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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM __________ TO __________
COMMISSION FILE NUMBER 0-17771
FRANKLIN CREDIT MANAGEMENT CORPORATION
DELAWARE 75-2243266
(State of incorporation) (I.R.S. ID)
SIX HARRISON STREET
NEW YORK, NEW YORK 10013
(212) 925-8745
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: COMMON
STOCK, $0.01 PAR VALUE.
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Exchange Act of 1934 during the past
12 months (or for such shorter period that the registrant was required to file
such reports), and (2) has been subject to such filing requirements for the past
90 days. Yes [X] [No].
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained in herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of common stock held by non-affiliates of the
registrant as of March 24, 2003 was approximately $2,932,652.
Portions of the registrant's definitive proxy statement, which will be filed
within 120 days of December 31, 2002, are incorporated by reference into Part
III.
FRANKLIN CREDIT MANAGEMENT CORPORATION
FORM 10-K
DECEMBER 31, 2002
INDEX
PAGE
----
PART I.
Item 1. Business 3
Item 2. Properties 8
Item 3. Legal Proceedings 9
Item 4. Submission of Matters to a Vote of Security Holders 9
PART II.
Item 5. Market for Registrant's Common Equity and Related Stockholders Matters 10
Item 6. Selected Financial Data 10
Item 7. Management's Discussion and Analysis of Financial Condition and Results 11
Of Operations
Factors Affecting our Business Condition
Item 7A. Quantitative and Qualitative Disclosure About Market Risk 20
Item 8. Financial Statements and Supplementary Data 21
Item 9. Change in and Disagreements with Accountants on Accounting and Financial Disclosures 21
PART III.
Item 10. Directors and Executive Officers of the Registrant 22
Item 11. Executive Compensation 22
Item 12. Security Ownership of Certain Beneficial Owners and Management 22
Item 13. Certain Relationships and Related Transactions 22
PART IV
Item 14 Controls and Procedures. 22
Item 15. Exhibits, Financial Statements Schedules and Reports on Form 8-K 22
2
PART I
ITEM 1. BUSINESS
BUSINESS OF REGISTRANT. Franklin Credit Management Corporation ("FCMC",
and together with its wholly-owned subsidiaries, the "Company") is a
specialty consumer finance and asset management company primarily
engaged in the acquisition, origination, servicing and resolution of
performing, sub-performing and non-performing residential mortgage
loans and residential real estate. The Company's portfolio consists
primarily of sub-prime assets. Mortgage loans are purchased at a
discount relative to the aggregate unpaid principal balance of the loan
and real estate is acquired in foreclosure or otherwise and is also
acquired at a discount relative to the appraised value of the asset.
During 2002, the Company took advantage of market opportunities to
increase its volume of loan acquisitions, pursuing a strategy of
acquiring primarily higher coupon non-investment grade performing
loans. Based on acquisition volume, the Company's portfolio grew 27% to
$458 million at December 31, 2002, as compared to $360 million at
December 31, 2001. The Company expects to continue this strategy, as
well as increase both the pace and amount of acquisitions, during 2003.
The Company believes it has built a strong servicing infrastructure and
developed a servicing expertise. In addition, the Company believes that
its ability to service and rehabilitate loans reduces its reliance on
secondary marketing of portfolios and may provide an advantage as
compared to competitors that rely on the secondary market as their
primary exit strategy.
In January 1997, the Company formed a wholly owned subsidiary, Tribeca
Lending Corp. ("Tribeca"), to originate primarily sub-prime 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 the FCMC database. Tribeca is currently licensed as a
mortgage banker in Alabama, California, Colorado, Connecticut, District
of Columbia, Florida, Georgia, Kentucky, Illinois, Maryland,
Massachusetts, Michigan, Missouri, Mississippi, 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 whole-loan, 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,
Tribeca has originated approximately $150 million in loans.
Since commencing operations in 1990, the Company has purchased, in
aggregate, approximately 27,778 loans with a face value of
approximately $952 million primarily from private institutions. The
Company seeks to develop relationships with mortgage bankers, banks,
and other specialty finance companies which may, through on-going
purchase arrangements, provide additional sources of mortgage
portfolios, individual mortgage assets and real estate assets.
During the year ended December 31, 2002, the Company purchased 4,331
loans with an aggregate face value of $212 million at an aggregate
purchase price of $184 million or 87% of face value. As of December 31,
2002, the Company's portfolio included approximately 11,246 loans with
an aggregate face
3
value of $458 million. An allowance for loan losses of approximately
$46 million has been recorded against this face value. At December 31,
2002, approximately 95% of the Company's loan portfolio consisted of
first mortgages, home equity/home improvement and second mortgages
collateralized by real estate, 3% consisted of loans collateralized by
other assets, and 2% consisted of unsecured loans. Although the Company
attempts to collect on all loans in its portfolio, it is unlikely that
the Company will be successful in collecting the full amount due for
each loan in its portfolio. In addition, significant administrative and
litigation expenses are often incurred in its collection efforts. See
"Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations" and "Item 8. Financial Statements".
Periodically, the Company sells portfolios of purchased performing,
reperforming and nonperforming loans on a whole loan basis. During
2002, the Company sold four performing loans with an aggregate face
value of $900,000, and one non-performing loan with face value of
$215,000. During 2001 the Company sold 125 performing loans with a face
value of $12.3 million, and 154 non-performing purchased loans with an
aggregate face value of $12 million. During 2002, the Company elected
not to sell bulk loans out of the portfolio but decided to hold the
loans for yield spread premium. The Company does not generally retain
the servicing rights on loans it sells.
As of December 31, 2002, the Company owed an aggregate of $395 million
("Senior Debt") to a bank (the "Senior Debt Lender"), which was
incurred in connection with the purchase of, and is secured by, the
Company's loan portfolios and Other Real Estate Owned ("OREO")
portfolios. On December 21, 2001, the Company's Senior Debt agreement
was amended. Under the amendment interest on Senior Debt accrues at
variable rates based on the Federal Home Loan Bank of Cincinnati
("FHLB") thirty (30) day advance rate plus an additional spread of
3.25%. For certain Senior Debt, acquired prior to March 1, 2000,
interest will be based on the Prime Rate plus a margin of between 0%
and 1.75%; approximately $59 million of total senior debt falls into
this category. At December 31, 2002, the weighted average interest rate
on Senior Debt was 4.85%. The Senior Debt Lender has advised the
Company that as of December 31, 2002, there was $105 million of
additional Senior Debt available to be used by the Company to purchase
additional portfolios of mortgage loans.
The Company employs standardized in-house servicing procedures in the
acquisition, origination, and collection of loans. The Company is
divided into five operating departments, which are described below:
ACQUISITION DEPARTMENT- The Acquisition Department is divided into two
units the bulk purchase unit, which is responsible for acquisitions in
excess of $1 million and a flow unit, which is responsible for
acquisitions less than $1 million. The Acquisition Department
identifies opportunities to purchase portfolios of mortgage loans,
performs due diligence, and assists in the integration of the acquired
assets into the Company's existing portfolio. The due diligence
process, includes an analysis of the majority of loans in a portfolio,
evaluating, among other things, lien position and the value of
collateral, debt-to-income ratios, the borrower's creditworthiness,
employment stability, years of home ownership, credit bureau reports
and mortgage payment history. The Acquisition Department reviews the
loan files comprising the portfolio, and where appropriate performs an
on-site evaluation of the seller's loan servicing department. This
process provides the Company additional information critical to
properly evaluating the portfolio. The information derived from due
diligence is compared to the Company's historical statistical data
base, and coupled with the Company's cumulative knowledge of the
sub-prime mortgage industry enables the Acquisition Department to
project a collection strategy and estimate the collectability and
timing of cash flows with respect to each loan. Based upon this
information, the Acquisition Department prepares a bid, which meets the
Company's established pricing and yield guidelines. When loans are
acquired the Acquisition Department, with the assistance of the
Management
4
Information Systems staff ("MIS"), monitors the electronic transfer of
loan data into the Company's data management system.
SERVICING DEPARTMENT- The Servicing Department manages the Company's
performing loans and seeks to provide quality customer service while
securing full payment of the total face value and accrued charges, by
monitoring monthly cash receipts, maintaining customer relations and,
where appropriate, entering into extension and modification agreements.
The Servicing Department is responsible for the maintenance of real
estate tax and insurance escrow accounts. The Servicing Department
members continuously review and monitor the status of collections and
individual loan payments in order to proactively identify and solve
potential collection problems. Upon acquisition of loan portfolios, the
Servicing Department: (i) issues introductory letters with information
regarding the change of ownership of the loan, payment information and
a toll-free Company information telephone number; (ii) conducts
internal audits of newly acquired loans to identify and address any
disputes or problems relating to the accounting for these loans; and
(iii) issues an audit letter advising the borrower of the outstanding
balance, last payment date and remaining term of the loan. As of
December 31, 2002, the Servicing Department managed approximately 8,447
accounts, with a total principal outstanding balance of approximately
$345 million.
LEGAL DEPARTMENT- The Legal Department manages and monitors the
progress of defaulted loans requiring legal action, and the loss
mitigation area, negotiates legal settlement strategies. These loans
are identified and referred by the Acquisition or Servicing Departments
to the Legal Department, which prepares an analysis of each loan to
determine a collection strategy to maximize the amount and speed of
recovery and minimize costs. This strategy is based upon the individual
borrowers' past payment history, current credit profile, current
ability to pay, collateral lien position and current collateral value.
The Legal Department sets up the collection strategy, negotiates
settlements, modification and forbearance agreements, manages their
costs, monitors ensuing litigation to insure the optimal recovery of
the remaining principal and interest balance and when appropriate
retains outside counsel. The Legal Department monitors each defaulted
loan through the foreclosure process, recovery of a money judgment or
other settlement, and continues to monitor recovery of deficiency
balances after a foreclosure has been completed. As of December 31,
2002, the Legal Department managed approximately 2,799 loans, with a
total principal outstanding balance of approximately $113 million.
REAL ESTATE DEPARTMENT - The Real Estate Department manages all
properties in order to preserve their value, realize rental income and
insure that maximum returns are realized upon sale. The Real Estate
Department is responsible for both the sale of OREO as well as for the
management of OREO that are held as rental properties until such time
as an economically beneficial sale can be arranged. As of December 31,
2002, the Real Estate Department managed approximately 142 OREO
properties, of which 7 were rental properties.
TRIBECA LENDING- Tribeca provides first and second mortgages to
individuals interested in purchasing real estate or refinancing their
existing loan. Tribeca focuses on developing an array of niche products
to fulfill needs such as sub-prime mortgages. Loans are originated by a
retail sales force that generates leads from the Company's database of
serviced loans, and external sources. The majority of loans are
expected to be warehoused until the inventory reaches the critical mass
needed to maximize profits through bulk sales in the secondary market.
Tribeca's staff processes, underwrites and closes all loans in its own
name.
During 2002, Tribeca originated 501 mortgages with an aggregate
principal balance of $70.4 million. During 2001, Tribeca originated 386
mortgages with an aggregate principal balance of $41.5 million.
5
OPERATING SEGMENTS
The Company has two reportable operating segments: (i)
portfolio asset acquisition and resolution; and (ii) mortgage banking.
