UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2005
|_| Transition report pursuant to Section 13 or 15(d) of the Securities Exchange
For the transition period from ________ to ___________ Act of 1934
Commission file number 0-17771
FRANKLIN CREDIT MANAGEMENT CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 75-2243266
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) identification No.)
Six Harrison Street
New York, New York 10013
(212) 925-8745
(Address of principal executive offices)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|.
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes|_| No |X|.
As of August 11, 2005 the issuer had 7,511,795 of shares of Common Stock, par
value $0.01 per share, outstanding.
================================================================================
FRANKLIN CREDIT MANAGEMENT CORPORATION
FORM 10-Q
INDEX
C O N T E N T S
PART I. FINANCIAL INFORMATION Page
Item 1. Financial Statements (unaudited)
Consolidated Balance Sheets at June 30, 2005 and
December 31, 2004 3
Consolidated Statements of Income for the three and
six months ended June 30, 2005 and June 30, 2004 4
Consolidated Statement of change in Stockholders' Equity
for the six months ended June 30, 2005 5
Consolidated Statements of Cash Flows for the
six months ended June 30, 2005 and June 30, 2004 6
Notes to Consolidated Financial Statements 7-16
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 17-49
Item 3. Quantitative and Qualitative Disclosures about Market Risk 49-50
Item 4. Controls and Procedures 50
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 51
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 51
Item 3. Defaults Upon Senior Securities 51
Item 4. Submission of Matters to a Vote of Security Holders 52
Item 5. Other Information 52
Item 6. Exhibits and Reports on Form 8-K 52-53
SIGNATURES 54
CERTIFICATIONS 55-58
FRANKLIN CREDIT MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (Unaudited)
- --------------------------------------------------------------------------------
ASSETS June 30, 2005 December 31, 2004
Cash and cash equivalents $ 27,027,055 $ 19,519,659
Restricted cash 159,106 128,612
Notes Receivable:
Principal 820,710,877 811,885,856
Purchase discount (25,200,595) (32,293,669)
Allowance for loan losses (80,280,816) (89,628,299)
--------------- ---------------
Net notes receivable 715,229,466 689,963,888
Originated loans held for sale 17,405,621 16,851,041
Originated loans held for investment-net 232,771,515 110,496,274
Accrued interest receivable 10,483,739 8,506,252
Other real estate owned 17,340,979 20,626,156
Other receivables 9,058,961 5,366,500
Deferred tax asset 373,734 583,644
Other assets 11,941,533 10,577,344
Building, furniture and equipment-net 2,260,222 1,290,442
Deferred financing costs-net 9,250,106 7,600,942
--------------- ---------------
Total assets $ 1,053,302,037 $ 891,510,754
=============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Accounts payable and accrued expenses $ 13,313,579 $ 11,572,764
Financing agreements 31,034,260 39,540,205
Notes payable 968,924,333 807,718,038
Deferred tax liability 4,828,029 3,123,865
--------------- ---------------
Total Liabilities 1,018,100,201 861,954,872
--------------- ---------------
Commitments and Contingencies
Stockholders' Equity
Preferred stock, $.001 par value; authorized 3,000,000; issued-none
Common stock, $.01 par value, 22,000,000 authorized shares; -- --
issued and outstanding: 6,133,295 in 2005 and 6,062,295 in 2004 61,333 60,623
Additional paid-in capital 7,820,531 7,354,778
Retained earnings 27,319,972 22,140,481
--------------- ---------------
Total stockholders' equity 35,201,836 29,555,882
--------------- ---------------
Total liabilities and stockholders' equity $ 1,053,302,037 $ 891,510,754
=============== ===============
See notes to consolidated financial statements
Page 3
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Three- Months Ended June 30, Six- Months Ended June 30,
2005 2004 2005 2004
----------- ----------- ----------- -----------
REVENUES:
Interest income $23,978,328 $11,354,267 $46,855,526 $21,990,608
Purchase discount earned 2,867,795 1,727,781 5,119,276 3,069,178
Gain on sale of notes receivable 665,902 -- 665,902 844,902
Gain on sale of originated loans held for sale 1,026,389 1,252,474 1,690,093 2,145,429
Gain on sale of other real estate owned 400,402 142,151 656,383 373,397
Prepayments and other income 2,202,930 1,310,493 4,045,846 2,423,417
----------- ----------- ----------- -----------
31,141,746 15,787,166 59,033,026 30,846,931
----------- ----------- ----------- -----------
OPERATING EXPENSES:
Interest expense 16,281,776 5,481,129 29,300,121 10,794,204
Collection, general and administrative 8,679,188 5,747,221 15,768,732 10,193,403
Provision for loan losses 1,052,714 812,383 2,250,932 1,708,259
Amortization of deferred financing costs 1,012,734 560,226 1,705,721 1,153,127
Depreciation 209,353 136,242 414,827 249,624
----------- ----------- ----------- -----------
27,235,765 12,737,201 49,440,333 24,098,617
----------- ----------- ----------- -----------
Income before provision for income taxes 3,905,981 3,049,965 9,592,693 6,748,314
----------- ----------- ----------- -----------
Provision for income taxes 1,797,314 1,409,000 4,413,202 3,074,000
----------- ----------- ----------- -----------
Net income $ 2,108,667 $ 1,640,965 $ 5,179,491 $ 3,674,314
=========== =========== =========== ===========
Net income per common share:
Basic $ 0.35 $ 0.28 $ 0.85 $ 0.62
Diluted $ 0.30 $ 0.25 $ 0.75 $ 0.56
=========== =========== =========== ===========
Weighted average number of shares 6,090,628 5,916,527 6,088,212 5,916,527
outstanding, basic
=========== =========== =========== ===========
Weighted average number of shares
outstanding, diluted 6,958,628 6,591,219 6,872,015 6,579,625
=========== =========== =========== ===========
See notes to consolidated financial statements.
Page 4
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
SIX- MONTHS ENDED JUNE 30, 2005 (Unaudited)
- --------------------------------------------------------------------------------
Common Stock Additional
--------------------------- Paid-In Retained
Shares Amount Capital Earnings Total
- --------------------------------------------------------------------------------------------------------------------------
Balance, January 1, 2005 6,062,295 $60,623 $7,354,778 $22,140,481 $29,555,882
Net income 5,179,491 5,179,491
Stock issuance 71,000 710 465,753 466,463
-----------------------------------------------------------------------------------
Balance, June 30, 2005 6,133,295 $61,333 $7,820,531 $27,319,972 $35,201,836
===================================================================================
See notes to consolidated financial statements.
Page 5
FRANKLIN CREDIT MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
- --------------------------------------------------------------------------------
Six Months Ended June 30,
2005 2004
------------- -------------
Cash flows from operating activities:
Net income $ 5,179,491 $ 3,674,314
Adjustments to reconcile income to net cash used in:
operating activities:
Gain on sale of notes receivable (665,902) (844,902)
Gain on sale of other real estate owned (656,383) (373,397)
Depreciation 414,827 249,624
Amortization of deferred financing costs 1,705,721 1,153,127
Origination of loans held for sale (30,053,155) (80,178,341)
Issuance of restricted stock 430,190 --
Proceeds from the sale of and principal collections on
loans held for sale-net of gain 28,450,972 55,617,504
Purchase discount earned (5,119,276) (3,069,178)
Provision for loan losses 2,250,932 1,708,259
Changes in operating assets and liabilities:
Accrued interest receivable (1,977,487) (2,924,867)
Other receivables (3,692,461) (461,965)
Deferred tax asset 209,910 229,306
Other assets (1,364,189) (243,744)
Deferred tax liability 1,704,164 (990,169)
Accounts payable and accrued expenses 1,740,815 (508,128)
------------- -------------
Net cash used in operating activities (1,441,831) (26,962,557)
------------- -------------
Cash flows from investing activities:
(Increase) decrease in restricted cash (30,494) 315,121
Purchase of notes receivable (173,407,681) (351,596,126)
Principal collections on notes receivable and loans held for investment 162,606,731 85,308,403
Originations of loans held for investment (163,253,882) --
Acquisition and loan fees (1,721,767) (3,308,399)
Proceeds from sale of other real estate owned 16,543,339 10,550,854
Proceeds from sale of loans held for investment 8,264,142 --
Proceeds from sale of notes receivable 8,596,823 6,556,853
Purchase of building, furniture and equipment (1,384,607) (230,311)
------------- -------------
Net cash used in investing activities (143,787,396) (252,403,605)
------------- -------------
Cash flows from financing activities:
Proceeds from notes payable 351,987,875 378,109,100
Principal payments of notes payable (190,781,580) (114,240,607)
Proceeds from financing agreements 194,041,589 82,346,598
Principal payments of financing agreements (202,547,534) (68,593,797)
Exercise of stock options 36,273
------------- -------------
Net cash provided by financing activities 152,736,623 277,621,294
------------- -------------
NET CHANGE IN CASH AND CASH EQUIVALENTS 7,507,396 (1,744,868)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 19,519,659 14,418,876
------------- -------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 27,027,055 $ 12,674,008
============= =============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash payments for interest $ 27,853,662 $ 10,876,632
============= =============
Cash payments for taxes $ 3,128,872 $ 3,807,300
============= =============
See notes to consolidated financial statements.
Page 6
FRANKLIN CREDIT MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
- --------------------------------------------------------------------------------
1. Business.
As used herein references to the "Company", FCMC, "we", "our" and "us"
refer to Franklin Credit Management Corporation, collectively with its
subsidiaries.
We are a specialty consumer finance company primarily engaged in two
related lines of business: (1) the acquisition, servicing and resolution
of performing, reperforming and nonperforming residential mortgage loans
and real estate assets; and (2) the origination of non-prime mortgage
loans, both for our portfolio and for sale into the secondary market. We
specialize in acquiring and originating loans secured by 1-to-4 family
residential real estate that generally fall outside the underwriting
standards of Fannie Mae and Freddie Mac and involve elevated credit risk
as a result of the nature or absence of income documentation, limited
credit histories, higher levels of consumer debt or past credit
difficulties. We typically purchase loan portfolios at a discount, and
originate loans with interest rates and fees, calculated to provide us
with a rate of return adjusted to reflect the elevated credit risk
inherent in the types of loans we acquire and originate. Unlike many of
our competitors, we generally hold for investment the loans we acquire and
a significant portion of the loans we originate.
From inception through June 30, 2005, we had purchased and originated in
excess of $2.5 billion in mortgage loans. As of June 30, 2005, we had
total assets of $1.05 billion, our portfolios of notes receivable and
loans held for investment and sale, net, totaled $965.4 million, and our
stockholders' equity was $35.2 million. For the six months ended June 30,
2005, we reported net income of $5.2 million.
Loan Acquisitions
Since commencing operations in 1990, we have become a nationally
recognized buyer of portfolios of residential mortgage loans and real
estate assets 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.
These portfolios generally consist of one or more of the following types
of mortgage loans:
o performing loans - loans to borrowers who are contractually
current, but may have been delinquent in the past and which
may have deficiencies relating to credit history,
loan-to-value ratios, income ratios or documentation;
o reperforming loans - loans to borrowers who are not
contractually current, but have recently made regular payments
and where there is a good possibility the loans will be repaid
in full; and
o nonperforming loans - loans to borrowers who are delinquent,
not expected to cure, and for which a primary avenue of
recovery is through the sale of the property securing the
loan.
We sometimes refer collectively to these types of loans as "scratch and
dent" or "S&D" loans.
Page 7
We have developed a specialized expertise at risk-based pricing, credit
evaluation and loan servicing that allows us to effectively evaluate and
manage the higher risks associated with this segment of the residential
mortgage industry, including the rehabilitation or resolution of
reperforming and nonperforming loans.
We refer to the S&D loans we acquire as "notes receivable." During
the first six months of 2005, we purchased notes receivable with an
aggregate unpaid principal balance of $193.6 million at an aggregate
purchase price equal to 90% of the face amount of the notes. In the second
quarter of 2005, we purchased notes receivable with an aggregate unpaid
principal balance of $81.8 million at an aggregate purchase price equal to
92% of the face amount of the notes.
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.
During the first six months of 2005, we originated $193.3 million in
non-prime mortgage loans. We originated approximately 45% of our mortgage
loans on a retail basis and approximately 55% through our wholesale
network of mortgage brokers during 2005. 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 June 30, 2005, we originated loans with a face value
of $639 million, $250.2 million of which we retained for sale or
investment as of June 30, 2005.
Loan Servicing
We have invested heavily to create a loan servicing capability that is
focused on collections, loss mitigation and default management. In
general, we seek to ensure that the loans we acquire and originate are
repaid in accordance with the original terms or according to amended
repayment terms negotiated with the borrowers. Because we expect our loans
will experience above average delinquencies, erratic payment patterns and
defaults, our servicing operation is focused on maintaining close contact
with our borrowers and as a result is more labor intensive than
traditional mortgage servicing operations. Through frequent communication
we are able to encourage positive payment performance, quickly identify
those borrowers who are likely to move into seriously delinquent status
and promptly apply appropriate loss mitigation strategies. Our servicing
staff employs a variety of collection strategies that we have developed to
successfully manage serious delinquencies, bankruptcy and foreclosure.
Additionally, we maintain a real estate department with extensive
experience in property management and the sale of residential properties.
Page 8
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.
The condensed consolidated financial statements (unaudited) have been
prepared by the Company in accordance with the rules and regulations of
the Securities and Exchange Commission and should be read in conjunction
with the Company's consolidated financial statements and notes thereto
included in the Company's most recent Annual Report on Form 10-K for the
year ended December 31, 2004. The condensed consolidated financial
statements reflect all adjustments (consisting only of normal recurring
adjustments) that are, in the opinion of management, necessary for the
fair statement of the results for the interim period. The results of
operations for interim periods are not necessarily indicative of results
for the entire year.
Reclassification- Certain prior period amounts have been reclassified to
conform to current period 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 has two reportable operating segments: (i) portfolio
asset acquisition and resolution; and (ii) mortgage banking. The portfolio
asset acquisition and resolution segment acquires performing, reperforming
or nonperforming notes receivable and promissory notes from financial
institutions, mortgage and finance companies, and services and collects
such notes receivable through enforcement of terms of the original note,
modification of original note terms and, if necessary, liquidation of the
underlying collateral. The mortgage-banking segment originates or
purchases, sub prime residential mortgage loans from 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. The accounting policies of the segments are the same as
those described in the summary of significant accounting policies.
