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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, 2003
Commission file number 0-17771
FRANKLIN CREDIT MANAGEMENT CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware
(State or other jurisdiction of incorporation or organization)
75-2243266
(I.R.S. Employer 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 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 .
As of August 12, 2003 the issuer had 5,916,527 of shares of Common Stock, par
value $0.01 per share, outstanding.
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FRANKLIN CREDIT MANAGEMENT CORPORATION
FORM 10-Q
For the Three and Six months ended June 30, 2003
C O N T E N T S
PART I. FINANCIAL INFORMATION Page
----
Item 1.
Financial Statements (unaudited)
Consolidated Balance Sheets at June 30, 2003
and December 31, 2002 3
Consolidated Statements of Income for the three
months ended June 30, 2003 and June 30, 2002 4
Consolidated Statements of Stockholders' Equity 5
Consolidated Statements of Cash Flows for the six
months ended June 30, 2003 and June 30, 2002 6
Notes to Consolidated Financial Statements 7-13
Item 2.
Management's Discussion and Analysis of Financial Condition and
Results of Operations 14-22
Item 3.
Quantitative and Qualitative Disclosure about Market Risk 23
Item 4.
Controls and Procedures 23
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 23
Item 2. Changes in Securities and Use of Proceeds 23
Item 3. Defaults Upon Senior Securities 23
Item 4. Submission of Matters to a Vote of Security Holders 23
Item 5. Other Information 23
Item 6. Exhibits and Reports on Form 8-K 24
SIGNATURES 25
CERFTIFICATIONS 26-27
FRANKLIN CREDIT MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS June 30,2003 December 31,2002
(Unaudited)
RESTRICTED CASH 500,952 632,883
NOTES RECEIVABLE:
Principal 481,450,824 435,259,394
Purchase discount (25,487,403) (22,974,310)
Allowance for loan losses (52,228,545) (45,841,651)
----------- -----------
NET NOTES RECEIVABLE 403,734,876 366,443,433
ORIGINATED LOANS HELD FOR SALE 13,204,162 22,869,947
ORIGINATED LOANS HELD FOR INVESTMENT 13,522,546 _
ACCRUED INTEREST RECEIVABLE 4,114,381 4,157,615
OTHER REAL ESTATE OWNED 10,355,740 9,353,884
OTHER RECEIVABLES 4,106,162 2,259,543
DEFERRED TAX ASSET 480,625 387,767
OTHER ASSETS 3,221,597 2,633,082
BUILDING, FURNITURE AND FIXTURES - Net 1,247,307 1,106,865
DEFERRED FINANCING COSTS- Net 4,339,482 3,997,405
------------ ------------
TOTAL ASSETS $467,909,451 $424,419,034
============ ============
LIABILITIES AND STOCKHOLDERS EQUITY
LIABILITIES:
Accounts payable and accrued expenses $ 3,952,147 $ 3,818,557
Financing agreements 15,742,609 11,557,369
Notes payable 431,509,565 395,266,144
Tax Liability
Deferred 434,661 783,115
----------- -----------
TOTAL LIABILITIES 451,638,982 411,425,185
----------- -----------
COMMITMENTS AND CONTENGENCIES
STOCKHOLDERS EQUITY
Common stock, $.01 par value, 10,000,000
authorized shares; issued and outstanding:
5,916,527 and 5,916,527 59,167 59,167
Additional paid-in capital 6,985,968 6,985,968
Retained earnings 9,225,334 5,948,714
----------- ------------
TOTAL STOCKHOLDERS' EQUITY 16,270,469 12,993,849
----------- ------------
TOTAL LIABILITIES AND STOCKHOLDERS EQUITY $467,909,451 $424,419,034
============ ============
See notes to consolidated financial statements
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
- -------------------------------------------------------------------------------
Three Months Six Months
Ended June 30 Ended June 30
2003 2002 2003 2002
-------- -------- ------- -------
REVENUES:
Interest income $10,722,418 $9,142,691 $21,283,669 $17,673,152
Purchase discount earned 1,078,019 754,677 1,980,922 1,718,706
Gain on sale of notes
receivable - - 596,114 -
Gain on sale of originated
loans held for sale 728,654 634,899 1,407,044 817,409
Gain on sale of other real
estate owned 449,399 17,258 753,194 398,375
Rental income 23,338 42,518 73,800 85,926
Other 956,125 714,255 1,802,438 1,284,191
---------- ---------- ---------- ----------
13,957,953 11,306,298 27,897,181 21,977,759
---------- ---------- ---------- ----------
OPERATING EXPENSES:
Interest expense 5,575,748 4,679,174 10,612,870 9,090,333
Collection, general and
administrative 4,411,539 2,866,044 8,519,096 5,615,495
Recovery of special charge - (1,662,598) - (1,662,598)
Provision for loan losses 734,851 841,764 1,584,445 1,095,764
Amortization of deferred
financing costs 417,078 375,779 840,391 643,923
Depreciation 107,161 85,822 207,459 161,644
---------- ---------- ---------- -----------
11,246,377 7,185,985 21,764,261 14,944,561
---------- ---------- ---------- -----------
INCOME BEFORE PROVISION FOR
INCOME TAXES 2,711,576 4,120,312 6,132,920 7,033,198
---------- ---------- ---------- ----------
PROVISION FOR INCOME TAXES 1,282,500 1,854,250 2,856,300 3,208,750
---------- ---------- ---------- ----------
NET INCOME $ 1,429,076 $2,266,062 $ 3,276,620 $ 3,824,448
=========== ========== =========== ===========
NET INCOME PER COMMON SHARE:
Basic $ 0.24 $ 0.38 $ 0.55 $ 0.65
Diluted $ 0.22 $ 0.36 $ 0.49 $ 0.61
=========== ========= =========== ===========
WEIGHTED AVERAGE NUMBER
OF SHARES OUTSTANDING
BASIC 5,916,527 5,916,527 5,916,527 5,916,527
=========== ========== =========== ==========
WEIGHTED AVERAGE NUMBER
OF SHARES OUTSTANDING
DILUTED 6,557,239 6,243,953 6,557,239 6,243,953
=========== ========== ========== ==========
See notes to consolidated financial statements
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOE THE YEAR
JUNE 30, 2003
- -------------------------------------------------------------------------------
Additional
Common Stock Paid-In Retained
----------------
Shares Amount Capital Earnings Total
- -------------------------------------------------------------------------------
January 1, 2003 5,916,527 $59,167 $6,985,968 $5,948,714 $12,993,849
Net Income 3,276,620 3,276,620
---------------------------------------------------------
June 30, 2003 5,916,527 $59,167 $6,985,968 $9,225,334 $16,270,469
=========================================================
See notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
- -------------------------------------------------------------------------------
Six months ended June 30,
2003 2002
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $3,276,620 $3,824,448
Adjustments to reconcile net income to
net cash used by operating activities:
Depreciation 207,459 161,644
Amortization of deferred financing costs 840,391 643,923
Origination of loans held for sale (42,101,242) (35,969,133)
Proceeds on sale of loans held for sale 37,223,887 18,546,111
Purchase discount earned (1,980,922) (1,718,706)
Gain on sale of other real estate owned (753,194) (398,376)
Provision for loan losses 1,584,445 1,095,764
Change in: (92,858) 687,248
Accrued interest receivable 43,234 461,251
Other receivables (1,846,619) 3,390,616
Other assets (588,515) (1,037,743)
Deferred tax liability (348,454) 277,146
Accounts payable and accrued expenses 133,590 (1,356,463)
------------ ------------
Net cash used by operating activities (4,402,178) (11,392,270)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Acquisition and loan fees (1,346,543) (1,126,460)
Acquisition of notes receivable (112,718,301) (90,045,271)
Proceeds from sale of other real estate owned 7,500,632 3,815,380
Proceeds from the sale of notes receivable 2,835,696 0
Purchase of building, furniture & equipment (347,902) (130,529)
Principal collection on notes receivable 66,423,015 52,426,980
(Increase) decrease in restricted cash 131,931 (119,949)
------------- ------------
Net cash used by investing activities (37,521,472) (35,179,849)
------------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on subordinated debentures - (24,262)
Payments on financing agreements (41,666,966) (37,054,703)
Proceeds from financing agreements 45,852,206 36,997,728
Proceeds from notes payable 118,389,550 106,507,117
Payments on notes payable (82,146,129) (62,603,684)
------------ ------------
Net cash provided by financing activities 40,428,661 43,822,196
------------ ------------
NET DECREASE IN CASH AND CASH EQUIVALENTS (1,494,989) (2,749,923)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 10,576,610 7,784,162
------------ ------------
CASH AND CASH EQUIVALENTS END OF PERIOD $9,081,621 $5,034,239
============ ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION:
Cash payments for interest $10,277,680 $9,554,063
============= ============
============= ============
Cash payment for taxes $3,285,985 $2,318,000
============= ============
NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Business - Franklin Credit Management Corporation (the "Company"),
a Delaware corporation, was formed to acquire performing, nonperforming,
nonconforming and subperforming notes receivable and promissory notes from
financial institutions, and mortgage and finance companies. The Company
services and collects such notes receivable through enforcement of the
original note term, modification of original note terms and, if necessary,
liquidation of the underlying collateral.
