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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, 2003
[ ] 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 June 30, 2003 was approximately $4,635,188.
Portions of the registrant's definitive proxy statement, which will be filed
within 120 days of December 31, 2003, are incorporated by reference into Part
III.
FRANKLIN CREDIT MANAGEMENT CORPORATION
FORM 10-K
DECEMBER 31, 2003
INDEX
PAGE
----
PART I.
Item 1. Business 3
Item 2. Properties 9
Item 3. Legal Proceedings 10
Item 4. Submission of Matters to a Vote of Security Holders 10
PART II.
Item 5. Market for Registrant's Common Equity and Related Stockholders Matters 10
Item 6. Selected Financial Data 11
Item 7. Management's Discussion and Analysis of Financial Condition and Results Of Operations 11
Item 7A. Quantitative and Qualitative Disclosure About Market Risk 21
Item 8. Financial Statements and Supplementary Data 22
Item 9. Change in and Disagreements with Accountants on Accounting and Financial Disclosures 22
Item 9a. Controls and Procedures 22
PART III.
Item 10. Directors and Executive Officers of the Registrant 24
Item 11. Executive Compensation 24
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder matters 24
Item 13. Certain Relationships and Related Transactions 24
Item 14 Principal Accountant Fees and Services. 24
PART IV
Item 15. Exhibits, Financial Statements Schedules and Reports on Form 8-K 25
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 acquires these mortgages from a
variety of mortgage bankers, banks, and other specialty finance companies.
These loans are generally purchased in pools at discounts from their
aggregate contractual balances, from sellers in the financial services
industry. Real estate is acquired in foreclosure or otherwise and is also
acquired at a discount relative to the appraised value of the asset. The
Company conducts its business from its executive and main office in New
York City and through its website www.franklincredit.com.
In January 1997, the Company formed a wholly owned subsidiary, Tribeca
Lending Corp. ("Tribeca"), to originate primarily 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. The majority of
first and second mortgages originated are on a retail basis through
marketing efforts, utilization of the FCMC database and the Internet.
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.
LOAN ACQUISITIONS - Since commencing operations in 1990, the Company has
purchased, in aggregate, approximately 31,254 loans with a face value of
approximately $1.2 billion primarily from private institutions. During
2003, the Company took advantage of market opportunities to increase its
volume of loan acquisitions purchasing $244 million in assets during 2003
versus $212 million in assets during 2002. Management may increase the
amount of loans purchased at par or at premium in the future. The following
table sets forth the acquisition amounts and prices by year:
YEAR ENDED DECEMBER 31,
2003 2002 2001
($ IN MILLIONS)
NUMBER OF LOANS 3,476 4,331 3,599
UNPAID PRINCIPAL BALANCE AT ACQUISITION $ 244 $ 212 $ 184
PURCHASE PRICE $ 214 $ 184 $ 162
PURCHASE PRICE PERCENTAGE 88% 87% 88%
LOAN ORIGINATIONS - Since commencing operations in 1997, Tribeca has
originated approximately $247 million in loans. During 2003, Tribeca
increased its origination volume through the expansion of its branch office
network adding offices in New Jersey, Maryland and Florida and hiring
additional sales personnel. The following table sets forth the origination
amounts by year:
YEAR ENDED DECEMBER 31,
2003 2002 2001
($ IN MILLIONS)
NUMBER OF LOANS 562 501 386
ORIGINAL PRINCIPAL BALANCE $ 97 $ 70 $ 42
3
LOAN PORTFOLIO - The Company's portfolio grew 9.8% to $503 million at
December 31, 2003, from $458 million at December 31, 2002. The increase
reflected loan acquisitions which were partially offset by a high volume of
prepayments resulting from a favorable refinancing market due to
historically low rates. At December 31, 2003, approximately 98% of the
Company's loan portfolio consisted of first mortgages, home equity/home
improvement and second mortgages collateralized by real estate, and 2%
consisted of unsecured consumer loans collateralized by other assets.
NOTES RECEIVABLE PORTFOLIO - As of December 31, 2003, the Company's notes
receivable portfolio included approximately 10,095 loans with an aggregate
face value of $466 million. An allowance for loan losses of approximately
$46 million has been recorded against this face value. The following table
provides a breakdown of the portfolio by year:
2003 2002 2001
------------ ------------ ------------
Performing Loans $322,345,537 $292,018,333 $228,979,679
Allowance for Loan Losses 15,584,769 11,096,115 7,275,013
------------ ------------ ------------
Total Performing Loans,
Net of Allowance for Loan Losses $306,760,768 $280,922,218 $221,704,666
============ ============ ============
Impaired Loans $126,341,722 $119,134,128 $ 74,563,057
Allowance for Loan losses 30,111,278 32,809,607 24,810,426
------------ ------------ ------------
Total Impaired Loans,
Net of Allowance for Loan Losses $ 96,230,444 $ 86,324,521 $ 49,752,631
============ ============ ============
Not Yet Boarded onto Servicing System, $ 16,866,611 $ 24,106,933 $ 28,100,340
Allowance for Loan Losses 551,183 1,935,929 1,405,017
------------ ------------ ------------
Not Yet Boarded onto Servicing System
Net of Allowance for Loan Losses $ 16,315,428 $ 22,171,004 $ 26,695,323
============ ============ ============
The following table provides a breakdown of the balance of the Company's
portfolio of Notes Receivable by coupon type, net of Allowance for Loan
Losses and excluding loans purchased but not boarded onto the Company's
servicing system as of December 31, 2003, December 31, 2002 and December
31, 2001 of $16,315,428, $22,171,005 and $26,695,323 respectively:
2003 2002 2001
Total Performing Loans
Total Fixed Rate Performing Loans $199,691,299 $ 213,429,977 $ 181,847,633
============ ================ ==============
Total Adjustable Performing Loans $107,069,469 $ 67,492,241 $ 39,857,033
============ ================ ==============
Total Impaired Loans
Total Fixed Rate Impaired Loans $ 58,752,534 $ 58,873,564 $ 40,557,413
============ ================ ==============
Total Adjustable Impaired Loans $ 37,477,910 $ 27,450,957 $ 9,195,218
============ ================ ==============
4
ORIGINATED LOANS - LOANS HELD FOR SALE & LOANS HELD FOR INVESTMENT - During
2003, the Company changed the holding strategy of several of its originated
loans and reclassified $13.5 million of principal and fees into loans held
for investments. The Company expects to hold these loans until maturity.
LOAN SALES - Periodically, the Company sells portfolios of purchased
performing, reperforming and nonperforming loans on a whole loan basis.
During 2003, the Company sold 148 performing loans with a face value of
$15.1 million, and 248 non-performing loans with an aggregate face value of
$4.2 million. 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 2003, the Company retained the servicing rights
on approximately $2.7 million of the performing loans sold; the Company
generally does not retain the servicing rights on loans it sells.
FUNDING - As of December 31, 2003, the Company owed an aggregate of $427
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.
