2003. The increase
was primarily due to an increase in collections on purchased notes receivable
and originated loans held for investment, caused primarily by an increase in the
portfolio balance in 2004 due to increased acquisitions and originations.
Primary sources of cash from operations include payments on purchased notes
receivable and originated loans.
Substantially all of the assets of the Company are invested in its portfolios of
notes receivable, loans held for investment, OREO and loans held for sale.
Primary sources of the Company's cash flow for operating and investing
activities are borrowings under its Senior Debt facilities, collections on notes
receivable and gain on sale of notes and OREO properties. Primary uses of cash
include purchases of notes receivable and origination of loans. We rely
significantly upon our Senior Lender to provide the funds necessary for the
purchase of notes receivable portfolios and the origination of loans. While we
have historically been able to finance these purchases and originations, we have
not had committed loan facilities in significant excess of the amount we
currently have outstanding under our Senior Debt facilities, described below.
Net cash used in operating activities was $7 million in 2004, compared to
approximately$12 million in 2003. The decrease was primarily due to an increased
sales volume of loans held for sale and increased net income, which provided
more cash in the Company's operating activities. These increases were partially
offset by the origination of mortgage loans held for sale, which were $108
million in 2004 as compared with $97 million in 2003, as well as payment of
interest expense, overhead and litigation expense incidental to its collections,
and for the foreclosure and improvement of OREO, partially offset by proceeds of
$101 million from the sale of originated loans in 2004, as compared with
proceeds of $80 million in 2003, and prepayment penalties and other income of
approximately $6 million, compared with approximately $4 million in 2003.
Net cash used in investing activities was approximately $384 million in 2004,
compared to approximately $28 million in 2003. The increase was primarily due to
increases in the purchase of notes receivable, which constituted approximately
$546 million in 2004 as compared to $214 million in 2003, partially offset by
principal collections of notes receivable of $209 million in 2004, as compared
with $157 million in 2003, originations of loans held for investments of $92
million as compared to a transfer of $14 million in 2003 and proceeds from sales
of notes receivable of $20 million in 2004 compared with $16 million in 2003 and
sales of OREO of $20 million in 2004 compared with $16 million in 2003.
Net cash provided by financing activities increased to approximately $397
million in 2004, from $44 million in 2003. The increase resulted primarily from
a net increase in Senior Debt of $381 million and a net increase in borrowings
under financing agreements of $16 million.
29
SENIOR DEBT
As of December 31, 2004, the Company owed an aggregate of $808 million to its
Senior Debt lender under several loans:
Senior Debt Facility
General. On October 13, 2004, the Company and all of its subsidiaries
other than Tribeca entered into a Master Credit and Security Agreement with Sky
Bank, an Ohio banking corporation (the "Bank"). Under the facility as amended,
the Company and its subsidiaries that are or become parties to the credit
agreement are entitled to request loans to finance the purchase of residential
mortgage loans or refinance existing outstanding loans. The credit agreement
amended and restated the borrowers' previous loan agreements with the Bank,
under which an aggregate principal balance of approximately $747 million was
outstanding immediately prior to the execution of the new facility. The facility
does not include a commitment to additional lendings, which are therefore
subject to the Bank's discretion as well as any regulatory limitations to which
the Bank is subject. The facility terminates on October 13, 2006.
Interest Rates and Fees. Interest on the loans is payable monthly at a
floating rate equal to the highest Federal Home Loan Bank of Cincinnati 30 day
advance rate as published daily by Bloomberg under the symbol FHL5LBRI or, "the
30 day advance rate", plus the applicable margin as follows:
If the 30 day advance rate is the applicable margin is
Less than 2.01% 350 basis points
2.01 to 4.75% 325 basis points
Greater than 4.75% 300 basis points
In addition, upon each closing of a subsidiary loan, the Company is
required to pay an origination fee equal to 1% of the amount of the subsidiary
loan unless otherwise agreed to by the Bank and the subsidiary. Upon repayment
of subsidiary loans, the Bank is generally entitled to receive a fee equal to
the lesser of (i) one half of one percent (0.50%) or with respect to certain
subsidiaries whose loans were originated before 1996, one percent 1% of the
original principal balance of the subsidiary loan or (ii) 50% of the remaining
cash flows of the pledged mortgage loans related to such subsidiary loan as and
when received by the relevant subsidiary after the repayment of the subsidiary
loan. In connection with certain subsidiary loans, the Company and the Bank have
agreed to specified minimum fees and fee waivers.
Principal; Prepayments; Termination of Commitments. The unpaid principal
balance of each loan is amortized over a period of ten years, but matures three
years after the date the loan was made. Historically the Bank and the Company
have routinely agreed to extend the maturities of such loans for additional
three-year terms upon their maturity. Each borrower is required to make monthly
payments of the principal of its outstanding loans.
In the event there is a material and adverse breach of the representations
and warranties with respect to a pledged mortgage loan that is not cured within
30 days after notice by the Bank, the Company will be required to prepay the
loan with respect to such pledged mortgage loan in an amount equal to the price
(as determined by the Bank) at which such mortgage loan could readily be sold.
Covenants; Events of Default. The facility contains affirmative, negative
and financial covenants customary for financings of this type, including, among
other things, a covenant that the Company and its subsidiaries together maintain
a minimum net worth of at least $10 million. The agreement contains events of
default customary for facilities of this type (with customary grace periods, as
applicable).
30
Security. The borrowers' obligations under the credit agreement are
secured by a first priority lien on the mortgage loans financed by proceeds of
loans made under the credit agreement. The mortgage loans securing each
borrower's obligations under the credit agreement also secure each other
borrower's obligations under the credit agreement. In addition, pursuant to a
lock-box arrangement, the Bank is entitled to receive all sums payable to a
subsidiary borrower in respect of any of the collateral.
Warehouse Facility
General. On September 30, 2003, Tribeca entered into a warehousing credit
and security agreement with the Bank. The facility was amended on April 7, 2004.
The agreement, as amended, provides for a commitment of $40 million which
expires on April 30, 2006. Tribeca is currently discussing with the Bank an
increase in the amount of the commitment to $60 million.
Interest Rates and Fees. Interest on advances is payable monthly at a rate
per annum equal to the greater of (i) a floating rate equal to the Wall Street
Journal Prime Rate or (ii) five percent (5%). In addition, Tribeca is required
to pay transaction fees equal to $25 for each mortgage loan financed by an
advance under the warehouse facility and an annual commitment fee equal to
$15,000 multiplied by a fraction the numerator of which is the average monthly
unborrowed commitment during the previous year and the denominator of which is
$40 million.
Principal Payment. Advances are required to be repaid upon the earlier of
the termination or expiration of the commitment or within 120 days after the
date of the advance or under certain other circumstances. From time to time, by
agreement between the Bank and the Company, amounts borrowed under the warehouse
facility are transferred to term loans. At the end of each month, 98% of any
amounts paid to repay advances are required to be repaid from the Company's
senior credit facility with the Bank. Amounts under the facility may be
borrowed, repaid and reborrowed by Tribeca from time to time until the warehouse
expiration of the commitment.
Prepayments; Termination of Commitment. Voluntary prepayments and
commitment reductions under the facility are permitted at any time without fee
upon proper notice and subject to a minimum dollar requirement. The Bank can
terminate the commitment at any time upon 60 days prior notice to Tribeca. The
Bank can terminate the facility at any time in the event there is a material
adverse change in Tribeca's financial condition.
Covenants; Events of Default. The facility contains affirmative, negative
and financial covenants customary for financings of this type, including, among
other things, maintenance of consolidated net worth requirements, a ratio of
total debt to total assets, maintenance of consolidated pretax net income. The
credit agreement contains events of default customary for facilities of this
type (with customary grace periods, as applicable).
Security and Guarantees. The facility is secured by a lien on all of the
mortgage loans delivered to the Bank or in respect of which an advance has been
made as well as by all mortgage insurance and commitments issued by insurers to
insure or guarantee pledged mortgage loans. Tribeca also assigns all of its
rights under third-party purchase commitments covering pledged mortgages and the
proceeds of such commitments and its rights with respect to investors in the
pledged mortgages to the extent such rights are related to pledged mortgages. In
addition, we have provided a guaranty of the facility which is secured by a lien
on substantially all of our personal property.
Availability. As of December 31, 2004, Tribeca had approximately $1.0
million available under the facility. From time to time, Tribeca's business
needs require that it borrow amounts at times when there is no availability
under the warehousing facility. At such times as the need for advances exceeds
availability, Tribeca reduces its outstanding advances by assigning loans
borrowed under the warehouse
31
facility to its subsidiaries. As of December 31, 2004 subsidiaries of Tribeca
had acquired $78 million of indebtedness from Tribeca. See "Term Loans" below.
Term Loans
As of December 31, 2004, from time to time, subsidiaries of Tribeca had
borrowed $78 million in term loans from the Bank. Interest on the loans is
payable, monthly, at a floating rate equal to the highest Federal Home Loan Bank
of Cincinnati 30 day advance rate published by Bloomberg under the symbol
FHL5LBRI, plus 325 basis points. In addition, upon the closing of each term
loan, the applicable borrower pays the Bank a merchant banking fee and the
amount of such fee is added to the principal of the loan. The unpaid balance of
each term loan is amortized over a period of 20 years, but matures three years
after the loan was made. Each term loan is subject to mandatory payment under
certain circumstances. Each borrower is required to make monthly payments of the
principal of its outstanding loan. Each term loan is secured by a lien on
certain promissory notes and hypothecation agreements, as well as all property,
monies, securities and other property of the applicable borrower held by,
received by or in transit to the Bank. The term loans contain affirmative and
negative covenants and events of default customary for financings of this type.