In January 1997, a wholly owned subsidiary was formed, to originate or
purchase, sub-prime residential mortgage loans to individuals whose credit
histories, income and other factors cause them to be classified as
nonconforming borrowers.
A summary of the Company's significant accounting policies follows.
Basis of Presentation- The consolidated balance sheet as of June 30, 2003,
the consolidated statements of income for the three and six months ended June
30, 2003 and 2002 and the consolidated statements of cash flows for the six
months ended June 30, 2003 and 2002, are unaudited. In the opinion of
management, all adjustments (which include only normal recurring
adjustments) necessary to present fairly the financial position, results of
operations and changes in cash flows have been made. Certain information and
footnote disclosures normally included in consolidated financial statements
prepared in accordance with accounting principles generally accepted in the
United States of America have been condensed or omitted. These condensed
consolidated financial statements should be read in conjunction with the
consolidated financial statements and notes there to included in the Company's
annual report on Form 10-K for the year ended December 31, 2002 as filed with
the Securities and Exchange Commission. The results of operations for the
three and six months ended June 30, 2003 are not necessarily indicative of the
operating results for the full year.
Principles of Consolidation - 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.
Reclassification- Certain prior years amounts have been reclassed to conform
with current year presentation.
Operating Segments-Statement of Financial Accounting Standards ("SFAS") No.131
"Disclosures about Segments of an Enterprise and Related Information" requires
companies to report financial and descriptive information about their
reportable operating segments, including segment profit or loss, certain
specific revenue and expense items, and segment assets. The Company is
currently operating in two business segments: (i) portfolio asset acquisition;
and (ii) mortgage banking.
Estimates - The preparation of consolidated 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 revenue and expenses during the reporting period. Actual results could
differ from those estimates.
Earnings per share- Basic earnings per share is calculated by dividing net
income by the weighted average number of shares outstanding during the year.
Diluted earnings per share is calculated by dividing net income by the
weighted average number of 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
short-term investments with maturities of three months or less, with the
exception of restricted cash. The Company maintains accounts at banks, which
at times may exceed federally insured limits. The Company has not experienced
any losses from such concentrations.
Notes Receivable and Income Recognition - The notes receivable portfolio
consists primarily of secured real estate mortgage loans purchased from
financial institutions, and mortgage and finance companies. Such notes
receivable are generally performing, nonperforming or underperforming 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 an allowance for loan losses. The
Company has the ability and intent to hold these notes until maturity, payoff
or liquidation of collateral. Impaired notes receivable are measured based on
the present value of expected future cash flows discounted at the note's
effective interest rate or, as a practical expedient, at the observable market
price of the note receivable or the fair value of the collateral if the note
is collateral dependent. The Company periodically evaluates the collectability
of both interest and principal of its notes receivable to determine whether
they are impaired. A note receivable is considered impaired when it is
probable the Company will be unable to collect all contractual principal and
interest payments due in accordance with the terms of the note agreement. In
general, interest on the notes receivable is calculated based on contractual
interest rates applied to daily balances of the collectible principal amount
outstanding using the accrual method. Accrual of interest on notes receivable,
including impaired notes receivable, is discontinued when management believes,
after considering economic and business conditions and collection efforts,
that the borrowers' financial condition is such that collection of interest is
doubtful. When interest accrual is discontinued, all unpaid accrued interest
is reversed. Subsequent recognition of income occurs only to the extent
payment is received subject to management's assessment of the collectability
of the remaining interest and principal. A non-accrual note is restored to an
accrual status when it is no longer delinquent and collectability of interest
and principal is no longer in doubt and past due interest is recognized at
that time.
Loan purchase discounts are amortized into income using the interest method
over the period to maturity. The interest method recognizes income by applying
the effective yield on the net investment in the loans to the projected cash
flows of the loans. Discounts are amortized if the projected payments are
probable of collection and the timing of such collections is reasonably
estimable. The projection of cash flows for purposes of amortizing purchase
loan discount is a material estimate, which could change significantly, in the
near term. Changes in the projected payments are accounted for as a change in
estimate and the periodic amortization is prospectively adjusted over the
remaining life of the loans.
In the event projected payments do not exceed the carrying value of the loan,
the periodic amortization is suspended and either the loan is written down or
an allowance for uncollectibility is recognized.
Allowance for Loan Losses - The allowance for loan losses, a material estimate
which could change significantly in the near term, is initially established by
an allocation of the purchase loan discount based on management's assessment
of the portion of purchase discount that represents uncollectable principal.
Subsequently, increases to the allowance are made through a provision for loan
losses charged to expense and the allowance is maintained at a level that
management considers adequate to absorb potential losses in the loan portfolio.
Management's judgment in determining the adequacy of the allowance is based on
the evaluation of individual loans within the portfolios, the known and
inherent risk characteristics and size of the note receivable 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. Notes receivable, including impaired notes receivable,
are charged against the allowance for loan losses when management believes
that the collectability of principal is unlikely based on a note-by-note
review. In connection with the determination of the allowance for loan losses,
management obtains independent appraisals for the underlying collateral when
considered necessary.
The Company's notes receivable are collateralized by real estate located
throughout the United States with a concentration in California, New York,
Texas, and Florida. Accordingly, the collateral value of a substantial portion
of the Company's real estate notes receivable and real estate acquired through
foreclosure is susceptible to changes in market conditions.
Management believes that the allowance for loan losses is adequate. While
management uses available information to recognize losses on notes receivable,
future additions to the allowance or write-downs may be necessary based on
changes in economic conditions.
Originated Loans Held for Sale- The loans held for sale consist primarily of
secured real estate first and second mortgages originated by the Company. Such
loans held for sale are performing and are carried at lower of cost or market.
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.