From December 31, 2001 until March 2003, the Company's Senior Debt incurred
after March 1, 2001, accrued interest at the Federal Home Loan Bank of
Cincinnati ("FHLB") thirty day advance rate plus a spread of 3.25%(the
"Spread"), and interest on Senior Debt incurred before March 1, 2001
accrued interest at the prime rate plus a margin of between 0% and 1.75%;
under a two year interest rate agreement. On March 19, 2003, the Company
and its Senior Debt lender agreed that the Spread would be increased to
3.5%, the spread shall remain at 3.5% until the index exceeds 2.00% at
which point it will revert back to 3.25%. Further, the Senior Debt lender
will reduce the spread to 3.00% in the event that the Index exceeds 4.75%.
At December 31, 2003, approximately $35 million of the Senior Debt incurred
before March 1, 2001 will continue to accrue interest at the prime rate
plus a margin of between 0% and 1.75%. At December 31, 2003, the weighted
average interest rate on Senior Debt was 4.82%.
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 $1.5 million and the flow unit, which is responsible for
acquisitions less than $1.5 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 review 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 Information
Systems staff ("MIS"), monitors the electronic transfer of loan data into
the Company's data management system.
5
TRIBECA LENDING- Tribeca Lending, a wholly-owned subsidiary, provides first
and second mortgages to individuals interested in purchasing real estate or
refinancing their existing loan. Tribeca Lending is currently licensed as a
mortgage banker in California, Colorado, Connecticut, Florida, Georgia,
Kentucky, Illinois, Maryland, Massachusetts, Michigan, New York, New
Jersey, North Carolina, 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. In addition, Tribeca Lending is exempt from licensing in
Alabama, Missouri and Indiana. Loans originated by Tribeca are either sold
in the secondary market through whole-loan sales, typically on a,
servicing-released basis, or held for investment. During 2003, Tribeca
Lending opened new branches in New Jersey, Maryland and Florida. Loans are
originated by a retail sales force that generates leads from the Internet,
the Company's database of serviced loans, and external sources. Tribeca's
staff processes, underwrites and closes all loans in its own name.
Operating Expenses of Tribeca. - During 2003, Tribeca recorded operating
income of $1.4 million compared to $1.8 million during 2002. This decrease
was primarily attributable to a reduction in interest spread due to the
transfer of $23 million in performing loans to Franklin Credit Management
Corporation on January 1, 2003. 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 $30 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
2003 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 $30 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 3.50%.
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.
LEGAL DEPARTMENT- The Legal Department manages and monitors the progress of
defaulted loans requiring legal action, and the loss mitigation area, which
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
6
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.
REAL ESTATE DEPARTMENT - The Real Estate Department manages all properties
in order to preserve their value, realize rental income and ensure 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.
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, 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, 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.
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.
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, Ameriquest 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.
CUSTOMERS. The Company's revenue is derived from interest amortization of
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
7
institutions, amortization of purchase discount and gains on the sale of
OREO. The Company's borrowers are a diverse population and no single
borrower represents 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.
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.
Tribeca Lending 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.
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
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
8
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. The Company recruits, hires, and retains individuals with the
specific skills that complement its corporate growth and business
strategies. As of December 31, 2003, the Company had 127 full time
employees.
ITEM 2. DESCRIPTION OF PROPERTIES
PROPERTIES. The Company maintains its corporate headquarters at 6 Harrison
Street, New York, NY, where the Company owns a 6,600 square foot
condominium unit. The second office is located at 99 Hudson Street, New
York, where the Company leases approximately 6,400 square feet of office
space under a lease that expires in December 2008. The Company extended
sub-leases 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. The Company extended the lease of office space on four floors
located at 185 Franklin Street for its Accounting and Tribeca Lending's
Operations departments; the leases expire in November 2008. 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. During
2003, the Company leased branch offices located in Marlton, NJ, St.
Petersburg, FL and Columbia, MD for the expansion of Tribeca, the leases
expire in 2006.
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, co-ops, 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
9
property is then evaluated independently and a decision is made on whether
the additional investment would generate an adequate return.
ITEM 3. LEGAL PROCEEDINGS
The Company is from time to time involved in legal action arising in
the ordinary course of its business. In the opinion of management after
consultation with legal counsel, the outcome of such matters is not
expected to have a material adverse effect on the Company's financial
statements.
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".
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 2003 and 2002 was compiled from information representing
the daily inter-dealer bid activity during the period.
2003 Bid 2002 Bid
----------------- ------------------
High Low High Low
---- --- ---- ---
First Quarter $1.75 $1.07 $1.05 $1.05
Second Quarter $5.25 $1.15 $1.80 $1.75
Third Quarter $3.25 $2.75 $1.35 $1.35
Fourth Quarter $3.20 $2.96 $1.05 $1.05
As of December 31, 2003, 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 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.
10
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data set forth below as of and for the years ended
December 31, 2003, 2002, 2001, 2000 and 1999 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.
2003 2002 2001 2000 1999
------------ ------------ ------------- ------------ -------------
STATEMENT ON INCOME DATA
Revenues $ 57,566,559 $ 46,842,437 $ 37,963,358 $ 29,047,390 $ 22,451,660
Expenses 45,186,102 34,664,987 34,637,210 28,476,727 22,319,812
------------ ------------ ------------- ------------ -------------
Income before provision for income taxes 12,380,457 12,177,450 3,326,148 570,663 131,848
provision for income taxes 5,695,000 5,514,000 444,000 - -
------------ ------------ ------------- ------------ -------------
Net Income $ 6,685,457 $ 6,663,450 $ 2,882,148 $ 570,663 $ 131,848
============ ============ ============= ============ =============
Earnings per share basic $ 1.13 $ 1.13 $ 0.49 $ 0.10 $ 0.02
Earnings per share diluted $ 1.02 $ 1.07 $ 0.49 $ 0.10 $ 0.02
BALANCE SHEET DATA
Total Assets $476,733,346 $424,419,034 $ 334,162,501 $243,235,288 $ 195,737,096
Total Liabilities 457,054,040 411,425,185 327,832,102 239,787,037 192,859,508
------------ ------------ ------------- ------------ -------------
TOTAL STOCKHOLDER'S EQUITY $ 19,679,306 $ 12,993,849 $ 6,330,399 $ 3,448,251 $ 2,877,588
============ ============ ============= ============ =============
Principal $465,553,870 $435,259,394 $ 331,643,076 $255,055,677 $ 206,262,651
Purchase discount (25,678,165) (22,974,310) (22,248,344) (23,392,400) (18,449,141)
Allowance for loan losses (46,247,230) (45,841,651) (33,490,456) (24,086,322) (22,185,945)
------------ ------------ ------------- ------------ -------------
Net Notes $393,628,475 $366,443,433 $ 275,904,276 $207,576,955 $ 165,627,565
============ ============ ============= ============ =============
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
GENERAL
FORWARD-LOOKING STATEMENTS. When used in this report, the words "believes",
"anticipates", and "expects" and similar expressions are intended to
identify forward-looking statements that involve certain risks and
uncertainties. Additionally statements contained herein that are not
historical fact may be forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of
the Securities Exchange Act of 1934, as amended, that are subject to a
variety of risks and uncertainties. There are a number of important factors
that could cause actual results to differ materially from those projected
or suggested in forward-looking statements made by the Company. These
factors include, but are not limited to: (i) unanticipated changes in the
U.S economy, including changes in business conditions and interest rates
and changes in the level of growth in the finance and housing markets; (ii)
the status of relations between the Company and its sole Senior Debt Lender
and the Senior Debt Lender's willingness to extend additional credit to the
Company; (iii) the availability for purchases of additional loans; (iv) the
status of relations between the Company and its sources for loan purchases;
(v) unanticipated difficulties in collections under loans in the Company's
portfolio; and (vi) other risks detailed from time to time in the Company's
SEC reports. Additional factors that would cause actual results to differ
materially from those projected or suggested in any forward-looking
statements are contained in the Company's filings with the Securities and
Exchange Commission, including, but not limited to, those factors discussed
11
under the caption "Quantitative and Qualitative Disclosures About Market
Risk" in the Company's Annual Report on Form 10-K, which the Company urges
investors to consider. The Company undertakes no obligation to publicly
release the revisions to such forward-looking statements that may be made
to reflect events or circumstances after the date hereof or to reflect the
occurrences of unanticipated events, except as other wise required by
securities and other applicable laws. Readers are cautioned not to place
undue reliance on these forward-looking statements, which speak only as of
the date thereof. The Company undertakes no obligation to release publicly
the results on any events or circumstances after the date hereof or to
reflect the occurrence of unanticipated events.