The portfolio asset acquisition and resolution segment acquires
performing, nonperforming, nonconforming and subperforming notes
receivable and promissory notes from financial institutions, and
services and collects such notes receivable through enforcement of
original note terms, modification of original note terms and, if
necessary, liquidation of the underlying collateral. The
mortgage-banking segment originates or purchases, sub prime residential
mortgage loans for individuals whose credit histories, income and other
factors cause them to be classified as non-conforming 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. See "Item 7. Management's Discussion and Analysis
of Financial Condition and Results of Operations" and "Item 8.
Financial Statements".
FORMATION OF THE COMPANY. The Company was organized in Delaware in
1990, by Thomas J. Axon, and Frank B. Evans, Jr., for the purpose of
acquiring consumer loan portfolios from the Resolution Trust Company
("RTC") and the Federal Deposit Insurance Corporation ("FDIC"). In
March 1993, the Company completed the private placement of $2,000,000
of 15% Debentures (the "15% Debentures") and warrants for the purchase
of the Company's common stock, the proceeds of which were used to
acquire interests in loan portfolios and for operations. In December
1994, the Company merged with Miramar Resources, Inc., a public oil and
gas company organized in Delaware that had emerged from bankruptcy
proceedings on December 6, 1993.
COMPETITION. The Company faces significant competition in the
acquisition of loan portfolios. Many of the Company's competitors have
financial resources, acquisition departments and servicing capacity
considerably larger than the Company's. Among the Company's largest
competitors are Residential Funding Corporation and Bayview Financial
Trading Group. Competition for acquisitions is generally based on
price, reputation of the purchaser, funding capacity and timing. See
"Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations: General - Cost of Funds".
The market for sub-prime loan origination is also highly competitive.
Tribeca competes with savings banks, and mortgage bankers for the
origination of mortgages. Among the largest of these competitors are
New Century Mortgage, Amquest Mortgage, and Household Financial
Service. Many of Tribeca's competitors possess greater financial
resources, longer operating histories, and lower costs of capital than
Tribeca. Competition for mortgage originations is based upon marketing
efforts, loan processing capabilities, funding capacity, loan product
desirability and the ability to sell the loans for a premium in the
secondary market.
The Company also experiences competition from finance companies in the
sale of reperforming and newly originated loan portfolios. Important
characteristics which impact competition in this market are price,
loan-to-value, size of pools and the integrity of portfolio data.
CUSTOMERS. The Company's revenue is derived from interest and purchase
discount recognized from the collection of loans, origination fees,
rental income, other fees, gains recorded from the bulk sale of
performing, non-performing and originated loans to banks and other
financial institutions, and gains on the sale of OREO. The Company's
borrowers are a diverse population and no single borrower represents
6
a significant portion of the Company's loans. The Company sells bulk
portfolios of performing and non-performing loans, when such sales are
economically beneficial to the Company. While the Company has
previously been successful in marketing loan portfolios, and believes
there are sufficient buyers for its products there can be no assurance
that the Company will be able to successfully market loan portfolios in
the future.
SUPPLIERS. The Company acquires its loans through a variety of methods
including private and public auctions, negotiated sales, ongoing
purchase agreements, and joint-bids with other institutions. The supply
of assets available for purchase by the Company is influenced by a
number of factors including knowledge by the seller of the Company's
interest in purchasing assets, the general economic climate, financial
industry regulation, and new loan origination volume. While the Company
continues to pursue additional sources for purchasing assets, there can
be no assurance that existing and future sources will provide
sufficient opportunities for the Company to purchase assets at
favorable prices. During the past year, several institutions supplied
the Company with its portfolio acquisitions. The Company's sources of
loan acquisition have varied from year to year and the Company expects
that this will continue to be the case. During the year, the Company
continued to grow it's niche of purchasing small individual loans, or
pools of assets under a million dollars from various sources. The
Company believes that this market is under served and will open up
additional opportunities to establish relationships with other sellers.
During 2002, the Company increased its volume of acquisition under this
method by 41%, purchasing $49 million during 2002 compared to $35
million during 2001.
REGULATION. The Company's lending activities are subject to the Federal
Truth-in-Lending Act ("TILA") and Regulation Z (including the Home
Ownership and Equity Protection Act of 1994), the Equal Credit
Opportunity Act of 1974, as amended ("ECOA") and Regulation B, the Fair
Credit Reporting Act of 1970, as amended, the Real Estate Settlement
Procedures Act of 1974, as amended ("RESPA") and Regulation X, the Home
Mortgage Disclosure Act ("HMDA") and Regulation C, the Federal Debt
Collection Practices Act and the Fair Housing Act, as well as other
federal and state statutes and regulations affecting the Company's
activities. Failure to comply with these requirements can lead to loss
of approved status, demands for indemnification or mortgage loan
repurchases, certain rights of recision for mortgage loans, class
action lawsuits and administrative enforcement actions.
The Company is subject to the rules and regulations of, and
examinations by, the Department of Housing and Urban Development
("HUD"), the Federal Trade Commission and other federal and state
regulatory authorities with respect to originating, underwriting,
funding, acquiring, selling and servicing mortgage loans. In addition,
there are other federal, state and city statutes and regulations
affecting such activities. These rules and regulations, among other
things, impose licensing obligations on the Company, establish
eligibility criteria for loans, prohibit discrimination, provide for
inspection and appraisals of properties, require credit reports on
prospective borrowers, regulate payment features and, in some cases,
fix maximum interest rates, fees and loan amounts. The Company is
required to submit annual audited financial statements to various
governmental regulatory agencies that require the maintenance of
specified net worth levels.
Regulation Z requires a written statement showing an annual percentage
rate of finance charges and requires that other information be
presented to debtors when consumer credit contracts are executed. RESPA
requires written disclosure concerning settlement fees and charges,
mortgage-servicing transfer practices and escrow or impound account
practices. It also prohibits the payment or receipt of "kickbacks" or
referral fees in connection with the performance of settlement
services. The Fair Credit Reporting Act requires certain disclosures to
applicants concerning information that is used as a basis for denial of
credit. HMDA requires collection and reporting of statistical data
concerning borrower
7
demographics. ECOA prohibits discrimination against applicants with
respect to any aspect of a credit transaction on the basis of sex,
marital status, race, color, religion, national origin, age, derivation
of income from public assistance programs, or the good faith exercise
of a right under the Federal Consumer Credit Protection Act. The Fair
Housing Act prohibits discrimination in mortgage lending on the basis
of race, color, religion, sex, handicap, familial status or national
origin.
The interest rates which the Company may charge on its loans are
subject to federal and state usury laws, which specify the maximum
rate, which may be charged to consumers. In addition, both federal and
state truth-in-lending regulations require that the Company disclose to
its borrowers prior to execution of the loans all material terms and
conditions of the financing, including the payment schedule and total
obligation under the loans. The Company believes that it is in
compliance in all-material respects with such regulations.
Failure to comply with any of the foregoing federal and state laws and
regulations could result in the imposition of civil and criminal
penalties on the Company, class action lawsuits and administrative
enforcement actions.
ENVIRONMENTAL MATTERS. In the course of its business the Company has
acquired, and may acquire in the future, properties securing loans that
are in default. It is possible that hazardous substances or waste,
contamination, pollutants or sources thereof could be discovered on
such properties after acquisition by the Company. In such event, the
Company would seek to have such loans repurchased by the prior seller,
as this discovery would constitute a breach of contract. In rare cases,
the Company may retain the property and the Company may be required by
law to remove such substances from the affected properties at its sole
cost and expense. There can be no assurance that (i) the cost of such
removal would not substantially exceed the value of the affected
properties or the loans secured by the properties, (ii) the Company
would have adequate remedies against the prior owner or other
responsible parties, or (iii) the Company would not find it difficult
or impossible to sell the affected properties either prior to or
following such removal.
EMPLOYEES. As of December 31, 2002, the Company had 110 full-time
employees, including 9 in the Acquisitions Department, 36 in the
Service Department, 14 in the Legal Department, 3 in the Real Estate
Department, 7 in the Accounting Department, 2 in the MIS Department,
and 3 in the Marketing Department, 2 clerical employees, 6 managerial
employees, and 28 employees in Tribeca.
The Company has never experienced a material work stoppage or slowdown
due to labor disagreements. The Company believes that its relations
with all employees are satisfactory. None of the Company's employees
are covered by a collective bargaining agreement.
ITEM 2. DESCRIPTION OF PROPERTIES
PROPERTIES. Our corporate offices consist of three locations in New
York City. The primary office is located at 6 Harrison Street where the
Company owns a 6,600 square foot condominium unit. The second office is
located at 99 Hudson Street, New York, where we currently lease
approximately 6,400 square feet of office space at an approximate
annual rent of $129,892 under a lease that expires in December 2008. In
November 2002, the Company extended a sub-lease on the fourth and fifth
floor of Six Harrison Street, New York, which houses Tribeca Lending's
sales force. The lease expires on September 1, 2009, and is at an
approximate annual rent of $78,354. In November 2002, the Company
extended the lease of office space on four floors located at 185
Franklin Street for its Accounting and Tribeca Operations departments.
The leases expire in November 2008, and is at an average approximate
annual
8
rent of $156,600. On March 1, 2003, the company leased additional
office space on the third and fourth floors of 185 Franklin Street.
This lease expires in March 2008, and is at an average approximate
annual rent of $50,000. Also in March 2003, the Company leased a branch
office located in Marlton, New Jersey for the expansion of Tribeca. The
lease expires in March 2005, and is at an average approximate rent of
$27,360.
OREO PROPERTIES. The Company owns OREO in various parts of the country
that were acquired through acquisition, foreclosure or a deed in lieu.
These properties are 1-4 family residences, coops, condos, or
commercial property. The Company acquires or forecloses on property
primarily with the intent to sell such property at a profit, or to rent
the property until an economically beneficial sale can be made. From
time to time OREO properties may be in need of repair or improvements.
The OREO property is then evaluated independently and a decision is
made on whether the additional investment would generate an adequate
return.
ITEM 3. LEGAL PROCEEDINGS
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Market Information. The Company's common stock is quoted on the
National Association of Securities Dealers, Inc. Automated Quotation
System ("Nasdaq") under the symbol "FCSC" since December 26, 1996 and
"FCMC" from December 30, 1994 until such date.
The following table sets forth the bid prices for the common stock on
Nasdaq Bulletin Board, for the periods indicated, trading during these
periods was limited and sporadic, therefore, the following quotes may
not accurately reflect the true market value of the securities. Such
prices reflect inter-dealer prices without retail markup or markdown or
commissions and may not represent actual transactions.
Information for 2002 and 2001 was compiled from information
representing the daily inter-dealer bid activity during the period.
2002 Bid 2001 Bid
-------- --------
High Low High Low
---- --- ---- ---
First Quarter $1.05 $1.05 $0.33 $0.33
Second Quarter $1.80 $1.75 $1.20 $1.20
Third Quarter $1.35 $1.35 $1.10 $1.01
Fourth Quarter $1.05 $1.05 $ .75 $ .70
As of December 31, 2002, there were approximately 525 record holders of
the Company's Common Stock.