Financing Agreements
The Company entered into a line of credit with the Bank, under which the
Company is permitted to borrow up to approximately $2.5 million at a rate per
annum equal to the Bank's prime rate plus two percent. Under this line of
credit, interest is payable monthly, the principal amount of each advance is due
9 months after the date of the advance. As of December 31, 2004, and December
31, 2003, $420,000 and $570,000, respectively, were outstanding under this line
of credit. Cash advances under this line of credit were used to satisfy senior
lien positions and fund capital improvements in connection with foreclosures of
certain real estate loans financed by the Company. Management believes the
ultimate sale of these properties will satisfy the related outstanding amounts
under the line of credit and accrued interest. When available, the Company uses
OREO sales proceeds to pay down financing arrangements to help reduce interest
expense.
The Company has a financing agreement with Citibank, N.A. which entitles
the Company to borrow a maximum of $150,000 at a rate per annum equal to
Citibank's prime rate plus 1%. As of December 31, 2004 and December 31, 2003,
$87,000 and $100,000, respectively, were outstanding pursuant to this agreement.
Management believes that sufficient cash flow from the collection of notes
receivable will be available to repay the Company's secured obligations and that
sufficient additional cash flows will exist, through collections of notes
receivable, the sale of loans, sales and rental of OREO or additional borrowing,
to repay the current liabilities arising from operations and to repay the long
term indebtedness of the Company.
FINANCING ACTIVITIES AND CONTRACTUAL OBLIGATIONS
Below is a schedule of the Company's contractual obligations and commitments at
December 31, 2004:
32
WEIGHTED AVERAGE MINIMUM CONTRACTUAL OBLIGATIONS
INTEREST RATE (EXCLUDING INTEREST)
CONTRACTUAL OBLIGATION SCHEDULE AS OF 12/31/04 TOTAL LESS THAN 1 YR 1-3 YRS 3-5 YRS THEREAFTER
Contractual Obligations
Notes Payable 5.73% 807,718,038 143,684,898 639,189,226 23,924,672 919,242
Warehouse Line 7.25% 39,540,205 39,540,205 - - -
Rent Obligations - 9,258,980 760,447 2,686,130 2,139,549 3,672,854
Capital Lease Obligations - 572,190 173,332 261,775 137,083 -
Employment Agreements - 1,781,750 563,000 650,000 568,750 -
------------- -------------- ------------- ------------ -----------
Total Contractual Cash Obligations $ 858,871,163 $ 184,721,882 $ 642,787,131 $ 26,770,054 $ 4,592,096
============= ============== ============= ============ ===========
The interest rates on the Notes Payable and the Warehouse Line are indexed to
the monthly Federal Home Loan Bank of Cincinnati 30 day LIBOR advance rate and
Prime as more fully described herein, and will increase or decrease over time.
Minimum contractual obligations are based on minimum required principal payments
including balloon maturities of the notes payable and warehouse line. Actual
payments will vary depending on cash collections and loan sales as described
herein. Historically, the Company and the Bank have extended the maturities and
balloon payments.
SAFE HARBOR STATEMENT
Statements contained herein that are not historical fact may be forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended,
that are subject to a variety of risks and uncertainties. There are a number of
important factors that could cause actual results to differ materially from
those projected or suggested in forward-looking statements made by the Company.
These factors include, but are not limited to: (i) unanticipated changes in the
U.S. economy, including changes in business conditions such as interest rates,
and changes in the level of growth in the finance and housing markets; (ii) the
status of relations between the Company and its sole Senior Debt Lender and the
Senior Debt Lender's willingness to extend additional credit to the Company;
(iii) the availability for purchases of additional portfolios; (iv) the
availability of non-prime borrowers for the origination of additional loans; and
(v) other risks detailed from time to time in the Company's SEC reports.
Additional factors that would cause actual results to differ materially from
those projected or suggested or suggested in any forward-looking statements are
contained in the Company's filings with the Securities and Exchange Commission,
including, but not limited to, those factors discussed herein under the caption
"Real Estate Risk", which the Company urges investors to consider. The Company
undertakes no obligation to publicly release the revisions to such
forward-looking statements that may be made to reflect events or circumstances
after the date hereof or to reflect the occurrences of unanticipated events,
except as other wise required by securities and other applicable laws. Readers
are cautioned not to place undue reliance on these forward-looking statements,
which speak only as of the date hereof. The Company undertakes no obligation to
release publicly the results on any events or circumstances after the date
hereof or to reflect the occurrence of unanticipated events.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
We are exposed to various types of market risk in the normal course of business,
including the impact of interest rate changes and changes in corporate tax
rates. A material change in these rates could adversely affect our operating
results and cash flows.
INTEREST RATE RISK
Interest rate fluctuations can adversely affect the Company's income and value
of its common shares in many ways and present a variety of risks, including the
risk of mismatch between asset yields and borrowing rates, variances in the
yield curve and changing prepayment rates.
33
Interest rates are highly sensitive to many factors, including governmental
monetary policies and domestic and international economic and political
conditions. Conditions such as inflation, recession, unemployment, money supply
and other factors beyond the Company's control may also affect interest rates.
Fluctuations in market interest rates are neither predictable nor controllable
and may have a material adverse effect on the Company's business, financial
condition and results of operations.
The Company's operating results will depend in large part on differences between
the income from its assets (net of credit losses) and its borrowing costs. Most
of the Company's assets, consisting primarily of mortgage notes receivable,
generate fixed returns and will have terms in excess of five years. The Company
funds the origination and acquisition of a significant portion of these assets
with borrowings, which have interest rates that are based on the monthly Federal
Home Loan Bank of Cincinnati 30-day advance rate ("FHLB"). In most cases, the
income from assets will respond more slowly to interest rate fluctuations than
the cost of borrowings, creating a mismatch between yields and borrowing rates.
Consequently changes in interest rates, particularly short-term rates may
influence the Company's net income. The Company's borrowing under agreements
with its Senior Debt Lender bear interest at rates that fluctuate with the FHLB
rate of Cincinnati and the prime rate. Based on approximately $787 and $21
million of borrowings outstanding under these facilities at December 31, 2004, a
1% change in FHLB and prime rate would impact the Company's annual net income
and cash flows by approximately $4.4 million. Increases in these rates will
decrease the net income and market value of the Company's net assets. Interest
rate fluctuations that result in interest expense exceeding interest income
would result in operating losses.
The value of the Company's assets may be affected by prepayment rates on
investments. Prepayments rates are influenced by changes in current interest
rates and a variety of economic, geographic and other factors beyond the
Company's control, and consequently, such prepayment rates cannot be predicted
with certainty. When the Company originates and purchases mortgage loans, it
expects that such mortgage loans will have a measure of protection from
prepayment in the form of prepayments lockout periods or prepayment penalties.
In periods of declining mortgage interest rates, prepayments on mortgages
generally increase. If general interest rates decline as well, the proceeds of
such prepayments received during such periods are likely to be reinvested by the
Company in assets yielding less than the yields on the investments that were
prepaid. In addition the market value of mortgage investments may, because the
risk of prepayment, benefit less from declining interest rates than from other
fixed-income securities. Conversely, in periods of rising interest rates,
prepayments on mortgage generally decrease, in which case the Company would not
have the prepayment proceeds available to invest in assets with higher yields.
Under certain interest rate and prepayment scenarios the Company may fail to
recoup fully its cost of acquisition of certain investments.
REAL ESTATE RISK
Multi-family and residential property values and net operating income derived
from such properties are subject to volatility and may be affected adversely by
number of factors, including, but not limited to, national, regional and local
economic conditions (which may be adversely affected by industry slowdowns and
other factors); local real estate conditions (such as the over supply of
housing). In the event net operating income decreases, a borrower may have
difficultly paying the Company's mortgage loan, which could result in losses to
the Company. In addition, decreases in property values reduce the value of the
collateral and the potential proceeds available to a borrower to repay the
Company's mortgage loans, which could also cause the Company to suffer losses.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The financial statements required by this Item are included herein, beginning on
page F1 of this report.
34
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
ITEM 9A. CONTROLS AND PROCEDURES.
(a) Evaluation of Disclosure Controls and Procedures. The Company's
management, with the participation of the Company's Chief Executive
Officer and Chief Financial Officer, has evaluated the effectiveness
of the Company's disclosure controls and procedures (such term is
defined in Rules 13a-15(e) and 15d-15(e) under the Securities
Exchange Act of 1934, as amended (the "Exchange Act") as of the end
of the period covered by this report. Based on such evaluation, the
Company' Chief Executive Officer and Chief Financial Officer have
concluded that, as of the end of such period, the Company's
disclosure controls and procedures are effective in alerting them on
a timely basis to material information relating to the Company
(including its consolidated subsidiaries) required to be included in
the Company's reports filed or submitted under the Exchange Act.
(b) Changes in Internal Controls. There has been no change in the
Company's internal control over financial reporting during the
quarter ended December 31, 2004 that has materially affected, or is
reasonably likely to materially affect, such internal control over
financial reporting.
ITEM 9B. OTHER INFORMATION.
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Information required under this Item is contained in the Company's definitive
proxy statement, which will be filed within 120 days of December 31, 2004, the
registrant's most recent fiscal year, and is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION.
Information required under this Item is contained in the Company's definitive
proxy statement, which will be filed within 120 days of December 31, 2004, the
registrant's most recent fiscal year, and is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS.
Information required under this Item is contained in the Company's definitive
proxy statement, which will be filed within 120 days of December 31, 2004, the
registrant's most recent fiscal year, and is incorporated herein by reference.
35
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Information required under this Item is contained in the Company's definitive
proxy statement, which will be filed within 120 days of December 31, 2004, the
registrant's most recent fiscal year, and is incorporated herein by reference.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
Information required under this Item is contained in the Company's definitive
proxy statement, which will be filed within 120 days of December 31, 2004, the
registrant's most recent fiscal year, and is incorporated herein by reference.
36
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES.
(a) Documents filed as part of Form 10-K:
(1) Financial Statements.
The financial statements required by Item 8 are included herein, beginning on
page F1 of this report.
(2) Financial Statement Schedules.
All financial statement schedules for which provision is made in the applicable
accounting regulation of the Securities and Exchange Commission are not required
under the related instructions or are inapplicable and therefore have been
omitted.