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 acquires these mortgages from a
variety of mortgage bankers, banks, and other specialty finance companies.
These loans are generally purchased in pools at discounts from their
aggregate contractual balances, from sellers in the financial services
industry. Real estate is acquired in foreclosure or otherwise and is also
acquired at a discount relative to the appraised value of the asset. The
Company conducts its business from its executive and main office in New
York City and through its website www.franklincredit.com.
In January 1997, the Company formed a wholly owned subsidiary, Tribeca
Lending Corp. ("Tribeca"), to originate primarily 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. The majority of
first and second mortgages originated are on a retail basis through
marketing efforts, utilization of the FCMC database and the internet.
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.
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
12
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 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
judgement and continuing assessment of the fair value of the underlying
collateral. Property is evaluated periodically to ensure that the recorded
amount is supported by current fair values and valuation allowances are
recorded as necessary to reduce the carrying amount to fair value less
estimated cost to sell. Revenue and expenses from the operation of OREO and
changes in the valuation allowance are included in operations. Direct costs
relating to the development and improvement of the property are
capitalized, subject to the limit of fair value of the collateral, while
costs related to holding the property are expensed. Gains or losses are
included in operations upon disposal.
INCOME TAXES - Income taxes are accounted for under Financial Accounting
Standards Board Statement No. 109 "Accounting for Income Taxes". This
method provides for deferred income tax assets or liabilities based on the
temporary difference between the income tax basis of assets and liabilities
and their carrying amount in the consolidated financial statements.
Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. Deferred tax assets
are reduced by a valuation allowance if management determines that it is
more likely than not that some portion or all of the deferred tax assets
will not be realized.
RESULTS OF OPERATIONS
YEAR ENDED FISCAL DECEMBER 31, 2003 COMPARED TO YEAR ENDED FISCAL DECEMBER
31, 2002
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, gain on holding securities, rental income
and other income, increased by $10,724,122 or 23%, to $57,566,559 during
fiscal 2003, from $46,842,437 during fiscal 2002.
Total revenue as a percentage of notes receivable, loans held for sale,
loans held for investment and OREO as of the last day of the fiscal year,
net of allowance for loan losses during fiscal 2003 was 12.2% as compared
with 11.5% during fiscal 2002. Interest income on notes receivable
increased by $5,970,975 or 16%, to $42,699,710 during fiscal 2003 from
$36,728,735 during fiscal 2002. The Company recognizes interest income on
notes included in its portfolio based upon three factors: (i) interest on
performing notes, (ii) interest received with settlement payments on
non-performing notes and (iii) the balance of settlements in excess of the
carried face value. Interest income increased due
13
to a 17.5% increase in the average balance outstanding a result of $244
million of loan acquisitions over the year that was partially offset by
both a decline in the yield on the portfolio and prepayments. The average
yield on the portfolio was 10.36% and 11.29% during 2003 and 2002
respectively.
Purchase discount earned increased by $1,312,674 or 34%, to $5,154,601
during fiscal 2003 from $3,841,927 during fiscal 2002. The increase in
purchase discount earned was due to an increase in prepayment activity
during the year due to a favorable refinancing environment resulting from
historically low interest rates.
Gains on sale of notes receivable increased by $978,720 or 701%, to
$1,118,239 during fiscal 2003 from $139,519 during fiscal 2002. This
increased reflected an increase in the volume of loans sold during 2003.
The Company sold a total of $19.4 million in face value notes receivable
during 2003, as compared to $1.1 million during 2002.
Gain on sale of loans held for sale increased by $976,637 or 43%, to
$3,236,616 during 2003 from $2,259,979 during fiscal 2002. This increase
was due to an increase in loan originations due to hiring additional sales
personnel and opening three branch offices, which increased the volume of
loans available to be sold by 88% as compared to 2002. Tribeca had loan
sales of $79 million during 2003 as compared to $42 million of loans during
2002.
Gain on sale of OREO increased by $230,568 or 29% to $1,027,130 during
fiscal 2003 from $796,562 during fiscal 2002. The Company sold 231 OREO
properties during 2003 as compared to 105 OREO properties during 2002.
Rental income decreased by $39,710 or 26% to $113,255 during fiscal 2003,
from $152,965 during fiscal 2002. Rental income decreased due to the
reduction of rental properties held during the year, the decrease was
partially offset by the recognition of security deposits as rent during the
year. The Company held three rental properties at December 31, 2003 as
compared to seven at December 31, 2002.
Other income increased by $1,293,505 or 44%, to $4,216,255 during fiscal
2003 from $2,922,750 during fiscal 2002. The increase was due primarily to
increases in the number of prepayment penalties due to an increase in
prepayments during 2003, increased late charges resulting primarily from
the growth in the size of the portfolio, and increased loan fees from an
increase in loans sold.
Total operating expenses increased by $8,858,516 or 24% to $45,186,101
during fiscal 2003 from $36,327,585 during fiscal 2002 net of the special
recovery. 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 $2,545,280 or 13%, to $21,672,993 during
fiscal 2003 from $19,127,713 during fiscal 2002. This increase was due to a
11% increase in Senior Debt, financing agreements and loans from
affiliates to $451 million as of December 31, 2003 as compared with $407
million as of December 31, 2002 and an increase in the spread.
Collection, general and administrative expenses increased by $4,982,651 or
39% to $17,864,786 during fiscal 2003 from $12,882,135 during fiscal 2002.
The primary components of collection, general and administrative expense
are personnel expenses, OREO related expenses, litigation expenses, office
expenses, and collection expenses.