Dividend Policy. The Company intends to retain all future earnings that
may be generated from operations to help finance the operations and
expansion of the Company and accordingly does not plan to
9
pay cash dividends to holders of the common stock during the reasonably
foreseeable future. Any decisions as to the future payment of dividends
will depend on the earnings and financial position of the company and
such factors, as the Company's Management and Board of Directors deem
relevant.
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data set forth below as of and for the years
ended December 31, 2002, 2001, 2000, 1999, and 1998 have been derived
from the Company's audited consolidated financial statements. This
information should be read in conjunction with "Item 1. Business" and
"Item 7. Management Discussion and Analysis of Financial Condition and
Results of Operations", as well as the audited financial statements and
notes thereto included in "Item 8. Financial Statements and
Supplementary Data".
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
Operations Data:
Revenue $ 46,842,437 $ 37,963,358 $ 29,047,390 $ 22,451,660 $ 16,996,886
Total expenses 34,664,987 34,637,210 28,476,727 22,319,812 18,288,268
------------- ------------- ------------- ------------- -------------
Operating income before Taxes 12,177,450 3,326,148 570,663 131,848 (1,291,382)
Income taxes 5,514,000 444,000 - - -
------------- ------------- ------------- ------------- -------------
Net Income $ 6,663,450 $ 2,882,148 $ 570,663 $ 131,848 $ (1,291,382)
============= ============= ============= ============= =============
Earnings per share basic 1.13 0.49 0.10 0.02 0.23
Earnings per share diluted 1.07 0.49 0.10 0.02 0.23
Balance sheet Data:
Total assets 424,419,034 334,162,501 243,235,288 195,737,096 146,891,427
Total liabilities 411,425,185 327,832,102 239,787,037 192,859,508 144,145,687
Total stockholders' equity 12,993,849 6,330,399 3,448,251 2,877,588 2,745,740
10
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
FORWARD-LOOKING STATEMENTS. When used in this report, press releases
and elsewhere by the Company from time to time, the words "believes",
"anticipates", and "expects" and similar expressions are intended to
identify forward-looking statements that involve certain risks and
uncertainties. Additionally, certain statements contained in this
discussion and the Form 10-K, may be deemed forward-looking statements
that involve a number of risks and uncertainties. Among the factors
that could cause actual results to differ materially are the following:
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, the status of relations
between the Company and its sole Senior Debt Lender, the availability
for purchases of additional loans, the status of relations between the
Company and its sources for loan purchases, unanticipated difficulties
in collections under loans in the Company's portfolio and other risks
detailed from time to time in the Company's SEC reports. 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. These financial
statements are prepared in accordance with accounting principles
generally accepted in the United States of America. In preparing the
financial statements, management is required to make various judgments,
estimates and assumptions that affect the reported amounts. Changes in
these estimates and assumptions could have a material effect on the
Company's consolidated financial statements. The following is a summary
of the Company's accounting policies that are the most affected by
management judgments, estimates and assumptions:
NOTES RECEIVABLE - The Company purchases real estate mortgage loans to
be held as long-term investments. Loan purchase discounts are
established at the acquisition date. Management must periodically
evaluate each of the purchase discounts to determine whether the
projection of cash flows for purposes of amortizing the purchase loan
discount has changed significantly. Changes in the projected payments
are accounted for as a change in estimate and the periodic amortization
is prospectively adjusted over the remaining life of the loans. Should
projected payments not exceed the carrying value of the loan, the
periodic amortization is suspended and either the loan is written down
or an allowance for uncollectibility is recognized. The allowance for
loan losses is initially established by an allocation of the purchase
loan discount based on management's assessment of the portion of
purchase discount that represents uncollectable principal.
Subsequently, increases to the allowance are made through a provision
for loan losses charged to expense. Given the nature of the Company's
loan portfolio and the underlying real estate collateral, significant
judgment is required in determining periodic amortization of purchase
discount, and allowance for loan losses. The allowance is maintained at
a level that management considers adequate to absorb potential losses
in the loan portfolio.
LOANS HELD FOR SALE AND OTHER REAL ESTATE OWNED - 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. Other real
estate owned ("OREO") consists of
11
properties acquired through, or in lieu of, foreclosure or other
proceedings and are held for sale and carried at the lower of cost or
fair value less estimated costs to sell. Any write-down to fair value,
less cost to sell, at the time of acquisition is charged to purchase
discount. Subsequent write-downs are charged to operations based upon
management's continuing assessment of the fair value of the underlying
collateral. Property is evaluated periodically to ensure that the
recorded amount is supported by current fair values and valuation
allowances are recorded as necessary to reduce the carrying amount to
fair value less estimated cost to sell. Revenue and expenses from the
operation of OREO and changes in the valuation allowance are included
in operations. Direct costs relating to the development and improvement
of the property are capitalized, subject to the limit of fair value of
the collateral, while costs related to holding the property are
expensed. Gains or losses are included in operations upon disposal.
ACCOUNTING FOR STOCK OPTIONS - The incentive stock option plan is
accounted for under the recognition and measurement principles of
Accounting Principles Board (APB) Opinion 25, "Accounting for Stock
Issued to Employees" and related interpretations. No stock-based
employee compensation costs 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.
INCOME TAXES - Income taxes are accounted for under Financial
Accounting Standards Board Statement No. 109 "Accounting for Income
Taxes". This method provides for deferred income tax assets or
liabilities based on the temporary difference between the income tax
basis of assets and liabilities and their carrying amount in the
consolidated financial statements. Deferred tax assets and liabilities
are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected
to be recovered or settled. Deferred tax assets are reduced by a
valuation allowance 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.
LOAN AND OREO ACQUISITIONS. - During the year ended December 31, 2002
("fiscal 2002") the Company purchased 4,331 loans consisting primarily
of first and second mortgages, with an aggregate face value of $212
million at an aggregate purchase price of $184 million or 87% of the
face value compared with the purchase during the year ended December
31, 2001 ("fiscal 2001") of 3,599 loans consisting primarily of first
and second mortgages, with an aggregate face value of $184 million at
an aggregate purchase price of $162 million or 88% of the face value.
Acquisition of these 2002 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 of loans will result in
substantial increases in the level of interest income during future
periods. Payment streams are generated once the loans are incorporated
into the Company's loan tracking system.
Management intends to continue to expand the Company's earning asset
base through the acquisition of additional portfolios including
performing and non-performing real estate secured loans.
COST OF FUNDS. - During the year 2002 there were several decreases in
the benchmark rates for the Company's costs of funds on Senior Debt
used to fund loan portfolio acquisitions. As of December 31, 2002, the
Company had Senior Debt outstanding under several loans with an
aggregate principal balance of $395 million. Additionally the Company
has financing agreements, which had an outstanding balance of $11.5
million at December 31, 2002.
12
The majority of the loans purchased by the Company bear interest at a
fixed rate, while the Senior Debt is at a variable rate. Consequently,
changes in market interest rate conditions have caused direct
corresponding changes in interest expense. On December 31, 2001, the
Company and its Senior Debt Lender agreed to a two year term interest
rate agreement pursuant to which the interest rate for certain Senior
Debt incurred after March 1, 2000, will be the Federal Home Loan Bank
of Cincinnati ("FHLB") thirty (30) day advance rate plus an additional
spread of 3.25%. Under the amendment certain Senior Debt incurred prior
to March 1, 2000 will accrue interest at a rate equal to the prime rate
plus a margin of between 0% and 1.75%; approximately $59 million of
total loans fall into this category. The Company believes that this new
agreement will continue to provide acquisition opportunities and
ongoing competitiveness in the market. Decreases in both the prime and
FHLB rate during the year positively impacted the net income of the
Company. The weighted average interest rate on borrowed funds for the
Senior Debt based on the balances as of December 31, 2002 and December
31, 2001 was 4.85% and 5.25%, respectively.
The impact of inflation on the Company's operations during fiscal 2002,
2001 and 2000 was immaterial.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
Total revenue, comprised of interest income, purchase discount earned,
gains on sale of notes receivable sale of notes, gain on sale of loans
held for sale, gain on sale of OREO, rental income and other income,
increased by $8,879,079 or 23%, to $46,842,437 during fiscal 2002, from
$37,963,358 during fiscal 2001.
Total revenue as a percentage of notes receivable, loans held for sale
and OREO as of the last day of the fiscal year, net of allowance for
loan losses during fiscal 2002 was 11.5% as compared with 11.1% during
fiscal 2001. Interest income on notes receivable increased by
$7,904,111 or 27%, to $36,728,735 during fiscal 2002 from $28,824,624
during fiscal 2001. 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
purchase of $212 million of performing loans during 2002, which
increased the size of the Company's outstanding portfolio of notes
receivable by 27%.
Purchase discount earned decreased by $144,571 or 4%, to $3,841,927
during fiscal 2002 from $3,986,498 during fiscal 2001. The decrease in
purchase discount earned was due to maturation of the portfolio, and
write-offs and reserve increases in certain portfolio's that would have
earned income.
Gains on sale of notes receivable decreased by $847,051 or 86%, to
$139,519 during fiscal 2002 from $986,570 during fiscal 2001. This
decrease reflected the Company's decision not to sell bulk performing
loans out of the portfolio this year to hold them for yield spread
premium instead. The Company sold approximately $1.1 million in face
value notes receivable during 2002 as compared to $24 million during
2001.
Gain on sale of loans held for sale increased by $1,417,928 or 168%, to
$2,259,979 during 2002 from $842,051 during fiscal 2001. This increase
was due to an increase in loan origination, which increased the
13
volume of loans sold during 2002 as compared to 2001. Tribeca had loan
sales of $42 million during 2002 as compared to $15 million of loans
during 2001.
Gain on sale of OREO decreased by $651,986 or 45% to $796,562 during
fiscal 2002 from $ 1,448,548 during fiscal 2001. The decrease resulted
from less inventory available for sale during the first half of the
year. The Company sold 105 OREO properties during 2002 as compared to
140 OREO properties during 2001.
Rental income decreased by $177,284 or 54% to $152,965 during fiscal
2002, from $330,250 during fiscal 2001. Rental income decreased due to
the sale of several rental properties where it was more advantageous to
sell than continue to hold for rent during the year. The Company held 7
rental properties at December 31, 2002 as compared to 16 at December
31, 2001.
Other income increased by $1,377,933 or 89%, to $2,922,750 during
fiscal 2002 from $1,544,817 during fiscal 2001. The increase was due
primarily to increases in the number of prepayment penalties due to an
increase in prepayments during 2002, increased late charges resulting
primarily from the growth in the size of the portfolio and increased
loan fees from loan originations.
Total operating expenses increased by $1,690,376 or 5% to $36,327,586
during fiscal 2002 from $34,637,210 during fiscal 2001. Total operating
expenses include interest expense, collection, general and
administrative expenses, provisions for loan losses, service fees,
amortization of loan commitment fees and depreciation expense.
Interest expense decreased by $1,626,568 or 7.84%, to $19,127,713
during fiscal 2002 from $20,754,281 during fiscal 2001. This decrease
was due to decreases in the Company's costs of funds and was partially
offset by a 27% increase in debt, reflecting the Company's 27% increase
in notes receivable and loans held at the end of fiscal 2002 over those
held at the end of fiscal 2001. Total debt increased by $85 million to
$407 million as of December 31, 2002 as compared with $322 million as
of December 31, 2001. Total debt includes Senior Debt, financing
agreements and loans from affiliates.