(3) Exhibits.
Exhibit
Number
- -------
3.1 Fifth Amended and Restated Certificate of Incorporation.
Incorporated by reference to Appendix A to the Registrant's
Definitive Information Statement on Schedule 14C, filed with the
Securities and Exchange Commission (the "Commission") on January 20,
2005.
3.2 Amended and Restated By-laws. Incorporated by reference to Appendix
B to the Registrant's Definitive Information Statement on Schedule
14C, filed with the Commission on January 20, 2005.
10.1 Master Credit and Security Agreement, dated as of October 13, 2004,
between the Registrant and Sky Bank, N.A. Incorporated by reference
to Exhibit 10(M) to the Registrant's Quarterly Report on Form 10-Q
for the quarterly period ended September 30, 2004, filed with the
Commission on November 15, 2004.
*10.2 Amendment to the Master Credit and Security Agreement, dated as of
December 30, 2004 between the Registrant and Sky Bank, N.A.
*10.3 Warehousing Credit and Security Agreement, dated as of September 30,
2003, between Tribeca Lending Corporation and Sky Bank, N.A.
*10.4 Letter, dated as of March 24, 2005, from Sky Bank, N.A. to Tribeca
Lending Corporation.
*10.5 Form of Term Loan and Security Agreement between subsidiaries of
Tribeca Lending Corporation and Sky Bank, N.A.
10.6 1996 Stock Incentive Plan, as amended. Incorporated by reference to
Exhibit 4.1 to the Registrant's Registration Statement on Form S-8
(File No. 333-122677), filed with the Commission on February 10,
2005.
10.7 Mortgage Loan Purchase and Sale Agreement, dated as of September 24,
2004, between the Registrant and Master Financial, Inc. Incorporated
by reference to Exhibit 10.1 to the Registrant's Current Report on
Form 8-K, filed with the Commission on October 20, 2004.
10.8 Mortgage Loan Purchase and Sale Agreement, dated as of June 30,
2004, between the Registrant and Bank One, Inc. Incorporated by
reference to Exhibit 2.1 to the Registrant's Current Report on Form
8-K/A, filed with the Commission on July 16, 2004.
*10.9 Employment Agreement, effective as of October 1, 2004, between the
Registrant and Jeffrey R. Johnson.
37
*10.10 Registration Rights Agreement, effective as of October 1, 2004,
between the Registrant and Jeffrey R. Johnson.
*10.11 Restricted Stock Grant Agreement, dated as of October 4, 2004,
between the Registrant and Jeffrey R. Johnson.
*10.12 Sublease Agreement, dated as of March 4, 2005, between the
Registrant and Lehman Brothers Holdings Inc.
*21.1 Subsidiaries of the Registrant.
*23.1 Consent of Deloitte & Touche LLP.
*31.1 Rule 13a-14(a) Certification of Chief Executive Officer of the
Company in accordance with Section 302 of the Sarbanes-Oxley Act of
2002.
*31.2 Rule 13a-14(a) Certification of Chief Financial Officer of the
Company in accordance with Section 302 of the Sarbanes-Oxley Act of
2002.
*32.1 Certification of Chief Executive Officer of the Company in
accordance with Section 906 of the Sarbanes-Oxley Act of 2002.
*32.2 Certification of Chief Financial Officer of the Company in
accordance with Section 906 of the Sarbanes-Oxley Act of 2002.
* Filed herewith.
38
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.
March 31, 2005 FRANKLIN CREDIT MANAGEMENT
CORPORATION
By: /s/ JEFFREY R. JOHNSON
-------------------------------------
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act, this report
has been signed below by the following persons on behalf of the registrant and
in the capacity and on the dates indicated.
Signature Title Date
/s/ JEFFREY R. JOHNSON President, Chief Executive Officer, Director March 31, 2005
- ----------------------
Jeffrey R. Johnson
/s/ ALAN JOSEPH Executive Vice President and Chief Financial Officer March 31, 2005
- ---------------
Alan Joseph
/s/ KIMBERLY SHAW Vice President and Treasurer March 31, 2005
- -----------------
Kimberly Shaw
/s/ THOMAS J. AXON
- ------------------
Thomas J. Axon Chairman of the Board and Director March 31, 2005
/s/ MICHAEL BERTASH Director March 31, 2005
- -------------------
Michael Bertash
/s/ FRANK EVANS Director March 31, 2005
- ---------------
Frank Evans
/s/ STEVEN LEFKOWITZ Director March 31, 2005
- --------------------
Steven Lefkowitz
/s/ ALLAN R. LYONS Director March 31, 2005
- ------------------
Allan R. Lyons
/s/ WILLIAM F. SULLIVAN Director March 31, 2005
- -----------------------
William F. Sullivan
/s/ A. GORDON JARDIN Director March 31, 2005
- --------------------
A. Gordon Jardin
39
FRANKLIN CREDIT MANAGEMENT CORPORATION AND SUBSIDIARIES
TABLE OF CONTENTS
PAGE
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
CONSOLIDATED FINANCIAL STATEMENTS:
Consolidated Balance Sheets at December 31, 2004 and 2003 F-2
Consolidated Statements of Income for the years ended December 31, 2004, 2003 and 2002 F-3
Consolidated Statements of Stockholders' Equity for the years ended December 31, 2004, 2003 and 2002 F-4
Consolidated Statements of Cash Flows for the years ended December 31, 2004, 2003 and 2002 F-5
Notes to Consolidated Financial Statements for the years ended December 31, 2004, 2003 and 2002 F-6
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Franklin Credit Management Corporation
New York, New York
We have audited the accompanying consolidated balance sheets of Franklin Credit
Management Company and subsidiaries (the "Company") as of December 31, 2004 and
2003, and the related consolidated statements of income, stockholders' equity,
and cash flows for each of the three years in the period ended December 31,
2004. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (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. The Company has determined it is
not required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting. Our audits included consideration of internal
control over financial reporting as a basis for designing audit procedures that
are appropriate in the circumstances but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also 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, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Franklin Credit Management
Corporation and subsidiaries as of December 31, 2004 and 2003, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 2004, in conformity with accounting principles
generally accepted in the United States of America
Deloitte & Touche LLP
New York, New York
March 28, 2005
FRANKLIN CREDIT MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2004 AND 2003
2004 2003
ASSETS
CASH AND CASH EQUIVALENTS $ 19,519,659 $ 14,418,876
RESTRICTED CASH 128,612 413,443
NOTES RECEIVABLE:
Principal 811,885,856 465,553,870
Purchase discount (32,293,669) (25,678,165)
Allowance for loan losses (89,628,299) (46,247,230)
------------- -------------
Net notes receivable 689,963,888 393,628,475
ORIGINATED LOANS HELD FOR SALE 16,851,041 27,372,779
ORIGINATED LOANS HELD FOR INVESTMENT, NET 110,496,274 9,536,669
ACCRUED INTEREST RECEIVABLE 8,506,252 4,332,419
OTHER REAL ESTATE OWNED 20,626,156 13,981,665
OTHER RECEIVABLES 5,366,500 2,893,735
DEFERRED TAX ASSET 583,644 681,398
OTHER ASSETS 10,577,344 3,922,234
BUILDING, FURNITURE AND EQUIPMENT - Net 1,290,442 1,252,711
DEFERRED FINANCING COSTS - Net 7,600,942 4,298,942
------------- -------------
TOTAL ASSETS $ 891,510,754 $ 476,733,346
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Accounts payable and accrued expenses $ 11,572,764 $ 4,979,806
Financing agreements 39,540,205 23,315,301
Notes payable 807,718,038 427,447,844
Deferred tax liability 3,123,865 1,311,089
------------- -------------
Total liabilities 861,954,872 457,054,040
------------- -------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value; authorized 3,000,000 issued-none - -
Common stock, $.01 par value, 22,000,000 authorized shares;
issued and outstanding: 6,062,295 in 2004 and 5,916,527 in 2003 60,623 59,167
Additional paid-in capital 7,354,778 6,985,968
Retained earnings 22,140,481 12,634,171
------------- -------------
Total stockholders' equity 29,555,882 19,679,306
------------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 891,510,754 $ 476,733,346
============= =============
See notes to consolidated financial statements
F-2
FRANKLIN CREDIT MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
2004 2003 2002
REVENUES:
Interest income $59,481,422 $ 42,699,710 $36,728,735
Purchase discount earned 9,234,896 5,154,601 3,841,927
Gain on sale of notes receivable 1,701,113 1,118,239 139,519
Gain on sale of loans held for sale 3,689,616 3,236,616 2,259,979
Gain on sale of other real estate owned 542,202 1,027,130 796,562
Rental income 42,300 113,255 152,965
Prepayment penalties and other income 5,793,466 4,217,008 2,922,750
----------- ------------ -----------
80,485,015 57,566,559 46,842,437
----------- ------------ -----------
OPERATING EXPENSES:
Interest expense 32,795,347 21,672,993 19,127,713
Collection, general and administrative 23,321,659 17,864,786 12,882,135
Recovery of a special charge - (1,662,598)
Provision for loan losses 3,705,333 3,164,103 2,713,864
Amortization of deferred financing costs 2,761,476 1,979,208 1,264,112
Depreciation 494,890 505,012 339,761
----------- ------------ -----------
63,078,705 45,186,102 34,664,987
----------- ------------ -----------
INCOME BEFORE PROVISION FOR INCOME TAXES 17,406,310 12,380,457 12,177,450
----------- ------------ -----------
PROVISION FOR INCOME TAXES 7,900,000 5,695,000 5,514,000
----------- ------------ -----------
NET INCOME $ 9,506,310 $ 6,685,457 $ 6,663,450
=========== ============ ===========
NET INCOME PER COMMON SHARE:
Basic $ 1.60 $ 1.13 $ 1.13
=========== ------------ -----------
Diluted $ 1.43 $ 1.02 $ 1.07
=========== ------------ -----------
WEIGHTED AVERAGE NUMBER OF SHARES
OUTSTANDING, BASIC 5,941,462 5,916,527 5,916,527
=========== ============ ===========
OUTSTANDING, DILUTED 6,648,381 6,536,639 6,216,337
=========== ============ ===========
See notes to consolidated financial statements.