Originated Loans Held for Investment- Such loans consist primarily of secured
real estate first and second mortgages originated by the Company. Such loans
held for investment are performing and are carried at amortized cost of the
loan. In the second quarter of 2003 the Company's holding strategy on several
loans originated changed. The unamortized cost of these loans were transferred
from the loans held for sale category into loans held for investment. The
Company has both the intent and ability to hold these loans to maturity.
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 the allowance for loan losses.
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 write-downs 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 Costs - Costs, incurred in connection with obtaining financing, are
deferred and are amortized over the term of the related debt. Costs associated
with loans, which are classified as held for investment, are deferred and
recorded net. Cost associated with loans held for sale are not amortized.
Cost associated with loans held for investment are amortized into income over
the life of loan.
Retirement Plan - The Company has a defined contribution retirement plan (the
"Plan") covering all full-time employees who have completed one month of
service. Contributions to the Plan are made in the form of payroll deductions
based on employees' pretax wages. Currently, the Company offers a company
match of 50% of the first 3% of the employees' 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.
Fair Value of Financial Instruments - SFAS No.107, Disclosures About Fair
Value of Financial Instruments, requires disclosure of fair value information
of financial instruments, for which it is practicable to estimate that value.
In cases where quoted market prices are not available, fair values are based
on estimates using present value or other valuation techniques. Those
techniques are significantly affected by the assumptions used, including the
discount rate and estimates of future cash flows. In that regard, the derived
fair value estimates cannot be substantiated by comparison to independent
markets and, in many cases, could not be realized in immediate settlement of
the instruments. Statement No. 107 excludes certain financial instruments and
all non-financial assets and liabilities from its disclosure requirements.
Accordingly, the aggregate fair value amounts do not represent the underlying
value of the Company.
The following methods and assumptions were used by the Company in estimating
the fair value of its financial instruments:
a. Cash, Restricted Cash, Accrued Interest Receivable, 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 future cash flows using the interest method.
The carrying amounts of the notes receivable approximate fair value.
c. Short-Term Borrowings - The carrying amounts of the financing agreements
and other short-term borrowings approximate their fair value.
d. Long-Term Debt - Fair value of the Company's long-term debt (including
notes payable, and subordinated debentures) is estimated using discounted
cash flow analysis based on the Company's current incremental borrowing
rates for similar types of borrowing arrangements. The carrying amounts
reported in the accompanying consolidated balance sheets approximate their
fair value.
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 during 2003 or 2002
therefore net income was the same as its comprehensive income.
Accounting for Stock Options- The stock option plan is accounted for under
the recognition and measurement principles of Accounting Principles Board
(APB) Opinion 25, Accounting for Stock Issued to Employees and related
interpretations. No stock-based employee compensation cost is reflected in
net income for stock options, as all options granted under these plans had an
exercise price equal to the market value of the underlying common stock on
the date of grant.
Recently Adopted Accounting Pronouncements
In April 2002, the FASB issued SFAS No. 145, Rescission of SFAS No. 4,
44, and 64, Amendment of SFAS No. 13, and Technical Correction. SFAS No. 145,
among other things, rescinds SFAS No. 4, Reporting Gains and Losses from
Extinguishment of Debt, and, accordingly, the reporting of gains or losses
from the early extinguishment of debt as extraordinary items will only be
allowed if they met the specific criteria for extraordinary items included in
APB Opinion 30, Reporting the Results of Operations. The Company adopted this
statement on January 1, 2003 and it did not have an effect on the Company's
consolidated financial statements.
In July 2002, the FASB issued SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities (effective January 1, 2003). SFAS
No. 146 replaces current accounting literature and requires the recognition
of costs associated with exit or disposal activities when they are incurred
rather than at the date of a commitment to an exit or disposal plan. The
adoption of this statement did not have an effect on the Company's
consolidated financial statements.
In November of 2002, the FASB issued Interpretation No. 45, Guarantors'
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others. The Interpretation elaborates on the
disclosures to be made by a guarantor in its financial statements about its
obligations under certain guarantees that it has issued. It also clarifies
that a guarantor is required to recognize, at the inception of a guarantee, a
liability for the fair value of the obligation undertaken in issuing the
guarantee. The disclosure provisions of this Interpretation were effective
for the Company's December 31, 2002 financial statements. The initial
recognition and initial measurement provisions of this Interpretation are
applicable on a prospective basis to guarantees issued or modified after
December 31, 2002.
In January of 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities. This Interpretation clarifies the application of
existing accounting pronouncements to certain entities in which equity
investors do not have the characteristics of a controlling financial interest
or do not have sufficient equity at risk for the entity to finance its
activities without additional subordinated financial support from other
parties. The provisions of the Interpretation are effective for all variable
interests in variabl interest entities created after January 31, 2003, and
the Company will need to apply its provisions to any existing variable
interest in variable interest entities by no later than the third quarter of
2003. The Company believes that it does not hold any investments in entities
that will be deemed variable interest entities, and accordingly, that the
implementation of this Interpretation will not have a material effect on the
Company's consolidated financial statements.
In December 2002, the FASB issued SFAS No. 148 Accounting for Stock-
Based Compensation-Transition and Disclosure. This statement amends SFAS No.
123 to provide alternative methods of transition for a voluntary change to
the fair value based method of accounting for stock-based employee
compensation and amends the disclosure requirements of SFAS No. 123. Other
than the additional disclosure requirements below adoption of the provisions
of the Statement on January 1, 2003 did not have any impact because the
Company will continue to use the intrinsic value method as set forth in APB
No. 25.
The Company applies APB Opinion 25 and related interpretations in
accounting for stock options. Had the Company determined compensation costs
based on the fair value of the stock options at the grant date consistent
with the method of SFAS No.123, the Company's six months ended June 30, 2003
and 2002 net income and earnings per share would have been reduced to the pro
forma amounts indicated in the table that follows.
2003 2002
Net income - as reported $ 1,429,076 $ 2,266,062
Net income - pro forma $ 1,409,658 $ 2,266,062
Net income per common share
- basic - as reported $ 0.24 $ 0.38
Net income per common share
- basic - pro forma $ 0.24 $ 0.38
Net income per common share
- diluted - as reported $ 0.22 $ 0.36
Net income per common share
- diluted - pro forma $ 0.21 $ 0.36
The Company's six months ended June 30, 2003 and 2002 net income
and earnings per share would have been reduced to the pro forma amounts
indicated in the table that follows.
2003 2002
Net income - as reported $ 3,276,620 $ 3,824,448
Net income - pro forma $ 3,240,688 $ 3,824,448
Net income per common share
- basic - as reported $ 0.55 $ 0.65
Net income per common share
- basic - pro forma $ 0.55 $ 0.65
Net income per common share
- diluted - as reported $ 0.50 $ 0.61
Net income per common share
- diluted - pro forma $ 0.49 $ 0.61
There were 39,000 options granted during the three months ended June 30, 2003.
The weighted average fair value of options granted during the three months
ended June 30, 2003 was $2.58. The fair value of the options granted was
estimated using the Black-Scholes option-pricing model.
In April 2003, the FASB issued SFAS No.149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities.SFAS 149 amends and clarifies
the accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under
SFAS 133, Accounting for Derivative Instruments and Hedging Activities. SFAS
149 is generally effective for contracts entered into or modified after June
30, 2003 and for hedging relationships designated after June 30, 2003. The
adoption of SFAS No.149 on July 1, 2003, as required, had no impact on the
Company's consolidated financial statements.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity. SFAS No 150
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity.
SFAS No. 150 requires that certain financial instruments be classified as
liabilities that were previously considered equity. The adoption of this
standard on July 1, 2003, as required, had no impact on the Company's
consolidated financial statements.