Page 9
Three Months Ended June 30,
2005 2004
CONSOLIDATED REVENUE
Portfolio asset acquisition and resolution $24,042,148 $12,956,448
Mortgage banking 7,099,598 2,830,718
----------- -----------
Consolidated Revenue $31,141,746 $15,787,166
=========== ===========
CONSOLIDATED INCOME BEFORE INCOME TAXES
Portfolio asset acquisition and resolution $ 2,607,377 $ 2,450,982
Mortgage banking 1,298,604 598,983
----------- -----------
Consolidated Income before income taxes $ 3,905,981 $ 3,049,965
=========== ===========
Six Months Ended June 30,
2005 2004
CONSOLIDATED REVENUE
Portfolio asset acquisition and resolution $46,519,872 $25,754,285
Mortgage banking 12,513,154 5,092,646
----------- -----------
Consolidated Revenue $59,033,026 $30,846,931
=========== ===========
CONSOLIDATED INCOME BEFORE INCOME TAXES
Portfolio asset acquisition and resolution $ 6,822,062 $ 5,722,330
Mortgage banking 2,770,631 1,025,984
----------- -----------
Consolidated Income before income taxes $ 9,592,693 $ 6,748,314
=========== ===========
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, mortgage and finance companies. Such notes
receivable are performing, non-performing or sub-performing at the time of
purchase and are generally 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.
Notes purchased after December 31, 2004 that meet the requirements of
AICPA Statement of Position (SOP) No. 03-3, "Accounting for Certain Loans
or Debt Securities Acquired in a Transfer" ("SOP 03-3") are stated net of
purchase discount. 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.
Page 10
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.
Discounts on Acquired Loans - Effective January 1, 2005, as a result of
the required adoption of SOP 03-3 the Company was required to change our
accounting for loans acquired subsequent to December 31, 2004 which have
evidence of deterioration of credit quality since origination and for
which it is probable, at the time of our acquisition, that the Company
will be unable to collect all contractually required payments. For these
loans, the excess of the undiscounted contractual cash flows over the
undiscounted cash flows estimated by us at the time of acquisition is not
accreted into income (nonaccretable discount). The amount representing the
excess of cash flows estimated by us at acquisition over the purchase
price is accreted into interest income over the life of the loan
(accretable discount).
For loans not addressed by SOP 03-3 that are acquired subsequent to
December 31, 2004, the discount, which represents the excess of the amount
of reasonably estimable and probable discounted future cash collections
over the purchase price, is accreted into purchase discount using the
interest method over the term of the loans. The discount is not accreted
on non-performing loans. This is consistent with the method of the Company
utilizes for its accounting for loans purchased prior to January 1, 2005,
except that for these loans an allowance allocation was also made at the
time of acquisition. We no longer increase the allowance through
allocations from purchase discount for loans that meet the requirements of
SOP 03-3.
There is judgment involved in estimating the amount of our future
cash flows. The amount and timing of actual cash flows could differ
materially from management's estimates, which could materially affect our
financial condition and results of operations. Depending on the timing of
an acquisition, a preliminary allocation may be utilized until a final
allocation is established. Generally, the allocation will be finalized no
later than ninety days from the date of purchase.
The nonaccretable discount is not accreted into income until it is
determined that the amount and timing of the related cash flows are
reasonably estimable and collection is probable. If cash flows cannot be
reasonably estimated for any loan, and collection is not probable, the
cost recovery method of accounting is used. Under the cost recovery
method, any amounts received are applied against the recorded amount of
the loan.
Subsequent to acquisition, if cash flow projections improve, and it is
determined that the amount and timing of the cash flows related to the
nonaccretable discount are reasonably estimable and collection is
probable, the corresponding decrease in the nonaccretable discount is
transferred to the accretable discount and is accreted into interest
income over the remaining life of the loan on the interest method. If cash
flow projections deteriorate subsequent to acquisition, the decline is
accounted for through the allowance for loan losses.
Page 11
Allowance for Loan Losses - The Company perform reviews of our loan
portfolio upon purchase, at loan boarding, and on a frequent basis
thereafter to segment impaired loans under ("SFAS") No. 114 Accounting by
Creditors for Impairment of a Loan. A loan is considered impaired when it
is probable that we 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 our
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. Management believes that the allowance for loan
losses is adequate. The allowance for loan losses is a material estimate,
which could change significantly in the near term.
Effective January 1, 2005, and as a result of the required adoption of SOP
03-3, additions to the valuation allowances relating to newly acquired
loans reflect only those losses incurred by us subsequent to acquisition.
The Company no longer increase the allowances through allocations from
purchase discount for loans that meet the requirements of SOP 03-3.
Additionally, general risk allocations are no longer applied to loans
purchased subsequent to December 31, 2004. Consequently, the allowance for
loan losses has declined since the adoption of SOP 03-3, and it is
anticipated that the allowance will continue to decline as credits for
loan losses may continue to be recorded if loans pay off and allowances
related to these loans are not required or additions due to loan
impairment are not required.
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- 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. In general, interest on originated loans
held for investment is calculated based on contractual interest rates
applied to daily balances of the principal amount outstanding using the
accrual method. Accrual of interest including impaired loans, 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 loan 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.
Page 12
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
or earnings if purchase discount is not sufficient to cover the
write-down. 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.
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.
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. SFAS 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.
Page 13
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 June 30,
2005 and December 31, 2004 was equivalent to their carrying value of
$715,229,466 and $689,963,888, respectively.
c. Loans held for Investment, Loans held for sale- the carrying values
reported in the consolidated balance sheets are a reasonable
estimate of fair value.
d. 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 June 30, 2005 and December 31, 2004 was
$31,034,260 and $39,540,205, respectively.
e. 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 $968,924,333 and $807,718,038 at June 30, 2005 and December
31, 2004, 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 therefore net income was the same as its
comprehensive income for all periods presented.
Accounting for Stock Options- We have adopted the disclosure requirements of
SFAS No. 148, Accounting for Stock-Based Compensation--Transition and
Disclosure, effective December 2002. SFAS No.148 amends SFAS No. 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 No. 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 No.148 and
SFAS No.123, we continue to apply the accounting provisions of Accounting
Principles Board ("APB") Opinion Number 25, Accounting for Stock Issued to
Employees ("APB Opinion 25"), and related interpretations, with regard to the
measurement of compensation cost for options granted under our Stock Option
Plans. SFAS No. 123 and APB Opinion 25 require only that the expense relating to
employee stock options be disclosed in the footnotes to the consolidated
financial statements.
Page 14
Our Stock Incentive Plan is accounted for under the recognition and
measurement principles of APB Opinion 25 and related interpretations. 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:
Three months Three months
Ended June 30, 2005 Ended June 30, 2004
Net income - as reported $2,108,667 $1,640,965
Net income - pro forma $2,065,408 $1,633,840
Earnings per share:
Net income per common share - basic - as reported $ 0.35 $ 0.28
Net income per common share - basic - pro forma $ 0.34 $ 0.28
Net income per common share - dilutive - as reported $ 0.30 $ 0.25
Net income per common share - dilutive - pro forma $ 0.30 $ 0.25
Six months Six months
Ended June 30, 2005 Ended June 30, 2004
Net income - as reported $5,179,491 $3,674,314
Net income - pro forma $5,133,156 $3,660,064
Earnings per share:
Net income per common share - basic - as reported $ 0.85 $ 0.62
Net income per common share - basic - pro forma $ 0.84 $ 0.62
Net income per common share - dilutive - as reported $ 0.75 $ 0.56
Net income per common share - dilutive - pro forma $ 0.75 $ 0.56
In December 2004, the FASB issued SFAS No. 123(R), a revision of SFAS No.
123. SFAS No. 123(R) requires that the compensation cost relating to
share-based payment transaction, including employee stock options,
restricted share plans, performance-based awards, share appreciation
rights, and employee share purchase plans, be recognized as an expense in
our consolidated financial statements. Under SFAS No. 123(R), the related
compensation cost will be measured based on the fair value of the award at
the time of grant.
We are required to adopt SFAS No. 123(R) on January 1, 2006. We are
currently evaluating the prospective effect of SFAS No.123(R) on our
results of operations.
There were 106,500 options granted to management and the board of
directors during the six months ended June 30, 2005.
Recent Accounting Pronouncements
Effective January 1, 2005, and as a result of the required adoption of SOP
03-3 the Company changed its discount accounting as it relates to loans
that are acquired subsequent to December 31, 2004 and which have evidence
of deterioration of credit quality since origination and, for which it is
probable, at acquisition, that the Company will be unable to collect all
contractually required payments. For such loans, the excess of contractual
cash flows over cash flows estimated at the time of acquisition
(nonaccretable discount) is not accreted into income . The remaining
amount, representing the excess of the loan's estimated cash flows over
the purchase price (accretable discount), is accreted into income over the
life of the loan.
SOP 03-3 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 impairment on the statement of income and a corresponding
valuation allowance would be created against the investment in notes
receivable on the balance sheet. SOP 03-3 applies to loans acquired in
fiscal years beginning after December 15, 2004, and accordingly, The
Company adopted the provisions of this SOP in the first quarter of 2005.
Adoption of SOP 03-3 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.
Page 15
This statement prohibits investors from displaying discount on the face of
the statement of condition, or the creation of valuation allowances at the
time of acquisition when such loans are within the scope of this
statement.
The following table sets forth certain information relating to the
activity in the accretable and nonaccretable discount in accordance with
SOP 03-3 for the periods indicated:
Three Months Ended Six Months Ended
June 30,
Accretable Discount 2005 2005
Balance, beginning of period $ 1,461,379 $ --
New Acquisitions 5,521,855 7,033,952
Accretion (206,266) (256,985)
Net reductions relating to loans sold (55,748) (55,747)
------------ ------------
Balance, 6/30/2005 $ 6,721,220 $ 6,721,220
============ ============
Three Months Ended Six Months Ended
June 30,
Non-Accretable Discount 2005 2005
Balance, beginning of period $ 11,518,409 $ --
New Acquisitions $ 1,879,326 $ 13,397,735
Net reductions relating to loans sold (59,656) (59,656)
------------ ------------
Balance, 6/30/2005 $ 13,338,079 $ 13,338,079
============ ============
Page 16
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
General
Safe Harbor Statements. 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 our relations with
our sole lender and the lender's willingness to extend additional credit to us;
(iii) the availability for purchases of additional loans; (iv) the availability
of sub-prime borrowers for the origination of additional loans; (vi) changes in
the statutes or regulations applicable to our business or in the interpretation
and enforcement thereof by the relevant authorities; (vii) the status of our
regulatory compliance; and (viii) other risks detailed from time to time in our
SEC reports and filings. Additional factors that would cause actual results to
differ materially from those projected 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
under the caption "Interest Rate Risk" and "Real Estate Risk" in the Company's
Annual Report on Form 10-K and Quarterly Reports on Form 10-Q, and "Risk
Factors" contained in the Company's S-1 filing, 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 thereof. 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.
Overview
Net income totaled $2.1 million for the second quarter of 2005, compared
with $1.6 million for the second quarter of 2004. Earnings per common share for
the second quarter of 2005 was $0.30 on a diluted basis and $.35 on a basic
basis, compared to $0.25 and $0.28 for the second quarter of 2004, respectively.
Our second quarter revenues increased by 97% to $31.1 million from second
quarter 2004 revenues of $15.8 million. The increase in 2005 second quarter net
income was driven largely by the 31% increase in net interest income, which was
the result of significant additions to the portfolio of notes receivable and
loans held for investment during the last three quarters of 2004 and in the
first half of 2005, from both loan portfolio acquisitions and originated loans.
During the second quarter, we acquired S&D loans with an aggregate face amount
of $81.8 million and we originated $105.4 million of non-prime loans. We
increased the size of our total portfolio of net notes receivable, loans held
for sale and loans held for investment at the end of the second quarter 2005 to
$965.4 million from $817.3 million at the end of 2004. Our total debt
outstanding grew to $1.0 billion at June 30, 2005 from $847.3 million at the end
of 2004. Our weighted average cost of funds during the second quarter 2005
increased to 6.51% from 4.79% during the second quarter of 2004. Stockholders
equity increased by 19% since year-end 2004 to $35.2 million, or 3.35% of June
30, 2005 assets due to the retention of net income.
Page 17
Application of Critical Accounting Policies and Estimates
The following discussion and analysis of financial condition and results of
operations is based on the amounts reported in our consolidated financial
statements, which are prepared in accordance with accounting principles
generally accepted in the United States of America, or GAAP. In preparing the
consolidated financial statements, management is required to make various
judgments, estimates and assumptions that affect the financial statements and
disclosures. Changes in these estimates and assumptions could have a material
effect on our consolidated financial statements. The following is a summary of
the accounting policies believed by management to be most critical in their
potential effect on our financial position or results of operations. The
Company's' significant accounting policies are described in Note 1 to the
December 31, 2004 consolidated financial statements filed on Form 10-K, and have
not been changed in 2005 except for adoption of SOP 03-3 as described below.
Notes Receivable and Income Recognition - Our notes receivable portfolio
consists primarily of secured real estate mortgage loans purchased from
financial institutions, mortgage banks and finance companies. Notes receivable
are performing, reperforming or nonperforming 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. Notes purchased after December 31, 2004,
under AICPA Statement of Position ("SOP") No. 03-3, Accounting for Certain Loans
or Debt Securities Acquired in a Transfer ("SOP 03-3"), are stated at amortized
cost. We have 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. We periodically evaluate the collectability of both
interest and principal of our notes receivable to determine whether they are
impaired. A note receivable is considered impaired when it is probable that we
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.
Discounts on Acquired Loans - Effective January 1, 2005, as a result of
the required adoption of SOP 03-3, the Company was required to change our
accounting for loans acquired subsequent to December 31, 2004 that have evidence
of deterioration of credit quality since origination and for which it is
probable, at the time of our acquisition, that we will be unable to collect all
contractually required payments. For these loans, the excess of the undiscounted
contractual cash flows over the undiscounted cash flows estimated by us at the
time of acquisition is not accreted into income, and is referred to as
nonaccretable discount. The amount representing the excess of cash flows
estimated by us at acquisition over the purchase price is accreted into interest
income over the life of the loan, and is referred to as accretable discount.
For loans not addressed by SOP 03-3 that are acquired subsequent to
December 31, 2004, the discount, which represents the excess of the amount of
reasonably estimable and probable discounted future cash collections over the
purchase price, is accreted into purchase discount using the interest method
over the term of the loans. The discount is not accreted on non-performing
loans. This is consistent with the method the Company utilizes for its
accounting for loans purchased prior to January 1, 2005, except that for these
loans an allowance allocation was also made at the time of acquisition.