14
Personnel expenses increased by $2,011,948 or 30%, to $8,735,747 from
$6,723,799 during fiscal 2002. This increase resulted from the growth in
size of the Company's staff, salary increases, and increased commissions
due to increased loan production due to the opening of three new branches
during the year. The total number of employees at December 31, 2003 and
2002 was 127 and 110 respectively. Legal expenses increased by $577,896 to
$2,324,196 or 33% from $1,746,300 due to an increase in the number of
foreclosures and asset protection litigation due to the growth in both the
OREO inventory and the nonperforming portfolio. Professional fees increased
by $553,412 to $1,021,626 or 118% from $468,214 due to nonrecurring
professional fees associated with the conversion to a new servicing system
and various other consulting projects during 2003. Collection expenses
increased by $506,812 to $1,164,692 or 77% from $657,880 this increase was
due to the growth in number of nonperforming assets. Travel and promotion
increased by $439,927 to $913,217 or 93% from $473,290 this increase was
due to a changed advertising strategy for Tribeca Lending during 2003, the
company purchased third party leads from an online provider, these leads
generated increased revenue for Tribeca. Computer consulting and supplies
increased by $230,995 to $504,230 or 85% from $273,235 due to consulting
expenses associated with the conversion to a new servicing system. Office
expenses increased by $171,564 to $1,026,933 or 20% from $855,369 this
increase was directly related to the opening of three new offices and the
growth in staffing. OREO related expenses increased by $155,310 to $622,148
or 33% from $466,838 due to a 49% increase in OREO inventory during the
year. OREO inventory was $14.0 million and $9.4 million at December 31,
2003 and 2002 respectively. Insurance expenses increased by $124,911 to
$374,851 or 50% from $249,940 due to a new forced placed insurance policy
issued for the portfolio during 2003. Other general and administrative
expenses increased by $209,875 to $1,177,146 or 22% from $967,271 due to
training expenses associated with the conversion to a new servicing system,
increased volume of loans closed in states that charge realty tax and
increased license and state filing fees.
Provisions for loan losses increased by $450,239 or 17%, to $3,164,103
during fiscal 2003 from $2,713,864 during fiscal 2002. This increase was
primarily due to an increase in write-offs and reserve increases in
portfolios that no longer have purchase discount and the increase in size
of the nonperforming portfolio. 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 2003 and fiscal 2002 were approximately 0.63%
and 0.58%, respectively.
Amortization of deferred financing costs increased by $715,096 or 57%, to
$1,979,208 during fiscal 2003 from $1,264,112 during fiscal 2002. This
increase resulted primarily from increased prepayments and collections,
which caused a corresponding increase in the pay down of Senior Debt.
Depreciation expense increased by $165,251 or 49%, to $505,012 during
fiscal 2003 from $339,761 during fiscal 2002. This increase resulted
primarily from the purchase of a new servicing system and new computer
equipment.
The Company's operating income increased by $203,007 or 2% to $12,380,457
during fiscal 2003 from $12,177,450 during fiscal 2002 for the reasons set
forth above.
During 2003, the Company had a provision for income taxes of $5,695,000 as
compared to 2002 when the provision was $5,514,000. The effective tax rate
for 2003 and 2002 was 46% and 45% respectively.
15
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, 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 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 to
continue to hold for rent during the year. The Company held seven rental
properties at December 31, 2002 as compared to sixteen 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.
16
Total operating expenses increased by $1,690,375 or 5% to $36,327,585
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. Senior Debt, and financing agreements increased by $85
million to $407 million as of December 31, 2002 as compared with $322
million as of December 31, 2001.
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.
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.
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
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 were 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.
17
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.
LOAN AND OREO ACQUISITIONS. - During the year ended December 31, 2003
("fiscal 2003") the Company purchased 3,476 loans consisting primarily of
first and second mortgages, with an aggregate face value of $244 million at
an aggregate purchase price of $214 million or 88% of the face value.
Acquisition of these 2003 portfolios was fully funded through Senior Debt
in the amount equal to the purchase price plus a 1% loan origination fee.
COST OF FUNDS. - As of December 31, 2003, the Company had Senior Debt
outstanding under several loans with an aggregate principal balance of $427
million. Additionally, the Company has financing agreements, which had an
outstanding balance of $23.3 million at December 31, 2003.
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. From December 31, 2001 until March 2003, the Company's
Senior Debt incurred after March 1, 2001, accrued interest at the Federal
Home Loan Bank of Cincinnati ("FHLB") thirty day advance rate plus a spread
of 3.50%(the "Spread"), and interest on Senior Debt incurred before March
1, 2001 accrued interest at the prime rate plus a margin of between 0% and
1.75%; under a two year interest rate agreement. At December 31, 2003 $35
million of senior debt incurred before March 1, 2001 remained outstanding.
The weighted average interest rate on borrowed funds for the Senior Debt
based on the balances as of December 31, 2003 and December 31, 2002 was
4.82% and 4.85%, respectively.
The impact of inflation on the Company's operations during fiscal 2003,
2002 and 2001 was immaterial.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity is a measurement of the Company's ability to meet potential cash
requirements including lending activities, ongoing commitments to repay
borrowings and other general business purposes. The primary source of funds
for liquidity is principal payments on loans, proceeds from sales and debt
thereof.
General- During fiscal 2003 the Company purchased 3,476 loans with an
aggregate face value of $244 million at an aggregate purchase price of $214
million or 88% of the face value. 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 face value. This increase
reflected the Company's enhanced marketing efforts, which resulted in the
growth in volume of the Company flow acquisition business during the year.
The Company achieved increased market penetration by establishing
relationships with sellers of small pools of single loans and continued to
build on existing relationships with certain repeat customers.
The Company's portfolio of notes receivable at December 31, 2003, had a
face value of $466 million and included net notes receivable of
approximately $394 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.
18
During fiscal 2003, the Company used cash in the amount of $11.8 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 $28.3 million in its investing
activities, which reflected primarily the use of $214 million for the
purchase of notes receivable offset by principal collections of its notes
receivable of $157 million and proceeds from sales of OREO of $16 million.
Net cash provided by financing activities was $44 million primarily from an
increase in Senior Debt of $32 million. The above activities resulted in a
net increase in cash at December 31, 2003 over December 31, 2002 of
approximately $3.8 million.
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, 2003 and 2002, the Company held
OREO recorded in the financial statements at $14 million and $9.4 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, 2003 has
a net realizable value (market value less estimated commissions and legal
expenses associated with the disposition of the asset) of approximately
$15.5 million based on market analyses of the individual properties less
the estimated closing costs. The Company generally sells such OREO in the
ordinary course of business when it is economically beneficial to do so.
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, 2003, the Company had unrestricted cash, cash equivalents
and marketable securities of $14.6 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, 2003, the Company owed an aggregate of
$427 million to the Senior Debt Lender, under several loans.
The Senior Debt is collateralized by first liens on the respective loan 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 of Cincinnati rate
plus a premium of 3.50% for all new Senior Debt and certain debt incurred
after March 1, 2000, and prime plus between 0% and 1.75% debt incurred
before such date, of which there was approximately $35 million at December
31, 2003. At December 31, 2003, the weighted average interest rate on
Senior Debt was 4.82%. The accelerated payment provisions are generally of
two types: the first requires
19
that all collections from notes receivable, other than a fixed monthly
allowance for servicing operations, be applied to reduce the Senior Debt,
and the second requires a weekly additional principal reduction from cash
collected before scheduled principal and interest payments have been made.
As a result of the accelerated payment provisions, the Company is repaying
the amounts due on the Senior Debt at a rate faster than the contractual
scheduled payments. While the Senior Debt remains outstanding, these
accelerated payment provisions may limit the cash flow that is available to
the Company.