BUSINESS SEGMENTS
The Company has two reportable operating segments: (i) portfolio asset
acquisition and resolution; and (ii) mortgage banking. The portfolio asset
acquisition and resolution segment acquires performing, nonperforming,
nonconforming and subperforming notes receivable and promissory notes from
financial institutions, mortgage and finance companies, and services and
collects such notes receivable through enforcement of terms of 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 for individuals whose credit histories,
income and other factors cause them to be classified as nonconforming
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.
Three Months Ended June 30,
2003 2002
CONSOLIDATED REVENUE
Portfolio asset acquisition and
resolution $ 12,238,233 $ 9,650,176
Mortgage banking 1,719,720 1,656,122
Consolidated Revenue $ 13,957,953 $ 11,306,298
CONSOLIDATED INCOME
Portfolio asset acquisition and
resolution $ 2,435,655 $ 3,422,721
Mortgage banking 275,921 697,591
Consolidated Income before income taxes $ 2,711,576 $ 4,120,312
Six Months Ended June 30,
2003 2002
CONSOLIDATED REVENUE
Portfolio asset acquisition and
resolution $ 24,553,980 $ 19,228,088
Mortgage banking 3,343,201 2,749,671
Consolidated Revenue $ 27,897,181 $ 21,977,759
CONSOLIDATED INCOME
Portfolio asset acquisition and
resolution $ 5,532,211 $ 5,998,857
Mortgage banking 600,709 1,034,341
Consolidated Income before income taxes $ 6,132,920 $ 7,033,198
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
General
Forward-Looking 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. (Forward-looking statements include, but are not
limited to, statements about (i)...(ii)... and (iii)... 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 and
interest rates and changes in the level of growth in the finance and housing
markets; (ii) the status of relations between the Company and its sole Senior
Debt Lender and the Senior Debt Lender willingness to extend additional
credit to the Comoany; (iii) the availability for purchases of additional
loans; (iv) the status of relations between the Company and its sources for
loan purchases; (v) unanticipated difficulties in collections under loans in
the Company's portfolio; and (vi) other risks detailed from time to time in
the Company's SEC reports. Additional factors that would cause actual results
to differ materially from those projected or suggested or suggested in any
forward-looking statements are contained in the Company's filings with the
Securities and Exchange Commission, including, but not limited to, those
factors discussed under the caption "Real Estate Risk" in the Company's
Annual Report on Form 10-K and Quarterly Reports on Form 10-Q, 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.
Critical Accounting Policies
The following management's discussion and analysis of financial condition and
results of operations is based on the amounts reported in the Company's
consolidated financial statements. In preparing the consolidated financial
statements in conformity with accounting principles generally accepted in the
United States of America ("GAAP"), management is required to make estimates
and assumptions that affect the financial statements and disclosures. These
estimates require management's most difficult, complex or subjective
judgments. The Company's critical accounting policies are described in its
Form 10-K for the year ended December 31, 2002. There have been no
significant changes in the Company's critical accounting policies since
December 31, 2002.
Acquisition Activity. During the six months ended June 30, 2003, the
Company purchased loans with an aggregate face value of $129.8 million for an
aggregate purchase price of $112.7 million or 87%, compared with the purchase
during the six months ended June 30, 2002 of $103.3 million at an aggregate
purchase price of $90 million or 87% of aggregate face value. The purchases
during the six months ended June 30, 2003 included 23 bulk portfolios
consisting primarily of first and second mortgages, with an aggregate face
value of $100.3 million at an aggregate purchase price of $86.9 million or
87% of the face value, and 122 flow purchase transactions consisting
primarily of first and second mortgages with an aggregate face value of $29.5
million at an aggregate purchase price of $25.8 million or 87% of face value.
Acquisition of these portfolios was fully funded through Senior Debt in the
amount equal to the purchase price plus a 1% loan origination fee.
The Company believes these acquisitions will result in increases in
the level of interest income and purchase discount income during future
periods. Payment streams are generated once the loans are incorporated into
the Company's loan tracking system.
There can be no assurance the Company will be able to acquire any
additional loans on favorable terms or at all.
Single-Family Residential Lending- In January 1997, the Company formed a
wholly owned subsidiary, Tribeca Lending Corp. ("Tribeca"), to originate
residential mortgage loans made to individuals whose credit histories, income
and other factors cause them to be classified as non-conforming borrowers.
Management believes that lower credit quality borrowers present an
opportunity for the Company to earn superior returns for the risks assumed.
Tribeca provides first and second mortgages that are originated on a retail
basis through marketing efforts that include utilization of marketing firms
that supply leads to the Company. Tribeca is currently licensed as a mortgage
banker in Alabama, California, Colorado, Connecticut, District of Columbia,
Florida, Georgia, Kentucky, Illinois, Maryland, Massachusetts, Michigan,
Missouri, New York, New Jersey, North Carolina, Ohio, Oklahoma, Oregon,
Pennsylvania, South Carolina, Tennessee, Texas, Virginia, Washington State,
and West Virginia and is a Department of Housing and Urban Development FHA
Title I and Title II approved lender. Tribeca-originated loans are typically
expected to be sold in the secondary market through servicing-released sales.
Tribeca anticipates holding certain of its mortgages in its portfolio when it
believes that the return from holding the mortgage, on a risk-adjusted basis,
outweighs the return from selling the mortgage in the secondary market. Since
commencing operations in 1997, Tribec has originated approximately $209
million in loans. For the three months period ended June 30 ,2003, the
Company changed the holding strategy of several of its originated loans and
reclassed $13.2 million of principal and fees into loans held for investments
as of June 30, 2003.
During the six months ended June 30, 2003, Tribeca originated 244 loans with
an aggregate principal amount of $42,101,242 and $3,839,300 in brokered loans
compared to 279 loans with an aggregate principal of $35,969,133 during the
six months ended June 30, 2002. During the six months ended June 30, 2003,
Tribeca had income before taxes of $600,708 as compared to $1,034,341 during
the six months ended June 30, 2002. This decrease in income reflected the
expansion of a three new branch offices in New Jersey, Florida and Maryland
and salaries for new employees during the period and slightly decreased
margins at point of sale due to originations of higher quality borrowers. As
of June 30, 2003, Tribeca had approximately $13.2 million face value of loans
held for sale and $13.5 million held for investment. Revenues and expenses
related to loans held for sale, other than periodic interest payments, and
fee are expected to be realized upon sale of such loans.
Cost of Funds. As of June 30, 2003, the Company had Senior Debt outstanding
under several loans with an aggregate principal balance of approximately $431
million. Additionally the Company has financing agreements, which had an
outstanding balance of approximately $16 million at June 30, 2003.
The majority of the loans purchased by the Company bear interest at a fixed
rate, while the Senior Debt incurred to acquire such loans bears interest at
a variable rate. Consequently, changes in market interest rate conditions
caused direct corresponding changes in the Company's interest expense. On
March 1, 2003, the Company and its Senior Debt Lender entered into a two-year
agreement that the interest rate for Senior Debt will be based on the Federal
Home Loan Bank of Cincinnati (FHLB) thirty (30) day advance rate plus an
additional spread of 3.50%. Under the amendment approximately $44 million of
Senior Debt will continue to accrue interest at a rate equal to the prime
rate plus a margin of between 0% and 1.75%.
Inflation. The impact of inflation on the Company's operations during the six
months ending June 30, 2003, and 2002 was immaterial.
Results of Operations
Three Months Ended June 30, 2003 Compared to Three Months Ended June 30, 2002.