Collection, general and administrative expenses increased by $2,471,123
or 24% to $12,882,135 during fiscal 2002 from $10,411,012 during fiscal
2001. The primary components of collection, general and administrative
expense are personnel expenses, OREO related expenses, litigation
expenses, office expenses, and collection expenses.
Personnel expenses increased by $1,285,516 or 24%, to $6,723,799 during
fiscal 2002 from $5,438,283 during fiscal 2001. This increase resulted
from the growth in size of the Company's staff, salary increases, and
increased commissions due to increased loan production and bonus
accruals. OREO related expenses decreased by $409,603 to $466,838
during fiscal 2002 from $876,441 during fiscal 2001 due to the selling
of OREO properties. Other general and administrative expenses increased
$1,595,210 or 39% to $5,691,499 during fiscal 2002 from $4,096,289
during fiscal 2001. This increase resulted primarily from increased
legal expenses for asset protection, and collection costs associated
with an increase in nonperforming loans.
Provisions for loan losses increased by $526,411 or 24%, to $2,713,864
during fiscal 2002 from $2,187,453 during fiscal 2001. This increase
was primarily due to an increase in write-offs and reserve increases in
portfolios that no longer have purchase discount. Provision for loan
loss expressed as a percentage of face value of notes receivable and
loans held as of the last day of such years for fiscal 2002 and fiscal
2001 were approximately 0.58% and 0.60%, respectively. Provisions for
loan losses are
14
incurred as soon as the valuation of the asset diminishes and there is
no unamortized discount remaining associated with that asset.
Amortization of deferred financing costs increased by $205,669 or 19%,
to $1,264,112 during fiscal 2002 from $1,058,443 during fiscal 2001.
This increase resulted primarily from the growth in size of the
portfolio, increased prepayments and collections, which caused a
corresponding increase in the pay down of Senior Debt. On December 31,
2002 and December 31, 2001, deferred financing costs, as a percentage
of Senior Debt outstanding was 1.01 % and 1.02%, respectively.
Depreciation expense increased by $113,740 or 50%, to $339,761 during
fiscal 2002 from $226,021 during fiscal 2001. This increase resulted
primarily from the purchase of computer equipment.
The Company's operating income increased by $8,851,302 or 266% to
$12,177,450 during fiscal 2002 from $3,326,148 during fiscal 2001 for
the reasons set forth above.
During 2002, the Company had a provision for income taxes of $5,514,000
as compared to 2001 when the provision was $444,000 after the
utilization of all available net operating losses.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000
Total revenue, comprised of interest income, purchase discount earned,
gains recognized on the bulk sale of notes, gain on sale of OREO, gain
on sale of loans originated, rental income and other income, increased
by $8,915,968 or 31%, to $37,963,358 during fiscal 2001, from
$29,047,390 during fiscal 2000.
Total revenue as a percentage of notes receivable in the Company's
portfolio as of the last day of the fiscal year, net of allowance for
loan losses during fiscal 2001 was 12.7% as compared with 12.6% during
fiscal 2000. Interest income on notes receivable increased by
$7,951,120 or 38%, to $28,824,624 during fiscal 2001 from $20,873,504
during fiscal 2000. 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
purchase of $184 million of performing loans during 2001, which
increased the size of the Company's outstanding portfolio of notes
receivable by 30%.
Purchase discount earned increased by $198,464 or 5%, to $3,986,498
during fiscal 2001 from $3,788,034 during fiscal 2000. The increase in
purchase discount earned reflected the growth in size of the portfolio.
Purchase discount increased at a lower rate than the growth in the
portfolio due to the maturation of the portfolio, and the purchase of
performing assets for yield spread as opposed to purchase discount
during the year.
Gains from the bulk sale of loans decreased by $688,537 or 41%, to
$986,570 during fiscal 2001 from $1,675,107 during fiscal 2000. This
decrease reflected the change in mix of loans sold to include a
significantly greater proportion of non-performing loans in 2001, which
resulted in lower margins. The
15
Company sold approximately $24 million in face value notes receivable
during 2001 as compared to $13 million during 2000.
Gain on sale of originated notes by Tribeca increased by $565,140 or
204%, to $842,051 during 2001 from $276,911 during fiscal 2000. This
increase was due to an increase in the number of loans sold during 2001
as compared to 2000. Tribeca had loan sales of $15 million during 2001
as compared to $5 million of loans during 2000.
Gain on sale of OREO increased by $747,609 or 107% to $1,448,548 during
fiscal 2001 from $ 700,939 during fiscal 2000. The increase resulted
from the sale of OREO properties during the year that had appreciated
in value in the Company's portfolio. The Company sold 140 OREO
properties during 2001 as compared to 120 OREO properties during 2000.
Rental income decreased by $342,498 or 51% to $330,250 during fiscal
2001, from $672,748 during fiscal 2000. Rental income decreased due to
the sale of several rental properties where it was more advantageous to
sell than continue to hold for rent during the year. The Company held
16 rental properties at December 31, 2001 as compared to 47 at December
31, 2000.
Other income increased by $484,670 or 46%, to $1,544,817 during fiscal
2001 from $1,060,147 during fiscal 2000. The increase was due primarily
to increases in the number of prepayment penalties due to an increase
in prepayments during 2001, late charges resulting primarily from the
growth in the size of the portfolio and increased loan fees from loan
originations.
Total operating expenses increased by $6,160,483 or 22% to $34,637,210
during fiscal 2001 from $28,476,727 during fiscal 2000. Total operating
expenses include interest expense, collection, general and
administrative expenses, provisions for loan losses, service fees,
amortization of loan commitment fees and depreciation expense.
Interest expense increased by $1,972,749 or 11%, to $20,754,281 during
fiscal 2001 from $18,781,532 during fiscal 2001. This increase resulted
primarily from the increase in debt reflecting the Company's 37 %
increase in notes receivable and loans held at the end of fiscal 2001
over those held at the end of fiscal 2000. Total debt increased by $88
million or 38%, to $321 million as of December 31, 2001 as compared
with $233 million as of December 31, 2000. Interest expense was
partially offset by decreases in the Company's costs of funds. Total
debt includes Senior Debt, debentures, financing agreements and loans
from affiliates.
Collection, general and administrative expenses increased by $1,896,270
or 22% to $10,411,012 during fiscal 2001 from $8,514,742 during fiscal
2000. The primary components of collection, general and administrative
expense are personnel expenses, OREO related expenses, litigation
expenses, office expenses, and collection expenses.
Personnel expenses increased by $1,409,613 or 35%, to $5,438,283 during
fiscal 2001 from $4,028,669 during fiscal 2000. This increase resulted
from the growth in size of the Company's staff, salary increases,
increased commissions due to increased loan production and bonus
accruals. OREO related expenses decreased by $386,066 to $876,441
during fiscal 2001 from $1,262,506 during fiscal 2000 due to the
selling of inventory. Office expenses increased by $258,080 or 49%, to
$ 789,711 during fiscal 2001 from $531,631 due to an increase in office
space for Tribeca on the fifth floor of 6 Harrison Street and new
office space at 185 Franklin Street for the file room, Accounting and
Tribeca operations. Other
16
general and administrative expenses increased $614,644 or 23% to
$3,306,577 during fiscal 2001 from $2,691,933 during fiscal 2000. This
increase resulted primarily from increased travel for marketing, due
diligence, increased legal expenses for asset protection, and
professional fees.
Provisions for loan losses increased by $1,776,448 or 432%, to
$2,187,453 during fiscal 2001 from $411,005 during fiscal 2000. This
increase was primarily due to reserve increases on two large loans that
are in litigation, the write off an $873,000 loan that was deemed
uncollectable and reserve increases in portfolios that no longer have
purchase discount. Provision for loan loss expressed as a percentage of
face value of notes receivable and loans held as of the last day of
such years for fiscal 2001 and fiscal 2000 was approximately 0.60% and
0.15%, respectively. Provisions for loan losses are incurred as soon as
the valuation of the asset diminishes and there is no unamortized
discount remaining associated with that asset.
Amortization of deferred financing costs increased by $438,551 or 71%,
to $1,058,443 during fiscal 2001 from $619,892 during fiscal 2000. This
increase resulted primarily from the growth in size of the portfolio,
increased prepayments, collections, and an increase in the aggregate
amount of assets sold, which sales generally accelerate the
amortization of financing costs. On December 31, 2001 and December 31,
2000, deferred financing costs, as a percentage of Senior Debt
outstanding was 1.02 % and 1.05%, respectively.
Depreciation expense increased by $76,465 or 51%, to $226,021 during
fiscal 2001 from $149,556 during fiscal 2000. This increase resulted
primarily the purchase of computer equipment.
The Company's operating income increased by $2,311,485 to $2,882,148
during fiscal 2001 from $570,663 during fiscal 2000 for the reasons set
forth above.
During 2001, the Company had a provision for income taxes of $444,000
after utilizing all available net operating losses and removed the
valuation allowance. The Company did not record a provision in 2000
since available net operating losses exceeded taxable income. A
valuation reserve was established against excess net operating losses.
LIQUIDITY AND CAPITAL RESOURCES
General- During fiscal 2002 the Company purchased 4,331 loans with an
aggregate face value of $212 million at an aggregate purchase price of
$184 million or 87% of the face value. During fiscal 2001, the Company
purchased 3,599 loans with an aggregate face value of $184 million at
an aggregate purchase price of $162 million or 88% of face value. This
increase reflected the Company's enhanced marketing efforts, which
generated increased market penetration.
Liquidity- The Company's portfolio of notes receivable at December 31,
2002, had a face value of $435 million and included net notes
receivable of approximately $366 million. Net notes receivable are
stated at the amount of unpaid principal, reduced by purchase discount
and allowance for loan losses. The Company has the ability and intent
to hold its notes until maturity, payoff or liquidation of collateral
or sale if it is economically advantageous to do so.
During fiscal 2002, the Company used cash in the amount of $15 million
in its operating activities primarily for interest expense, overhead,
litigation expense incidental to its collections and for the
foreclosure and improvement of OREO. The Company used $68 million in
its investing activities, which reflected primarily the use of $184
million for the purchase of notes receivable offset by principal
17
collections of its notes receivable of $111 million and proceeds from
sales of OREO of $7 million. Net cash provided by financing activities
was $85 million primarily from an increase in Senior Debt of $81
million. The above activities resulted in a net increase in cash at
December 31, 2002 over December 31, 2001 of $2,792,448.
In the ordinary course of its business, the Company accelerates its
foreclosures of real estate securing non-performing notes receivable
included in its portfolio. As a result of such foreclosures and
selective direct purchases of OREO, at December 31, 2002 and 2001, the
Company held OREO recorded in the financial statements at $9.3 million
and $3.8 million, respectively. OREO is recorded on the financial
statements of the Company at the lower of cost or fair market value
less estimated costs of disposal. The Company believes that the OREO
inventory held at December 31, 2002 has a net realizable value (market
value less estimated commissions and legal expenses associated with the
disposition of the asset) of approximately $10.2 million based on
market analyses of the individual properties less the estimated closing
costs. 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.