In February 2004, 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 $2,075,000 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 and to
refinance loans in the Company's own portfolio. The restricted cash is
maintained in an interest bearing account, with the Company's Senior Debt
Lender. The aggregate balance of restricted cash in such accounts was
$413,443 on December 31, 2003 and $632,883 on December 31, 2002.
Total Senior Debt funding capacity was $500 million at December 31, 2003 of
which approximately $427 million had been drawn down as of such date. As a
result, the Company has approximately $73 million available to purchase
additional portfolios of notes receivable. Together, expected principal
collections and the available $73 million and an increase to $550 million
in the line 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 $30 million. At December 31, 2003, Tribeca had drawn
down $23.3 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 $30 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 $2,500,000
at a rate equal to the bank's prime rate plus two 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, 2003 and December 31,
2002, was $569,451 and $1,250,451 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. During 2003, Management reached an
agreement with its Senior Debt Lender to increase the availability under
this credit facility from $1.5 million to $2.5 million to cover additional
properties
20
foreclosed upon by the Company, which the Company may be required to hold
as rental property to maximize its return.
FINANCING ACTIVITIES AND CONTRACTUAL OBLIGATIONS
Below is a schedule of the Company's contractual obligations and
commitments at December 31, 2003.
LESS THAN
(AMOUNTS IN THOUSANDS) TOTAL 1 YEAR 1 - 3 YEARS 3 - 5 YEARS THEREAFTER
- ----------------------------- -------------- ------------ ------------- ------------- -------------
Contractual Cash Obligations:
Notes Payable $ 427,447,844 $ 42,947,946 $ 122,065,463 $ 35,966,791 $ 226,467,644
Warehouse Line 23,315,301 23,315,301 -- -- --
Operating Leases 2,327,166 514,269 1,566,641 246,256 --
Capital Lease 480,328 162,859 317,469 -- --
Employment Agreements 275,000 220,000 55,000 -- --
-------------- ------------ ------------- ------------- -------------
Total Contractual Cash
Obligations $ 453,845,639 $ 67,160,375 $ 124,004,573 $ 36,213,047 $ 226,467,644
============== ============ ============= ============= =============
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
THE COMPANY IS VULNERABLE TO CHANGES IN INTEREST RATES
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.
Interest rates are highly sensitive to many factors, including governmental
monetary policies and domestic and international economic and political
conditions. Conditions such as inflation, recession, unemployment, money supply
and other factors beyond the Company's control may also affect interest rates.
Fluctuations in market interest rates are neither predictable nor controllable
and may have a material adverse effect on the Company's business, financial
condition and results of operations.
The Company's operating results will depend in large part on differences between
the income from its assets (net of credit losses) and its borrowing costs. Most
of the Company's assets, consisting primarily of mortgage notes receivable,
generate fixed returns and will have terms in excess of five years. The Company
funds the origination and acquisition of a significant portion of these assets
with borrowings, which have interest rates that are based on the monthly Federal
Home Loan Bank of Cincinnati 30-day advance rate ("FHLB"). In most cases, the
income from assets will respond more slowly to interest rate fluctuations than
the cost of borrowings, creating a mismatch between yields and borrowing rates.
Consequently changes in interest rates, particularly short-term rates may
influence the Company's net income. The Company's borrowing under agreements
with its Senior Debt Lender bear interest at rates that fluctuate with the FHLB
rate of Cincinnati and the prime rate. Based on approximately $392 and $35
million of borrowings outstanding under these facilities at December 31, 2003, a
1% change in FHLB and prime rate, would impact the Company's annual net income
and cash flows by approximately $2.3 million. Increases in these rates will
decrease the net income and market value of the Company's net assets. Interest
rate fluctuations that result in interest expense exceeding interest income
would result in operating losses.
21
The value of the Company's assets may be affected by prepayment rates on
investments. Prepayments rates are influenced by changes in current interest
rates and a variety of economic, geographic and other factors beyond the
Company's control, and consequently, such prepayment rates cannot be predicted
with certainty. When the Company originates and purchases mortgage loans, it
expects that such mortgage loans will have a measure of protection from
prepayment in the form of prepayments lockout periods or prepayment penalties.
In periods of declining mortgage interest rates, prepayments on mortgages
generally increase. If general interest rates decline as well, the proceeds of
such prepayments received during such periods are likely to be reinvested by the
Company in assets yielding less than the yields on the investments that were
prepaid. In addition the market value of mortgage investments may, because the
risk of prepayment, benefit less from declining interest rates than from other
fixed-income securities. Conversely, in periods of rising interest rates,
prepayments on mortgage generally decrease, in which case the Company would not
have the prepayment proceeds available to invest in assets with higher yields.
Under certain interest rate and prepayment scenarios the Company may fail to
recoup fully its cost of acquisition of certain investments.
REAL ESTATE RISK
Multi-family and residential property values and net operating income derived
from such properties are subject to volatility and may be affected adversely by
number of factors, including, but not limited to, national, regional and local
economic conditions (which may be adversely affected by industry slowdowns and
other factors); local real estate conditions (such as the over supply of
housing). In the event net operating income decreases, a borrower may have
difficultly paying the Company's mortgage loan, which could result in losses to
the Company. In addition, decreases in property values reduce the value of the
collateral and the potential proceeds available to a borrower to repay the
Company's mortgage loans, which could also cause the Company to suffer losses.
ITEM 8. FINANCIAL STATEMENTS
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.
ITEM 9A. CONTROLS AND PROCEDURES.
(a) Evaluation of Disclosure Controls and Procedures. The Company's
management, with the participation of the Company's Chief Executive
Officer and Chief Financial Officer, has evaluated the effectiveness
of the Company's disclosure controls and procedures (such term is
defined in Rules 13a-14 (c) and 15d14(c) under the Securities Exchange
Act of 1934, as amended (the "Exchange Act") as of the end of the
period covered by this report. Based on such evaluation, the Company'
Chief Executive Officer and Chief Financial Officer have concluded
that, as of the end of such period, the Company's disclosure controls
and procedures are effective in alerting them on a timely basis to
material information relating to the Company (including its
consolidated subsidiaries) required to be included in the Company's
reports filed or submitted under the Exchange Act.
22
(b) Changes in Internal Controls. There has been no change in the
Company's internal control over financial reporting during the quarter
ended December 31, 2003 that has materially affected, or is reasonably
likely to materially affect, such internal control over financial
reporting.
23
PART III
INFORMATION WITH RESPECT TO ITEMS 10, 11, 12, 13 AND 14 ON FORM 10K WILL BE SET
FORTH IN THE DEFINITIVE PROXY STATEMENT, WHICH WILL BE FILED WITHIN 120 DAYS OF
DECEMBER 31, 2003, 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 TRANSACTIONS
PART IV
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
ITEM 15. EXHIBITS AND REPORTS ON FORM 8-K
24
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.
*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.
31.1 Certification of Chief Executive Officer
31.2 Certification of Chief Financial Officer
32.1 Section 1350 Certification of Chief Executive officer and Chief
Financial Officer
*Previously filed.
25
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
March 31, 2004 FRANKLIN CREDIT MANAGEMENT
CORPORATION
By: /s/ THOMAS J. AXON
-----------------------------------
Thomas J. Axon
Chairman
Pursuant to the requirements of the Securities Exchange Act, this
report has been signed below by the following persons on behalf of the
registrant and in the capacity and on the dates indicated.