Page 18
There is judgment involved in estimating the amount of the future cash
flows. The amount and timing of actual cash flows could differ materially from
management's estimates, which could materially affect our financial condition
and results of operations. Depending on the timing of an acquisition, a
preliminary allocation may be utilized until a final allocation is established.
Generally, the allocation will be finalized no later than ninety days from the
date of purchase.
The nonaccretable discount is not accreted into income until it is
determined that the amount and timing of the related cash flows are reasonably
estimable and collection is probable. If cash flows cannot be reasonably
estimated for any loan, and collection is not probable, the cost recovery method
of accounting is used. Under the cost recovery method, any amounts received are
applied against the recorded amount of the loan.
Subsequent to acquisition, if cash flow projections improve, and it is
determined that the amount and timing of the cash flows related to the
nonaccretable discount are reasonably estimable and collection is probable, the
corresponding decrease in the nonaccretable discount is transferred to the
accretable discount and is accreted into interest income over the remaining life
of the loan on the interest method. If cash flow projections deteriorate
subsequent to acquisition, the decline is accounted for through the allowance
for loan losses.
Allowance for Loan Losses - The Company performs reviews of our 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 that we 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 our 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.
Management believes that the allowance for loan losses is adequate. The
allowance for loan losses is a material estimate, which could change
significantly in the near term.
Effective January 1, 2005, and as a result of the required adoption of SOP 03-3,
additions to the valuation allowances relating to newly acquired loans reflect
only those losses incurred by us subsequent to acquisition. The Company no
longer increases the allowance through allocations from purchase discount for
loans acquired subsequent to December 31, 2004. Consequently, the allowance for
loan losses has declined since the adoption of SOP 03-3, and it is anticipated
that the allowance will continue to decline as an allowance for loan loss is no
longer established at time of acquisition, as loans pay off and allowances
related to these loans may not be required or future additions due to loan
impairment may decline or are no longer required.
Page 19
Portfolio Characteristics
Loan Acquisitions
We purchased $81.8 million of loans during the second quarter of 2005, as
compared with approximately $368.2 million in loans during the second quarter
2004. For the six-months ended June 30, 2005, we purchased $193.6 million of
loans as compared with $416.1 million for the same 2004 period. On June 30,
2004, the Company purchased a $310.4 million pool of performing, sub-performing
and non-performing first and second, residential mortgage loans from Bank One.
The following table sets forth the unpaid principal balance at acquisition,
purchase price and purchase price as a percentage of unpaid principal balance
for the Company's loan acquisitions during the three and six-month periods ended
June 30, 2005 and 2004:
Three- Months Ended June 30, Six- Months Ended June 30,
2005 2004 2005 2004
------------ ------------ ------------ ------------
Aggregate unpaid principal balance $ 81,808,510 $368,179,775 $193,583,799 $416,057,515
at acquisition
Purchase price $ 74,884,736 $312,603,653 $173,407,681 $351,596,126
Purchase price percentage 92% 85% 90% 85%
Loan Dispositions
In the ordinary course of our loan servicing process and through the periodic
review of our portfolio of purchased loans, there are certain loans that, for
various reasons, we determine to sell. We typically sell these loans for cash on
a whole-loan, servicing-released basis. The following table sets forth our
dispositions of purchased loans during the three and six months periods of 2005
and 2004:
Three-Ended Months June 30, Six- Months Ended June 30,
2005 2004 2005 2004
----------- ----------- ----------- -----------
Sale of Performing Loans
Aggregate unpaid principal balance $ 7,337,363 -- $ 7,337,363 $ 8,662,461
Gain on sale $ 618,881 -- $ 618,881 $ 844,902
Sale of Non-Performing Loans
Aggregate unpaid principal balance $23,483,652* -- $23,483,652* --
Gain on sale $ 47,021 -- $ 47,021 --
* Sale of credit card portfolio; allowance for loan losses amounted to $22.3
million.
Page 20
Other Real Estate Owned
The following table sets forth our other real estate owned, or OREO, and
OREO sales at and for the three and six month periods ended June 30, 2005 and
June 30, 2004:
Three- Months ended June 30, Six- Months ended June 30,
2005 2004 2005 2004
----------- ----------- ----------- -----------
Other real estate owned $17,340,979 $11,969,034 $17,340,979 $11,969,034
OREO as a percentage of total assets 1.65% 1.58% 1.65% 1.58%
OREO sold $ 9,108,242 $ 5,514,031 $15,886,956 $10,224,464
Gain on sale $ 400,402 $ 142,151 $ 656,383 $ 373,397
Loan Originations
The following table sets forth loan originations during the three and six months
of 2005 and 2004, as well as loan sales. During 2004, we began to originate
loans, principally, adjustable rate loans with a fixed rate for the first two
years, to be held in our portfolio.
Three- Months ended June 30, Six- Months ended June 30,
2005 2004 2005 2004
------------ ------------ ------------ ------------
Number of loans originated 485 294 873 517
Amount of loans originated $105,382,820 $ 46,901,063 $193,307,037 $ 80,178,341
Average loan amount $ 217,284 $ 159,527 $ 221,428 $ 155,084
Originated as fixed $ 10,357,605 $ 16,790,082 $ 17,276,905 $ 36,503,309
Originated as ARM * $ 95,025,215 $ 30,110,981 $176,030,132 $ 43,675,032
Number of loans sold 114 224 185 332
Amount of loans sold $ 23,191,382 $ 31,107,590 $ 36,602,558 $ 50,408,793
Gain on sale $ 1,026,389 $ 1,252,474 $ 1,690,093 $ 2,145,429
* Originated ARM loans are principally fixed rate for the first two years
and six-month adjustable rate for the remaining term.
Page 21
Notes Receivable Portfolio
As of June 30, 2005, our notes receivable portfolio, which consists of purchased
loans, included 19,831 loans with an aggregate principal balance of $820.7
million and a net balance of $740.4 million (after allowance for loan losses of
$80.3 million). Impaired loans comprise and will continue to comprise a
significant portion of our portfolio. Many of the loans we acquire are impaired
at the time of purchase. We generally purchase such loans at significant
discounts and have considered the payment status, underlying collateral value
and expected cash flows when determining our purchase price. While interest
income is not accrued on impaired loans, interest and fees are received on a
portion of loans classified as impaired. The following table provides a
breakdown between performing loans and impaired loans for the notes receivable
portfolio as of June 30, 2005 and December 31, 2004:
June 30, 2005 December 31, 2004
------------- -----------------
Performing loans $482,883,642 $436,366,894
Allowance for loan losses 19,716,833 19,154,311
------------ ------------
Total performing loans,
net of allowance for loan losses $463,166,809 $417,212,583
------------ ------------
Impaired loans $233,977,110 $280,078,060
Allowance for loan losses 50,524,516 57,889,091
------------ ------------
Total impaired loans,
net of allowance for loan losses $183,452,594 $222,188,969
------------ ------------
Not recorded onto servicing system $123,909,424 $ 95,440,903
Allowance for loan losses 10,039,467 12,584,898
------------ ------------
Not recorded onto servicing system,
net of allowance for loan losses $113,869,957 $ 82,856,005
------------ ------------
Total notes, net of allowance for loan losses $760,489,360 $722,257,557
------------ ------------
*Accretable Discount $ 6,721,220 $ --
------------ ------------
*Non-Accretable Discount $ 13,338,079 $ --
------------ ------------
Notes receivable, net of allowance for
loan losses and accretable/nonaccretable discount $740,430,061 $722,257,557
============ ============
At June 30, 2005, $157.2 million of loans acquired after December 31, 2004 are
included in the table above at their face value, inclusive of purchase discount.
* Purchase discount not reflected on the face of the statement of condition
in accordance with SOP 03-3.
Page 22
The following table provides a breakdown of the balance of our portfolio of
notes receivable between fixed rate and adjustable rate loans, net of allowance
for loan losses and excluding loans purchased but not yet boarded onto our
servicing operations system as of June 30, 2005 and December 31, 2004, of
$113,869,957 and $82,856,005 respectively:
June 30, 2005 December 31, 2004
------------- -----------------
Performing Loans:
Fixed Rate Performing Loans $327,152,808 $300,286,566
------------ ------------
Adjustable Rate Performing Loans 136,014,000 $116,926,017
------------ ------------
Total performing Loans $463,166,808 $417,212,583
============ ============
Impaired Loans:
Fixed Rate Impaired Loans $153,410,984 $184,312,204
------------ ------------
Adjustable Rate Impaired Loans 30,041,611 $ 37,876,765
------------ ------------
Total Impaired Loans $183,452,595 $222,188,969
============ ============
Total notes $646,619,403 $639,401,552
============ ============
*Accretable Discount $ 5,134,850 $ --
============ ============
*Non-Accretable Discount $ 3,394,038 $ --
============ ============
Total Notes Receivable, net of allowance for loan losses,
excluding loans not boarded onto servicing systems $638,090,515 $639,401,552
============ ============
* Purchase discount not reflected on the face of the statement of condition
in accordance with SOP 03-3.
* Accretable and non-accretable discount for loans not recorded in the
servicing system amounted to $11,530,411.
The decrease in the amount of impaired loans principally reflects payoffs ($19.5
million) and transfers to OREO ($14.7 million).
Page 23
Overall Portfolio
At June 30, 2005, our portfolio (excluding OREO) consisted of $840.8 million of
notes receivable, inclusive of purchase discount (not shown on the face of the
balance sheet) for loans acquired in 2005, $233.5 million of loans held for
investment, net of allowance for loan losses, and $17.4 million of loans held
for sale. Our total loan portfolio grew 16% to $1.09 billion at June 30, 2005,
from $939.2 million at December 31, 2004. 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 as of June 30,
2005.
Percentage of Total
Property Types Principal Balance Principal Balance
Residential 1-to-4 family $ 865,109,517 79.24%
Condos, coops, Pud dwelling 72,469,264 6.64%
Manufactured homes 16,010,708 1.47%
Multi-family 1,857,246 0.17%
Commercial 2,468,972 0.23%
Unsecured loans 9,511,993 0.87%
Other 290,266 0.03%
Not boarded 124,000,661 11.36%
-------------- --------------
Total $1,091,718,626 100.00%
============== ==============
Geographic Dispersion. The following table sets forth information regarding the
geographic location of properties securing the loans in our portfolio at June
30, 2005:
Percentage of Total
Location Principal Balance Principal Balance
New York $ 111,745,207 10.24%
New Jersey 92,422,395 8.47%
Ohio 81,757,051 7.49%
California 78,410,326 7.18%
Florida 69,257,321 6.34%
Pennsylvania 51,080,530 4.68%
Georgia 44,373,689 4.06%
Texas 43,758,283 4.01%
Michigan 39,353,970 3.60%
North Carolina 37,628,395 3.45%
All Others 441,931,461 40.48%
-------------- --------------
$1,091,718,626 100.00%
============== ==============
Amounts included above in the tables of Property Types and Location under the
heading "Principal Balance" represents the aggregate unpaid principle balance
outstanding of notes receivable, loans held for investment and loans held for
sale.
Page 24
Results of Operations
Three-Months Ended June 30, 2005 Compared to Three-Months Ended June 30, 2004.
Overview. Net income totaled $2.1 million for the second quarter of 2005,
compared with $1.6 million for the second quarter of 2004. Earnings per common
share for the second quarter of 2005 was $.30 on a diluted basis and $.35 on a
basic basis, compared to $0.25 and $0.28 for 2004, respectively. Our second
quarter revenues increased by 97% to $31.1 million from second quarter 2004
revenues of $15.8 million. Net income increased 29% to $2.1 million in the
second quarter 2005, compared with net income of $1.6 million in the second
quarter of 2004. The increase in 2005 second quarter net income was driven
largely by the 31% increase in net interest income, which was the result of
significant additions to the portfolio of notes receivable and loans held for
investment during last three quarters of 2004 and in the first half of 2005,
from both loan portfolio acquisitions and originated loans. During the second
quarter, we acquired S&D loans with an aggregate face amount of $81.8 million
and we originated $105.4 million of non-prime loans. We increased the size of
our total portfolio of net notes receivable, loans held for sale, loans held for
investment and OREO at the end of the second quarter 2005 to $982.7 million from
$837.9 million at the end of 2004. Our total debt outstanding grew to $1.0
billion at June 30, 2005 from $847.3 million at the end of 2004. Our weighted
average cost of funds during the second quarter 2005 increased to 6.51% from
4.79% during the second quarter of 2004.
Revenues. Total revenues increased by $15.3 million, or 97%, to $31.1
million during the three- months ended June 30, 2005, from $15.8 million during
the three-months ended June 30, 2004. Revenues include interest income, purchase
discount earned, gain on sale of notes receivable, gain on sale of originated
loans held for sale, gain on sale of OREO, prepayments penalties, other
servicing and loan origination income.
Interest income increased by $12.6 million, or 111%, to $24.0 million
during the three-months ended June 30, 2005, from $11.4 million during the
corresponding period of 2004. The increase in interest income reflected the
significant growth in the portfolio of gross notes receivable and loans held for
both investment and sale during the second quarter of 2005 compared to the
second quarter of 2004, which was the result of the growth in the volume of loan
purchases and loan originations in the last nine months of 2004 and in the first
half of 2005.
Purchase discount earned increased by $1.1 million, or 66%, to $2.9
million during the three months ended June 30, 2005, from $1.7 million during
the second quarter of 2004. This increase resulted primarily from the
significant growth in notes receivable and increased prepayments during the
second quarter of 2005, which resulted in accelerated income recognition of the
associated purchase discount compared with the second quarter of 2004. We
received $73.5 million of principal payments from notes receivable in the second
quarter of 2005, compared with $40.5 million of principal payments in the second
quarter of 2004.
During the three-months ended June 30, 2005, we sold notes receivable with
an outstanding principal amount, which we refer to as face value, of $7.3
million and we recognized a gain of $619,000. In addition, we sold our portfolio
of credit cards with a face value of $23 million for a gain of $47,000. We did
not sell any notes receivable during the three-months ended June 30, 2004.
Gain on sale of originated loans held for sale decreased by $226,000, or
18%, to $1.0 million during the second quarter of 2005 from $1.3 million during
the comparable quarter in 2004. This decrease reflected a decrease in the volume
of originated loans sold during the period. The average gain on loans sold was
4.43% and 4.03%, respectively, during the six-months ended June 30, 2005 and
2004. During the first half of 2004, our policy was to sell substantially all
loans originated. Originated loans sold amounted of $23.2 million and $31.1
million during the three-months ended June 30, 2005 and June 30, 2004,
respectively.