Operating Expenses of Tribeca. - During 2002, Tribeca recorded
operating income of $1.8 million compared to $396,788 during 2001. This
increase was due to increased origination volume due to an increased
sales force and increased delivery in the secondary market. This
increase in sales force was responsible for a 70% increase in loan
originations, a 180% increase in loans sold and a 354% increase in
operating income. The Company funded the start-up of Tribeca with $1.1
million of proceeds from the refinancing of two loan portfolios through
its Senior Debt Lender. Additionally, such lender has provided Tribeca
with a warehouse financing agreement of $15 million. There can be no
assurances that Tribeca will earn a profit in the future, however,
management believes that Tribeca's existing cash balances, credit
lines, and anticipated cash flow from operations will provide
sufficient working capital resources for Tribeca's anticipated
operating needs. During fiscal 2002 Tribeca negotiated with the Senior
Debt Lender to allow Tribeca to convert debt incurred under it's
warehouse line into Senior Debt each time the aggregate amount
outstanding hit $15 million dollars. This has allowed Tribeca to hold
its loans while continuing its origination activity and thereby
allowing Tribeca greater flexibility to time its bulk sales in the
secondary market to its greatest advantage. The Senior Debt generally
accrues interest at a variable rate based on the FHLB rate of
Cincinnati plus a premium of 3.25%.
CASH FLOWS FROM OPERATING AND INVESTING ACTIVITIES
Substantially all of the assets of the Company are invested in its
portfolios of notes receivable. The Company's primary source of cash
flow for operating and investing activities is collections on notes
receivable and gains on sale of notes and OREO properties.
At December 31, 2002, the Company had unrestricted cash, cash
equivalents and marketable securities of $10.7 million. A portion of
the Company's available funds may be applied to fund acquisitions of
companies or assets of companies in complementary or related fields,
which may cause the Company to incur additional capital expenditures,
outside the acquisitions of additional notes receivable.
CASH FLOW FROM FINANCING ACTIVITIES
Senior Debt. - As of December 31, 2002, the Company owed an aggregate
of $395 million to the Senior Debt Lender, under several loans.
18
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 contractual 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 at a variable rate
based on the FHLB rate of Cincinnati plus a premium of 3.25% for all
new Senior Debt and debt incurred after March 1, 2000, and prime plus
between 0% and 1.75% debt incurred before such date, of which there was
approximately $59 million at December 31, 2002. At December 31, 2002,
the weighted average interest rate on Senior Debt was 4.85%. 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.
On December 31, 2001, the Company negotiated with its Senior Debt
Lender a modification to the Senior Debt obligation, pursuant to which
the Senior Debt Lender has provided the Company with cash of $1,345,000
per month for the year. Management believes that this modification will
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 sale of loans,
sales and rental of OREO, or additional borrowing, to repay the current
liabilities arising from operations and to repay the long term
indebtedness of the Company.
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. 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 $632,883 on December
31, 2002 and $541,443 on December 31, 2001.
Total Senior Debt funding capacity was $500 million at December 31,
2002 of which approximately $395 million had been drawn down as of such
date. As a result, the Company has approximately $105 million available
to purchase additional portfolios of notes receivable. Together,
expected principal collections and the available $105 million should
give the Company sufficient liquidity to fund next year's acquisitions.
The Company's Senior Debt Lender has provided Tribeca with a warehouse
financing agreement of $15 million. At December 31, 2002, Tribeca had
drawn down $10.2 million on the line. The warehouse line accrues
interest based a variable rate of prime plus 2%. The Senior Debt lender
has provided Tribeca with the ability to hold its originated notes by
providing them with the option of rolling the outstanding warehouse
line into the senior debt facility when and if it reaches the $15
million warehouse line cap.
Financing Agreement- The Company has a financing agreement with the
Senior Debt Lender permitting it to borrow a maximum of approximately
$1,500,000 at a rate equal to the bank's prime rate plus two
19
percent per annum. Principal repayment of the line is due six months
from the date of each cash advance and interest is payable monthly. The
total amount outstanding under the financing agreement as of December
31, 2002 and December 31, 2001, was $1,250,451 and $647,791
respectively. Advances made under the financing agreement were used to
satisfy senior lien positions and fund capital improvements on certain
real estate assets owned by the Company. Management believes the
ultimate sale of these properties will satisfy the related outstanding
financing agreement. 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 be required to hold as rental property
to maximize its return.
Aggregate maturities of all long-term debt at currently effective
principal payment requirements for the next five years, at December 31,
are as follows:
2003 $ 32,378,627
2004 31,960,860
2005 31,725,523
2006 31,379,679
2007 31,067,714
Thereafter 236,753,742
------------
$395,266,144
============
ITEM 7A. 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 will have terms in excess of five years. The Company
funds the origination and acquisition of a significant portion of these assets
with borrowings, which have interest rates that are based on the monthly Federal
Home Loan Bank of Cincinnati 30-day advance rate ("FHLB"). In most cases, the
income from assets will respond more slowly to interest rate fluctuations than
the cost of borrowings, creating a mismatch between yields and borrowing rates.
Consequently changes in interest rates, particularly short-term rates may
influence the Company's net income. The Company's borrowing under agreements
with its Senior Debt Lender bear interest at rates that fluctuate with the FHLB
rate of Cincinnati and the prime rate. Based on approximately $336 and $59
million of borrowings outstanding under these facilities at December 31, 2002, a
1% change in FHLB and prime rate, would impact the Company's annual net income
and cash flows by approximately $4,000,000. 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
20
measure of protection from prepayment in the form of prepayments lockout periods
or prepayment penalties. In periods of declining mortgage interest rates,
prepayments on mortgages generally increase. If general interest rates decline
as well, the proceeds of such prepayments received during such periods are
likely to be reinvested by the Company in assets yielding less than the yields
on the investments that were prepaid. In addition the market value of mortgage
investments may, because the risk of prepayment, benefit less from declining
interest rates than from other fixed-income securities. Conversely, in periods
of rising interest rates, prepayments on mortgage generally decrease, in which
case the Company would not have the prepayment proceeds available to invest in
assets with higher yields. Under certain interest rate and prepayment scenarios
the Company may fail to recoup fully its cost of acquisition of certain
investments.
REAL ESTATE RISK
Multi-family and residential property values and net operating income derived
from such properties are subject to volatility and may be affected adversely by
number of factors, including, but not limited to, national, regional and local
economic conditions (which may be adversely affected by industry slowdowns and
other factors); local real estate conditions (such as the over supply of
housing). In the event net operating income decreases, a borrower may have
difficultly paying the Company's mortgage loan, which could result in losses to
the Company. In addition, decreases in property values reduce the value of the
collateral and the potential proceeds available to a borrower to repay the
Company's mortgage loans, which could also cause the Company to suffer losses.
ITEM 8. FINANCIAL STATEMENTS
See the financial statements and notes related thereto, beginning on page 29,
included elsewhere in this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not Applicable.
21
PART III
INFORMATION WITH RESPECT TO ITEMS 10, 11, 12 AND 13 ON FORM 10K WILL BE SET
FORTH IN THE DEFINITIVE PROXY STATEMENT, WHICH WILL BE FILED WITHIN 120 DAYS OF
DECEMBER 31, 2002, THE COMPANY'S MOST RECENT FISCAL YEAR. SUCH INFORMATION IS
INCORPORATED HEREIN BY REFERENCE.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
ITEM 11. EXECUTIVE COMPENSATION
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTION
PART IV
ITEM 14. 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 annual report on Form 10K 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.
ITEM 15. EXHIBITS AND REPORTS ON FORM 8-K
22
PART IV
(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 Leftkowitz, 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(l) Employment Agreement dated July 17, 2000 between the Company and Seth Cohen. Previously filed with, and
incorporated herein by reference to, the Company's 10-KSB, filed with the Commission on March 31, 2001.
23
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.
March 28, 2003 FRANKLIN CREDIT MANAGEMENT
CORPORATION
By: THOMAS J. AXON
---------------
Thomas J. Axon
Chairman
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 President, Chief Executive Officer, Director March 28, 2003
- -------------
Seth Cohen
(principal executive officer)
JOSEPH CAIAZZO Executive Vice President, Chief Operating March 28, 2003
- -------------- Officer, Secretary and Director
Joseph Caiazzo
(Secretary)
ALAN JOSEPH Executive Vice President, Chief Financial Officer March 28, 2003
- ----------- and Director
Alan Joseph
(principal financial officer)
24
CERTIFICATION
I, Seth Cohen, Chief Executive Officer of Franklin Credit Management Corporation
(the "Company"), certify that:
1. I have reviewed this annual report on Form 10-K of the
Company;
2. Based on my knowledge, this annual 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
annual report;
3. Based on my knowledge, the financial statements, and other
financial information included in this annual 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 annual 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 annual
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
annual report (the "Evaluation Date"); and
c) presented in this annual 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
6. The Company's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
DATE: March 28, 2003 By: /s/
--------
Chief Executive Officer
25
CERTIFICATION
I, Alan Joseph, Chief Financial Officer of Franklin Credit Management
Corporation (the "Company"), certify that:
1. I have reviewed this annual report on Form 10-K of the Company;
2. Based on my knowledge, this annual 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 annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual 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
annual 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 annual 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 annual report (the "Evaluation Date");
and
c) presented in this annual 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
6. The Company's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
DATE: March 28, 2003 By: /s/
------
Chief Financial Officer
26
FRANKLIN CREDIT MANAGEMENT CORPORATION AND SUBSIDIARIES
TABLE OF CONTENTS
PAGE
INDEPENDENT AUDITORS' REPORT 28
CONSOLIDATED FINANCIAL STATEMENTS:
Consolidated Balance Sheets at December 31, 2002 and 2001 29
Consolidated Statements of Income for the years ended December 31, 2002,2001 and 2000 30
Consolidated Statements of Stockholders' Equity 31
Consolidated Statements of Cash Flows 32-33
Notes to Consolidated Financial Statements 34-52
27
INDEPENDENT AUDITORS' REPORT
To the Board of Directors
Franklin Credit Management Corporation and Subsidiaries
We have audited the accompanying consolidated balance sheets of Franklin Credit
Management Corporation and Subsidiaries (the "Company") as of December 31, 2002
and 2001, and the related consolidated statements of income, stockholders'
equity, and cash flows for each of the three years in the period ended December
31, 2000, 2001, and 2002. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of the Company as of December 31, 2002
and 2001, and the results of its operations and its cash flows for each of the
three years in the period ended December 31, 2000, 2001 and 2002 in conformity
with accounting principles generally accepted in the United States of America.