Signature Title Date
/s/SETH COHEN President, Chief Executive Officer, Director March 31, 2004
- ------------------
Seth Cohen
(Principal executive officer)
/s/JOSEPH CAIAZZO Executive Vice President, Chief Operating March 31, 2004
- ----------------- Officer, Secretary and Director
Joseph Caiazzo
(Secretary)
/s/ALAN JOSEPH Executive Vice President, Chief Financial Officer March 31, 2004
- -------------- and Director
Alan Joseph
(Principal financial officer)
26
FRANKLIN CREDIT MANAGEMENT CORPORATION AND SUBSIDIARIES
TABLE OF CONTENTS
PAGE
INDEPENDENT AUDITORS' REPORT 32
CONSOLIDATED FINANCIAL STATEMENTS:
Consolidated Balance Sheets at December 31, 2003 and 2002 33
Consolidated Statements of Income for the years ended December 31, 2003, 2002 and 2001 34
Consolidated Statements of Stockholders' Equity for the years ended December 31, 2003, 2002 and 2001 35
Consolidated Statements of Cash Flows for the years ended December 31, 2003, 2002 and 2001 36-37
Notes to Consolidated Financial Statements for the years ended December 31, 2003, 2002 and 2001 38-57
31
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Stockholders of
Franklin Credit Management Corporation
We have audited the accompanying consolidated balance sheets of Franklin Credit
Management Corporation and subsidiaries (the "Company") as of December 31, 2003
and 2002, and the related consolidated statements of income, stockholders'
equity, and cash flows for each of the three years in the period ended December
31, 2003. 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 Franklin Credit Management
Corporation and subsidiaries as of December 31, 2003 and 2002, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 2003 in conformity with accounting principles
generally accepted in the United States of America.
New York, New York
March 31, 2004
32
FRANKLIN CREDIT MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2003 AND 2002
2003 2002
ASSETS
CASH AND CASH EQUIVALENTS $ 14,418,876 $ 10,576,610
RESTRICTED CASH 413,443 632,883
NOTES RECEIVABLE:
Principal 465,553,870 435,259,394
Purchase discount (25,678,165) (22,974,310)
Allowance for loan losses (46,247,230) (45,841,651)
------------- -------------
Net notes receivable 393,628,475 366,443,433
ORIGINATED LOANS HELD FOR SALE 27,372,779 22,869,947
ORIGINATED LOANS HELD FOR INVESTMENT 9,536,669 -
ACCRUED INTEREST RECEIVABLE 4,332,419 4,157,615
OTHER REAL ESTATE OWNED 13,981,665 9,353,884
OTHER RECEIVABLES 2,893,735 2,259,543
MARKETABLE SECURITIES 202,071 -
DEFERRED TAX ASSET 681,398 387,767
OTHER ASSETS 3,720,163 2,633,082
BUILDING, FURNITURE AND EQUIPMENT - Net 1,252,711 1,106,865
DEFERRED FINANCING COSTS- Net 4,298,942 3,997,405
------------- -------------
TOTAL ASSETS $ 476,733,346 $ 424,419,034
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Accounts payable and accrued expenses $ 4,979,806 $ 3,818,557
Financing agreements 23,315,301 11,557,369
Notes payable 427,447,844 395,266,144
Deferred tax liability 1,311,089 783,115
------------- -------------
Total liabilities 457,054,040 411,425,185
------------- -------------
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 12,634,171 5,948,714
------------- -------------
Total stockholders' equity 19,679,306 12,993,849
------------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 476,733,346 $ 424,419,034
============= =============
33
FRANKLIN CREDIT MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 2003, 2002 and 2001
2003 2002 2001
REVENUES:
Interest income $ 42,699,710 $ 36,728,735 $ 28,824,624
Purchase discount earned 5,154,601 3,841,927 3,986,498
Gain on sale of notes receivable 1,118,239 139,519 986,570
Gain on sale of loans held for sale 3,236,616 2,259,979 842,051
Gain on sale of other real estate owned 1,027,130 796,562 1,448,548
Rental income 113,255 152,965 330,250
Prepayments penalties and other income 4,217,008 2,922,750 1,544,817
------------ ------------ ------------
57,566,559 46,842,437 37,963,358
------------ ------------ ------------
OPERATING EXPENSES:
Interest expense 21,672,993 19,127,713 20,754,281
Collection, general and administrative 17,864,786 12,882,135 10,411,012
Recovery of a special charge - (1,662,598) -
Provision for loan losses 3,164,103 2,713,864 2,187,453
Amortization of deferred financing costs 1,979,208 1,264,112 1,058,443
Depreciation 505,012 339,761 226,021
------------ ------------ ------------
45,186,102 34,664,987 34,637,210
------------ ------------ ------------
INCOME BEFORE PROVISION FOR INCOME TAXES 12,380,457 12,177,450 3,326,148
PROVISION FOR INCOME TAXES 5,695,000 5,514,000 444,000
------------ ------------ ------------
NET INCOME $ 6,685,457 $ 6,663,450 $ 2,882,148
============ ============ ============
NET INCOME PER COMMON SHARE:
Basic $ 1.13 $ 1.13 $ 0.49
============ ============ ============
Diluted $ 1.02 $ 1.07 $ 0.49
============ ============ ============
WEIGHTED AVERAGE NUMBER OF SHARES
OUTSTANDING, BASIC 5,916,527 5,916,527 5,916,527
============ ============ ============
OUTSTANDING, DILUTED 6,536,639 6,216,337 5,916,527
============ ============ ============
See notes to consolidated financial statements.
34
FRANKLIN CREDIT MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2003, 2002 and 2001
COMMON STOCK ADDITIONAL
----------------------------- PAID-IN RETAINED
SHARES AMOUNT CAPITAL EARNINGS TOTAL
BALANCE, JANUARY 1, 2001 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
Net income - - - 6,685,457 6,685,457
------------ ------------ ------------ ------------ ------------
BALANCE, DECEMBER 31, 2003 5,916,527 $ 59,167 $ 6,985,968 $ 12,634,171 $ 19,679,306
============ ============ ============ ============ ============
See notes to consolidated financial statements.