Page 25
Gain on sales of OREO increased by $258,000, or 182%, to $400,000 during
the quarter ended June 30, 2005 compared with $142,000 for the 2004 second
quarter. A total of 147 and 78 OREO properties were sold during the three-months
ended June 30, 2005 and June 30, 2004, respectively. The increase in the number
of properties sold reflected growth in our OREO inventory due to both an
increase in foreclosures as our notes receivable portfolio grew and the purchase
of loans during 2004 that were already in the foreclosure process.
Prepayment penalties and other servicing and origination income increased
by $900,000, or 68%, to $2.2 million during the three-months ended June 30,
2005, from $1.3 million during the second quarter of 2004. The increase was
primarily due to increases in prepayment penalties received as a result of an
increase in loan payoffs during the three-months ended June 30, 2005, as
compared with the same period in 2004, which is primarily attributable to the
increased volume of both purchased loans and loans held for investment and the
continued low interest rate environment. Increased late charges resulting
primarily from the growth in the size of our notes receivable portfolio and
increased loan application fees due to the growth in the volume of Tribeca's
non-prime loan originations also contributed to the increase.
Operating Expenses. Total operating expenses increased by $14.5 million,
or 114%, to $27.2 million during the second quarter of 2005, from $12.7 million
during the second quarter of 2004. Total operating expenses include interest
expense, collection, general and administrative expenses, provisions for loan
losses, amortization of deferred financing costs and depreciation.
Interest expense increased by $10.8 million, or 197%, to $16.3 million
during the three-months ended June 30, 2005 from $5.5 million during the
three-months ended June 30, 2004. This increase reflected the large increase in
the balance of total debt used to fund the growth in total assets during the
past year, to $1.0 billion as of June 30, 2005, as compared with $728.0 million,
as of June 30, 2004. In addition, our weighted average cost of funds during the
three-months ended June 30, 2005 increased to 6.51%, from 4.79% during the
three-months ended June 30, 2004, reflecting the effect of the rise in
short-term interest rates during the past twelve months and the monthly
adjustable rate composition of our borrowed funds.
Collection, general and administrative expenses increased by $2.9 million,
or 51%, to $8.7 million during the three-months ended June 30, 2005, from $5.7
million during the three-months ended June 30, 2004. Personnel expenses
increased by $912,000, or 32%, and reflected expenses arising from restricted
stock granted to certain recently hired members of senior management and
increases in personnel in certain areas in order to meet the demands of growth
in our business. We ended the second quarter of 2005 with 213 employees as
compared to 188 at the end of the second quarter of 2004. Legal fees relating to
increased activity with respect to foreclosures increased by $468,000, or 65%,
to $1.1 million from $722,000 during the same period last year. The increase in
foreclosure activity was the result of a larger total portfolio of notes
receivable and certain loans purchased in various stages of delinquency and
foreclosure. Occupancy costs increased $546,000 during the second quarter of
2005 primarily due to one-time lease termination and other rent expenses
incurred in preparation for our relocation of administrative and operating
functions to New Jersey, effective August 8, 2005. All other expenses increased
$1.0 million, or 55%, to $2.8 million from $1.8 million during the three-months
ended June 30, 2005, and reflect the overall increase in our business activity.
Collection, general and administrative expenses as a percentage of average
assets declined from 3.73% during the second quarter of 2004 to 3.39% in the
current quarter.
Page 26
The provision for loan losses increased by $240,000, or 30%, to $1.1
million during the three- months ended June 30, 2005, from $812,000 during the
second quarter of 2004. This increase was primarily due to reserve increases in
specific portfolios of notes receivable and, to a lesser extent, loans held for
investment as a result of an increase in impaired loans.
Amortization of deferred financing costs increased by $453,000, or 81%, to
$1.0 million during the second quarter of 2005, from $560,000 during the second
quarter of 2004. This increase resulted primarily from the growth in outstanding
debt and the increased amount of prepayments on our portfolio of loans, which
resulted in a corresponding increase in the pay down of debt, and increased
amortization of the deferred fees paid to our lender.
Our pre-tax income increased by $856,000, or 28%, to $3.9 million during
the second quarter of 2005 from $3.0 million during the second quarter of 2004
for the reasons set forth above.
During the second quarter of 2005, we had a provision for income taxes of
$1.8 million as compared to a provision of $1.4 million in the second quarter of
2004. The effective tax rate for the three-months ended June 30, 2005 and June
30, 2004 was 46% and 45%, respectively.
Six-Months Ended June 30, 2005 Compared to Six-Months Ended June 30, 2004.
Overview. Net income totaled $5.2 million for the first half of 2005,
compared with $3.7 million for the first half of 2004, an increase of 41%.
Earnings per common share for the six-months ended June 30, 2005 was $.75 on a
diluted basis and $.85 on a basic basis, compared to $.56 and $.62 for 2004,
respectively. Revenues increased by 91% to $59.0 million, from $30.8 million
during the six-months ended June 30, 2004. The increase in net income was driven
largely by the 56.8% increase in net interest income, which was the result of
significant additions to the portfolio of notes receivable and loans held for
investment during the last seven months of 2004 and in the first half of 2005,
from both loan portfolio acquisitions and originated loans. During 2005, we
acquired S&D loans with an aggregate face amount of $193.6 million and we
originated $192.5 million of non-prime loans. We increased the size of our total
portfolio of net notes receivable, loans held for sale, loans held for
investment and OREO at the end of the second quarter 2005 to $982.7 million from
$720.7 million at the end of the same period in 2004. Our total debt outstanding
grew to $1.0 billion at June 30, 2005 from $847.3 million at the end of 2004.
Our weighted average cost of funds during the six-months ended June 30, 2005
increased to 6.20% from 4.98% during the six-months ended June 30,2004.
Revenues. Total revenues increased by $28.2 million, or 91%, to $59.0
million during 2005, from $30.8 million during 2004, reflecting the significant
growth in the volume of loan purchases and, growth in Tribeca's loan origination
volume.
Interest income increased by $24.9 million, or 113%, to $46.9 million
during 2005, from $22.0 million during 2004. The increase in interest income
reflected the substantial increase in notes receivable, loans held for
investment and loans held for sale during the six-months ended June 30, 2005,
compared to the six-months ended June 30, 2004, which was the result of the
growth in the volume of loan purchases and loan originations.
Purchase discount earned increased by $2.0 million, or 67%, to $5.1
million during the six-months ended June 30, 2005, from $3.1 million during the
six-months of 2004. This increase resulted primarily from an increase in average
gross notes receivable from the end of 2004 to June 30, 2005, and increased
prepayments in the six-month period ended June 30, 2005, which resulted in an
acceleration of income recognition of the associated purchase discount compared
with the six-months ended June 30, 2004. We received $130.5 million of principal
notes receivable payments during the first half of 2005, compared with $85.3
million of principal payments in the first half of 2004 due to the growth in
notes receivable and interest rates that remained relatively low during the 2005
six months period.
Page 27
Gains on sale of notes receivable decreased by $179,000, or 21%, to
$666,000 during the six-months ended June 30, 2005, from $845,000 during the
six-months ended June 30, 2004. We sold a total of $7.3 million of performing
notes receivable and credit card receivables with a face amount of $23.5 million
during the first half of 2005, as compared to a total of $6.4 million in
performing loans during the same period last year.
Gain on sale of originated loans held for sale decreased by $455,000, or
21% to $1.7 million during the six-months ended June 30, 2005, from $2.1 million
during the six-months ended June 30, 2004. This decrease reflected a 38%
decrease in the principal amount of originated loans sold during the six-months
ended June 30, 2005, to $36.6 million compared with $50.4 million during the
six-months ended 2004. The average gain on loans sold was 4.62% and 4.26%,
respectively, during the six-months ended June 30, 2005 and 2004. During 2004
our policy was to realize the gains associated with loan origination activities
by selling substantially of our originated loans into the secondary market. In
mid-2004, we began to retain for portfolio most of the adjustable-rate loans
originated by Tribeca.
Gain on sales of OREO increased by $283,000, or 76%, to $656,000 during
the six-months ended June 30, 2005, from $373,000 during the six-months ended
June 30, 2004. We sold 253 OREO properties at an aggregate sales price of $19.1
million during 2005, as compared to 157 OREO properties at an aggregate sales
price of $12.0 million during the first six months of 2004. The increase in the
number of properties sold reflected the growth in our OREO inventory due to both
an increase in foreclosures as our notes receivable portfolio grew and the
purchase of loans during the past year that were already in the foreclosure
process.
Prepayment penalties and other servicing and origination fee income
increased by $1.6 million, or 67%, to $4.0 million during the six-months ended
June 30, 2005, from $2.4 million during the same period last year. The increase
was primarily due to an increase in prepayment penalties received as a result of
accelerated loan pay offs during the six-months ended June 30, 2005, as compared
with the same period in 2004, which is primarily attributable to the increased
volume of purchased loans and loans held for investment and the low interest
rate environment. Increased late charges resulting primarily from the growth in
the size of our notes receivable portfolio and increased loan application fees
due to the growth in the volume of Tribeca's non-prime loan originations also
contributed to the increase.
Operating Expenses. Total operating expenses increased by $25.3 million,
or 105%, to $49.4 million during the six-months ended June 30, 2005, from $24.1
million during the six-months ended June 30, 2004.
Interest expense increased by $18.5 million, or 171%, to $29.3 million
during the six-months ended June 30, 2005, from $10.8 million during the
six-months ended June 30, 2004. This increase was the result of the increase in
the balance of total debt, which increased to $1.0 billion as of June 30, 2005
as compared with $728.0 million as of June 30, 2004, that was used to fund the
growth in total assets during the period. In addition, our weighted average cost
of funds during the six-months ended June 30, 2005, increased to 6.20% from
4.98% during the six-months ended June 30, 2004, reflecting the rise in
short-term interest rates during the past twelve months.
Page 28
Collection, general and administrative expenses increased by $5.6 million,
or 55%, to $15.8 million during the six-months ended June 30, 2005, from $10.2
million during the six-months ended June 30, 2004. Personnel expenses increased
by $1.8 million, or 34%, and reflected an increase in the number of employees in
certain areas in order to meet the demands of significant asset growth, combined
with expenses arising from restricted stock granted to certain recently hired
members of senior management in the second quarter of 2005. We ended the second
quarter of 2005 with 213 employees as compared to 188 at the end of the second
quarter of 2004. Legal fees relating to increased activity with respect to
foreclosures increased by $941,000, or 89%, to $2.0 million from $1.1 million
during the same period last year. This increase in foreclosure activity was the
result of a larger total portfolio of notes receivable and certain loans
purchased in various stages of delinquency and foreclosure. Occupancy costs
increased $641,000 during the second quarter of 2005 primarily due to one-time
lease termination and rent expenses incurred in preparation for our relocation
of administrative and operating functions to New Jersey, effective August 8,
2005. All other expenses increased $2.2 million, or 66%, to $5.6 million from
$3.3 million during the six-months ended June 30, 2005, which reflected an
overall increase in our business activity. Collection, general and
administrative expenses as a percentage of average assets increased from 3.24%
during the six month ended June 30, 2004 to 3.31% during the six-months ended
June 30, 2005.
The provision for loan losses increased by $543,000, or 32%, to $2.3
million during the six-months ended June 30, 2005, from $1.7 million during the
six-months ended June 30, 2004. This increase was primarily due to reserve
increases in specific portfolios of notes receivable.
Amortization of deferred financing costs increased by $553,000, or 48%, to
$1.7 million during the six-months ended June 30, 2005, from $1.2 million during
the six-months ended June 30, 2004. This increase resulted primarily from the
growth in outstanding debt used to fund our loan portfolio growth and the
increased amount of loan prepayments on our portfolio of loans, which caused a
corresponding increase in the pay down of debt, both of which resulted in
increased amortization of the deferred fees paid to our lender.
Our pre-tax income increased by $2.8 million, or 42%, to $9.6 million
during the six-months ended June 30, 2005, from $6.7 million during the
six-months ended 2004 for the reasons set forth above.
During the six-months ended June 30, 2005, we had a provision for income
taxes of $4.4 million as compared to a provision of $3.0 million in the same
period last year. The effective tax rate for the six-months ended June 30, 2005
and June 30, 2004 was 46% and 45%, respectively.
Page 29
Liquidity and Capital Resources
Commencing July 1, 2005, our lender has agreed to reduce the interest rate
charged on all new borrowings (both new term loans and warehouse loans) by .50%,
or 50 basis points. In addition, origination fees charged on new borrowings
after June 30, 2005, have been reduced by between .25% and .50%, or between 25
and 50 basis points, depending on the borrowing facility.
We have one principal source of external funding to meet our liquidity
requirements, in addition to the cash flow provided from borrower payments of
interest and principal on mortgage loans. (See "Borrowings" below). In addition,
we have the ability to sell loans in the secondary market. We sell pools of
acquired mortgage loans from time to time and we sell loans that we originate
specifically for sale into the secondary market on a regular basis.
During the three-months ended June 30, 2005, we purchased 1,044 loans,
consisting primarily of first and second mortgages, with an aggregate face value
of $81.8 million at an aggregate purchase price of $74.9 million, or 92% of face
value. During the six-months ended June 30, 2005, we purchased 5,160 loans with
an aggregate face value of $193.5 million at an aggregate purchase price of
$173.4 million, or 90% of the face value. All acquisitions were funded through
borrowings under our master credit facility in the amount equal to the purchase
price plus a 1% loan origination fee.
During the three and six-months ended June 30, 2005, we originated $105.1
million and $192.5 million of loans through our origination subsidiary, Tribeca.
Originations are initially funded through borrowings under our warehouse
facility, and loans originated for portfolio are subsequently funded with term
debt after transfer to portfolio.
Cost of Funds. As of June 30, 2005, we had total borrowings of $1.0 billion, of
which $968.9 million was under our term loan facilities and an aggregate of
$31.0 million was under our warehouse facility. Substantially all of the debt
under our term loan facilities was incurred in connection with the purchase and
origination of, and is secured by, our acquired notes, originated loans held for
investment and OREO portfolios. Substantially all of the borrowings under our
term loan facilities incurred after March 1, 2001 currently accrue interest at
the Federal Home Loan Bank of Cincinnati thirty-day advance rate plus a spread
of 3.25%. Borrowings under our term loan facilities incurred before March 1,
2001 accrue interest at prime rate plus a margin of between 0% and 1.75%. At
June 30, 2005, approximately $15.4 million of debt incurred before March 1, 2001
remained outstanding under one of our term loan facilities and will continue to
accrue interest at the prime rate plus a margin of between 0% and 1.75%. At June
30, 2005, the weighted average interest rate on debt under our term loan
facilities was 6.49%. Our warehouse facility represents loans to fund Tribeca's
originations of loans pending sale to others or transfer to held for investment.