New York, New York
March 25, 2003
28
FRANKLIN CREDIT MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2002 AND 2001
2002 2001
ASSETS
CASH AND CASH EQUIVALENTS $ 10,576,610 $ 7,784,162
RESTRICTED CASH 632,883 541,443
NOTES RECEIVABLE:
Principal 435,259,394 331,643,076
Purchase discount (22,974,310) (22,248,344)
Allowance for loan losses (45,841,651) (33,490,456)
--------------- ---------------
Net notes receivable 366,443,433 275,904,276
LOANS HELD FOR SALE-Net 22,869,947 28,203,047
ACCRUED INTEREST RECEIVABLE 4,157,615 4,795,789
OTHER REAL ESTATE OWNED 9,353,884 3,819,673
OTHER RECEIVABLES 2,259,543 5,305,409
DEFERRED TAX ASSET 387,767 1,567,588
OTHER ASSETS 2,633,082 1,894,052
BUILDING, FURNITURE AND EQUIPMENT - Net 1,106,865 1,151,171
DEFERRED FINANCING COSTS- Net 3,997,405 3,195,891
--------------- ---------------
TOTAL ASSETS $ 424,419,034 $ 334,162,501
=============== ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Accounts payable and accrued expenses $ 3,818,557 $ 4,230,203
Financing agreements 11,557,369 7,542,511
Notes payable 395,266,144 313,943,808
Subordinated debentures - 24,262
Tax liability
Current - 225,000
Deferred 783,115 1,866,318
--------------- ---------------
Total liabilities 411,425,185 327,832,102
--------------- ---------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Common stock, $.01 par value, 10,000,000 authorized shares;
issued and outstanding: 5,916,527 59,167 59,167
Additional paid-in capital 6,985,968 6,985,968
Retained Earnings/(Accumulated deficit) 5,948,714 (714,736)
--------------- ---------------
Total stockholders' equity 12,993,849 6,330,399
--------------- ---------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 424,419,034 $ 334,162,501
=============== ===============
See notes to consolidated financial statements.
29
FRANKLIN CREDIT MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
2002 2001 2000
REVENUES:
Interest income $ 36,728,735 $ 28,824,624 $ 20,873,504
Purchase discount earned 3,841,927 3,986,498 3,788,034
Gain on sale of notes receivable 139,519 986,570 1,675,107
Gain on sale of loans held for sale 2,259,979 842,051 276,911
Gain on sale of other real estate owned 796,562 1,448,548 700,939
Rental income 152,965 330,250 672,748
Other 2,922,750 1,544,817 1,060,147
------------- -------------- --------------
46,842,437 37,963,358 29,047,390
------------- -------------- --------------
OPERATING EXPENSES:
Interest expense 19,127,713 20,754,281 18,781,532
Collection, general and administrative 12,882,135 10,411,012 8,514,742
Recovery of a special charge (1,662,598) - -
Provision for loan losses 2,713,864 2,187,453 411,005
Amortization of deferred financing costs 1,264,112 1,058,443 619,892
Depreciation 339,761 226,021 149,556
------------- -------------- --------------
34,664,987 34,637,210 28,476,727
------------- -------------- --------------
INCOME BEFORE PROVISION FOR INCOME TAXES 12,177,450 3,326,148 570,663
PROVISION FOR INCOME TAXES 5,514,000 444,000 -
------------- -------------- --------------
NET INCOME $ 6,663,450 $ 2,882,148 $ 570,663
============= ============== ==============
NET INCOME PER COMMON SHARE:
Basic $ 1.13 $ 0.49 $ 0.10
============= ============== ==============
Dilutive $ 1.07 $ 0.49 $ 0.10
============= ============== ==============
WEIGHTED AVERAGE NUMBER OF SHARES
OUTSTANDING, BASIC 5,916,527 5,916,527 5,916,527
============= ============== ==============
OUTSTANDING, DILUTED 6,216,337 5,916,527 5,916,527
============= ============== ==============
See notes to consolidated financial statements.
30
FRANKLIN CREDIT MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
Accumulated
Common Stock Additional Earnings,
----------------------- Paid-in Retained
Shares Amount Capital Earnings Total
BALANCE, JANUARY 1, 2000 5,916,527 $ 59,167 $ 6,985,968 $ (4,167,547) $ 2,877,588
Net Income - - - 570,663 570,663
--------- --------- ------------ ------------- -----------
BALANCE, DECEMBER 31, 2000 5,916,527 $ 59,167 $ 6,985,968 $ (3,596,884) $ 3,448,251
========= ========= ============ ============= ===========
Net Income - - - 2,882,148 2,882,148
--------- --------- ------------ ------------- -----------
BALANCE, DECEMBER 31, 2001 5,916,527 $ 59,167 $ 6,985,968 $ (714,736) $ 6,330,399
========= ========= ============ ============= ===========
Net Income - - - 6,663,450 6,663,450
--------- --------- ------------ ------------- -----------
BALANCE, DECEMBER 31, 2002 5,916,527 $ 59,167 $ 6,985,968 $ 5,948,714 $12,993,849
========= ========= ============ ============= ===========
See notes to the financial statements.
31
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
2002 2001 2000
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 6,663,450 $ 2,882,148 $ 570,663
Adjustments to reconcile income to net cash used in
operating activities:
Gain on sale of notes receivable (139,519) (986,570) (1,675,107)
Gain on sale of other real estate owned (796,562) (1,448,548) (700,939)
Depreciation 339,761 226,021 149,556
Amortization of deferred financing costs 1,264,112 1,058,443 619,892
Origination of loans held for sale (70,444,721) (39,594,000) (9,219,250)
Proceeds from the sale of and principal collections on
loans held for sale 53,355,507 17,930,017 3,837,127
Purchase discount earned (3,841,927) (3,986,498) (3,788,034)
Provision for loan losses 2,713,864 2,187,453 411,005
Changes in operating assets and liabilities:
Decrease (Increase) in accrued interest receivable 638,174 (1,399,384) (971,047)
(Increase) Decrease in other receivables (3,045,866) (3,370,966) 892,858
Decrease in deferred tax asset 1,179,821 1,913,414 -
(Increase) in other assets (739,030) (451,365) (287,590)
Decrease in deferred tax liability (1,308,203) (1,469,743) -
(Decrease) Increase in accounts payable and accrued expenses (411,646) 1,295,406 (182,542)
(Decrease) Increase in notes payable, affiliates and stockholde - (146,835) 37,485
------------ ------------- ------------
Net cash used in operating activities (14,572,785) (25,361,007) (10,305,923)
------------ ------------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
(Increase) Decrease in restricted cash (91,440) 391,131 (544,602)
Purchase of notes receivable (184,090,904) (162,340,435) (95,738,251)
Principal collections on notes receivable 110,541,717 72,930,175 43,610,229
Acquisition and loan fees (2,065,626) (1,420,254) (1,405,446)
Proceeds from sale of other real estate owned 7,053,926 8,609,271 7,739,083
Proceeds from sale of notes receivable 1,000,083 19,905,420 10,974,326
Purchase of building, furniture and fixtures (295,455) (508,722) (133,125)
------------ ------------- ------------
Net cash used in investing activities (67,947,699) (62,433,414) (35,497,786)
------------ ------------- ------------
Continued on next page
32
FRANKLIN CREDIT MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
2002 2001 2000
CONTINUED FROM PREVIOUS PAGE
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from notes payable 205,224,166 176,562,187 98,024,623
Principal payments of notes payable (123,901,830) (93,668,864) (51,993,943)
Proceeds from financing agreements 74,886,326 38,495,144 8,296,532
Payments on financing agreements (70,871,468) (32,973,967) (7,066,273)
Principal payments of subordinated debentures (24,262) (48,263) (260,451)
------------- ------------- ------------
Net cash provided by financing activities 85,312,932 88,366,237 47,000,488
------------- ------------- ------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 2,792,448 571,816 1,196,779
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 7,784,162 7,212,346 6,015,567
------------- ------------- ------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 10,576,610 $ 7,784,162 $ 7,212,346
============= ============= ============
SUPPLEMENTAL DISCLOSURES OF CASH
FLOW INFORMATION:
Cash payments for interest $ 19,404,197 $ 18,931,784 $ 18,116,762
============= ============= ============
Cash payments for taxes $ 5,425,000 $ 56,875 $ 43,584
============= ============= ============
See notes to consolidated financial statements.
33
FRANKLIN CREDIT MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
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.
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. (See note 9)
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.
34
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 collectibility 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 he 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
35
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 Texas,
Florida, New York, and California. 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.
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.
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 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, incurred in connection with obtaining
financing, are deferred and are amortized over the term of the related
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
36
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, whether or not recognized in the
balance sheet for which it is practicable to estimate that value. In
cases where quoted market prices are not available, fair values are
based on estimates using present value or other valuation techniques.
Those techniques are significantly affected by the assumptions used,
including the discount rate and estimates of future cash flows. In that
regard, the derived fair value estimates cannot be substantiated by
comparison to independent markets and, in many cases, could not be
realized in immediate settlement of the instruments. Statement No. 107
excludes certain financial instruments and all non-financial assets and
liabilities from its disclosure requirements. Accordingly, the
aggregate fair value amounts do not represent the underlying value of
the Company.
The following methods and assumptions were used by the Company in
estimating the fair value of its financial instruments:
a. CASH, RESTRICTED CASH, ACCRUED INTEREST RECEIVABLES, OTHER
RECEIVABLE AND ACCRUED INTEREST PAYABLE - The carrying values
reported in the consolidated balance sheets are a reasonable
estimate of fair value.
b. NOTES RECEIVABLE - Fair value of the net note receivable
portfolio is estimated by discounting the 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 in 2002, 2001 and 2000 therefore net income was
the same as its comprehensive income.
ACCOUNTING FOR STOCK OPTIONS - The incentive stock option plan is
accounted for under the recognition and measurement principles of
Accounting Principles Board (APB) Opinion 25, "Accounting for Stock
Issued to Employees" and related interpretations. 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.
37
RECENT 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 required if
they met the specific criteria for extraordinary items included in APB
Opinion 30, Reporting the Results of Operations. The rescission of SFAS
No. 4 is effective January 1, 2003. Management believes that adoption
of this statement will not have a material 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 Company does not anticipate the adoption of
this statement will 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. Adoption of the provisions of the
Statement in 2003 will not have any impact since 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; accordingly, no compensation cost has
been recognized. Had compensation cost been determined upon the fair
value of the stock options at the grant date consistent with the method
of SFAS No.123, the Company's 2002, 2001 and 2000 net income and
earnings per share would have been reduced to the pro forma amounts
indicated in the table that follows.
2002 2001 2000
Net income - as reported $ 6,663,450 $ 2,882,148 $ 570,663
Net income - pro forma $ 6,585,073 $ 2,882,148 $ 426,847
Net income per common share - basic - as reported 1.13 0.49 0.10
Net income per common share - basic - pro forma 1.11 0.49 0.07
Net income per common share - dilutive - as reported 1.07 0.49 0.10
Net income per common share - dilutive - pro forma 1.06 0.49 0.07
The fair value of each option grant is estimated on the date of the
grant using the Black-Scholes option pricing model with the following
weighted average assumptions used for grants in 2002:
38
Dividend yield 0% 0% 0%
Volatility 139% 241% 241%
Risk-free interest rate 5.2% 3.62% 3.62%
Weighted average expected lives 5 years 3 years 2 years
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. This
Interpretation does not prescribe a specific approach for subsequently
measuring the guarantor's recognized liability over the term of the
related guarantee. The disclosure provisions of this Interpretation are
effective for the Company's December 31, 2002 financial statements.
(See note 11) 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. The Company
does not believe that the initial recognition and measurement of the
Interpretation will have a material effect on the Company's
consolidated financial statements.
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 will be immediately effective for
all variable interests in variable 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.