F-3
FRANKLIN CREDIT MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
ADDITIONAL
COMMON STOCK PAID-IN RETAINED
---------------------
SHARES AMOUNT CAPITAL EARNINGS TOTAL
BALANCE, JANUARY 1, 2002 5,916,527 $ 59,167 $ 6,985,968 $ (714,736) $ 6,330,399
Net income - - - 6,663,450 6,663,450
--------- -------- ----------- ------------ ------------
BALANCE, DECEMBER 31, 2002 5,916,527 59,167 6,985,968 5,948,714 12,993,849
Net income - - - 6,685,457 6,685,457
--------- -------- ----------- ------------ ------------
BALANCE, DECEMBER 31, 2003 5,916,527 59,167 6,985,968 12,634,171 19,679,306
--------- -------- ----------- ------------ ------------
Issuance of common stock 145,768 1,206 128,800 130,006
Exercise of options 250 18,500 18,750
Issuance of in-the-money stock options 221,510 221,510
Net income - - - 9,506,310 9,506,310
--------- -------- ----------- ------------ ------------
BALANCE, DECEMBER 31, 2004 6,062,295 $ 60,623 $ 7,354,778 $ 22,140,481 $ 29,555,882
========= ======== =========== ============ ============
See notes to consolidated financial statements.
F-4
FRANKLIN CREDIT MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
2004 2003 2002
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 9,506,310 $ 6,685,457 $ 6,663,450
Adjustments to reconcile income to net cash used in
operating activities:
Gain on sale of notes receivable (1,701,113) (1,118,239) (139,519)
Gain on sale of other real estate owned (542,202) (1,027,130) (796,562)
Depreciation 494,890 505,012 339,761
Amortization of deferred financing costs 2,761,476 1,979,208 1,264,112
Issuance of options and stock for services rendered 240,110
Proceeds from the sale of and principal collections on
loans held for sale-net 100,887,103 80,810,221 53,355,507
Origination of loans held for sale (108,432,590) (97,143,554) (70,444,721)
Deferred tax provision 1,910,530 234,343 (128,382)
Purchase discount earned (9,234,896) (5,154,601) (3,841,927)
Provision for loan losses 3,705,333 3,164,103 2,713,864
Changes in operating assets and liabilities:
Accrued interest receivable (4,173,833) (174,804) 638,174
Other receivables (2,472,765) (634,192) (3,045,866)
Other assets (6,655,110) (1,087,834) (739,030)
Accounts payable and accrued expenses 6,592,959 1,161,249 (411,646)
------------- ------------- -------------
Net cash used in operating activities (7,113,798) (11,800,761) (14,572,785)
------------- ------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
(Increase) decrease in restricted cash 284,831 (219,440) (91,440)
Purchase of notes receivable (546,269,608) (213,638,801) (184,090,904)
Principal collections on notes receivable 209,206,383 156,924,859 110,541,717
Principal collections on loans held for investment 8,693,192 - -
Origination of loans held for investment (92,818,695) - -
Investment in marketable securities - (203,771) -
Acquisition and loan fees (5,309,462) (2,564,246) (2,065,626)
Proceeds from sale of other real estate owned 20,856,448 16,407,503 7,053,926
Proceeds from sale of loans held for investment 1,233,122
Proceeds from sale of notes receivable 20,241,957 15,648,149 1,000,083
Purchase of building, furniture and fixtures (527,585) (650,858) (295,455)
------------- ------------- -------------
Net cash used in investing activities (384,409,417) (28,296,605) (67,947,699)
------------- ------------- -------------
Continued on next page
F-5
FRANKLIN CREDIT MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
2004 2003 2002
CONTINUED FROM PREVIOUS PAGE
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from notes payable 663,023,803 226,367,253 205,224,166
Principal payments of notes payable (282,753,609) (194,185,553) (123,901,830)
Proceeds from financing agreements 206,219,638 101,322,968 74,886,326
Payments on financing agreements (189,994,734) (89,565,036) (70,871,468)
Proceeds from exercise of options 18,500
Proceeds from common stock purchase 110,400 - -
Principal payments of subordinated debentures - - (24,262)
------------ ------------ ------------
Net cash provided by financing activities 396,623,998 43,939,632 85,312,932
------------ ------------ ------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 5,100,783 3,842,266 2,792,448
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 14,418,876 10,576,610 7,784,162
------------ ------------ ------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 19,519,659 $ 14,418,876 $ 10,576,610
============ ============ ============
SUPPLEMENTAL DISCLOSURES OF CASH
FLOW INFORMATION:
Cash payments for interest $ 30,296,647 $ 21,204,660 $ 19,404,197
============ ============ ============
Cash payments for taxes $ 7,849,900 $ 5,713,700 $ 5,425,000
============ ============ ============
Non-cash investing and financing activity:
Transfer of loans from held for sale to loans held for investment $ 18,067,224 $ 13,721,717 -
============ ============ ============
F-6
FRANKLIN CREDIT MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
1. ORGANIZATION AND BUSINESS
As used herein references to the "Company", FCMC", "we", "our" and "us"
refer to Franklin Credit Management Corporation, collectively with its
subsidiaries.
The Company is a specialty consumer finance company primarily engaged in
the acquisition, origination, servicing and resolution of performing,
sub-performing and non-performing residential mortgage loans. The Company
purchases and originates loans primarily on the basis of the borrower's
ability and willingness to repay the mortgage loan, the borrower's
historical pattern of debt repayment and the adequacy of the collateral
securing the loan. FCMC's loan investment strategy focuses on acquiring
loans made to borrowers who generally do not meet conforming underwriting
guidelines because of higher loan-to-value ratios, the nature or absence
of income documentation, limited credit histories, high levels of consumer
debt or past credit difficulties. Through our wholly-owned subsidiary,
Tribeca Lending Corp., the Company also originates non-prime mortgage
loans. In both cases, the Company holds and services a substantial
majority of loans through resolution. As of December 31, 2004, the Company
had purchased and originated in excess of $2.2 billion in mortgage loans,
$939 million of which the Company held in our portfolio and serviced as of
December 31, 2004.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION - The consolidated financial statements include the
accounts of the Company and its wholly owned subsidiaries. All significant
intercompany accounts and transactions have been eliminated in
consolidation.
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates. The most significant estimates
of the Company are allowance for loan losses. The Company's estimates and
assumptions primarily arise from risks and uncertainties associated with
interest rate volatility and credit exposure. Although management is not
currently aware of any factors that would significantly change its
estimates and assumptions in the near term, future changes in market
trends and conditions may occur which could cause actual results to differ
materially.
RECLASSIFICATION- Certain prior year's amounts have been reclassed to
conform to current year presentation.
OPERATING SEGMENTS- Statement of Financial Accounting Standards ("SFAS")
No. 131, Disclosures about Segments of an Enterprise and Related
Information requires companies to report financial and descriptive
information about their reportable operating segments, including segment
profit or loss, certain specific revenue and expense items, and segment
assets. The Company is currently operating in
F-7
two business segments: (i) portfolio asset acquisition and resolution; and
(ii) mortgage banking. (See note 9)
EARNINGS PER SHARE- Basic earnings per share is calculated by dividing net
income by the weighted average number of common shares outstanding during
the year. Diluted earnings per share is calculated by dividing net income
by the weighted average number of common shares outstanding, including the
dilutive effect, if any, of stock options outstanding, calculated under
the treasury stock method.
CASH AND CASH EQUIVALENTS - Cash and cash equivalents includes cash and
investments with original maturities of three months or less, with the
exception of restricted cash. The Company maintains accounts at banks,
which at times may exceed federally insured limits. The Company has not
experienced any losses from such concentrations.
NOTES RECEIVABLE AND INCOME RECOGNITION - The notes receivable portfolio
consists primarily of secured real estate mortgage loans purchased from
financial institutions, and mortgage and finance companies. Such notes
receivable are performing, non-performing or sub-performing at the time of
purchase and are usually purchased at a discount from the principal
balance remaining. Notes receivable are stated at the amount of unpaid
principal, reduced by purchase discount and allowance for loan losses. The
Company has the ability and intent to hold these notes until maturity,
payoff or liquidation of the collateral. Impaired notes receivable are
measured based on the present value of expected future cash flows
discounted at the note's effective interest rate or, as a practical
expedient, at the observable market price of the note receivable or the
fair value of the collateral if the note is collateral dependent. The
Company periodically evaluates the collectability of both interest and
principal of its notes receivable to determine whether they are impaired.
A note receivable is considered impaired when it is probable the Company
will be unable to collect all contractual principal and interest payments
due in accordance with the terms of the note agreement.
In general, interest on the notes receivable is calculated based on
contractual interest rates applied to daily balances of the principal
amount outstanding using the accrual method. Accrual of interest on notes
receivable, including impaired notes receivable, is discontinued when
management believes, after considering economic and business conditions
and collection efforts, that the borrowers' financial condition is such
that collection of interest is doubtful. When interest accrual is
discontinued, all unpaid accrued interest is reversed. Subsequent
recognition of income occurs only to the extent payment is received,
subject to management's assessment of the collectability of the remaining
interest and principal. A non-accrual note is restored to an accrual
status when it is no longer delinquent and collectability of interest and
principal is no longer in doubt and past due interest is recognized at
that time.
Loan purchase discounts are amortized into income using the interest
method over the period to maturity. The interest method recognizes income
by applying the effective yield on the net investment in the loans to the
projected cash flows of the loans. Discounts are amortized if the
projected payments are probable of collection and the timing of such
collections is reasonably estimable. The projection of cash flows for
purposes of amortizing purchase loan discount is a material estimate,
which could change significantly, in the near term. Changes in the
projected payments are accounted for as a change in estimate and the
periodic amortization is prospectively adjusted over the remaining life of
the loans.