Cash Flow From Operating, Investing and Financing Activities
Liquidity represents our ability to obtain cost effective funding to meet our
financial obligations. Our liquidity position is affected by mortgage loan
purchase and origination volume, mortgage loan payments, including prepayments,
loan maturities and the amortization and maturity structure of borrowings under
our term loan facilities.
As of June 30, 2005, we had cash and cash equivalents of $27.0 million compared
with $19.5 million at December 31, 2004. The increase in cash in 2005 was
primarily due to an increase in collections of interest and principal on
purchased notes receivable and originated loans held for investment. The
increase in collections of interest and principal was due to an increase in the
portfolio balance due to increased acquisitions and originations and higher
levels of prepayments.
Page 30
Substantially all of our assets are invested in our portfolios of notes
receivable, loans held for investment, OREO and loans held for sale. Primary
sources of our cash flow for operating and investing activities are borrowings
under our debt facilities, collections of interest and principal on notes
receivable and loans held for investment and proceeds from sales of notes and
OREO properties. Primary uses of cash include purchases of notes receivable,
origination of loans and for operating expenses. We rely significantly upon our
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 debt facilities, described below.
Net cash used in operating activities was $1.4 million in 2005, compared with
$27.0 million during the first six-months of 2004. The decrease in cash used in
operating activities during the first six-months of 2005 was due primarily to a
decrease in the volume of loans originated for sale as a result of our shift in
strategy in the latter part of 2004 to hold for our portfolio a significant
portion of originated loans.
Net cash used in investing activities was $143.8 million in the six-months ended
June 30, 2005, compared to $252.4 million of cash provided in the six months
ended June 30, 2004. The decrease during the first six-months of 2005 was
primarily due to the origination of loans held for investment of $163.3 million
(in the first half of 2004 we originated loans primarily for sale), a decrease
of $178.2 million in purchases of notes receivable, which constituted $173.4
million during the first six-months of 2005, partially offset by an increase in
principal collections of notes receivable and loans held for investment of $77.3
million and sales of OREO of $16.5 million during the six-months ended June 30,
2005.
Net cash provided by financing activities decreased to approximately $152.7
million during the six-months ended June 30, 2005, from $277.6 million used in
financing activities during the six-months ended June 30, 2004. The decrease
resulted primarily from increased note receivable prepayment activity, which
caused a corresponding increase in the repayment of notes payable.
Offering of Common Stock
In early August 2005, we completed the public offering of 1,265,000 of shares of
our common stock at a public offering price of $11.50 per share (including an
exercise in full of the underwriter's over allotment option to purchase 165,000
shares) pursuant to our registration statement that was declared effective by
the Securities and Exchange Commission on July 19, 2005. The offering resulted
in net proceeds to us and the addition to equity estimated to be approximately
$12.5 million, after deduction of the estimated fees and commissions of the
offering. In conjunction with the public offering, the Company's common stock
ceased to be quoted on the Over-the-Counter Bulletin Board under the symbol
"FCSC" and commenced trading on The NASDAQ National Market under the symbol
"FCMC".
Page 31
Borrowings
As of June 30, 2005, we owed an aggregate of $1.0 billion under several credit
facilities.
Master Credit Facility
On October 31, 2004, the Company, and its finance subsidiaries, entered into a
Master Credit and Security Agreement with Sky Bank, an Ohio banking corporation,
which we refer to as our lender. Under this master credit facility, we request
loans to finance the purchase of residential mortgage loans or refinance
existing outstanding loans. The facility does not include a commitment to
additional lendings, which are therefore subject to our lender's discretion as
well as any regulatory limitations to which our lender is subject. The facility
terminates on October 13, 2006.
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, we are required to pay an
origination fee equal to 1% of the amount of the subsidiary loan unless
otherwise agreed to by our lender and the subsidiary. Upon repayment of
subsidiary loans, our lender 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, we and our lender have agreed
to specified minimum fees and fee waivers.
The unpaid principal balance of each loan is amortized over a period of twenty
years, but matures three years after the date the loan was made. Historically,
our lender has agreed to extend the maturities of such loans for additional
three-year terms upon their maturity. We are required to make monthly payments
of the principal on each of our outstanding loans.
Our obligations under the master credit facility are secured by a first priority
lien on loans acquired by us that are financed by proceeds of loans made to us
under the facility. In addition, pursuant to a lock-box arrangement, our lender
is entitled to receive all sums payable to us in respect of any of the
collateral
Warehouse Facility
On September 30, 2003, our Tribeca subsidiary entered into a warehousing credit
and security agreement with our lender. The facility was amended on April 7,
2004. The agreement, as amended, provides for a commitment of $40 million that
expired on July 31, 2005. Our lender has agreed to an increase in the amount of
the commitment to $60 million effective August 1, 2005.
Page 32
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%).
The warehouse facility is secured by a lien on all of the mortgage loans
delivered to our lender 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 Tribeca's obligations under the
warehouse facility, which is secured by a lien on substantially all of our
personal property.
As of June 30, 2005, Tribeca had approximately $9.0 million available under the
facility.
Term Loans
As of June 30, 2005, Tribeca, through its subsidiaries, had borrowed an
aggregate of $218.8 million in term loans refinancing outstanding advances under
the warehouse facility. Each of the term loans is made pursuant and subject to a
term loan and security agreement, or term loan agreement, between Tribeca and
our lender and a term note. 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
subsidiary-borrower pays an origination fee of approximately 1% of the amount of
the loan, and pays certain other fees at the termination of the applicable term
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
subsidiary-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 monies, securities and other
property held by, received by or in transit to our lender. The term loan
agreements contain affirmative and negative covenants and events of default
customary for financings of this type.
Page 33
Financing Activities and Contractual Obligations
Below is a schedule of the Company's contractual obligations and commitments at
June 30, 2005:
Paymnt Due by Period
Weighted Average Minimum Contractual Obligations
Interest Rate (excluding interest)
As of 6/30/05 Total Less Than 1 yr 1-3 yrs 3-5 yrs Thereafter
Contractual Obligations
Notes Payable 6.49% $ 968,924,332 $ 70,355,284 $ 896,997,950 $ 90,984 $ 1,480,114
Warehouse Line 6.05% 31,034,260 31,034,260 -- -- --
Rent Obligations -- 5,429,289 742,717 1,888,165 1,875,560 922,849
Capital Lease Obligations -- 449,202 77,021 234,752 137,429 --
Employment Agreements -- 1,374,584 399,584 650,000 325,000 --
-------------- -------------- -------------- -------------- --------------
Total $1,007,211,667 $ 102,608,866 $ 899,770,867 $ 2,428,973 $ 2,402,963
============== ============== ============== ============== ==============
Interest rates on our borrowings are indexed to the monthly Federal Home Loan
Bank of Cincinnati 30 day LIBOR advance rate or Prime, as more fully described
above, and accordingly will increase or decrease over time. Minimum contractual
obligations are based on minimum required principal payments, including balloon
maturities of loans under the master credit facility, the warehouse facility and
the term loans. Actual payments will vary depending on actual cash collections
and loan sales. Historically, our lender has extended the maturities and balloon
payments, although there is no assurance that it will continue to do so.
Risks Related to Our Business
If we are not able to identify and acquire portfolios of "scratch and dent"
residential mortgage loans on terms acceptable to us, our revenues and
profitability could be materially reduced.
Our success depends upon the continued availability of portfolios of
scratch and dent loans, or S&D loans, that meet our purchasing criteria, and our
ability to identify and successfully bid to acquire such portfolios. The
availability of such portfolios at favorable prices and on terms acceptable to
us depends on a number of factors outside of our control, including:
o general conditions in the U.S. and regional economies;
o interest rates;
o the demand for residential real estate purchases, refinancing or
home equity lines of credit;
o real estate values;
o underwriting criteria used by originators;
o the prices other acquirers are willing to pay;
o the securitization market; and
Page 34
o laws and regulations governing consumer lending.
Significant changes in any of these factors could affect the availability
and/or the cost for us to acquire S&D loans. Any increase in the prices we are
required to pay for such loans in turn will reduce the profit, if any, we
generate from these assets. We cannot predict our future acquisition volume or
our ability to submit successful bids to purchase portfolios of S&D loans and we
cannot guarantee that we will be able to purchase these assets at the same
volume or with the same yields as we have historically purchased. Our
acquisition volume has in the past varied substantially from quarter to quarter,
and we expect that it will continue to fluctuate in the future. As a result of
our business strategy of purchasing pools of mortgage loans and the volatility
of such purchases in both amount and timing, our quarter-to-quarter and
year-to-year net income may be more volatile than those of other financial
services companies. If the volume of S&D loans purchased declines or the yields
of those assets decline, we could experience a material decrease in revenues and
profitability.
We may not be able to successfully market our residential mortgage loan
origination products to non-prime borrowers.
The success of the loan origination business of our wholly-owned
subsidiary, Tribeca Lending Corp., depends on our ability to market Tribeca's
loan origination products to non-prime borrowers seeking to obtain residential
mortgage loans. Adverse changes in the U.S. economy and the real estate market
could result in a decrease in borrowing activity generally, as well as an
increase in competition for non-prime borrowers among loan originators, which
could reduce the number of loans Tribeca is able to originate. Further, changes
in the regulatory environment that result in our adopting more demanding
underwriting standards or documentation requirements or other increased
restrictions on loans to non-prime borrowers, or the perception that such
changes are likely, may also reduce the number of loans Tribeca is able to
originate. A reduction in Tribeca's origination business would curtail the
growth of the number of loans in our portfolio from which we generate revenue
through interest and fee income, loan sales and servicing, which could
negatively affect our revenues and financial condition.
Our business is dependent on external financing, and we currently receive all of
our financing from a single source. If that source ceases to provide financing
to us or increases the cost to us of such financing and we are unable to access
alternative external sources of financing on favorable terms or at all, we would
not be able to fund and grow our operations and our business will be materially
harmed.
We currently receive all of our external financing from a single source,
Sky Bank, under a series of credit facilities, including our master credit
facility, term loan agreements, and our warehouse credit and security agreement,
or warehouse facility. We refer to our master credit facility, term loan
agreements, and certain other agreements under which we have immaterial amounts
of debt outstanding collectively as our term loan facilities, and to our term
loan facilities and our warehouse facility collectively as our credit
facilities. If we lose access to this sole external source of financing for any
reason, we will not have the liquidity to fund our business operations.
We depend on our credit facilities to:
o provide the cash necessary to fund our acquisition of S&D loans;
o fund our loan originations; and
o enable us to hold our loans for investment or pending sale.
Our credit facilities do not obligate our lender to make any additional
credit available to us. Accordingly, there is no guarantee that we will continue
to receive additional financing under our current agreements or that our lender
will enter into new agreements with us upon the expiration of the current
agreements on terms favorable to us or at all. If our lender refuses to extend
additional credit to us for any reason, including, for example, a change in its
policies, management or control, a change in its criteria for eligible mortgage
loans to secure credit advances, a change in the regulatory environment,
including a change in the financing of mortgage loans where the lending decision
is based entirely or primarily on the borrower's equity in his or her home and
not, or to a lesser extent, on a determination of the borrower's ability to
repay the loan, or a lack of available funds, we would need to secure comparable
financing from the two other banks currently participating with our lender
and/or other sources in order to continue to fund our acquisition and
origination activities and possibly working capital. There is no guarantee that,
in such an event, we would be able to secure other external financing on
favorable terms or at all.
Page 35
Even if our lender does agree to provide additional financing to us, there
is no guarantee that such financing will be on terms as favorable as our current
facilities. Our ability to be competitive in both portfolio acquisitions and
loan originations depends on the cost of our financing, and any new facility
could bear interest at higher rates than we currently pay. Such an increase in
our cost of funds would adversely affect our ability to bid competitively for
portfolio acquisitions and profitably originate loans, which in turn would have
an adverse effect on our business prospects and financial condition.
Our ability to fund increased operating expenses depends on the agreement of our
lender to increases in our operating allowance.
Under our credit facilities, we are required to submit all payments we
receive from obligors under pledged mortgage loans to a lockbox maintained by
our lender, from which we receive an operating allowance, which is renegotiated
from time to time and at least annually, to sustain our business. All amounts
submitted to the lockbox in excess of the agreed upon operating allowance are
used to pay down amounts outstanding under our credit facilities. The operating
allowance may not be sufficient to meet our liquidity needs in the future,
particularly as we seek to grow our operations. If it is insufficient, there is
no guarantee that our lender will increase our operating allowance, which would
have a material adverse impact on our business.
If our lender ceases to renew our maturing loans for additional terms or provide
us with refinancing opportunities, our indebtedness will become due and payable
upon the contractual maturity of each borrowing.
The unpaid principal balance of each loan under our master credit facility
and term loan agreements is amortized over a twenty-year period, but matures
three years after the date the loan was made. Historically, our lender has
routinely agreed to renew such loans for additional three-year terms upon their
maturity. Similarly, advances under our warehouse facility are required to be
repaid within 120 days after the date of advance (or, in some cases, earlier).
Our lender has typically allowed us to convert our indebtedness under the
warehouse facility to term loans outside the warehouse facility. There is no
guarantee that our lender will continue to renew our loans under the term loan
agreements or provide us with opportunities to convert borrowings under the
warehouse facility into term loans outside the warehouse facility, thereby
relieving our immediate repayment obligations. Our lender's refusal to provide
us with such renewal and conversion opportunities could cause our indebtedness
to become immediately due and payable upon the contractual maturity of such
indebtedness, which could result in our insolvency if we are unable to refinance
our debt through alternative lenders or other financing vehicles and preclude us
from further borrowings. There is no guarantee that we would be able to
refinance our debt through alternative lenders on favorable terms or at all
because we are highly leveraged and, even taking into consideration the proceeds
of this offering, our ratio of equity to assets and/or our ratio of debt to
equity may not be sufficient to support traditional borrowing.
Page 36
Our credit facilities require us to observe certain covenants, and our failure
to satisfy such covenants could render us insolvent or preclude our seeking
additional financing from this or other sources.
Our credit facilities require us to observe certain affirmative, negative
and financial covenants customary for financings of this type, including a
covenant under the master credit facility requiring that we and our subsidiaries
maintain a minimum consolidated net worth of at least $10.0 million and a
covenant under the warehouse facility requiring that Tribeca and its
subsidiaries maintain a minimum consolidated net worth of at least $2.5 million.
Failure to satisfy any of these covenants could:
o cause our indebtedness to become immediately payable, which could
result in our insolvency if we are unable to repay our debt; and
o preclude us from further borrowings.