39
2. NOTES RECEIVABLE, LOANS HELD FOR SALE, PURCHASE DISCOUNT AND
ALLOWANCE FOR LOAN LOSSES
Notes receivable consist principally of real estate mortgages as of
December 31, 2002 and 2001 and are classified as follows:
2002 2001
Real estate secured $ 399,197,450 $ 311,667,321
Consumer unsecured 19,345,544 7,599,633
Mobile homes 12,091,393 12,211,946
Other 4,625,007 164,176
-------------- -------------
435,259,394 331,643,076
Less:
Purchase discount (22,974,310) (22,248,344)
Allowance for loan losses (45,841,651) (33,490,456)
-------------- -------------
$ 366,443,433 $ 275,904,276
============== =============
Loans held for sale, net consist primarily of real estate mortgages as
December 31, 2002 and 2001 and are classified as follows:
2002 2001
Real estate secured $ 23,119,914 $ 28,477,873
Consumer unsecured 18,999 13,383
Mobile homes - 33,370
-------------- -------------
23,138,913 28,524,626
Less:
Purchase discount - (97,899)
Allowance for loan losses (268,966) (223,680)
-------------- -------------
$ 22,869,947 $ 28,203,047
============== =============
40
As of December 31, 2002, contractual maturities of notes receivables
and loans held for sale net of the allowance for loan losses were as
follows:
YEAR ENDING NOTES LOANS HELD
DECEMBER 31, RECEIVABLE FOR SALE
2003 $ 30,344,355 2,434,855
2004 27,331,912 1,858,772
2005 25,130,171 1,909,824
2006 22,332,974 1,955,369
2007 20,283,603 627,230
Thereafter 263,995,228 14,083,397
-------------- -------------
$ 389,418,243 $ 22,869,447
============== =============
It is the Company's experience that a portion of the notes receivable
portfolio may be renewed or repaid before contractual maturity dates.
The above tabulation, therefore, is not to be regarded as a forecast of
future cash collections. During the years ended December 31, 2002 and
2001, cash collections of principal amounts totaled approximately
$120,000,000 and $72,900,000, respectively, and the ratios of these
cash collections to average principal balances were approximately 29.3%
and 23.3%, respectively.
Changes in the allowance of loan losses on notes receivable for the
years ended December 31, 2002, 2001 and 2000 are as follows:
2002 2001 2000
Balance, beginning $ 33,490,456 $ 24,086,322 $ 22,185,945
Allowance allocated on purchased portfolio 15,551,056 9,198,705 2,329,546
Loans charged to allowance (5,913,724) (1,982,024) (840,174)
Provision for loan losses 2,713,864 2,187,453 411,005
------------- ------------- -------------
Balance, ending $ 45,841,651 $ 33,490,456 $ 24,086,322
============= ============= =============
At December 31, 2002 and 2001, principal amounts of notes receivable
included approximately $122,000,000 and $75,000,000, respectively, of
notes for which there was no accrual of interest income. The following
information relates to impaired notes receivable which include all
nonaccrual loans as of and for the year ended December 31, 2002 and
2001:
41
Total impaired notes receivable $ 122,310,112 $ 74,904,866
============== ============
Allowance for loan losses related to impaired
notes receivable $ 33,761,457 $ 25,022,497
============== ============
Average balance of impaired notes receivable
during the year $ 98,607,489 $ 64,049,206
============== ============
Interest income recognized $ 5,866,377 $ 2,223,530
============== ============
In the normal course of business, the Company restructures or modifies
terms of notes receivable to enhance the collectability of certain
notes that were impaired at the date of acquisition and were included
in certain portfolio purchases. Notes that are current under their
restructured or modified terms are not considered impaired.
3. BUILDING, FURNITURE AND EQUIPMENT
At December 31, 2002 and 2001, building, furniture and equipment
consisted of the following:
2002 2001
Building and improvements $ 1,060,359 $ 997,259
Furniture and equipment 1,255,044 1,022,689
----------- ------------
2,315,403 2,019,948
Less accumulated depreciation 1,208,538 868,778
----------- ------------
$ 1,106,865 $ 1,151,171
=========== ============
4. NOTES PAYABLE
Notes payable ("Senior Debt") consists primarily of loans made to the
Company from a bank ("Senior Debt Lender") to acquire portfolios of
notes receivable. The Company has a credit facility ("Facility") with
the Senior Debt Lender. The Facility was amended on December 31, 2001
and provides the Company with the ability to borrow up to an aggregate
of $500,000,000 at rates based on the Federal Home Loan Bank of
Cincinnati (FHLB) 30-day advance rate plus an additional spread of
3.25%. As of December 31, 2002 and 2001, the Company had several loans
outstanding to its Senior Debt Lender with an aggregate principal
balance of $395,011,306 and $313,670,618 respectively. As a result, the
Company has approximately $105,000,000 available to purchase additional
portfolios of notes receivable. All notes payable are secured by an
interest in the notes receivable, payments to be received under the
notes and the underlying collateral securing the notes. At December 31,
2002, approximately $ 59,091,318 of borrowings accrues interest at a
rate of prime plus a margin of 0% to 1.75%. The remaining $335,919,988
accrues interest at the FHLB 30 day advance rate plus 3.25%. The above
42
financing agreement requires all cash collections received on the notes
receivable to be paid to the Senior Debt Lender and the Company is
provided with $1,345,000 monthly, to fund operations.
At December 31, 2002 and 2001, the weighted average interest rate on
the Senior Debt was 4.85% and 5.25%, respectively.
The above financing agreements also require additional monthly
principal reductions based on cash collections received by the Company.
The remaining note payable consists of a bank loan made to the Company
to acquire its principal offices. The principal offices secure the note
payable. As of December 31, 2002 and 2001, the Company had a note
payable of $254,838 and $273,190 respectively, which accrues interest
at 8.53%.
Certain loan agreements require that a non-interest bearing cash
account be established at the closing of the loan and may require
additional deposits based on a percentage of monthly collections up to
a specified dollar limit. The aggregate balance of restricted cash at
December 31, 2002 and 2001 was $632,883 and $541,443, respectively.
Substantially all of the Company's outstanding financing with respect
to its notes receivable portfolio acquisition activities is provided by
the Senior Debt Lender.
Aggregate maturities of all notes payable at currently effective
principal payment requirements, at December 31, 2002 are as follows:
2003 $ 32,378,627
2004 31,960,860
2005 31,725,523
2006 31,379,679
2007 31,067,714
Thereafter 236,753,741
------------
$395,266,144
============
5. SUBORDINATED DEBENTURES
In connection with the acquisition of a notes receivable portfolio
during 1995, the Company offered $800,000 in subordinated debentures.
The debentures bear interest at a rate of 12% per annum payable in
quarterly installments. The principal was payable over three years in
ten equal quarterly installments of $22,200 commencing September 30,
1997 with the remaining balance of $310,800 payable on June 30, 2000.
On June 30, 2000, the Company made a balloon payment of $232,952 funded
(through the incurrence of Senior Debt) and agreed with the holder of
$97,048 of 12% debentures to the extension of payment of such principal
amount to December 31, 2001, this agreement was subsequently extended
to March 31, 2002. This debt was paid in full in March of 2002.
43
6. FINANCING AGREEMENTS
The Company has the following financing agreements with a certain
banks: warehouse financing agreement, credit facility, and line of
credit.
The warehouse financing agreement provides the Company with the ability
to borrow a maximum of $15,000,000 at a rate equal to the bank's prime
rate plus 2.00%. This credit facility is to be utilized for the purpose
of originating mortgage loans. As of December 31, 2002 and 2001,
$10,196,976 and $6,776,481, respectively, are outstanding on the
warehouse financing agreement and are secured by loans held for sale.
The credit facility provides the Company with the ability to borrow a
maximum of $1,500,000 at a rate equal to the bank's prime rate plus two
percent per annum. The credit facility is to be utilized through a
series of loans made to purchase the underlying collateral of certain
nonperforming real estate secured loans. Principal repayment of each
respective loan is due six months from the date of each advance and
interest is payable monthly. As of December 31, 2002 and 2001,
$1,250,451 and $647,791, respectively, are outstanding on this credit
facility.
The credit facility is secured by a first priority security interest in
the respective notes receivable, the individual real estate that may be
purchased, payments to be received under the notes receivable, an
unconditional guarantee by one of the stockholders of the Company, and
collateral securing the notes of certain loan portfolios.
The line of credit provides the Company with a line of credit to borrow
a maximum of $150,000 at a rate equal to the bank's prime rate plus one
percent per annum. As of December 31, 2002, and 2001, $109,942 and
$118,239, respectively, are outstanding on the line of credit.
44
7. INCOME TAX MATTERS
The components of income tax provision for the years ended December 31,
2002, 2001 and 2000 are as follows:
2002 2001 2000
Current provision:
Federal $ 3,317,000 $ 146,000 $ -
State and local 1,043,000 79,000 -
-------------- ------------ -------------
4,360,000 225,000 -
-------------- ------------ -------------
Deferred provision :
Federal 945,000 671,000 217,000
State and local 209,000 588,000 68,000
-------------- ------------ -------------
1,154,000 1,259,000 285,000
-------------- ------------ -------------
Decrease in valuation allowance - (1,040,000) (285,000)
-------------- ------------ -------------
Provision $ 5,514,000 $ 444,000 $ -
============== ============ =============
A reconciliation of the anticipated income tax expense (computed by
applying the Federal statutory income tax rate of 35% to income before
income tax expense) to the provision for income taxes in the
accompanying statements of income for the years ended December 31,
2002, 2001, and 2000 are as follows:
2002 2001 2000
Tax determined by applying U.S. statutory rate
to income $ 4,262,000 $ 1,164,000 $ 194,000
Increase in taxes resulting from:
State and local income taxes, net of Federal benefit 1,252,000 331,000 68,000
Meals and Entertainment (net of adjustments) - 5,000 23,000
Decrease in valuation allowance - (1,040,000) (285,000)
Other items, net - (16,000) -
------------ ------------ -------------
$ 5,514,000 $ 444,000 $ -
============ ============ =============
45
The tax effects of temporary differences that give rise to significant
components of deferred tax assets and deferred tax liabilities at
December 31, 2002, and 2001 are presented below:
2002 2001
Deferred liabilities:
Purchase discount $ 783,115 $ 1,866,318
------------ ------------
Gross deferred tax liabilities $ 783,115 $ 1,866,318
============ ============
Deferred tax assets:
Inventory, repossessed collateral $ 387,767 $ 116,357
Special charge on purchased loans 575,042
Bad Debt Reserve 876,189
------------ ------------
Gross deferred tax assets $ 387,767 $ 1,567,588
============ ============
8. STOCK OPTION PLAN
During 1996, the Company adopted an incentive stock option plan (the
"Plan") for certain of its officers and directors. Under the terms of
the Plan, options to purchase an aggregate of up to 800,000 shares of
the Company's common stock may be granted. During 2000, the Company
revised its incentive stock plan increasing the plan to aggregate to
1,600,000 shares. Each option has an exercise price at least equal to
the fair market value of the shares of common stock at the time the
option is granted. Options become exercisable at various times after
the date granted and expire ten years after the date granted.
During 2002, the Company granted 121,000 options to members of the
Company's Board of Directors and 275,000 options to various management
employees of the Company. Also during 2002, 130,000 options were
forfeited by former Company officers. There were no options granted
during 2001.