35
FRANKLIN CREDIT MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
2003 2002 2001
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 6,685,457 $ 6,663,450 $ 2,882,148
Adjustments to reconcile income to net cash used in
operating activities:
Gain on sale of notes receivable (1,118,239) (139,519) (986,570)
Gain on sale of other real estate owned (1,027,130) (796,562) (1,448,548)
Depreciation 505,012 339,761 226,021
Amortization of deferred financing costs 1,979,208 1,264,112 1,058,443
Origination of loans held for sale (97,143,554) (70,444,721) (39,594,000)
Proceeds from the sale of and principal collections on
loans held for sale - net of gain 80,810,221 53,355,507 17,930,017
Purchase discount earned (5,154,601) (3,841,927) (3,986,498)
Provision for loan losses 3,164,103 2,713,864 2,187,453
Changes in operating assets and liabilities:
Accrued interest receivable (174,804) 638,174 (1,399,384)
Other receivables (634,192) (3,045,866) (3,370,966)
Deferred tax asset (293,631) 1,179,821 1,913,414
Other assets (1,087,834) (739,030) (451,365)
Deferred tax liability 527,974 (1,308,203) (1,469,743)
Accounts payable and accrued expenses 1,161,249 (411,646) 1,295,406
Notes payable, affiliates and stockholders - - (146,835)
------------- ------------- -------------
Net cash used in operating activities (11,800,761) (14,572,785) (25,361,007)
------------- ------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
(Increase) decrease in restricted cash (219,440) (91,440) 391,131
Purchase of notes receivable (213,638,801) (184,090,904) (162,340,435)
Principal collections on notes receivable and loans held
for Investment 156,924,859 110,541,717 72,930,175
Investment in marketable securities (203,771) - -
Acquisition and loan fees (2,564,246) (2,065,626) (1,420,254)
Proceeds from sale of other real estate owned 16,407,503 7,053,926 8,609,271
Proceeds from sale of notes receivable 15,648,149 1,000,083 19,905,420
Purchase of building, furniture and fixtures (650,858) (295,455) (508,722)
------------- ------------- -------------
Net cash used in investing activities (28,296,605) (67,947,699) (62,433,414)
------------- ------------- -------------
Continued on next page
36
FRANKLIN CREDIT MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
CONTINUED FROM PREVIOUS PAGE
2003 2002 2001
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from notes payable 226,367,253 205,224,166 176,562,187
Principal payments of notes payable (194,185,553) (194,165,519) (123,901,830) (93,668,864)
Proceeds from financing agreements 101,322,968 74,886,326 38,495,144
Payments on financing agreements (89,565,036) (70,871,468) (32,973,967)
Principal payments of subordinated debentures - (24,262) (48,263)
------------- ------------- -------------
Net cash provided by financing activities 43,939,632 85,312,932 88,366,237
------------- ------------- -------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 3,842,266 2,792,448 571,816
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 10,576,610 7,784,162 7,212,346
------------- ------------- -------------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 14,418,876 $ 10,576,610 $ 7,784,162
============= ============= =============
SUPPLEMENTAL DISCLOSURES OF CASH
FLOW INFORMATION:
Cash payments for interest $ 21,204,660 $ 19,404,197 $ 18,931,784
============= ============= =============
Cash payments for taxes $ 5,713,700 $ 5,425,000 $ 56,875
============= ============= =============
See notes to consolidated financial statements.
37
FRANKLIN CREDIT MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
1. ORGANIZATION AND 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.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION - The consolidated financial statements include the
accounts of the Company and its wholly owned subsidiaries. All significant
intercompany accounts and transactions have been eliminated in
consolidation.
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates. The most significant estimates
of the Company are allowance for loan losses. The Company's estimates and
assumptions primarily arise from risks and uncertainties associated with
interest rate volatility and credit exposure. Although management is not
currently aware of any factors that would significantly change its
estimates and assumptions in the near term, future changes in market trends
and conditions may occur which could cause actual results to differ
materially.
RECLASSIFICATION- Certain prior 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)
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
38
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 original maturities of three months or less,
with the exception of restricted cash. The Company maintains accounts at
banks, which at times may exceed federally insured limits. The Company has
not experienced any losses from such concentrations.
NOTES RECEIVABLE AND INCOME RECOGNITION - The notes receivable portfolio
consists primarily of secured real estate mortgage loans purchased from
financial institutions, and mortgage and finance companies. Such notes
receivable are performing, 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 allowance for loan losses. The Company has
the ability and intent to hold these notes until maturity, payoff or
liquidation of collateral. Impaired notes receivable are measured based on
the present value of expected future cash flows discounted at the note's
effective interest rate or, as a practical expedient, at the observable
market price of the note receivable or the fair value of the collateral if
the note is collateral dependent. The Company periodically evaluates the
collectability of both interest and principal of its notes receivable to
determine whether they are impaired. A note receivable is considered
impaired when it is probable the Company will be unable to collect all
contractual principal and interest payments due in accordance with the
terms of the note agreement.
In general, interest on the notes receivable is calculated based on
contractual interest rates applied to daily balances of the collectible
principal amount outstanding using the accrual method. Accrual of interest
on notes receivable, including impaired notes receivable, is discontinued
when management believes, after considering economic and business
conditions and collection efforts, that the borrowers' financial condition
is such that collection of interest is doubtful. When interest accrual is
discontinued, all unpaid accrued interest is reversed. Subsequent
recognition of income occurs only to the extent payment is received subject
to management's assessment of the collectability of the remaining interest
and principal. A non-accrual note is restored to an accrual status when it
is no longer delinquent and collectability of interest and principal is no
longer in doubt and past due interest is recognized at that time.
Loan purchase discounts are amortized into income using the interest method
over the period to maturity. The interest method recognizes income by
applying the effective yield on the net investment in the loans to the
projected cash flows of the loans. Discounts are amortized if the projected
payments are probable of collection and the timing of such collections is
reasonably estimable. The projection of cash flows for purposes of
amortizing purchase loan discount is a material estimate, which could
change significantly, in the near term. Changes in the projected payments
are accounted for as a change in estimate and the periodic amortization is
prospectively adjusted over the remaining life of the loans.
In the event projected payments do not exceed the carrying value of the
loan, the periodic amortization is suspended and either the loan is written
down or an allowance for uncollectibility is recognized.
ALLOWANCE FOR LOAN LOSSES - The allowance for loan losses, a material
estimate which could change significantly in the near term, is initially
established by an allocation of the purchase loan discount based on
management's assessment of the portion of purchase discount that represents
uncollectable principal. Subsequently, increases to the allowance are made
through a provision for loan losses charged to
39
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. Impaired notes receivable, are
charged against the allowance for loan losses when management believes that
the collectability of principal is unlikely based on a note-by-note review.
In connection with the determination of the allowance for loan losses,
management obtains independent appraisals for the underlying collateral
when considered necessary.
The Company's notes receivable are collateralized by real estate located
throughout the United States with a concentration in California, New York,
Georgia, and Florida. Accordingly, the collateral value of a substantial
portion of the Company's real estate notes receivable and real estate
acquired through foreclosure is susceptible to changes in certain specific
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. An allowance of
$46,247,230 and $45,841,651 is included in notes receivable at December 31,
2003 and 2002, respectively.
ORIGINATED LOANS HELD FOR SALE- The loans held for sale consist primarily
of secured real estate first and second mortgages originated by the
Company. Such loans held for sale are performing and are carried at lower
of cost or market. The gain/loss on sale is recorded as the difference
between the carrying amount of the loan and the proceeds from sale on a
loan-by-loan basis. The Company records a sale when the title transfers to
the seller. In the second quarter of 2003, the Company's holding strategy
on several loans originated changed and the unamortized cost of these loans
was transferred from the loans held for sale category into loans held for
investment.
ORIGINATED LOANS HELD FOR INVESTMENT - Such loans consist primarily of
secured real estate first and second mortgages originated by the Company.
Such loans held for investment are performing and are carried at amortized
cost of the loan.
OTHER REAL ESTATE OWNED - Other real estate owned ("OREO") consists of
properties acquired through, or in lieu of, foreclosure or other
proceedings and are held for sale and carried at the lower of cost or fair
value less estimated costs to sell. Any write-down to fair value, less cost
to sell, at the time of acquisition is charged to purchase discount.