In addition, under our master credit facility, Thomas J. Axon, our
Chairman, ceasing to possess, directly or indirectly, the power to direct our
management and policies through his ownership of our voting stock constitutes an
event of default, which, without a waiver from our lender, would cause our
indebtedness to become immediately payable and could result in our insolvency if
we are unable to repay our debt.
Our business is sensitive to, and can be materially affected by, changes in
interest rates.
Our business may be adversely affected by changes in interest rates,
particularly changes that are unexpected in timing or size. The following are
some of the risks we face related to an increase in interest rates:
o All of our borrowings bear interest at variable rates, while a
significant majority of the loans in our portfolio have fixed rates.
As a result, an increase in rates is likely to result in an increase
in our interest expense without an offsetting increase in interest
income. Further, our adjustable rate loans typically provide for
less frequent adjustments in response to rate increases than do our
borrowings, and sometimes also include interest rate caps. To the
extent this is the case, an increase in interest rates would result
in a greater increase in our interest expense than in our interest
income, which would adversely affect our profitability.
o An increase in interest rates would adversely affect the value that
we would receive upon a sale of loans that bear interest at fixed
rates, and our results of operations could be adversely affected.
o An increase in our funding costs without an offsetting increase in
revenue would cause our cash flow to decrease, which in turn may
have an adverse impact on our ability to meet our monthly debt
service obligations. In the event we are unable to meet our monthly
debt service obligations for this or for any other reason, we would
be in default under the obligations of our credit facilities and our
lender would have the right to accelerate payments under our credit
facilities.
o A substantial and sustained increase in interest rates could harm
Tribeca's loan origination volume because refinancings of existing
loans, including cash-out refinancings and interest rate-driven
refinancings, would be less attractive and qualifying for a purchase
loan may be more difficult. Lower origination volume may harm our
earnings by reducing origination income, net interest income,
prepayment and other servicing fees and gain on sale of loans.
o An increase in interest rates would result in a slowdown of borrower
prepayments and a reduction of revenue as purchase discount accreted
into income would decline. An increase in interest rates may also
lead to an increase in our borrower defaults, if borrowers have
difficulties making their adjustable rate mortgage payments, and a
corresponding increase in nonperforming assets, which could decrease
our revenues and our cash flows, increase our loan servicing costs
and our provision for loan losses, and adversely affect our
profitability.
Page 37
We are also subject to risks from decreasing interest rates. For example,
a significant decrease in interest rates could increase the rate at which loans
are prepaid and reduce our interest income in subsequent periods.
We do not currently hedge against changes in interest rates because we
have determined that the costs associated with establishing hedging strategies
outweigh the potential benefits. Our lack of hedges means that we have
potentially greater exposure to interest rate volatility, particularly as a
result of increases in interest rates, than we would if we were able to
successfully employ hedging strategies.
A prolonged economic slowdown or a lengthy or severe recession could harm our
operations, particularly if it results in a decline in the real estate market.
The risks associated with our business are more acute during periods of
economic slowdown or recession because these periods may be accompanied by
decreased demand for mortgage loans and decreased real estate values, as well as
an increased rate of delinquencies, defaults and foreclosures. In particular,
any material decline in real estate values would increase the loan-to-value
ratios on loans that we hold and, therefore, weaken our collateral coverage,
increase the likelihood of a borrower with little or no equity in his or her
home defaulting and increase the possibility of a loss if a borrower defaults.
The residential mortgage origination business is a cyclical industry, has
recently been at its highest levels ever and may decline, which could reduce the
number of mortgage loans we originate and could adversely impact our business.
The residential mortgage origination business has historically been a
cyclical industry, enjoying periods of strong growth and profitability followed
by periods of shrinking volumes and reduced profits. The residential mortgage
industry has experienced rapid growth over the past three years due to interest
rates that are low by historical standards. The Mortgage Bankers Association of
America has predicted that residential mortgage originations will decrease in
2005 due to rising interest rates. During periods of rising interest rates,
refinancing originations decrease, as higher interest rates reduce economic
incentives for borrowers to refinance their existing mortgages. We expect this
to result in a decreased volume of industry-wide originations in the foreseeable
future. Historically, the non-prime market has been impacted less by the
interest rate cycle than has the market for prime residential mortgage loans.
However, there is no assurance that this will continue to be the case in the
future. Due to decreasing and stable interest rates over recent years, our
historical performance may not be indicative of results in a rising interest
rate environment, and our results of operations may be materially adversely
affected if interest rates continue to rise.
When we acquire S&D loans, the price we pay is based on a number of assumptions.
A material difference between the assumptions we use in determining the value of
S&D loans we acquire and our actual experience could harm our financial
position.
The purchase price and carrying value of the S&D loans we acquire is
determined largely by estimating expected future cash flows from such loans
based on the delinquency, loss, prepayment speed and discount rate assumptions
we use. If the amount and timing of actual cash flows are materially different
from our estimates, our cash flow and profitability would be materially
adversely affected and we could be required to record write-downs that could
adversely affect our financial condition.
We may experience higher loan losses than we have reserved for in our financial
statements.
Page 38
Our loan losses could exceed the allowance for loan losses that we have
reserved for in our financial statements. Reliance on historic loan loss
experience may not be indicative of future loan losses. Regardless of the
underwriting criteria we utilize, losses may be experienced as a result of
various factors beyond our control, including, among other things, changes in
market conditions affecting the value of our loan collateral and problems
affecting the credit and business of our borrowers.
We use estimates for recognizing revenue on a majority of our portfolio
investments and our earnings would be reduced if actual results are less than
our estimates.
We recognize income from the purchase discount on our portfolio of notes
receivable using the interest method. We use this method only if we can
reasonably estimate the expected amount and timing of cash to be collected based
on historic experience and other factors. We reevaluate estimated future cash
flows quarterly. If future cash collections are less than what we estimated they
would be, we would recognize less than anticipated purchase discount, which
would reduce our earnings.
If we do not manage our growth effectively, our financial performance could be
harmed.
In recent years, we have experienced rapid growth that has placed, and
will continue to place, certain pressures on our infrastructure. We will need to
continue to upgrade and expand our financial, operational, administrative and
managerial systems and controls. Further, continued growth could require capital
resources beyond what we possess following this offering. In particular, our
acquisition and servicing of large "bulk" portfolios relative to our size, such
as the two large portfolios acquired in 2004, and our creation of new product
lines, such as our Liberty Loan product, requires a significant amount of
financial, operational and administrative resources. As a result, we may not
able to support such bulk purchases and new product lines without corresponding
increases in our general and administrative costs. If we do not manage our
growth effectively, our expenses could increase and our business, liquidity and
financial condition could be significantly harmed.
We have outgrown our current office space and have recently completed
relocating most of our operating and administrative functions to new facilities
in Jersey City, New Jersey. While we are taking precautions to ensure that we
retain existing personnel, we may encounter difficulties integrating our new
facility, identifying and hiring new personnel and preventing interruptions in
our service, communications and other technology.
The inability to attract and retain qualified employees could significantly harm
our business.
We continually need to attract, hire and successfully integrate additional
qualified personnel in an intensely competitive hiring environment in order to
manage and operate our growing business. The market for skilled acquisitions
management, account executives and loan officers is highly competitive and
employers have historically experienced a high rate of turnover. Competition for
qualified personnel may lead to increased hiring and retention costs. If we are
unable to attract, successfully integrate and retain a sufficient number of
skilled personnel at manageable costs, we will be unable to continue to acquire,
originate and service mortgage loans, which would harm our business, results of
operations and financial condition.
We may have to outsource a portion of the servicing of the loans we hold due to
capacity constraints or lack of sufficient personnel.
We require sufficient qualified personnel to service the loans that we
hold. On occasion, due to capacity constraints or lack of personnel, we
temporarily outsource the servicing of a newly acquired portfolio to a qualified
third-party servicer under a sub-servicing agreement. In our experience, a high
quality of servicing often has a positive effect on lowering delinquency and
default rates. To the extent that we deem it necessary to outsource the
servicing of a portion of our loans, we cannot guarantee that the servicing
performed by the contracted sub-servicers is at the same level that we would
typically perform or that the cash flows realized from the sub-serviced loans
will be as good as those we had projected in pricing the acquisition of such
loans or realized from otherwise similar loans in our portfolio that we service.
Page 39
We face intense competition that could adversely impact our market share and our
revenues.
We face intense competition in our loan acquisition and loan origination
business from other specialty finance companies, finance and mortgage banking
companies, Internet-based lending companies and, to a growing extent, from
traditional bank and thrift lenders that are entering the non-prime mortgage
industry. Some of our competitors are much larger than we are, have better name
recognition than we do, and have far greater financial and other resources than
us. Many of our competitors have superior access to capital sources and can
arrange or obtain lower costs of financing, resulting in a competitive
disadvantage to us with respect to such competitors.
Competition in our industry can take many forms, including the price and
other terms of bids for portfolio acquisitions, the speed with which
acquisitions can be completed, interest rates and costs of a loan, stringency of
underwriting standards, customer service, amount and term of a loan, and
marketing and distribution channels. The need to maintain mortgage loan volume
in this competitive environment creates a risk of price competition and may
result in increased purchase prices and reduced profitability, potentially to
such an extent that we believe that prices in the market are not supported by
the fundamentals. In addition, price competition could cause us to lower the
interest rates on loans originated by Tribeca, which could lower the value of
our loans. Any increase in these pricing and underwriting pressures could reduce
the volume of our loan acquisitions and originations and significantly harm our
business, results of operations, liquidity and financial condition.
A significant amount of our mortgage loan originations are secured by property
in New York and New Jersey, and our operations could be harmed by economic
downturns or other adverse events in these states.
A significant portion of Tribeca's mortgage loan origination activity is
concentrated in the northeastern United States, particularly in New York and New
Jersey. Of the loans originated by Tribeca and held for investment as of June
30, 2005, a substantial majority of the aggregate principal was secured by
property in these two states. An overall decline in the economy or the
residential real estate market, the occurrence of events such as a natural
disaster or an act of terrorism in the northeastern United States could decrease
the value of residential properties in this region. This could result in an
increase in the risk of delinquency, default or foreclosure on mortgage loans in
our portfolio and restrict Tribeca's ability to originate new mortgage loans,
each of which could reduce our revenues, increase our expenses and reduce our
profitability.
Competition with other lenders for the business of independent mortgage brokers
could negatively affect the volume and pricing of our originated loans.
We depend in large measure on independent mortgage brokers to source our
Liberty Loan product, which currently constitutes the majority of Tribeca's loan
production. These independent mortgage brokers have relationships with multiple
lenders and are not obligated by contract or otherwise to do business with us.
We compete with other lenders for independent brokers' business on pricing,
service and other factors. Such competition could negatively affect the volume,
quality and pricing of our loans, which could harm our revenues and
profitability.
We may not be adequately protected against the risks inherent in non-prime
residential mortgage loans.
Page 40
The vast majority of the loans we originate are underwritten generally in
accordance with standards designed for non-prime residential mortgages. Mortgage
loans underwritten under these underwriting standards are likely to experience
rates of delinquency, foreclosure and loss that are higher, and may be
substantially higher, than prime residential mortgage loans. A majority of the
loans originated to date by Tribeca were made under a "limited documentation"
program, which generally places the most significant emphasis on the loan-to-
value ratio based on the appraised value of the property, and not, or to a
lesser extent, on a determination of the borrower's ability to repay the loan.
We cannot be certain that our underwriting and loan servicing practices will
afford adequate protection against the higher risks associated with loans made
to such borrowers. If we are unable to mitigate these risks, our cash flows,
results of operations, financial condition and liquidity could be materially
harmed.
We are subject to losses due to fraudulent and negligent acts on the part of
loan applicants, mortgage brokers, vendors and our employees.
When we acquire and originate mortgage loans, we typically rely heavily
upon information supplied by third parties, including the information contained
in the loan application, property appraisal, title information and, in some
cases, employment and income stated on the loan application. If any of this
information is intentionally or negligently misrepresented and such
misrepresentation is not detected prior to the acquisition or funding of the
loan, the value of the loan may be significantly lower than expected. Whether a
misrepresentation is made by the loan applicant, the mortgage broker, another
third party or one of our employees, we generally bear the risk of loss
associated with the misrepresentation except when we purchase loans pursuant to
contracts that include a right of return and the seller remains sufficiently
creditworthy to render such right meaningful.
An interruption in or breach of our information systems may result in lost
business and increased expenses.
We rely heavily upon communications and information systems to conduct our
business. Any failure, interruption or breach in security of or damage to our
information systems or the third-party information systems on which we rely
could cause delays in performing due diligence, pricing, servicing and
underwriting our loans. This could result in increased difficulty in effectively
identifying, evaluating and pricing loan portfolios available for purchase,
fewer loan applications being received, slower processing of applications,
increased expenses and reduced efficiency in loan servicing. In addition, we are
required to comply with significant federal and state regulations relating to
the handling of customer information, particularly with respect to maintaining
the confidentiality of such information. A failure, interruption or breach of
our information systems could result in regulatory action and litigation against
us. We cannot assure you that such failures or interruptions will not occur or
if they do occur that they will be adequately addressed by us or the third
parties on which we rely.
The success and growth of our business will depend on our ability to adapt to
and implement technological changes to remain competitive, and any failure to do
so could result in a material adverse effect on our business.
Our mortgage loan acquisition, origination and servicing businesses are
dependent upon our ability to effectively interface with our sellers, brokers,
borrowers and other third parties and to efficiently process loan purchases,
applications and closings. Technological advances, such as the ability to
automate loan servicing, process applications over the Internet, accept
electronic signatures and provide instant status updates, are playing an
increasing role in our ability to effectively interact with these third parties.
The intense competition in our industry has led to rapid technological
developments, evolving industry standards and frequent releases of new products
and enhancements. The failure to acquire new technologies or technological
solutions when necessary could limit our ability to remain competitive in our
industry and our ability to increase the cost-efficiencies of our operating
model, which would harm our business, results of operations and financial
condition. Alternatively, adapting to technological changes in the industry to
remain competitive may require us to make significant and costly changes to our
loan origination and information systems, which could in turn reduce our
profitability.
Page 41
We are exposed to the risk of environmental liabilities with respect to
properties to which we take title.