Transactions in stock options under the Plan are summarized as follows:
46
WEIGHTED
AVERAGE
EXERCISE
SHARES PRICE
Options outstanding at January 1, 2000 320,000 $ 1.56
Granted 532,500 0.75
Forfeitured (140,000) 1.56
-------- -----------
Options outstanding at December 31, 2000 712,500 1.00
======== ===========
Granted - -
Exercised - -
Forfeitured - -
Options outstanding at December 31, 2001 712,500 1.00
======== ===========
Granted 396,000 0.75
Forfeitured (130,000) 1.00
Expired - -
-------- -----------
Options outstanding at December 31, 2002 978,500 $ 0.90
======== ===========
As of December 31, 2002, 2001, and 2000, 978,500, 712,500 and 712,500
options are exercisable respectively.
9. OPERATING SEGMENTS
The Company has two reportable operating segments: (i) portfolio asset
acquisition and resolution; and (ii) mortgage banking. The portfolio
asset acquisition and resolution segment acquires performing,
nonperforming, nonconforming and sub performing notes receivable and
promissory notes from financial institutions, mortgage and finance
companies, and services and collects such notes receivable through
enforcement of original note terms, modification of original note terms
and, if necessary, liquidation of the underlying collateral. The
mortgage banking segment originates or purchases, 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 (see Note 1).
47
PORTFOLIO ASSET ACQUISITION AND RESOLUTION
2002 2001 2000
REVENUES:
Interest income $ 33,435,447 $ 27,065,644 $ 20,292,305
Purchase discount earned 3,841,927 3,986,498 3,788,034
Gain on sale of notes receivable 139,519 986,570 1,675,107
Gain on sale of other real estate owned 796,562 1,448,548 700,939
Rental income 152,965 330,250 672,748
Other 2,402,977 1,327,927 1,039,037
-------------- -------------- ------------
40,769,397 35,145,437 28,168,170
-------------- -------------- ------------
OPERATING EXPENSES:
Interest expense 17,423,341 20,068,167 18,489,548
Collection, general and administrative 10,646,814 8,894,760 7,859,020
Recovery of a special charge (1,662,598) - -
Provision for loan losses 2,612,361 2,077,588 370,674
Amortization of deferred financing costs 1,095,529 996,412 593,624
Depreciation 279,616 179,150 118,901
-------------- -------------- ------------
30,395,063 32,216,077 27,431,767
-------------- -------------- ------------
INCOME BEFORE PROVISION FOR INCOME
TAXES $ 10,374,334 $ 2,929,360 $ 736,403
============== ============== ============
48
MORTGAGE BANKING
2002 2001 2000
REVENUES:
Interest income $ 3,293,289 $ 1,758,979 $ 581,199
Gain on sale of notes originated 2,259,979 842,051 276,911
Other 519,772 216,891 21,110
------------- --------------- ---------------
6,073,040 2,817,921 879,220
------------- --------------- ---------------
OPERATING EXPENSES:
Interest expense 1,704,372 686,114 291,984
Collection, general and administrative 2,235,321 1,516,252 655,722
Provision for loan loss 101,503 109,865 40,331
Amortization of deferred financing costs 168,583 62,031 26,268
Depreciation 60,145 46,871 30,655
------------- --------------- ---------------
4,269,924 2,421,133 1,044,960
------------- --------------- ---------------
INCOME (LOSS) BEFORE PROVISION FOR INCOME
TAXES $ 1,803,116 $ 396,788 $ (165,740)
============= =============== ===============
CONSOLIDATED ASSETS:
Portfolio asset acquisition and resolution assets $ 400,088,702 $ 303,705,008 $ 233,728,060
Mortgage banking assets 24,330,332 29,520,868 9,507,228
------------- --------------- ---------------
Consolidated assets $ 424,419,034 $ 333,225,876 $ 243,235,288
============= =============== ===============
TOTAL ADDITIONS TO BULIDING, FURNITURE
AND FIXTURES:
Portfolio asset acquisition and resolution assets $ 253,140 $ 471,402 $ 68,419
Mortgage banking assets 42,314 37,320 64,706
------------- --------------- ---------------
Consolidated additions to building,
furniture and fixtures $ 295,455 $ 508,722 $ 133,125
============= =============== ===============
CONSOLIDATED REVENUE:
Portfolio asset acquisition and resolution $ 40,769,397 $ 35,145,437 $ 28,168,170
Mortgage banking 6,073,040 2,817,921 879,220
------------- --------------- ---------------
Consolidated Revenue $ 46,842,437 $ 37,963,358 $ 29,047,390
============= =============== ===============
CONSOLIDATED NET INCOME (LOSS):
Portfolio asset acquisition and resolution $ 5,671,774 $ 2,485,360 $ 736,403
Mortgage banking 991,676 396,788 (165,740)
------------- --------------- ---------------
Consolidated Net Income $ 6,663,450 $ 2,882,148 $ 570,663
============= =============== ===============
49
10. CERTAIN CONCENTRATIONS
Geographic Concentrations of Notes Receivable - Approximately 30% of
the Company's secured consumer real estate notes receivable are with
customers in the northeastern region of the U.S. Such real estate notes
receivable are collateralized by real estate with a concentration in
this region. 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 in
this region. In the event of sustained adverse economic conditions, it
is possible that the Company could experience a negative impact in its
ability to collect on existing loans, or liquidate foreclosed assets in
this region, which could impact the Company's related loan loss
estimates.
Financing - Substantially all of the Company's existing debt and
available credit facilities are with one financial institution. The
Company's purchases of new portfolios are contingent upon the continued
availability of these credit facilities.
11. COMMITMENTS AND CONTINGENCIES
Employment Agreement - Effective March 25, 1996, the Company entered
into a five-year employment agreement with its Chief Operating Officer.
The agreement provides for, among other things, a stipulated base
salary, and a bonus up to 3.0% of the Company's net income in excess of
$500,000. This agreement has been extended through April 15, 2003.
Effective July 17, 2000, the Company entered into a three-year
employment agreement with its Chief Executive Officer. The agreement
provides for, among other things, a stipulated base salary, and a bonus
of up to 3.5% of the Company's net income in excess of $500,000.
Operating Leases - Certain secondary office and file space is leased
under operating leases. The combined future minimum lease payments are
as follows:
2003 442,207
2004 460,803
2005 472,535
2006 477,872
2007 505,704
Thereafter 465,812
--------------
$ 2,824,933
==============
Legal Actions - The Company is also involved in legal proceedings and
litigation arising in the ordinary course of business. In the opinion
of management, the outcome of such proceedings and litigation currently
pending will not materially affect the Company's financial statements.
Sale of Notes Receivable with recourse - In June 1996, the Company sold
notes receivable with a net carrying value of approximately $5,400,000
for approximately $6,400,000 to the Company's Senior Debt Lender and
retained the servicing rights. Such notes were sold with recourse. The
recourse provision amounted to approximately $600,000 and provides that
should a note become sixty days past due the Company must either buy it
back or replace it with a note that is approximately equivalent to the
50
outstanding principal and accrued interest. In addition, the buyer of
the notes has the right to proceed to foreclose on the delinquent note
and, after sale of the collateral, require the Company to pay any
deficiency balance on the note. At December 31, 2002 and 2001, the
remaining obligation under the recourse provision is approximately
$425,000.
In June 1997, the Company sold notes receivable with a net carrying
value of approximately $3,900,000 for approximately $4,900,000 to the
Company's Senior Debt Lender and retained the servicing rights. Such
notes were sold with recourse. The recourse provision amounted to
approximately $500,000 and provides that should a performing note
become sixty days past due the Company must either buy it back or
replace it with a note that is approximately equivalent to the
outstanding principal and accrued interest. In addition, the buyer of
the notes has the right to proceed to foreclose on the delinquent note
and, after sale of the collateral, require the Company to pay any
deficiency balance on the note. At December 31, 2002 and 2001, the
remaining obligation under the recourse provision was approximately
$28,938 and $48,183, respectively.
As of December 31, 2002 and 2001, the unpaid balances of the above
mortgage loans being serviced by the Company were $1,600,928 and
$2,622,362, respectively. Mortgage loans serviced for others are not
included in the Company's consolidated balance sheets.
12. RELATED PARTY TRANSACTIONS
On December 31, 2002, Tribeca Lending, a wholly owned subsidiary,
transferred approximately $23,500,000 of refinanced loans to the
Company to be held for investment. These loans were originated by
refinancing loans previously held in the Company's portfolio, and had
previously been held for sale. The Company subsequently decided to hold
the loans for investment and therefore reclassified them for balance
sheet purposes as notes receivables rather than notes held for sale.
During 2000, Mr. Axon, the Company's Chairman, purchased from the
Company a New York condominium held by the Company in its other real
estate owned inventory. The consideration included the issuance by Mr.
Axon of a note to the Company in the amount of $165,000. The note bears
interest at a rate of 8% per annum, is secured by the condominium
property, and is due together with all accrued interest and other
charges on January 30, 2002. Mr. Axon extended the note for two more
years. The note and accrued interest is included in other assets.
On December 31, 1998, with the approval of the Board of Directors, the
Company sold one of its mortgage notes to the President of the Company
for $418,500. The mortgage note was paid for through the reduction of
a note payable of $184,335 due to an affiliated company, in which the
President is a partner and through the issuance of a promissory note
from the President for $234,165. The note is included in notes
receivable.
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13. SUMMARY OF QUARTERLY RESULTS (UNAUDITED)
The table below sets forth selected unaudited financial information for each
quarter of the last two fiscal years.
1ST QUARTER 2ND QUARTER 3RD QUARTER 4TH QUARTER
2002
Revenue $ 10,671,462 $ 12,968,896 $ 12,220,502 $ 12,644,177
Operating expenses 7,758,576 8,848,583 9,374,721 10,345,706
-------------- ------------- ------------- -------------
Income before provision for
income taxes $ 2,912,886 $ 4,120,312 $ 2,845,781 $ 2,298,471
============== ============= ============= =============
Income per common share
Basic $ 0.49 $ 0.70 $ 0.48 $ 0.39
============== ============= ============= =============
Diluted $ 0.49 $ 0.70 $ 0.48 $ 0.39
============== ============= ============= =============
2001
Revenue $ 8,165,024 $ 9,329,718 $ 9,544,946 $ 10,923,670
Operating expenses 8,052,978 8,206,786 8,564,135 9,813,311
-------------- ------------- ------------- -------------
(Loss) income before benefit
for income income taxes and
net (loss) income $ 112,046 $ 1,122,932 $ 980,811 $ 1,110,359
============== ============= ============= =============
(Loss) income per common share
Basic $ 0.02 $ 0.19 $ 0.17 $ 0.19
============== ============= ============= =============
Diluted $ 0.02 $ 0.19 $ 0.17 $ 0.19
============== ============= ============= =============
During the second quarter of 2002, the Company received a $1,662,598 cash
settlement representing a recovery of a special charge taken to income during
1997, to reserve for a portfolio purchase of $1.8 million.
14. SUBSEQUENT EVENTS
The credit facility with the Senior Debt Lender was amended on March 1,
2003 and provides the Company with the ability to borrow up to an
aggregate of $500,000,000 at rates based on the Federal Home Loan Bank
of Cincinnati (FHLB) 30-day advance rate plus an additional spread of
3.50%. The above financing agreement requires all cash collections
received on the notes receivable to be paid to the Senior Debt Lender
and the Company is provided with $1,825,000 monthly, to fund
operations.
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