Total revenue, which is comprised of interest income, purchase
discount earned, gains on bulk sale of notes receivable, gain on sale of
notes receivable originated, gain on sale of OREO, rental income and other
income, increased by $2,651,655 or 23%, to $13,957,953 11,306,298 during the
three months ended June 30, 2003, from $11,306,298 during the three months
ended June 30, 2002.
Interest income on notes receivable increased by $1,579,727 or 17%, to
$10,722,418 during the three months ended June 30, 2003 from $9,142,691
during the three months ended June 30, 2002. The Company recognizes interest
income on notes included in its portfolio based upon three factors: (i)
interest on performing notes, (ii) interest received with settlement
payments on non-performing notes and (iii) the balance of settlements in
excess of the carried face value. This increase resulted primarily from the
net increase of $90,655,723 or 22% in the size of the portfolio between June
30, 2002 and June 30, 2003.
Purchase discount earned increased by $323,342 or 43%, to $1,078,019
during the three months ended June 30, 2003, from $754,677 during the three
months ended June 30, 2002. This increase reflected the growth in size of the
portfolio and prepayments in portfolio's that earn purchase discount which
accelerated the earning of discount income.
Gain on sale of notes originated by Tribeca increased by $93,755 or
15% to $728,654 during the three months ended June 30, 2003, from $634,899
during the three months ended June 30, 2002. This increase is based on an
increase in the volume of notes sold during the three months ended June 30,
2003, compared to the three months ended June 30, 2002 and was partially
offset by a decline in margin. The Company sold $21 million during the three
months ended June 30, 2003 as compared to $9 million during the three months
ended June 30, 2002.
Gain on sale of OREO increased by $432,141 or 2504% to $449,399 during
the three months ended June 30, 2003 from $17,258 during the three months
ended June 30, 2002. The Company sold 67 and 23 OREO properties during the
three months ended June 30, 2003 and June 30, 2002 respectively. This
increase reflected an increase in the quantity of OREO properties sold during
the three months ended June 20, 2003.
Rental income decreased by $19,180 or 45% to $23,338 during the three
months ended June 30, 2003, from $42,518 during the three months ended June
30, 2002. Rental income decreased due to the reduction of rental properties
held during the three months ended June 30, 2003 as compared to June 30, 2002.
The Company had 6 and 13 rental properties during the three months ended June
30, 2003 and June 30, 2002 respectively.
Other income increased by $241,870 or 34%, to $956,125 during the
three months ended June 30, 2003 from $714,255 during the three months ended
June 30, 2002. This increase reflected increases in prepayment penalty income
due to the growth in the size of the portfolio and increased loans fees
associated with Tribeca loans sold.
Total operating expenses increased by $4,060,392 or 56% to $11,246,377
during the three months ended June 30, 2003 from $7,185,985 during the three
months ended June 30, 2002. Exclusive of the one-time recovery of a special
charge related to the PCC transaction of $1,662,598 total operating expenses
increased by $2,397,793 or 27% during the three months ended June 30, 2003 as
compared to the three months ended June 30, 2002. Total operating expenses
includes interest expense, collection, general and administrative expenses,
provisions for loan losses, amortization of deferred financing costs and
depreciation expense.
Interest expense increased by $896,574 or 19%, to $5,575,748 during the
three months ended June 30, 2003, from $4,679,174 during the three months
ended June 30, 2002. This increase resulted primarily from a 22% increase in
debt measured on the last day of the two periods, which was partially offset
by a 7% decrease in costs of funds. The weighted average cost of funds was
4.98% and 5.33% during the three months ended June 30, 2003 and June 30, 2002.
Total debt increased by $82 million or 22%, to $447 million as of June 30,
2003, from $365 million as of June 30, 2002. Total debt consists principally
of Senior Debt and financing agreements.
Collection, general and administrative expenses increased by
$1,545,495 or 54% to $4,411,539 during the three months ended June 30, 2003
from $2,866,044 during the three months ended June 30, 2002. The overall
increase resulted in part from a 22% increase in the Company's portfolio at
June 30, 2003 as compared with June 30, 2002. Collection, general and
administrative expense consists primarily of personnel expense, and all other
collection expenses including OREO related expense, litigation expense, and
miscellaneous collection expense.
Personnel expenses increased by $610,077 or 37% to $2,254,421 during
the three months ended June 30, 2003 from $1,644,344 during the three months
ended June 30,2002. This increase resulted largely from increases in
staffing in Tribeca as the Company opened three new branch offices during
the quarter and increased commissions due to increased loan production. All
other collection expenses increased by $935,418 or 76% to $2,157,118 during
the three months ended June 30, 2003 from $1,221,700 during the three months
ended June 30, 2002. This increase resulted primarily from increased legal
and collection expenses associated with the growth in size of the Company's
nonperforming portfolio and increased professional and advertising expenses.
Provisions for loan losses decreased by $106,913 or 13% to $734,851
during the three months ended June 30, 2003 from $841,764 during the three
months ended June 30, 2002. This decrease resulted primarily from fewer
write-offs in portfolios where there was no longer purchase discount
available to increase reserves.
Amortization of deferred financing costs increased by $41,299 or 11%
to $417,078 during the three months ended June 30, 2003, from $375,779 during
the three months ended June 30, 2002. This increase resulted primarily from
an increase in collections due to prepayments due to the growth in size of
the portfolio. On June 30, 2003 and June 30, 2002, deferred financing costs,
as a percentage of Senior Debt outstanding was 1.01% and 1.01%, respectively
Depreciation expense increased by $21,339 or 25%, to $107,161 during
the three months ended June 30, 2003, from $85,822 during the three months
ended June 30, 2002. This increase resulted from increased purchases of
computer equipment, furniture, and the leasehold improvements on new office
space.
Operating income decreased by $1,408,736 or 34% to $2,711,576 during
the three months ended June 30, 2003 from $4,120,312 during the three months
ended June 30, 2002. This was primarily due to the nonrecurring recovery of
special charge received during the three months ended June 30, 2002.
During the three months ended June 30, 2003 the Company made a
provision for income taxes of $1,282,500 as compared to $1,854,250 during the
three months ended June 30, 2002.
Net income decreased by $836,986 or 37% to $1,429,076 during the three
months ended June 30, 2003 from $2,266,062 during the three months ended June
30, 2002 for the reason set forth above.
Six Months Ended June 30, 2003 Compared to Six Months Ended June 30, 2002.
Total revenue, increased by $5,919,421 or 27%, to $27,897,181 during
the six months ended June 30, 2003, from $21,977,759 during the six months
ended June 30, 2002.
Interest income on notes receivable increased by $3,610,517 or 20%, to
$21,283,669 during the six months ended June 30, 2003 from $17,673,152 during
the six months ended June 30, 2002. The Company recognizes interest income on
notes included in its portfolio based upon three factors: (i) interest on
performing notes, (ii) interest received with settlement payments on
non-performing notes and (iii) the balance of settlements in excess of the
carried face value. This increase resulted primarily from the net increase of
$90,655,723 or 22% in the size of the portfolio between June 30, 2002 and
June 30, 2003.
Purchase discount earned increased by $262,216 or 15%, to $1,980,922
during the six months ended June 30, 2003 from $1,718,706 during the six
months ended June 30, 2002. This increase reflected the growth in size of the
portfolio and prepayments in portfolio's that earn purchase discount
accelerating the earning of the related discount income.
Gain on portfolio sale increased by $596,114 during the six months
ended June 30, 2003. The Company did not consummate any portfolio sales
during the six months ending June 30, 2002.