In the course of our business, we may foreclose on defaulted mortgage
loans and take title to the properties underlying those mortgages. If we do take
title, we could be subject to environmental liabilities with respect to these
properties. Hazardous substances or wastes, contaminants, pollutants or sources
thereof may be discovered on these properties during our ownership or after a
sale to a third party. Environmental defects can reduce the value of and make it
more difficult to sell such properties, and we may be held liable to a
governmental entity or to third parties for property damage, personal injury,
investigation, and cleanup costs incurred by these parties in connection with
environmental contamination, or may be required to investigate or clean up
hazardous or toxic substances or chemical releases at a property. These costs
could be substantial. If we ever become subject to significant environmental
liabilities, our business, financial condition, liquidity and results of
operation could be materially and adversely affected. Although we have not to
date incurred any environmental liabilities in connection with our real estate
owned, there can be no guarantee that we will not incur any such liabilities in
the future.
The loss of any of our key executive officers may adversely affect our
operations.
Thomas J. Axon, our Chairman, and Jeffrey R. Johnson, our President and
Chief Executive Officer, are responsible for making substantially all of the
most significant policy and managerial decisions in our business operations,
including determining which large bulk mortgage portfolios to purchase, the
purchase price and other material terms of such portfolio acquisitions. These
decisions are paramount to the success and growth of our business. These
individuals are also instrumental in securing our external financing. The loss
of the services of Thomas J. Axon or Jeffrey R. Johnson could disrupt our
operations and adversely affect our ability to successfully finance, acquire and
service mortgage portfolios, which would harm the prospects of our business.
If we do not obtain and maintain the appropriate state licenses we will not be
allowed to originate, purchase and service mortgage loans in some states, which
would adversely affect our operations.
State mortgage finance licensing laws vary considerably. Most states and
the District of Columbia impose a licensing obligation to originate first and/or
subordinate residential mortgage loans. In some of the states that impose a
licensing obligation to originate residential mortgage loans, the licensing
obligation also arises to purchase closed mortgage loans. Many of those mortgage
licensing laws impose a licensing obligation to service residential mortgage
loans. Certain state collection agency licensing laws require entities
collecting on delinquent or defaulted loans for others or to acquire such loans
to be licensed. If we are unable to obtain and maintain the appropriate state
licenses or do not qualify for an exemption, our operations may be adversely
affected.
New legislation and regulations directed at curbing predatory lending practices
could restrict our ability to originate, purchase, price, sell, or finance
non-prime residential mortgage loans, which could adversely impact our earnings.
The Federal Home Ownership and Equity Protection Act, or HOEPA, identifies
a category of residential mortgage loans and subjects such loans to restrictions
not applicable to other residential mortgage loans. Loans subject to HOEPA
consist of loans on which certain points and fees or the annual percentage rate,
which is based on the interest rate and certain finance charges, exceed
specified levels. 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 that exceed certain cost parameters.
These state and local laws generally have lower thresholds and broader
prohibitions than under the federal law. The 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 originating loans without a reasonable
expectation that the borrowers will be able to repay the loans without regard to
the value of the mortgaged property.
Page 42
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 and impact the way in which 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. Liability for violations of
HOEPA, as well as violations of many of the state and local equivalents, would
extend not only to us, but to assignees, which may include our warehouse lenders
and whole-loan buyers, regardless of whether such assignee knew of or
participated in the violation.
It is our policy not to originate loans that are subject to either HOEPA
or these state and local laws and not to purchase high cost loans that violate
those laws. If we miscalculate the numerical thresholds described above,
however, we may mistakenly originate or purchase such loans and bear the related
marketplace and legal risks and consequences. These thresholds below which we
try to originate 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 cease doing business in
jurisdictions in the future where we, or our counterparties, make similar
determinations with respect to anti-predatory lending laws. In California, for
example, a recently proposed amendment to its state anti-predatory lending law
substantially could broaden the trigger test for loans subject to its
restrictions. If the numerical thresholds were miscalculated, certain variations
of our Liberty Loan product, where the lending decision is or may have been
based entirely or primarily on the borrower's equity in his or her home and not,
or to a lesser extent, on a determination of the borrower's ability to repay the
loan, would violate HOEPA and many of these state and local anti-predatory
lending laws. In the past, we have sold a small portion of our Liberty Loan
production to third parties on a servicing-released, whole-loan basis. Going
forward, however, our ability to finance the origination of Liberty Loans and
sell the Liberty Loan product to third parties could be impaired if our
financing sources or mortgage investors are required or choose to incorporate
prohibitions from certain anti-predatory lending practices into their
eligibility criteria, even if the laws themselves do not specifically apply to
us.
We may decide to 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 originate loans subject to these laws, rules and regulations, we will
be subject to greater risks for actual or perceived non-compliance, 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. Any of the foregoing could
materially harm our business, financial condition and results of operations.
Some of our competitors that are national banks or federally chartered
thrifts and their operating subsidiaries may not be subject to these state and
local laws and may as a consequence be able to capture market share from us and
other lenders. Federal regulators have expressed their position that these
preemption provisions benefit mortgage subsidiaries of federally chartered
institutions as well. In January 2004, the Comptroller of the Currency finalized
preemption rules that confirm and expand the scope of this federal preemption
for national banks and their operating subsidiaries. Such federal preemption
rules and interpretations generally have been upheld in the courts. At least one
national rating agency has announced that, in recognition of the benefits of
federal preemption, it will not require additional credit enhancement by federal
institutions when they issue securities backed by mortgages from a state that it
deems to have anti-predatory lending laws with clear and objective standards. As
a non-federal entity, we will continue to be subject to such rating agency
requirements arising from state or local lending-related laws or regulations.
Accordingly, as a mortgage lender that is generally subject to the laws of each
state in which we do business, except as may specifically be provided in federal
rules applicable to all lenders, we may be subject to state legal requirements
and legal risks under state laws to which these federally regulated competitors
are not subject, and this disparity may have the effect of giving those federal
entities legal and competitive advantages. Passage of additional laws in other
jurisdictions could increase compliance costs, lower fee income and lower
origination volume, all of which would have a material adverse effect on our
results of operations, financial condition and business prospects.
Page 43
The 108th United States Congress considered legislation, such as the
Ney-Lucas Responsible Lending Act introduced in 2003, which, among other
provisions, would limit fees that a lender is permitted to charge, including
prepayment fees, restrict the terms lenders are permitted to include in their
loan agreements and increase the amount of disclosure required to be given to
potential borrowers. Similar legislation has been introduced in the
recently-convened 109th Congress. We cannot predict whether or in what form
Congress or the various state and local legislatures may enact legislation
affecting our business. We are evaluating the potential impact of these
initiatives, if enacted, on our lending practices and results of operations. As
a result of these and other initiatives, we are unable to predict whether
federal, state, or local authorities will require changes in our lending
practices in the future, including reimbursement of fees charged to borrowers,
or will impose fines. These changes, if required, could adversely affect our
profitability, particularly if we make such changes in response to new or
amended laws, regulations or ordinances in states where we originate a
significant portion of our mortgage loans.
The broad scope of our operations exposes us to risks of noncompliance with an
increasing and inconsistent body of complex laws and regulations at the federal,
state and local levels.
Because we may originate, purchase and service mortgage loans in all 50
states, we must comply with the laws and regulations pertaining to licensing,
disclosure and substantive practices, as well as judicial and administrative
decisions, of all of these jurisdictions, as well as an extensive body of
federal laws and regulations. The volume of new or modified laws and regulations
has increased in recent years, and government agencies enforcing these laws, as
well as the courts, sometimes interpret the same law in different ways. The laws
and regulations of each of these jurisdictions are different, complex and, in
some cases, in direct conflict with each other. As our operations continue to
grow, it may be more difficult to identify comprehensively and to interpret
accurately applicable laws and regulations and to employ properly our policies,
procedures and systems and train our personnel effectively with respect to all
of these laws and regulations, thereby potentially increasing our exposure to
the risks of noncompliance with these laws and regulations. For example,
individual cities and counties have begun to enact laws that restrict non-prime
loan origination activities in those cities and counties. State and local
governmental authorities have focused on the lending practices of companies in
the non-prime mortgage lending industry, sometimes seeking to impose sanctions
for practices such as charging excessive fees, imposing interest rates higher
than warranted by the credit risk of the borrower, imposing prepayment fees,
failing to adequately disclose the material terms of loans and abusive servicing
and collection practices.
Our failure to comply with this regulatory regimen can lead to:
o civil and criminal liability, including potential monetary
penalties;
o loss of lending licenses or approved status required for continued
lending and servicing operations;
Page 44
o demands for indemnification or loan repurchases from purchasers of
our loans;
o legal defenses causing delay and expense;
o adverse effects on our ability, as servicer, to enforce loans;
o the borrower having the right to rescind or cancel the loan
transaction;
o adverse publicity;
o individual and class action lawsuits;
o administrative enforcement actions;
o damage to our reputation in the industry;
o inability to sell our loans; or
o inability to obtain credit to fund our operations.
Although we have systems and procedures directed to compliance with these
legal requirements and believe that we are in material compliance with all
applicable federal, state and local statutes, rules and regulations, we cannot
assure you that more restrictive laws and regulations will not be adopted in the
future, or that governmental bodies will not interpret existing laws or
regulations in a more restrictive manner, which could render our current
business practices non-compliant or which could make compliance more difficult
or expensive. 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 regulatory investigations, governmental enforcement actions or private causes
of action, such as class action lawsuits, with respect to our compliance with
applicable laws and regulations.
If financial institutions face exposure stemming from legal violations committed
by the companies to which they provide financing or underwriting services, this
could increase our borrowing costs and negatively affect the market for
whole-loans and mortgage-backed securities.
In June 2003, a California jury found a warehouse lender and
securitization underwriter liable in part for fraud on consumers committed by a
lender to whom it provided financing and underwriting services. The jury found
that the investment bank was aware of the fraud and substantially assisted the
lender in perpetrating the fraud by providing financing and underwriting
services that allowed the lender to continue to operate, and held it liable for
10% of the plaintiff's damages. This is the first case we know of in which an
investment bank was held partly responsible for violations committed by a
mortgage lender customer. Shortly after the announcement of the jury verdict in
the California case, the Florida Attorney General filed suit against the same
financial institution, seeking an injunction to prevent it from financing
mortgage loans within Florida, as well as damages and civil penalties, based on
theories of unfair and deceptive trade practices and fraud. The suit claims that
this financial institution aided and abetted the same lender involved in the
California case in its commission of fraudulent representations in Florida. As
of the date of this prospectus, there has been no ruling in this case. If other
courts or regulators adopt this "aiding and abetting" theory, investment banks
may face increased litigation as they are named as defendants in lawsuits and
regulatory actions against the mortgage companies with which they do business.
Some investment banks may exit the business, charge more for warehouse lending
and reduce the prices they pay for whole-loans in order to build in the costs of
this potential litigation. This could, in turn, have a material adverse effect
on our results of operations, financial condition and business prospects.
Page 45
We may be subject to fines or other penalties based upon the conduct of our
independent brokers.
Mortgage brokers, from which we source some of our Tribeca loans, have
parallel and separate legal obligations to which they are subject. While these
laws may not explicitly hold the originating lenders responsible for the legal
violations of mortgage brokers, increasingly federal and state agencies have
sought to impose such assignee liability. For example, the FTC entered into a
settlement agreement with a mortgage lender where the FTC characterized a broker
that had placed all of its loan production with a single lender as the "agent"
of the lender. The FTC imposed a fine on the lender in part because, as
"principal," the lender was legally responsible for the mortgage broker's unfair
and deceptive acts and practices. In the past, the United States Department of
Justice has sought to hold a non- prime mortgage lender responsible for the
pricing practices of its mortgage brokers, alleging that the mortgage lender was
directly responsible for the total fees and charges paid by the borrower under
the Fair Housing Act even if the lender neither dictated what the mortgage
broker could charge nor kept the money for its own account. Accordingly, we may
be subject to fines or other penalties based upon the conduct of our independent
mortgage broker customers.
We are subject to significant legal and reputational risks and expenses under
federal and state laws concerning privacy, use and security of customer
information.
The federal Gramm-Leach-Bliley financial reform legislation imposes
significant privacy obligations on us in connection with the collection, use and
security of financial and other nonpublic information provided to us by
applicants and borrowers. In addition, California has enacted, and several other
states are considering enacting, even more stringent privacy or
customer-information-security legislation, as permitted under federal law.
Because laws and rules concerning the use and protection of customer information
are continuing to develop at the federal and state levels, we expect to incur
increased costs in our effort to be and remain in full compliance with these
requirements. Nevertheless, despite our efforts we will be subject to legal and
reputational risks in connection with our collection and use of customer
information, and we cannot assure you that we will not be subject to lawsuits or
compliance actions under such state or federal privacy requirements. To the
extent that a variety of inconsistent state privacy rules or requirements are
enacted, our compliance costs could substantially increase.
If many of our borrowers become subject to the Servicemembers Civil Relief Act
of 2003, our cash flows and interest income may be adversely affected.
Under the Servicemembers Civil Relief Act, which in 2003 re-enacted the
Soldiers' and Sailors' Civil Relief Act of 1940, or the Civil Relief Act,
members of the military services on active duty receive certain protections and
benefits. Under the Civil Relief Act, a borrower who enters active military
service after the origination of his or her mortgage loan generally may not be
required to pay interest above an annual rate of 6%, and the lender is
restricted from exercising certain enforcement remedies, including foreclosure,
during the period of the borrower's active duty status. The Civil Relief Act
also applies to a borrower who was on reserve status and is called to active
duty after origination of the mortgage loan. Considering the large number of
U.S. Armed Forces personnel on active duty and likely to be on active duty in
the future, compliance with the Civil Relief Act could reduce our cash flow and
the interest payments collected from those borrowers, and in the event of
default or delay, prevent us from exercising the remedies for default that
otherwise would be available to us.
Page 46
Thomas J. Axon effectively controls our company, substantially reducing the
influence of our other stockholders.
Thomas J. Axon, our Chairman, beneficially owned more than 40% of our
outstanding common stock. As a result, Mr. Axon will be able to influence
significantly the actions that require stockholder approval, including:
o the election of our directors; and
o the approval of mergers, sales of assets or other corporate
transactions or matters submitted for stockholder approval.
Furthermore, the members of the board of directors as a group (including
Mr. Axon) beneficially owned a substantial majority of our outstanding common
stock. As a result, our other stockholders may have little or no influence over
matters submitted for stockholder approval. In addition, Mr. Axon's influence
and/or that of our current board members could preclude any unsolicited
acquisition of us and consequently materially adversely affect the price of our
common stock.
Our organizational documents, Delaware law and our credit facility may make it
harder for us to be acquired without the consent and cooperation of our board of
directors, management and lender.