In the event projected payments do not exceed the carrying value of the
loan, the periodic amortization of purchase discount is suspended and
either the loan is written down or an allowance for uncollectibility is
recognized.
F-8
ALLOWANCE FOR LOAN LOSSES - The Company performs reviews of its loan
portfolio upon purchase, at loan boarding, and on a frequent basis
thereafter to segment impaired loans under Statement of Financial
Accounting Standards ("SFAS") No. 114. A loan is considered impaired when
it is probable the Company will be unable to collect all contractual
principal and interest payments due in accordance with the terms of the
note agreement. An allowance for loan losses is estimated based on the
Company's impairment analysis. Management's judgment in determining the
adequacy of the allowance for loan losses is based on the evaluation of
individual loans within the portfolios, the known and inherent risk
characteristics and size of the portfolio, the assessment of current
economic and real estate market conditions, estimates of the current value
of underlying collateral, past loan loss experience and other relevant
factors. In connection with the determination of the allowance for loan
losses, management obtains independent appraisals for the underlying
collateral when considered necessary. The allowance for loan losses is a
material estimate, which could change significantly, in the near term.
Management believes that the allowance for loan losses is adequate. While
management uses available information to recognize losses on notes
receivable, future additions to the allowance or write-downs may be
necessary based on changes in economic conditions. An allowance of
$89,628,299 and $46,247,230 is included in notes receivable at December
31, 2004 and 2003, respectively.
ORIGINATED LOANS HELD FOR SALE- The loans held for sale consists primarily
of secured real estate first and second mortgages originated by the
Company. Such loans held for sale are performing and are carried at lower
of cost or market. The gain/loss on sale is recorded as the difference
between the carrying amount of the loan and the proceeds from sale on a
loan-by-loan basis. The Company records a sale upon settlement and when
the title transfers to the seller.
ORIGINATED LOANS HELD FOR INVESTMENT - In the second quarter of 2003, the
Company adopted a strategy to originate loans for its portfolio and for
sale. As a result, certain loans were transferred from "Loans held for
Sale" to "Loans held for Investment" at lower of cost or market value. At
the date of transfer, the estimated market value of the loans transferred
was greater than cost, and therefore, the loans were transferred at
amortized cost. Originated loans held for investment consists primarily of
secured real estate first and second mortgages originated by the Company.
Such loans are performing and are carried at the amortized cost of the
loan.
OTHER REAL ESTATE OWNED - Other real estate owned ("OREO") consists of
properties acquired through, or in lieu of, foreclosure or other
proceedings and are held for sale and carried at the lower of cost or fair
value less estimated costs to sell. Any write-down to fair value, less
cost to sell, at the time of acquisition is charged to purchase discount.
Subsequent write-downs are charged to operations based upon management's
continuing assessment of the fair value of the underlying collateral.
Property is evaluated periodically to ensure that the recorded amount is
supported by current fair values and valuation allowances are recorded as
necessary to reduce the carrying amount to fair value less estimated cost
to sell. Revenue and expenses from the operation of OREO and changes in
the valuation allowance are included in operations. Direct costs relating
to the development and improvement of the property are capitalized,
subject to the limit of fair value of the collateral, while costs related
to holding the property are expensed. Gains or losses are included in
operations upon disposal.
BUILDING, FURNITURE AND EQUIPMENT - Building, furniture and equipment is
recorded at cost net of accumulated depreciation. Depreciation is computed
using the straight-line method over the estimated useful lives of the
assets, which range from 3 to 40 years. Maintenance and repairs are
expensed as incurred.
F-9
DEFERRED FINANCING COSTS - Costs which include origination fees and
incurred in connection with obtaining financing are deferred and are
amortized over the term of the related loan.
RETIREMENT PLAN - The Company maintains a savings plan, which is intended
to qualify under Section 401(k) of the Internal Revenue Code. All
employees are eligible to be a participant in the plan. The plan provides
for voluntary contributions by participating employees in amounts up to
20% of their annual compensation, subject to certain limitations.
Currently, the Company matches 50% of the first 3% of the employee's
contribution.
INCOME TAXES - Income taxes are accounted for under SFAS No. 109
Accounting for Income Taxes which requires an asset and liability approach
in accounting for income taxes. This method provides for deferred income
tax assets or liabilities based on the temporary difference between the
income tax basis of assets and liabilities and their carrying amount in
the consolidated financial statements. Deferred tax assets and liabilities
are measured using enacted tax rates expected to apply to taxable income
in the years in which those temporary differences are expected to be
recovered or settled. Deferred tax assets are reduced by a valuation
allowance when management determines that it is more likely than not that
some portion or all of the deferred tax assets will not be realized.
Deferred tax assets and liabilities are adjusted for the effects of
changes in tax laws and rates on the date of the enactment of the changes.
PREPAYMENTS AND OTHER INCOME - Prepayments and other income consists of
prepayment penalties, application fees on originated loans, late charges,
and other miscellaneous income. Such income is recognized on a cash basis.
RENTAL INCOME - The Company rents out certain OREO properties. Rental
income is recognized on a accrual basis where a lease exists and a cash
basis if no lease exists.
FAIR VALUE OF FINANCIAL INSTRUMENTS - SFAS No. 107, Disclosures About Fair
Value of Financial Instruments, requires disclosure of fair value
information of financial instruments, whether or not recognized in the
balance sheets, for which it is practicable to estimate that value. In
cases where quoted market prices are not available, fair values are based
on estimates using present value or other valuation techniques. Those
techniques are significantly affected by the assumptions used, including
the discount rate and estimates of future cash flows. In that regard, the
derived fair value estimates cannot be substantiated by comparison to
independent markets and, in many cases, could not be realized in immediate
settlement of the instruments. Statement No. 107 excludes certain
financial instruments and all non-financial assets and liabilities from
its disclosure requirements. Accordingly, the aggregate fair value amounts
do not represent the underlying value of the Company.
The following methods and assumptions were used by the Company in
estimating the fair value of its financial instruments:
a. CASH, RESTRICTED CASH, ACCRUED INTEREST RECEIVABLES, OTHER
RECEIVABLE AND ACCRUED INTEREST PAYABLE - The carrying values
reported in the consolidated balance sheets are a reasonable
estimate of fair value.
b. NOTES RECEIVABLE - Fair value of the net note receivable portfolio
is estimated by discounting the estimated future cash flows using
the interest method. The fair value of notes receivable at December
31, 2004 and 2003 was equivalent to their carrying value of
$689,963,888 and $393,628,475, respectively.
F-10
c. SHORT-TERM BORROWINGS - The interest rates on financing agreements
and other short-term borrowings reset on a monthly basis therefore,
the carrying amounts of these liabilities approximate their fair
value. The fair value at December 31, 2004 and 2003 was $39,540,205
and $23,315,301, respectively.
d. LONG-TERM DEBT - The interest rate on the Company's long-term debt
(notes payable) is a variable rate that resets monthly; therefore,
the carrying value reported in the balance sheet approximates fair
value at $807,718,038 and $427,447,844 at December 31, 2004 and
2003, respectively.
COMPREHENSIVE INCOME - SFAS No. 130, Reporting Comprehensive Income
defines comprehensive income as the change in equity of a business
enterprise during a period from transactions and other events and
circumstances, excluding those resulting from investments by and
distributions to stockholders. The Company had no items of other
comprehensive income in 2004, 2003 and 2002 therefore net income was the
same as its comprehensive income.
ACCOUNTING FOR STOCK OPTIONS- The incentive stock option plan is accounted
for under the recognition and measurement principles of Accounting
Principles Board (APB) Opinion 25, Accounting for Stock Issued to
Employees and related interpretations. Generally, options are issued with
exercise prices at least equal to the market price of the common stock at
the grant date, and no compensation expense is recorded. However, during
2004, the Company issued 26,500 stock options to certain board members as
compensation for service in prior years as required by the Company's
agreement with such board members. These options were issued with exercise
prices based on the stock prices in effect in such prior years, which
resulted in stock-based compensation expense of approximately $221,510 in
2004, based on the excess of the market price of the common stock at the
grant date over the exercise price of the options. Also during 2004, the
Company issued 10,000 warrants to a consultant for services rendered. The
warrants were issued with an exercise price equal to the market value of
the underlying common stock on the date of grant. The fair value of the
warrants was de minims at December 31, 2004. The following table
illustrates the effect on net income and earnings per share if the fair
value based method had been applied to all awards:
2004 2003 2002
Net income - as reported $ 9,506,310 $ 6,685,457 $ 6,663,450
Stock based compensation expense actual $ 99,680
Stock based compensation expense
determined under fair value method, net
of related tax effects $ (53,362) $ (65,333) $ (78,377)
Net income - pro forma $ 9,552,628 $ 6,620,124 $ 6,585,073
=========== =========== ==============
Earnings per share:
Net income per common share - basic - as reported $ 1.60 $ 1.13 $ 1.13
Net income per common share - basic - pro forma $ 1.61 $ 1.12 $ 1.12
Net income per common share - dilutive - as reported $ 1.43 $ 1.02 $ 1.07
Net income per common share - dilutive - pro forma $ 1.44 $ 1.01 $ 1.06
The fair value of each option grant is estimated on the date of the grant
using the Black-Scholes option pricing model with the following weighted
average assumptions used for grants in 2004, 2003 and 2002:
F-11
2004 2003 2002
Dividend yield 0% 0% 0%
Volatility 83% 97% 139%
Risk-free interest rate 5% 5% 5%
Weighted average expected lives 5 years 5 years 5 years
During 2004 and 2003 there were 46,500 and 39,000 options granted
respectively.