Gain on sale of notes originated by Tribeca increased by $589,635 or
72% to $1,407,044 during the six months ended June 30, 2003 from $817,409
during the six months ended June 30, 2002. This increase reflected an
increase in the number of Tribeca loans sold during the six months ended June
30, 2003, as compared to the six months ended June 30, 2002 and was partially
offset by a decline in margin. The Company sold $37 million in loans during
the three months ended June 30, 2003 as compared to $15 million in loans
during the three months ended 2002.
Gain on sale of OREO increased by $354,818 or 89% to $753,194 during
the six months ended June 30, 2003, from $398,375 during the six months ended
June 30,2002. This increase resulted from the increase in the Company's
portfolio of OREO held for sale. The Company sold 110 OREO properties during
the six months ended June 30, 2003, and 47 OREO properties during the six
months ended June 30, 2002.
Rental income decreased by $12,126 or 14% to $73,800 during the six
months ended June 30, 2003, from $85,926 during the six months ended June 30,
2002. Rental income decreased due to the reduction of rental properties held
during the six months ended June 30, 2003 as compared to June 30, 2002. The
Company had 6 and 13 rental properties during the six months ended June 30,
2003 and June 30, 2002 respectively.
Other income increased by $518,247 or 40%, to $1,802,438 during the
six months ended June 30, 2003 from $1,284,191 during the six months ended
June 30, 2002. This increase reflected increases in prepayment penalties, and
late charges, resulting from the increase in size of the Company's portfolio
and loan fees associated with Tribeca loans sold.
Total operating expenses increased by $5,157,102 or 31%, to
$21,764,261 during the six months ended June 30, 2003, from $16,607,159
exclusive of the special recovery transaction during the six months ended
June 30, 2002.
Interest expense increased by $1,522,537 or 17%, to $10,612,870
during the six months ended June 30, 2003 from $9,090,333 during the six
months ended June 30, 2002. This increase resulted primarily from a 22%
increase in debt measured on the last day of the two periods, which was only
partially offset by a 7% decrease in costs of funds. The weighted average
cost of funds was 4.98% and 5.33% during the six months ended June 30, 2003
and June 30, 2002. Total debt increased by $82 million or 22%, to $447
million as of June 30, 2003, from $365 million as of June 30, 2002.
Collection, general and administrative expenses increased by
$2,903,601 or 52%, to $8,519,096 during the six months ended June 30, 2003
from $ 5,615,495 during the six months ended June 30, 2002. The overall
increase resulted in part from a 22% increase in the Company's portfolio at
June 30, 2003 as compared with June 30, 2002.
Personnel expenses increased by $1,177,973 or 37%, to $4,350,494
during the six months ended June 30, 2003 from $3,172,521 during the six
months ended June 30, 2002. This increase resulted largely from increases in
staffing in Tribeca as the Company opened three new branch offices during the
period, increased commissions due to increased loan production and additions
to legal and servicing staff. All other collection expenses increased by
$1,725,628 or 71%, to $4,168,602 during the six months ended June 30, 2003
from $2,442,974 during the six months ended June 30, 2002. This increase
resulted primarily from increased legal and collection expenses associated
with the growth in size of the Company's nonperforming portfolio and
increased professional and advertising expenses.
Provisions for loan losses increased by $488,681 or 45% to $1,584,445
during the six months ended June 30, 2003 from $1,095,764 during the six
months ended June 30, 2002. This increase resulted primarily from higher
write-offs in maturing portfolios where there is no longer purchase discount
available to increase reserves.
Amortization of deferred financing costs increased by $196,468 or 31%,
to $840,391 during the six months ended June 30, 2003, from $643,923 during
the six months ended June 30, 2002. This increase resulted primarily from an
increase in collections primarily a result of prepayments due to the growth
in size of the portfolio.
Depreciation expense increased by $45,815 or 28%, to $207,459 during
the six months ended June 30, 2003, from $161,644 during the six months ended
June 30,2002. This increase resulted from increased purchases of computer
equipment, furniture, and the renovations of office space.
Operating income decreased by $900,278 or 13% to $6,132,920 during the
six months ended June 30, 2003, from $7,033,198 during the six months ended
June 30, 2002. This was primarily due to the nonrecurring recovery of special
charge received during the six months ended June 30, 2002.
During the six months ended June 30, 2003 the Company made a provision
for income taxes of $2,856,300 as compared to $3,208,750 during the six
months ended June 30, 2002.
Net income decreased by $547,828 or 14% to $3,276,620 during the six
months ended June 30, 2003 from $3,824,448 during the six months ended June
30, 2002 for the reasons set forth above.
Liquidity and Capital Resources
General. During the six months ended June 30, 2003 the Company
purchased 1,878 loans in several portfolios with an aggregate face value of
$130 million at an aggregate purchase price of $113 million or 87% of face
value. During the six months ended June 30, 2002 the Company purchased 1,959
loans in several portfolios with an aggregate face value of $103 million at
an aggregate purchase price of $90 million or 87% of aggregate face value.
The Company's portfolio of notes receivable at June 30, 2003 had a
face value of $481 million and included net notes receivable of approximately
$403 as compared with a face value of $435 million and net notes receivable
of approximately $366 million as of December 31, 2002. Net notes receivable
are stated at the amount of unpaid principal, net of purchase discount and
allowance for loan losses. The Company has the ability to hold its notes
until maturity, payoff or liquidation of collateral or, where deemed to be
economically advantageous to sell. The Company's portfolio of originated
loans, which includes mortgages originated by Tribeca and held for sale and
investment at June 30, 2003, had a combined face value of $27 million as
compared to $ 23 million at December 31, 2002. Originated loans held for
investment are stated at the amount of unpaid principal, reduced by net
deferred cost and fees. The Company has the ability to hold its originated
loans held for investment, that have a higher coupon than cost of funds,
until maturity, payoff or liquidation of collateral.
During the six months ended June 30, 2003, the Company used cash in
the amount of $4.4 million in its operating activities primarily for the
originations of loans, interest expense, increased infrastructure in the
Company's core business, litigation expense incidental to its ordinary
collection activities and for the foreclosure and improvement of OREO. The
Company used $37.5 million in its investing activities, primarily reflecting
purchases of notes receivable which purchases were offset by principal
collections upon its notes receivable and proceeds from sales of loans and
OREO. The amount of cash used in operating and investing activities was
funded by $40.4 million of net cash provided by financing activities,
including primarily, a net increase in Senior Debt of $36.3 million. The
above activities resulted in a net decrease in cash at June 30, 2003 over
December 31, 2002 of $1.5 million.
In the ordinary course of its business, the Company accelerates and
forecloses upon real estate securing non-performing notes receivable included
in its portfolio. As a result of such foreclosures and selective direct
purchases of OREO, at June 30, 2003 and December 31, 2002, the Company held
OREO recorded on the financial statements at $10.4 million and $9.3 million,
respectively. OREO is recorded on the financial statements of the Company at
the lower of cost or fair market value. The Company estimates, based on third
party appraisals and broker price opinions, that the OREO inventory held at
June 30, 2003, in the aggregate, had a net realizable value (market value
less estimated commissions and legal expenses associated with the disposition
of the asset) of approximately $11.4 million. There can be no assurance,
however, that such estimate is substantially correct or that an amount
approximating such amount would actually be realized upon liquidation of such
OREO. The Company generally holds OREO as rental property or sells such OREO
in the ordinary course of business when it is economically beneficial to do
so.
Cash Flow From Operating and Investing Activities
Substantially all of the assets of the Company are invested in its
portfolios of notes receivable and OREO. Primary sources of the Company's
cash flow for operating and investing activities are borrowings under its
senior debt facilities, collections on notes receivable and gain on sale of
notes and OREO properties.