Several provisions of our organizational documents, Delaware law and our
credit facility may deter or prevent a takeover attempt, including a takeover
attempt in which the potential purchaser offers to pay a per share price greater
than the current market price of our common stock.
Our classified board of directors will make it more difficult for a person
seeking to obtain control of us to do so. Also, our supermajority voting
requirements may discourage or deter a person from attempting to obtain control
of us by making it more difficult to amend the provisions of our certificate of
incorporation to eliminate an anti-takeover effect or the protections they
afford minority stockholders, and will make it more difficult for a stockholder
or stockholder group to put pressure on our board of directors to amend our
certificate of incorporation to facilitate a takeover attempt. In addition,
under the terms of our certificate of incorporation, our board of directors has
the authority, without further action by the stockholders, to issue shares of
preferred stock in one or more series and to fix the rights, preferences,
privileges and restrictions thereof. The ability to issue shares of preferred
stock could tend to discourage takeover or acquisition proposals not supported
by our current board of directors.
Section 203 of the Delaware General Corporation Law, subject to certain
exceptions, prohibits a Delaware corporation from engaging in any business
combination with any interested stockholder (such as the owner of 15% or more of
our outstanding common stock) for a period of three years following the date
that the stockholder became an interested stockholder. The preceding provisions
of our organizational documents, as well as Section 203 of the Delaware General
Corporation Law, could discourage potential acquisition proposals, delay or
prevent a change of control and prevent changes in our management, even if such
events would be in the best interests of our stockholders.
In addition, our controlling shareholder ceasing to possess, directly or
indirectly, the power to direct our management and policies through his
ownership of our voting stock constitutes an event of default under our master
credit facility, which, without a waiver from our lender, would cause our
indebtedness to become immediately payable and could result in our insolvency if
we are unable to repay our debt.
Our quarterly operating results may fluctuate and cause our stock price to
decline.
Page 47
Because of the nature of our business, our quarterly operating results may
fluctuate, which may adversely affect the market price of our common stock. Our
results may fluctuate as a result of any of the following:
o the timing and amount of collections on loans in our portfolio;
o the rate of delinquency, default, foreclosure and prepayment on the
loans we hold and service;
o changes in interest rates;
o deviations in the amount or timing of collections on loans purchased
from our expectations when we purchased such loans;
o our inability to identify and acquire additional mortgage loan
portfolios or to originate loans;
o a decline in the estimated value of real property securing mortgage
loans;
o increases in operating expenses associated with the growth of our
operations;
o general economic and market conditions;
o the effects of state and federal tax, monetary and fiscal policies;
and
o our inability to obtain additional financing to fund our growth.
Many of these factors are beyond our control, and we cannot predict their
potential effects on the price of our common stock. If the market price of our
common stock declines significantly, you may be unable to resell your common
stock at or above the offering price. We cannot assure you that the market price
of our common stock will not fluctuate or decline significantly, including a
decline below the offering price, in the future.
Various factors unrelated to our performance may cause the market price of our
common stock to become volatile, which could harm our ability to access the
capital markets in the future.
The market price of our common stock may experience fluctuations that are
unrelated to our operating performance. In particular, our stock price may be
affected by general market movements as well as developments specifically
related to the consumer finance industry and the financial services sector.
These could include, among other things, interest rate movements, quarterly
variations or changes in financial estimates by securities analysts,
governmental or regulatory actions or investigations of us or our lenders, or a
significant reduction in the price of the stock of another participant in the
consumer finance industry. This volatility may make it difficult for us to
access the capital markets through additional secondary offerings of our common
stock, regardless of our financial performance, and such difficulty may preclude
us from being able to take advantage of certain business opportunities or meet
our obligations.
Future sales of our common stock may depress our stock price.
Sales of a substantial number of shares of our common stock in the public
market could cause a decrease in the market price of our common stock. As of the
conclusion of our recent public offering, 5,179,052 shares held by current
stockholders and members of our senior management will be subject to a lock-up
period through January 21, 2006. The remainder of our outstanding shares are
freely tradeable. We may also issue additional shares in connection with our
business and may grant additional stock options to our employees, officers,
directors and consultants under our stock option plans or warrants to third
parties. If a significant portion of these shares were sold in the public
market, the market value of our common stock could be adversely affected.
Page 48
Compliance with the rules of the market in which our common stock trades and
proposed and recently enacted changes in securities laws and regulations are
likely to increase our costs.
The Sarbanes-Oxley Act of 2002 and the related rules and regulations
promulgated by the Securities and Exchange Commission and the national
securities exchanges have increased the scope, complexity and cost of corporate
governance, reporting and disclosure practices for public companies, including
ourselves. These rules and regulations could also make it more difficult for us
to attract and retain qualified executive officers and members of our board of
directors, particularly to serve on our audit committee. Our common stock has
been approved for listing on The Nasdaq National Market. Accordingly, we will
have to comply with a number of qualitative and quantitative requirements. We
have no prior experience with the level of compliance required by Nasdaq, and,
as a result, such compliance will require additional cost and effort on our
part.
Item 3. 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 our operating results and
present a variety of risks, including the risk of a mismatch between the
repricing of interest-earning assets and borrowings, variances in the yield
curve and changing prepayment rates on notes receivable, loans held for
investment and loans held for sale.
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 our control may also affect interest rates.
Fluctuations in market interest rates are neither predictable nor controllable
and may have a material adverse effect on our business, financial condition and
results of operations.
The Company's operating results will depend in large part on differences between
the interest earned on its assets and the interest paid on its borrowings. Most
of the Company's assets, consisting primarily of mortgage notes receivable,
generate fixed returns and have terms in excess of five years, while the
majority of loans held for investment generate fixed returns for the first two
years and six-month adjustable returns thereafter. We fund the origination and
acquisition of these assets with borrowings, which have interest rates that are
based on the monthly Federal Home Loan Bank of Cincinnati ("FHLB") 30-day
advance rate. In most cases, the interest income from our assets will respond
more slowly to interest rate fluctuations than the cost of our borrowings,
creating a mismatch between interest earned on our interest-yielding assets and
the interest paid on our borrowings. Consequently, changes in interest rates,
particularly short-term rates, will significantly impact our net interest income
and, therefore, net income. Our borrowings bear interest at rates that fluctuate
with the FHLB Bank of Cincinnati 30-day advance rate or, to a lesser extent, the
prime rate. Based on approximately $1.0 billion of borrowings under term loan
and warehouse facilities outstanding at June 30, 2005, a 1% increase in both
FHLB and prime rates could increase quarterly interest expense by approximately
$2.5 million, pre tax, which would negatively impact our quarterly after tax net
income. Due to our liability-sensitive balance sheet, increases in these rates
will decrease both net income and the market value of our net assets.
Page 49
The value of our assets may be affected by prepayment rates on investments.
Prepayment rates are influenced by changes in current interest rates and a
variety of economic, geographic and other factors beyond our control.
Consequently, such prepayment rates cannot be predicted with certainty. When we
originate and purchase mortgage loans, we expect that such mortgage loans will
have a measure of protection from prepayment in the form of prepayment 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 us in assets yielding less than the yields on the
investments that were prepaid. In addition, the market value of mortgage
investments may, because of the risk of prepayment, benefit less from declining
interest rates than other fixed-income securities. Conversely, in periods of
rising interest rates, prepayments on mortgages generally decrease, in which
case we would not have the prepayment proceeds available to invest in assets
with higher yields. Under certain interest rate and prepayment scenarios we may
fail to recoup fully our cost of acquisition of certain investments.
Real Estate Risk
Residential property values are subject to volatility and may be affected
adversely by a 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
supply of housing or the rapid increase in home values). Decreases in property
values reduce the value of the collateral and the potential proceeds available
to a borrower to repay our mortgage loans, which could cause us to suffer losses
on the ultimate disposition of foreclosed properties.
We purchase and originate principally fixed and adjustable rate residential
mortgage loans, which are secured primarily by the underlying single-family
properties. Because the vast majority of our loans are to non-prime borrowers,
delinquencies and foreclosures are substantially higher than those of prime
mortgage loans, and if not serviced actively and effectively could result in an
increase in losses on dispositions of properties acquired through foreclosure.
In addition, a decline in real estate values would reduce the value of the
residential properties securing our loans, which could lead to an increase in
borrower defaults, reductions in interest income and increased losses on the
disposition of foreclosed properties.
Item 4. Controls and Procedures.
As of the end of the period covered by this Quarterly Report on Form 10-Q, the
Company carried out an evaluation, under the supervision and with the
participation of senior management, including the Company's Chief Executive
Officer and Chief Financial Officer, of the effectiveness of the design and
operation of its disclosure controls and procedures. Based upon that evaluation,
the Company's Chief Executive Officer and Chief Financial Officer concluded that
the Company's disclosure controls and procedures are effective for gathering,
analyzing and disclosing the information that the Company is required to
disclose in reports filed under the Securities Exchange Act of 1934.
There have been no significant changes in the Company's internal controls over
financial reporting or in other factors during the fiscal quarter ended June 30,
2005 that materially affected, or are reasonably likely to materially affect,
the Company's internal control over financial reporting subsequent to the date
the Company carried out its most recent evaluation.
Page 50
Part II Other Information
Item 1. 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 2. Unregistered Sales of Equity Securities and Use of Proceeds.
We issued and/or sold the following securities during the period covered by this
Quarterly Report on Form 10Q.
In April 2005, we issued Paul D. Colasono, our Chief Financial Officer, 17,000
shares of restricted common stock as compensation.
In April 2005, we issued 7,000 shares of restricted stock as compensation to
each of Craig Galea, Managing Director of Tribeca Lending Corporation, a
wholly-owned subsidiary of the Registrant, and Paride "Alex de Calice, Managing
Director of Sales and Marketing Acquisition of the Registrant.
We offered and sold the above shares in reliance upon the exemption from the
registration provisions of the Securities Act of 1933, as amended, or the "Act",
pursuant to section 4(2) of the Act. No underwriters were involved in connection
with any of the sales or issuances of securities of the shares.
Item 3. Defaults Upon Senior Securities
None
Page 51
Item 4. Submission of Matters to a Vote of Security Holders
On May 5, 2005 at the Company's annual meeting the shareholders
voted to elect nine directors to the Company's Board of Directors, and to ratify
the appointment of Deloitte & Touche LLP as the Company's independent public
auditors for the fiscal year ending December 31, 2005
- -------------------------------------------------------------------------------------------------------------------------
Election of Directors For Against Abstained No-votes Total
- --------------------- --- ------- --------- -------- -----
Director
- --------
- -------------------------------------------------------------------------------------------------------------------------
Thomas J. Axon 4,258,154 0 185 1,792,693 6,062,295
- -------------------------------------------------------------------------------------------------------------------------
Jeff Johnson 4,258,154 0 185 1,792,693 6,062,295
- -------------------------------------------------------------------------------------------------------------------------
Robert M. Chiste 4,258,154 0 185 1,792,693 6,062,295
- -------------------------------------------------------------------------------------------------------------------------
Michael Bertash 4,258,154 0 185 1,792,693 6,062,295
- -------------------------------------------------------------------------------------------------------------------------
Frank B. Evans 4,258,154 0 185 1,792,693 6,062,295
- -------------------------------------------------------------------------------------------------------------------------
Alexander Gordon Jardin 4,258,154 0 185 1,792,693 6,062,295
- -------------------------------------------------------------------------------------------------------------------------
Steven W. Lefkowitz 4,258,154 0 185 1,792,693 6,062,295
- -------------------------------------------------------------------------------------------------------------------------
Allan R. Lyons 4,258,154 0 185 1,792,693 6,062,295
- -------------------------------------------------------------------------------------------------------------------------
William F. Sullivan 4,258,154 0 185 1,792,693 6,062,295
- -------------------------------------------------------------------------------------------------------------------------
Independent Public Auditors For Against Abstained No Votes Total
- --------------------------------------------------------------------------------------------------------------------
Deloitte & Touche LLP 4,251,654 0 6,685 1,803,959 6,062,295
Item 5. Other information None
Item 6. Exhibits
EXHIBIT INDEX
Exhibit
No. Exhibit
- ------- -------
3.1 Fifth Amended and Restated Certificate of Incorporation.
Incorporated by reference to Appendix A to Franklin Credit
Management Corporation's (the "Company") 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 Company's Definitive Information Statement on Schedule 14C,
filed with the Commission on January 20, 2005.
10.1 Restricted Stock Grant Agreement, dated as of April 13, 2005,
between the Company and Paul D. Colasono. Incorporated by reference
to Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q,
filed with the Commission on May 16, 2005.
10.2 Second Amendment to the Warehouse Credit Agreement, effective as of
May 19, 2005, between Tribeca Lending Corporation and Sky Bank.
Incorporated by reference to Exhibit 10.5 to the Company's
Registration Statement on Form S-1 (File No. 333-125681) (the
"Registration Statement"), filed with the Commission on June 9,
2005.
10.3 Employment Agreement, dated as of June 7, 2005, between the Company
and Joseph Caiazzo. Incorporated by reference to Exhibit 10.1 to the
Company's Current Report on Form 8-K, filed with the Commission on
June 9, 2005.
10.4 Letter, dated July 19, 2005, from Sky Bank to the Company.
Incorporated by reference to Exhibit 10.20 to Amendment No. 2 to the
Registration Statement, filed with the Commission on July 19, 2005..
52
10.5 Letter, dated July 19, 2005, from Sky Bank to Tribeca Lending
Corporation. Incorporated by reference to Exhibit 10.21 to Amendment
No. 2 to the Registration Statement, filed with the Commission on
July 19, 2005.
10.6 Underwriting Agreement, dated July 19, 2005, between the Company and
Ryan Beck & Co., Inc. Incorporated by reference to the Exhibit 10.3
of the Company's Current Report on Form 8-K, filed with the
Commission on July 20, 2005.
10.7 Lease, dated July 27, 2005, between the Company and 101 Hudson
Leasing Associates. Incorporated by reference to Exhibit 10.1 to the
Company's Current Report on Form 8-K, filed with the Commission on
July 29, 2005.
*21.1 Subsidiaries of the Company.
*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. Filed with the Commission on April 4, 2005.
*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.
Page 53
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
August 15, 2005
FRANKLIN CREDIT MANAGEMENT CORPORATION
By: /s/ JEFFREY R. JOHNSON
--------------------------
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
- ---------------------- Chief Executive Officer August, 15 2005
Jeffrey R. Johnson and Director ---------------
(Chief Executive Officer)
/s/PAUL COLASONO
- ---------------------- Executive Vice President, August 15, 2005
Paul Colasono Chief Financial Officer ---------------
(Principal Financial Officer)
Page 54