RECENT ACCOUNTING PRONOUNCEMENTS
We have adopted the disclosure requirements of SFAS No. 148, Accounting
for Stock-Based Compensation--Transition and Disclosure effective December
2002. SFAS 148 amends FASB Statement 123, Accounting for Stock-Based
Compensation to provide alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based
compensation and also amends the disclosure requirements of SFAS 123 to
require prominent disclosures in both annual and interim financial
statements about the methods of accounting for stock based employee
compensation and the effect of the method used on reported results. As
permitted by SFAS 148 and SFAS 123, we continue to apply the accounting
provisions of Accounting Principles Board Opinion Number 25, "Accounting
for stock Issued to Employees," and related interpretations, with regard
to the measurement of compensation cost for options granted under our
Stock Option Plans.
In January of 2003, the Financial Accounting Standards Board ("FASB")
issued Interpretation No. 46, Consolidation of Variable Interest Entities,
which was amended by Interpretation No. 46(R) in December of 2003. This
Interpretation clarifies the application of existing accounting
pronouncements to certain entities in which equity investors do not have
the characteristics of a controlling financial interest or do not have
sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties. As it
applies to the Company, Interpretation No. 46(R) became effective for all
variable interests in variable interest entities created after December
31, 2003, and to all variable interest entities on March 31, 2004. The
adoption of Interpretation No. 46(R) did not have a material impact on the
Company's consolidated financial statements.
In December 2003, the AICPA issued Statement of Position 03-03 ("SOP
03-03"), "Accounting for Certain Debt Securities Acquired in a Transfer."
SOP 03-03 addresses accounting for differences between contractual cash
flows and cash flows expected to be collected from an investor's initial
investment in loans or debt securities acquired in a transfer if those
differences are attributable, at least in part, to credit quality. This
SOP limits the yield that may be accreted to the excess of the investor's
estimate of undiscounted expected principal, interest, and other cash
flows over the investor's initial investment in the loan. Subsequent
increases in cash flows expected to be collected generally would be
recognized prospectively through adjustment of the loan's yield over its
remaining life. Decreases in cash flows expected to be collected would be
recognized as an impairment on the statement of operations and a
corresponding valuation allowance would be created against the investment
in receivable portfolios on the statement of financial condition. SOP
03-03 applies to loans acquired in fiscal years beginning after December
15, 2004, and accordingly, we will adopt the provisions of this SOP in the
first quarter of 2005. Adoption of SOP 03-03 may result in an increase in
our provision for loan losses in future periods but may also result in an
increase in purchase discount earned in future periods.
F-12
3. NOTES RECEIVABLE, LOANS HELD FOR SALE, PURCHASE DISCOUNT AND ALLOWANCE FOR
LOAN LOSSES
Notes receivable consist principally of mortgages as of December 31, 2004
and 2003 secured as follows:
2004 2003
Real estate secured $ 777,719,050 $ 436,748,611
Consumer unsecured 10,218,900 8,382,427
Mobile homes 16,413,026 14,871,762
Other 7,534,880 5,551,070
------------- -------------
811,885,856 465,553,870
Less:
Purchase discount (32,293,669) (25,678,165)
Allowance for loan losses (89,628,299) (46,247,230)
------------- -------------
Balance $ 689,963,888 $ 393,628,475
============= =============
Originated loans held for sale of $16,851,041 and $27,372,779 as of
December 31, 2004 and 2003 respectively represent real estate secured
mortgages.
Originated loans held for investment represent real estate mortgages as of
December 31, 2004 and 2003 secured as follows:
2004 2003
Real estate secured $ 110,684,391 $ 9,575,896
Consumer unsecured 58,050 $ 53,816
Mobile homes 84,707 85,240
------------- -----------
110,827,148 9,714,952
Less:
Allowance for loan losses (330,874) (178,283)
------------- -----------
Balance $ 110,496,274 $ 9,536,669
============= ===========
In the second quarter of 2003, the Company's holding strategy on certain
loans originated changed and, as a result, such loans were transferred
from the loans held for sale category into loans held for investment at
their amortized cost. This new strategy continued and, as a result, the
Company originated $92 million dollars in loans held for investment during
2004.
As of December 31, 2004, contractual maturities of notes receivable,
originated loans held for sale and originated loans held for investment
net of the allowance for loan losses if any, were as follows:
F-13
YEAR ENDING NOTES LOANS HELD LOANS HELD
DECEMBER 31, RECEIVABLE FOR SALE FOR INVESTMENT
2005 $ 40,891,498 $ 191,384 $ 615,275
2006 36,968,178 206,246 604,867
2007 35,162,873 222,311 643,044
2008 33,310,104 239,681 710,569
2009 45,475,369 255,095 1,158,122
Thereafter 530,449,535 15,736,324 106,764,397
------------- ------------ -------------
Balance, December 31, 2004 $ 722,257,557 $ 16,851,041 $ 110,496,274
============= ============ =============
It is the Company's experience that a portion of the notes receivable
portfolio may be refinanced or repaid before contractual maturity dates.
The above tabulation, therefore, is not to be regarded as a forecast of
future cash collections. During the years ended December 31, 2004, 2003
and 2002, cash collections of principal amounts totaled approximately
$230,000,000, $157,000,000 and $ 120,000,000 respectively, and the ratios
of these cash collections to average principal balances were approximately
32 %, 33% and 29%, respectively.
Changes in the allowance of loan losses on notes receivable for the years
ended December 31, 2004, 2003 and 2002 are as follows:
2004 2003 2002
Balance, beginning $ 46,247,230 $ 45,841,651 $ 33,490,456
Allowance allocated on purchased portfolio 53,836,759 11,413,944 15,551,056
Net change in allowance (14,161,023) (14,172,468) (5,913,725)
Provision for loan losses 3,705,333 3,164,103 2,713,864
------------ ------------ ------------
Balance, ending $ 89,628,299 $ 46,247,230 $ 45,841,651
============ ============ ============
The net change in allowance presented above represents chargeoffs,
recoveries, and subsequent increases in the allowance for notes
receivable.
The provision for loan losses represents additional allowance on notes
receivable that had no remaining purchase discount.
At December 31, 2004, 2003 and 2002, principal amounts of notes receivable
included approximately $307,000,000, $126,000,000 and $119,000,000
respectively, of notes for which there was no accrual of interest income.
The following information relates to impaired notes receivable, which
include all such notes receivable as of and for the years ended December
31, 2004, 2003 and 2002:
F-14
2004 2003 2002
Total impaired notes receivable $ 306,840,734 $ 126,341,722 $ 119,134,128
============= ============= =============
Allowance for loan losses related to impaired
notes receivable $ 68,858,866 $ 30,111,278 $ 32,809,607
============ ============= =============
Average balance of impaired notes receivable
during the year $ 216,591,228 $ 122,737,925 $ 96,848,593
============= ============= =============
Interest income recognized $ 9,959,069 $ 2,196,003 $ 5,866,377
============= ============= =============
In the normal course of business, the Company restructures or modifies
terms of notes receivable to enhance the collectability of certain notes
that were impaired at the date of acquisition and were included in certain
portfolio purchases.
4. BUILDING, FURNITURE AND EQUIPMENT
At December 31, 2004 and 2003, building, furniture and equipment consisted
of the following:
2004 2003
Building and improvements $ 1,234,202 $ 1,094,336
Furniture and equipment 2,259,644 1,871,925
------------ -----------
3,493,846 2,966,261
Less accumulated depreciation (2,203,404) (1,713,550)
------------ -----------
$ 1,290,442 $ 1,252,711
============ ===========
5. NOTES PAYABLE
Notes payable consists primarily of loans ("Subsidiary Loans") made to the
Company by Sky Bank, an Ohio banking corporation (the "Bank" or "Senior
Debt Lender") to acquire portfolios of notes receivable ("Pledged
Collateral") and term loans made by the Senior Debt Lender to Tribeca to
principally finance originated loans held for investment (collectively
with Subsidiary Loans, "Notes Payable").
On October 13, 2004, the Company and all of its subsidiaries other than
Tribeca entered into a Master Credit and Security Agreement with the
Senior Debt Lender ("Credit Agreement"). The Credit Agreement amended and
restated the Company's previous loan agreements with the Senior Debt
Lender, under which an aggregate principal balance of approximately $747
million was outstanding immediately prior to the execution of the Credit
Agreement. Under the Credit Agreement, the Company and its subsidiaries
that are or become parties to the Credit Agreement are entitled to request
new Subsidiary Loans to finance the purchase of residential mortgage loans
or to refinance existing outstanding Subsidiary Loans. The Credit
Agreement requires that all cash collections received on the notes
receivable be paid to the Senior Debt Lender, subject to the Company being
provided with a
F-15
monthly allowance to fund operations and pay taxes. The Credit Agreement expires
on October 13, 2006.
As part of the Credit Agreement, the Company is required to pay the Senior Debt
Lender a fee on each Subsidiary Loan contingent on the successful payoff of the
Subsidiary Loan ("Success Fee"). After payoff, the Success Fee is based on the
lesser of (i) up to 1% of the Subsidiary Loan's original principal balance or
(ii) 50% of the remaining cash flows from the Subsidiary Loan's Pledged
Collateral. On December 30, 2004, the Company executed an amendment to the
Credit Agreement ("Amendment"). As part of the Amendment, the Company agreed
that, in addition to any Success Fees previously paid the Senior Debt Lender,
and based on an analysis of the likelihood and timing of the payment of the
Success Fees due, a minimum aggregate Success Fees of $2,952,830 would be
payable in accordance with the terms of the Credit Agreement for certain
Subsidiary Loans entered into with the Senior Debt Lender, prior to December 31,
2003. The Amendment did not change the contingent aspects of the Success Fee
including the estimated timing of the payments. The Amendment also provides for
a separate fee of approximately $198,000 from certain Tribeca originated loans
which is to be paid over 23 months beginning in January 2005 and additionally
states that no Success Fees would be due on certain other Subsidiary Loans
representing approximately $2.2 million of potential Success Fees. At December
31, 2004, the Company estimated and recorded an asset and concurrent liability
in the amount of $2,664,145, which represents the net present value of the
minimum aggregate Success Fees based on projections of when the fees would
likely become due. The amounts are included in other assets and accounts payable
and accrued expenses on the accompanying consolidated balance sheet. The Company
amortized $100,000 of Success Fees as additional interest expense in the fourth
quarter of 2004. The amortization amount was derived using the straight-lined
method based on the estimated weighted average life of the relevant Subsidiary
Loans and the related Success Fee payments. The unamortized amount will be
re-evaluated each reporting period for changes in assumptions.