At June 30, 2003, the Company had unrestricted cash, cash equivalents
and marketable securities of $9 million.
Cash Flow From Financing Activities
Senior Debt. As of June 30, 2003, the Company owed an aggregate of
$432 million to the Lender of Senior Debt, under several loans.
The Senior Debt is collateralized by first liens on the respective loan
portfolios for the purchase of which the debt was incurred and is guaranteed
by the Company. The monthly payments on the Senior Debt have been, and the
Company intends for such payments to continue to be, met by the collections
from the respective loan portfolios. The loan agreements for the Senior Debt
call for minimum interest and principal payments each month and accelerated
payments based upon the collection of the notes receivable securing the debt
during the preceding month. The Senior Debt accrues interest based on the
Federal Home Loan Bank of Cincinnati (FHLB) 30-day advance rate plus an
additional spread of 3.50%. Approximately $44 million of Senior Debt will
accrue interest at a rate equal to the prime rate plus a margin of between 0%
and 1.75%. The accelerated payment provisions are generally of two types: the
first requires that all collections from notes receivable, other than a fixed
monthly allowance for servicing operations, be applied to reduce the Senior
Debt, and the second requires a weekly additional principal reduction from
cash collected before scheduled principal and interest payments have been
made. As a result of the accelerated payment provisions, the Company is
repaying the amounts due on the Senior Debt at a rate faster than the
contractual scheduled payments. While the Senior Debt remains outstanding,
these accelerated payment provisions may limit the cash flow that is
available to the Company.
In March 2003, the Company negotiated with its Senior Debt Lender a
modification to provisions of the Senior Debt, pursuant to which the Senior
Debt Lender has provided the Company with a cash advance of $1,825,000 per
month. Management believes that this modification may reduce irregular
periods of cash flow shortages arising from operations. Management believes
that sufficient cash flow from the collection of notes receivable will be
available to repay the Company's secured obligations and that sufficient
additional cash flows will exist, through collections of notes receivable,
the bulk sale of performing loan portfolios, sales and rental of OREO, or
additional borrowing, to repay the current liabilities arising from
operations and to repay the long term indebtedness of the Company.
Certain Senior Debt credit agreements required establishment of
restricted cash accounts, funded by an initial deposit at the loan closing
and additional deposits based upon monthly collections up to a specified
dollar limit. The Company is no longer required to maintain these restricted
accounts but has continued to under the prior agreement. The Company
typically uses these funds to place deposits on loan portfolio bids and to
refinance loans in the Company's own portfolio. The restricted cash is
maintained in an interest bearing account, with the Company's Senior Debt
Lender. The aggregate balance of restricted cash in such accounts was
$1,166,854 on June 30, 2003 and $1,359,693 on December 31, 2002. The decrease
in restricted cash at June 30, 2003 was due to funding the origination of two
OREO properties during the six months ended June 30, 2003.
Total Senior Debt availability was approximately $500 million at June
30, 2003, of which approximately $358 million had been drawn down as of such
date. As a result, the Company has approximately $142 million available to
purchase additional portfolios of notes receivable and OREO.
The Company's Senior Debt Lender has provided Tribeca with a
warehouse financing agreement of $15 million. This Senior Debt accrues
interest based on prime plus an additional spread of 2.00%. At June 30, 2003,
Tribeca had drawn down $ 15 million on the line. The Company is actively
seeking other sources of financing for Tribeca.
Financing Agreements. The Company has a financing agreement with the Senior
Debt Lender permitting it to borrow a maximum of approximately $2,500,000 at
a rate equal to such lender's prime rate plus two percent per annum.
Principal repayment of the lines is due six months from the date of each cash
advance and interest is payable monthly. The total amounts outstanding under
the financing agreements as of June 30, 2003 and December 31, 2002, were
$500,952 and $632,883 respectively. Advances made under the financing
agreement were used to satisfy senior lien positions and fund capital
improvements in connection with foreclosures of certain real estate loans
financed by the Company. Management believes the ultimate sale of these
properties will satisfy the related outstanding financing agreements and
accrued interest, as well as surpass the collectible value of the original
secured notes receivable. Management has reached an agreement in principal
with its Senior Debt Lender to increase the availability under this credit
facility to cover additional properties foreclosed upon by the Company, which
the Company may choose to hold as rental property to maximize its return. The
Company uses when available OREO sales proceeds to pay down financing
agreements to help reduce interest expense
Additionally, the Company has a financing agreement with Citibank.
The agreement provides the Company with the ability to borrow a maximum of
$150,000 at a rate equal to the bank's prime rate plus one percent per annum.
As of June 30, 2003 and December 31, 2002 $104,736 and $109,942 respectively,
were outstanding on the financing agreement.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Interest rate fluctuations can adversely affect the Company's income and
value of its common shares in many ways and present a variety of risks,
including the risk of mismatch between asset yields and borrowing rates,
variances in the yield curve and changing prepayment rates.
The Company's operating results will depend in large part on differences
between the income from its assets (net of credit losses) and its borrowing
costs. Most of the Company's assets, consisting primarily of mortgage notes
receivable, generate fixed returns and have terms in excess of five years.
The Company funds the origination and acquisition of a significant portion of
these assets with borrowings, which have interest rates that are based on
the monthly Federal Home Loan Bank of Cincinnati 30-day advance rate ("FHLB").
In most cases, the income from assets will respond more slowly to interest
rate fluctuations than the cost of borrowings, creating a mismatch between
yields and borrowing rates. Consequently changes in interest rates,
particularly short-term rates may influence the Company's net income. The
Company's borrowing under agreements with its Senior Debt Lender bear
interest at rates that fluctuate with the FHLB rate of Cincinnati and the
prime rate. Based on approximately $387 and $44 million of borrowings
outstanding under this facility at June 30, 2003, a 1% increase in FHLB and
prime rate, would decrease the Company's quarterly net income and net cash
flows by approximately $583,000, absent any other changes. Increases in these
rates will decrease the net income and market value of the Company's net
assets. Interest rate fluctuations that result in interest expense exceeding
interest income would result in operating losses.
The value of the Company's assets may be affected by prepayment rates on
investments. Prepayments rates are influenced by changes in current interest
rates and a variety of economic, geographic and other factors beyond the
Company's control, and consequently, such prepayment rates cannot be
predicted with certainty. When the Company originates and purchases mortgage
loans, it expects that such mortgage loans will have a measure of protection
from prepayment in the form of prepayments lockout periods or prepayment
penalties. In periods of declining mortgage interest rates, prepayments on
mortgages generally increase. If general interest rates decline as well, the
proceeds of such prepayments received during such periods are likely to be
reinvested by the Company in assets yielding less than the yields on the
investments that were prepaid. In addition the market value of mortgage
investments may, because the risk of prepayment, benefit less from declining
interest rates than from other fixed-income securities. Conversely, in
periods of rising interest rates, prepayments on mortgage, generally
decrease, in which case the Company would not have the prepayment proceeds
available to invest in assets with higher yields. Under certain interest rate
and prepayment scenarios the Company may fail to recoup fully its cost of
acquisition of certain investments.
Real Estate Risk
Multi-family and residential property values and net operating income derived
from such properties are subject to volatility and may be affected adversely
by number of factors, including, but not limited to, national, regional and
local economic conditions (which may be adversely affected by industry
slowdowns and other factors); local real estate conditions (such as the over
supply of housing). In the event net operating income decreases, a borrower
may have difficultly paying the Company's mortgage loan, which could result
in losses to the Company. In addition, decreases in property values reduce
the value of the collateral and the potential proceeds available to a
borrower to repay the Company's mortgage loans, which could also cause the
Company to suffer losses.
Item 4. Controls and Procedures.
The Company's Chief Executive Officer and Chief Financial Officer evaluated
the Company's disclosure controls and procedures within the 90 days preceding
the filing of this quarterly report on Form 10Q and judged such controls and
procedures to be adequate and effective.
There have been no significant changes in the Company's internal controls or
in other factors that could significantly affect those controls subsequent to
the date of that evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Part II Other Information
Item 1. Legal Proceedings
None.
Item 2. Changes in Securities
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
On May 8, 2003 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, 2003.
- ------------- ----------- ----------- ---------- ----------- ----------
Election of
Directors For Against Abstained No-votes Total
Director
- ----------------- --------- ---------- --------- ---------- ---------
- ----------------- --------- ---------- --------- ---------- ---------
Thomas J. Axon 4,183,579 0 2,115 1,730,833 5,916,527
- ------------------ --------- ---------- --------- ---------- ---------
- ------------------ --------- ---------- --------- ---------- ---------
Seth Cohen 4,183,579 0 2,115 1,730,833 5,916,527
- ------------------ --------- ---------- --------- ---------- ---------
- ------------------ --------- ---------- --------- ---------- ---------
Joseph Caiazzo 4,183,579 0 2,115 1,730,833 5,916,527
- ------------------ --------- ---------- --------- ---------- ---------
- ------------------ --------- ---------- --------- ---------- ---------
Michael Bertash 4,183,579 0 2,115 1,730,833 5,916,527
- ------------------ --------- ---------- --------- ---------- ---------
- ------------------ --------- ---------- --------- ---------- ---------
Frank B. Evans 4,183,579 0 2,115 1,730,833 5,916,527
- ------------------ --------- ---------- --------- ---------- ---------
- ------------------ --------- ---------- --------- ---------- ---------
Alan Joseph 4,183,579 0 2,115 1,730,833 5,916,527
- ------------------- --------- ---------- --------- ---------- ---------
- ------------------- --------- ---------- --------- ---------- ---------
Steven W. Lefkowitz 4,183,579 0 2,115 1,730,833 5,916,527
- ------------------- --------- ---------- --------- ---------- ---------
- ------------------- --------- ---------- --------- ---------- ---------
Allan R. Lyons 4,183,579 0 2,115 1,730,833 5,916,527
- ------------------- --------- ---------- --------- ---------- ---------
- ------------------- --------- ---------- --------- ---------- ---------
William F. Sullivan 4,183,579 0 2,115 1,730,833 5,916,527
- ------------------- --------- ---------- --------- ---------- ---------
Independent Public
Auditors For Against Abstained No Votes Total
- -------------------------------------------------------------------------------
Deloitte & Touche
LLP 4,183,579 0 1,450 1,731,498 5,916,527
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) EXHIBIT TABLE
Exhibit No. Description
3(a) Restated Certificate of Incorporation. Previously filed
with, and incorporated herein by reference to, the
Company's 10-KSB, filed with the Commission on December 31,
1994.
b) Bylaws of the Company. Previously filed with, and
incorporated herein by reference to, the Company's
Registration Statement on Form S-4, No. 33-81948, filed
with the Commission on November 24, 1994.
10(i) Promissory Note between Thomas J. Axon and the Company
dated December 31,1998. Previously filed with, and
incorporated herein by reference to, the Company's 10-KSB,
filed with the Commission on April 14, 1999.
10(j) Promissory Note between Steve Lefkowitz, board member, and
the Company dated March 31,1999. Previously filed with, and
incorporated herein by reference to, the Company's 10-KSB,
filed with the Commission on March 30, 2000.
10(k) Loan Purchase Agreement dated March 31,1999 between the
Company and Steve Lefkowitz. Previously filed with, and
incorporated herein by reference to, the Company's 10-KSB,
filed with the Commission on March 30, 2000.
10(l) Employment Agreement dated July 17, 2000 between the Company
and Seth Cohen. Filed with the Commission with form 10KSB on
March 31, 2001.
99-1 Certification from the Chief Executive Officer pursuant to
section 906 of the Sarbanes Oxley Act of 2002.
99-2 Certifications from the Chief Financial Officer pursuant to
section 906 of the Sarbanes Oxley Act of 2002.
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
August 12, 2003
FRANKLIN CREDIT MANAGEMENT
CORPORATION
By: THOMAS J. AXON
--------------
Thomas J. Axon
Chairman of the Board
In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the registrant and in the capacities and
on the dates indicated.
Signature Title Date
SETH COHEN Chief Executive Officer August 12, 2003
------------ ---------------
Seth Cohen
(Principal executive
officer)
JOSEPH CAIAZZO Senior Vice President, Chief August 12, 2003
-------------- Operating ---------------
Joseph Caiazzo Officer, Secretary and Director
(Secretary)
ALAN JOSEPH Executive Vice President, Chief August 12, 2003
----------- Financial ---------------
Alan Joseph Officer and Director
(Principal financial
officer)
CERTIFICATION
I, Seth Cohen, Chief Executive Officer of Franklin Credit Management
Corporation (the "Company"), certify that:
1. I have reviewed this quarterly report on Form 10-Q of the Company;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect
to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the Company as of, and for, the periods presented in
this quarterly report;
4. The Company's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the Company
and we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the Company, including
its consolidated subsidiaries, is made known to us by others
within those entities, particularly during the period in
which this quarterly report is being prepared;
b) evaluated the effectiveness of the Company's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure
controls and procedures as of the end of the period covered
by this report based on such evaluation (the "Evaluation
Date"); and
c) Disclosed in this report any change in the registrant's
internal control over financial reporting that occurred
during the Company's most recent fiscal quarter(the Company's
fourth fiscal quarter in the case of an annual report) that
has materially affected, or is reasonably likely to
materially affect, the Company's internal control over
financial reporting; and
5. The Company's other certifying officers and I have disclosed, based
on our most recent evaluation of internal control over financial
reporting to the Company's auditors and the Audit Committee of the
Board of Directors:
a) all significant deficiencies and material weaknesses in the
design or operation of internal controls over financial
reporting which are reasonably likely to adversely affect the
Company's ability to record, process, summarize and report
financial data and have identified for the Company's auditors
any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
Company's internal controls over financial reporting; and
DATE: August 12, 2003 By: /s/
--------------------------
Chief Executive Officer
CERTIFICATION
I, Alan Joseph, Chief Financial Officer of Franklin Credit Management
Corporation (the "Company"), certify that:
1. I have reviewed this quarterly report on Form 10-Q of the Company;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material
fact necessary to make the statements made, in light of the
circumstances under which such statements were made, not misleading
with respect to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report, fairly
present in all material respects the financial condition, results
of operations and cash flows of the Company as of, and for, the
periods presented in this quarterly report;
4. The Company's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the Company
and we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the Company, including
its consolidated subsidiaries, is made known to us by others
within those entities, particularly during the period in
which this quarterly report is being prepared;
b) evaluated the effectiveness of the Company's disclosure
controls and procedures as of a date within 90 days prior
to the filing date of this quarterly report (the "Evaluation
Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The Company's other certifying officers and I have disclosed, based
on our most recent evaluation, to the Company's auditors and the
Audit Committee of the Board of Directors:
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the Company's
ability to record, process, summarize and report financial
data and have identified for the Company's auditors any
material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
Company's internal controls; and
DATE: August 12, 2003 By: /s/
-------------------------
Chief Financial Officer