As of December 31, 2004 and 2003, the Company had Notes Payable with an
aggregate principal balance of $807,718,038 and 427,447,844, respectively. All
Notes Payable are secured by an interest in the notes receivable, payments to be
received under the notes receivable and the underlying collateral securing the
notes receivable. At December 31, 2004, approximately $21,068,027 of the Notes
Payable accrues interest at a rate of prime plus a margin of 0% to 1.75%,
$785,499,152 accrue interest at the FHLB 30 day LIBOR advance rate plus 3.50%,
and $937,848 accrues interest at the FHLB 30 day LIBOR advance rate plus 3.875%.
The remaining $213,012 accrues interest at 8.93%.
At December 31, 2004 and 2003, the weighted average interest rate on the Notes
Payable was 5.73% and 4.82%, respectively. The above loans also require
additional monthly principal reductions based on cash collections received by
the Company.
Aggregate contractual maturities of all notes payable at December 31, 2004 are
as follows:
2005 $ 143,684,898
2006 135,276,228
2007 503,912,998
2008 23,873,616
2009 51,056
Thereafter 919,242
-------------
$ 807,718,038
=============
F-16
6. FINANCING AGREEMENTS
The Company and Tribeca have the following financing agreements:
Tribeca and the Bank have entered into a warehouse financing agreement,
which provides Tribeca with the ability to borrow a maximum of $40,000,000
at a rate equal to the Bank's prime rate or a floor of 5%, if prime is
lower than 5%. This credit facility is to be utilized for the purpose of
originating mortgage loans. As of December 31, 2004 and 2003, $39,033,806
and $22,646,114, respectively, were outstanding under the warehouse
financing agreement and secured by originated loans held for sale. The
prime rate at December 31, 2004 was 5.25%.
The Company and the Bank have entered into a credit facility, which
provides the Company with the ability to borrow a maximum of $2,500,000 at
a rate equal to the Bank's prime rate plus two percent per annum. The
credit facility may be utilized to pay real estate taxes or to purchase
the underlying collateral of certain nonperforming real estate secured
loans. Principal repayment of each respective advance is due six months
from the date of such advance and interest is payable monthly. As of
December 31, 2004 and 2003, $419,663 and $569,451, respectively, were
outstanding on this credit facility. The credit facility is secured by a
first priority security interest in the respective notes receivable, any
purchased real estate, payments received under the notes receivable, and
collateral securing the notes of certain loan portfolios.
The Company has entered into a line of credit with another bank, which
provides the Company with an unsecured line of credit to borrow a maximum
of $150,000 at a rate equal to such bank's prime rate plus one percent per
annum. As of December 31, 2004, and 2003, $86,736 and $99,736,
respectively, were outstanding on this line of credit. The bank's prime
rate at December 31, 2004 was 5.25%.
F-17
7. INCOME TAX MATTERS
The components of the income tax provision for the years ended December
31, 2004, 2003 and 2002 are as follows:
2004 2003 2002
Current provision:
Federal $ 4,683,558 $ 4,131,000 $ 3,317,000
State and local 1,305,912 1,036,000 1,043,000
------------- ------------- -------------
5,989,470 5,167,000 4,360,000
------------- ------------- -------------
Deferred provision :
Federal 1,452,000 422,000 945,000
State and local 458,530 106,000 209,000
------------- ------------- -------------
1,910,530 528,000 1,154,000
------------- ------------- -------------
Provision $ 7,900,000 $ 5,695,000 $ 5,514,000
============= ============= =============
The current and deferred income tax provisions include adjustments as a
result of the reclassification of certain current and deferred income tax
amounts.
A reconciliation of the anticipated income tax expense (computed by
applying the Federal statutory income tax rate to income before income tax
expense) to the provision for income taxes in the accompanying
consolidated statements of income for the years ended December 31, 2004,
2003, and 2002 is as follows:
2004 2003 2002
Tax determined by applying U.S. statutory rate to income $ 6,092,208 $ 4,546,000 $ 4,262,000
Increase in taxes resulting from:
State and local taxes, net of Federal benefit 1,764,442 1,142,000 1,252,000
Meals and entertainment 43,350 7,000 -
----------- ----------- -----------
$ 7,900,000 $ 5,695,000 $ 5,514,000
=========== =========== ===========
F-18
The tax effects of temporary differences that give rise to significant
components of deferred tax assets and deferred tax liabilities at December
31, 2004, and 2003 are presented below:
Deferred liabilities:
Purchase discount $ 1,690,175 $ 926,596
Deferred cost 1,433,690 384,493
------------- ------------
Deferred tax liabilities $ 3,123,865 $ 1,311,089
============= ============
Deferred tax assets:
Inventory, repossessed collateral $ 583,644 $ 681,398
------------- ------------
Deferred tax assets $ 583,644 $ 681,398
============= ============
Net deferred tax liability $ 2,540,221 $ 629,691
============= ============
The Company has not recorded a valuation allowance, as the Company has
determined that it is more likely than not that all of the deferred tax
assets will be realized.
8. STOCK OPTION PLAN
During 1996, the Company adopted an incentive stock option plan for
certain of its officers and directors. Under the terms of the Plan, as
amended, options to purchase an aggregate of up to 1,600,000 shares of the
Company's common stock may be granted. Generally, each option has an
exercise price at least equal to the market price of the common stock at
the time the option is granted. Options become exercisable at various
times after the date granted and unless otherwise provided in the
applicable option agreements, expire ten years after the date granted.
The Company granted 15,000 options to five members of the Board of
Directors at market price in May 2004; these options are granted to each
board member annually as compensation. In August 2004 5,000 options were
also issued to a member of the Company's management team. On December 29,
2004 the Company also granted 26,500 options to certain members of the
Board of Directors that represented vested options earned by the directors
in prior years but through an oversight were never issued. The weighted
average fair value per share of options granted during the year was $5.10.
The fair value of the options granted was estimated using the
Black-Scholes option-pricing model.
The Company granted 39,000 options to five members of the Board of
Directors during 2003. The weighted average fair value per share of
options granted during the year was $2.41. The fair value of the options
granted was estimated using the Black-Scholes option-pricing model.
F-19
Transactions in stock options under the plan are summarized as follows:
2004 2003 2002
---- ---- ----
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
SHARES EXERCISE SHARES EXERCISE SHARES EXERCISE
--------- -------- --------- -------- -------- --------
OUTSTANDING OPTIONS AT THE
BEGINNING OF YEAR 1,017,500 $ 0.95 978,500 $ 0.90 712,500 $ 1.00
OPTIONS GRANTED 46,500 $ 2.24 39,000 $ 2.25 396,000 $ 0.75
OPTIONS CANCELLED (228,000) $ 0.75 (130,000) $ 1.00
OPTIONS EXERCISED (25,000) $ 0.75
OUTSTANDING OPTIONS AT THE END OF THE YEAR 811,000 $ 1.04 1,017,500 $ 0.95 978,500 $ 0.90
Options outstanding at December 31,
NUMBER
RANGE OF EXERCISE PRICE OF OPTIONS: OUTSTANDING
$0.75 566,000
$0.85 20,000
$1.04 6,000
$1.15 25,000
$1.56 155,000
$2.25 19,000
$3.55 15,000
$5.50 5,000
-------
TOTAL OPTIONS 811,000
=======
The company has the following warrants outstanding at December 31, 2004:
NUMBER
RANGE OF EXERCISE PRICE OF WARRANTS: OUTSTANDING
$ 5.00 10,000
$ 1.56 87,000
------
TOTAL WARRANTS OUTSTANDING 97,000
======
F-20
9. OPERATING SEGMENTS
The Company has two reportable operating segments: (i) portfolio asset
acquisition and resolution; and (ii) mortgage banking. The portfolio asset
acquisition and resolution segment acquires performing, nonperforming,
nonconforming and sub performing notes receivable and promissory notes
from financial institutions, mortgage and finance companies, and services
and collects such notes receivable through enforcement of original note
terms, modification of original note terms and, if necessary, liquidation
of the underlying collateral. The mortgage-banking segment originates or
purchases for sale and investment purposes residential mortgage loans to
individuals whose credit histories, income and other factors cause them to
be classified as sub-prime borrowers.
The Company's management evaluates the performance of each segment based
on profit or loss from operations before unusual and extraordinary items
and income taxes.
PORTFOLIO ASSET ACQUISITION AND RESOLUTION OPERATING RESULTS FOR THE YEARS ENDED
DECEMBER 31:
2004 2003 2002
------------ ------------ ------------
REVENUES:
Interest income $ 52,889,964 $ 39,472,458 $ 33,435,447
Purchase discount earned 8,637,055 4,912,686 3,841,927
Gain on sale of notes receivable 1,701,113 1,118,239 139,519
Gain on sale of other real estate owned 448,805 995,899 796,562
Rental income 42,300 113,255 152,965
Other 4,512,999 3,567,165 2,402,977
------------ ------------ ------------
68,232,236 50,179,702 40,769,397
------------ ------------ ------------
OPERATING EXPENSES:
Interest expense 29,571,575 20,069,282 17,423,341
Collection, general and administrative 18,377,783 13,741,836 10,646,814
Recovery of a special charge - - (1,662,598)
Provision for loan losses 3,369,803 3,100,524 2,612,361
Amortization of deferred financing costs 2,426,826 1,851,339 1,095,529
Depreciation 380,547 428,906 279,616
------------ ------------ ------------
54,126,534 39,191,887 30,395,063
------------ ------------ ------------
INCOME BEFORE PROVISION FOR INCOME
TAXES $ 14,105,702 $ 10,987,815 $ 10,374,334
============ ============ ============
F-21
MORTGAGE BANKING OPERATING FOR THE YEARS ENDED DECEMBER 31,:
2004 2003 2002
------------ ------------ ------------
REVENUES:
Interest income $ 6,591,458 $ 3,227,252 $ 3,293,289
Purchase discount earned 597,841 241,915 -
Gain on sale of loans held for sale 3,689,616 3,236,616 2,259,979
Gain on sale of other real estate owned 93,397 31,231 -
Other 1,280,467 649,843 519,772
------------ ------------ ------------
12,252,779 7,386,857 6,073,040
------------ ------------ ------------
OPERATING EXPENSES:
Interest expense 3,223,772 1,603,711 1,704,372
Collection, general and administrative 4,941,300 4,122,950 2,235,321
Provision for loan loss 335,530 63,579 101,503
Amortization of deferred financing costs 334,651 127,869 168,583
Depreciation 114,342 76,106 60,145
------------ ------------ ------------
8,949,595 5,994,215 4,269,924
------------ ------------ ------------
INCOME BEFORE PROVISION FOR INCOME
TAXES $ 3,303,184 $ 1,392,642 $ 1,803,116
============ ============ ============
OTHER SELECTED SEGMENT RESULTS
CONSOLIDATED ASSETS:
Portfolio asset acquisition and resolution $754,234,144 $428,436,923 $400,088,702
Mortgage banking 137,276,610 48,296,423 24,330,332
------------ ------------ ------------
Consolidated assets $891,510,754 $476,733,346 $424,419,034
============ ============ ============
TOTAL ADDITIONS TO BULIDING, FURNITURE
AND FIXTURES:
Portfolio asset acquisition and resolution $ 372,011 $ 503,221 $ 253,140
Mortgage banking 155,574 147,637 42,314
------------ ------------ ------------
Consolidated additions to building,
furniture and fixtures $ 527,585 $ 650,858 $ 295,455
============ ============ ============
CONSOLIDATED REVENUE:
Portfolio asset acquisition and resolution $ 68,232,236 $ 50,179,702 $ 40,769,397
Mortgage banking 12,252,779 7,386,857 6,073,040
------------ ------------ ------------
Consolidated Revenue $ 80,485,015 $ 57,566,559 $ 46,842,437
============ ============ ============
CONSOLIDATED NET INCOME :
Portfolio asset acquisition and resolution $ 7,721,435 $ 5,933,419 $ 5,671,774
Mortgage banking 1,784,875 752,038 991,676
------------ ------------ ------------
Consolidated Net Income $ 9,506,310 $ 6,685,457 $ 6,663,450
============ ============ ============
F-22
10. CERTAIN CONCENTRATIONS
The following table summarizes geographic locations of mortgage loans held as
of December 31, 2004:
PERCENTAGE OF TOTAL
LOCATION PRINCIPAL BALANCE
- -------- -------------------
Ohio 9.08%
New York 7.46%
California 7.41%
Florida 7.39%
Georgia 5.22%
New Jersey 5.16%
Michigan 4.37%
Pennsylvania 4.36%
North Carolina 4.20
Texas 4.14%
All Others 41.21%
-----
100.00%
=====
Such real estate mortgage loans held are collateralized by real estate with a
concentration in these regions. Accordingly, the collateral value of a
substantial portion of the Company's real estate mortgage loans held and real
estate acquired through foreclosure is susceptible to changes in market
conditions in these regions. In the event of sustained adverse economic
conditions, it is possible that the Company could experience a negative impact
in its ability to collect on existing real estate mortgage loans held, or
liquidate foreclosed assets in these regions, which could impact the Company's
related loan loss estimates.
Financing - Substantially all of the Company's existing debt and available
credit facilities are with one financial institution. The Company's purchases of
new portfolios and financing of its mortgage banking operations are contingent
upon the continued availability of these credit facilities.
11. COMMITMENTS AND CONTINGENCIES
Operating Leases - Certain secondary office and file space is leased under
operating leases. The combined future minimum lease payments at December 31,
2004 are as follows:
F-23
YEAR ENDED AMOUNT
- ---------- ----------
2005 $ 760,447
2006 1,332,493
2007 1,353,637
2008 1,203,783
2009 935,767
THEREAFTER 3,672,854
----------
$9,258,981
==========
YEAR ENDED AMOUNT
- ---------- ----------
2005 $ 173,332
2006 160,733
2007 101,042
2008 83,091
2009 53,992
---------
$ 572,190
=========
Legal Actions - The Company is involved in legal proceedings and
litigation arising in the ordinary course of business. In the opinion of
management, the outcome of such proceedings and litigation currently
pending will not materially affect the Company's financial statements.
During 2003, the Company sold $2,730,605 of loans to one investor and
retained the servicing rights. SFAS 140 requires that entities that
acquire servicing assets through either purchase or origination of loans
and sell or securitize those loans with servicing assets retained must
allocate the total costs of the loans to the servicing assets and the
loans (without the servicing assets) based on their relative fair values.
The amount attributable to the servicing assets was determined to be
$20,480 and was capitalized as a servicing asset in other assets in the
consolidated balance sheet. During 2004, a significant portion of the
serviced portfolio paid off and the Company judged the servicing asset to
be immaterial, and wrote off the remaining balance.
As of December 31, 2004 the unpaid balances of mortgage loans being
serviced by the Company for others were $1,128,460. Mortgage loans
serviced for others are not included in the Company's consolidated balance
sheet.
12. RELATED PARTY TRANSACTIONS
In 1998, Mr. Axon, the Company's Chairman, purchased from the Company, a
Florida condominium unit subject to considerable title defects, held by
the Company in its OREO available for sale. The consideration included
forgiveness of $ 184,335 of indebtedness of the Company to an affiliated
F-24
Company and issuance by Mr. Axon of a note to the Company in the amount of
$234,165. The note bore interest at a rate of 8% per annum, was secured by
the condominium property, and was due June 1, 2001. During 2001, the
parties agreed to extend the note until December 31, 2003 and it has since
been repaid.
During 2000, Mr. Axon purchased from the Company a New York condominium
held by the Company in its OREO. The consideration included the issuance
by Mr. Axon of a note to the Company in the amount of $165,000. The note
bore interest at a rate of 8% per annum, was secured by the condominium
property, and was due January 30, 2004. The note has since been repaid.
On March 31, 1999, Mr. Steven W. Lefkowitz, a board member, purchased from
the Company without recourse a delinquent non-performing note receivable
held by the Company. The consideration given included a note for $270,000
payable to the Company. The note bore interest at a rate of 8% per annum,
payable monthly, and was secured by a mortgage on real estate. The note
has since been repaid.
The Company currently leases approximately 2,500 square feet of office
space on the fifth floor at Six Harrison Street in New York, New York,
from RMTS Associates, LLC, of which Mr. Axon owns 80%. Pursuant to the
lease, the Company paid RMTS rent of approximately $50,500 in 2003 and
$51,500 in 2004.
The Company currently subleases approximately 7,400 square feet of office
space at 185 Franklin Street in New York, New York from 185 Franklin
Street Development Associates, a limited partnership, of which 185
Franklin Street Development Corp., which is wholly-owned by Mr. Axon, is
the general partner. Pursuant to the sublease, the Company paid 185
Franklin Street Development Associates rent of $11,575 per month in 2003
and $11,500 per month in 2004.
13. SUMMARY OF QUARTERLY RESULTS (UNAUDITED)
The table below sets forth selected unaudited financial information for
each calendar quarter of each the years ended December 31, 2004 and 2003.
F-25
1ST QUARTER 2ND QUARTER 3RD QUARTER 4TH QUARTER
2004
Revenue $15,059,765 $15,787,166 $21,965,456 $27,672,629
Operating expenses 11,361,416 12,737,201 17,345,667 21,634,420
----------- ----------- ----------- -----------
Income before income taxes $ 3,698,349 $ 3,049,965 $ 4,619,789 $ 6,038,209
----------- ----------- ----------- -----------
Provision for Income taxes 1,665,000 1,409,000 2,102,004 2,723,996
----------- ----------- ----------- -----------
Net Income $ 2,033,349 $ 1,640,965 $ 2,517,785 $ 3,314,213
=========== =========== =========== ===========
Income per common share
Basic $ 0.34 $ 0.28 $ 0.43 $ 0.53
=========== =========== =========== ===========
Diluted $ 0.30 $ 0.25 $ 0.37 $ 0.48
=========== =========== =========== ===========
1ST QUARTER 2ND QUARTER 3RD QUARTER 4TH QUARTER
2003
Revenue $13,939,228 $13,957,953 $14,057,724 $15,611,654
Operating expenses 10,517,883 11,246,377 11,386,400 12,035,442
----------- ----------- ----------- -----------
Income before income taxes $ 3,421,345 $ 2,711,576 $ 2,671,324 $ 3,576,212
----------- ----------- ----------- -----------
Provision for Income taxes 1,573,800 1,282,500 1,215,900 1,622,800
----------- ----------- ----------- -----------
Net Income $ 1,847,545 $ 1,429,076 $ 1,455,424 $ 1,953,412
=========== =========== =========== ===========
Income per common share
Basic $ 0.31 $ 0.24 $ 0.25 $ 0.33
=========== =========== =========== ===========
Diluted $ 0.30 $ 0.22 $ 0.22 $ 0.30
=========== =========== =========== ===========
14. SUBSEQUENT EVENTS
On March 4, 2005, the Company entered into a sublease agreement with Lehman
Brothers Holdings Inc. to sublease approximately 33,866 square feet of space at
101 Hudson Street, Jersey City, New Jersey for use as executive and
administrative offices. We currently expect the term of the sublease, which is
subject to certain conditions, to commence by April 1, 2005. The term of the
sublease is through December 30, 2010.
We are negotiating with certain of our landlords regarding the cost of
terminating certain of our current leases in New York.
F-26