Subsequent write-downs are charged to operations based upon management's
continuing assessment of the fair value of the underlying collateral.
Property is evaluated periodically to ensure that the recorded amount is
supported by current fair values and valuation allowances are recorded as
necessary to reduce the carrying amount to fair value less estimated cost
to sell. Revenue and expenses from the operation of OREO and changes in the
valuation allowance are included in operations. Direct costs relating to
the development and improvement of the property are capitalized, subject to
the limit of fair value of the collateral, while costs related to holding
the property are expensed. Gains or losses are included in operations upon
disposal.
BUILDING, FURNITURE AND EQUIPMENT - Building, furniture and equipment is
recorded at cost net of accumulated depreciation. Depreciation is computed
using the straight-line method over the estimated
40
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
covering all full-time employees who have completed one month of service.
Contributions to the plan are made in the form of payroll deductions based
on employees' pretax wages. Currently, the Company offers a company match
of 50% of the first 3% of the employees' contribution.
INCOME TAXES - Income taxes are accounted for under SFAS No. 109 Accounting
for Income Taxes" which requires an asset and liability approach in
accounting for income taxes. This method provides for deferred income tax
assets or liabilities based on the temporary difference between the income
tax basis of assets and liabilities and their carrying amount in the
consolidated financial statements. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. Deferred tax assets are reduced by a valuation allowance when
management determines that it is more likely than not that some portion or
all of the deferred tax assets will not be realized. Deferred tax assets
and liabilities are adjusted for the effects of changes in tax laws and
rates on the date of the enactment.
FAIR VALUE OF FINANCIAL INSTRUMENTS - SFAS No. 107, Disclosures About Fair
Value of Financial Instruments, requires disclosure of fair value
information of financial instruments, whether or not recognized in the
balance sheets for which it is practicable to estimate that value. In cases
where quoted market prices are not available, fair values are based on
estimates using present value or other valuation techniques. Those
techniques are significantly affected by the assumptions used, including
the discount rate and estimates of future cash flows. In that regard, the
derived fair value estimates cannot be substantiated by comparison to
independent markets and, in many cases, could not be realized in immediate
settlement of the instruments. Statement No. 107 excludes certain financial
instruments and all non-financial assets and liabilities from its
disclosure requirements. Accordingly, the aggregate fair value amounts do
not represent the underlying value of the Company.
The following methods and assumptions were used by the Company in
estimating the fair value of its financial instruments:
a. CASH, RESTRICTED CASH, ACCRUED INTEREST RECEIVABLES, OTHER RECEIVABLE
AND ACCRUED INTEREST PAYABLE - The carrying values reported in the
consolidated balance sheets are a reasonable estimate of fair value.
b. NOTES RECEIVABLE - Fair value of the net note receivable portfolio is
estimated by discounting the future cash flows using the interest
method. The fair value of notes receivable at December 31, 2003 and
2002 was $393,628,475 and 366,443,433, respectively.
c. SHORT-TERM BORROWINGS - The interest rate on financing agreements and
other short-term borrowings reset on a monthly basis therefore, the
carrying amounts of these liabilities approximate their fair value.
The fair value at December 31, 2003 and 2002 was $23,315,301 and
$11,557,369, respectively.
d. LONG-TERM DEBT - Fair value of the Company's long-term debt (notes
payable) is estimated using discounted cash flow analysis based on the
Company's current incremental borrowing rates for
41
similar types of borrowing arrangements. The fair value approximates
$427,447,844 at December 31, 2003.
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
2003, 2002 and 2001 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, because 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.
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 2003, 2002, and 2001 net income and earnings per share would have
been reduced to the pro forma amounts indicated in the table that follows.
2003 2002 2001
Net income - as reported $ 6,685,457 $ 6,663,450 $ 2,882,148
Net income - pro forma $ 6,620,124 $ 6,585,073 $ 2,882,148
Net income per common share - basic - as reported $1.13 $1.13 $0.49
Net income per common share - basic - pro forma $1.12 $1.12 $0.49
Net income per common share - dilutive - as reported $1.02 $1.07 $0.49
Net income per common share - dilutive - pro forma $1.01 $1.06 $0.49
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 2003, 2002 and 2001:
Dividend yield 0% 0% 0%
Volatility 97% 139% 241%
Risk-free interest rate 5% 5.20% 3.62%
Weighted average expected lives 5 years 5 years 3 years
There were 39,000 options granted during the 2003. The weighted average
fair value of options granted during the year was $2.41. The fair value of
the options granted was estimated using the Black-Scholes option-pricing
model.
42
RECENT ACCOUNTING PRONOUNCEMENTS
The Company adopted SFAS No. 143, Accounting for Asset Retirement
Obligations on January 1, 2003. On January 1, 2003, the Company also
adopted SFAS No. 145, Rescission of SFAS No. 4, 44 and 64, Amendment of
SFAS No. 13, and Technical Corrections and SFAS No. 146, Accounting for
Costs Associated with Exit or Disposal Activities. In addition, in 2003,
Interpretation No. 45 "Guarantors' Accounting and Disclosure Requirements
for Guarantees, Including Indirect Guarantees of Indebtedness of Others"
was adopted by the Company. Implementation of these statements did not
have a material impact 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 did not have any impact since the
Company will continue to use the intrinsic value method as set forth in APB
No. 25.
In January of 2003, the Financial Accounting Standards Board ("FASB")
issued Interpretation No. 46, "Consolidation of Variable Interest
Entities", which was amended by Interpretation No. 46(R) in December of
2003. This Interpretation clarifies the application of existing accounting
pronouncements to certain entities in which equity investors do not have
the characteristics of a controlling financial interest or do not have
sufficient equity at risk for the entity to finance its activities without
additional subordinated financial support from other parties. As it applies
to the Company, Interpretation No. 46(R) will be immediately effective for
all variable interests in variable interest entities created after December
31, 2003, and to all variable interest entities on March 31, 2004. The
adoption of Interpretation No. 46(R) is expected to have no impact on the
Company's consolidated financial statements.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities". SFAS No. 149 amends and
clarifies the accounting for derivative instruments, including certain
derivative instruments embedded in other contracts and for hedging
activities under SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities". SFAS No. 149 is generally effective for contracts
entered into or modified after June 30, 2003 and for hedging relationships
designated after June 30, 2003. The adoption of SFAS No. 149 had no impact
on the Company's consolidated financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity".
SFAS No. 150 establishes standards for how an issuer classifies and
measures certain financial instruments with characteristics of both
liabilities and equity. SFAS No. 150 requires that certain financial
instruments be classified as liabilities that were previously considered
equity. In October of 2003, the FASB agreed to defer, indefinitely, the
application of paragraphs 9 and 10 of SFAS No. 150 regarding mandatorily
redeemable non-controlling interests in subsidiaries that would not be
liabilities under SFAS No. 150 for the subsidiary. The adoption of the
remaining provisions of this pronouncement on July 1, 2003 had no impact on
the Company's consolidated financial statements.
43
3. 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, 2003 and 2002 and are classified as follows:
2003 2002
Real estate secured $ 436,748,611 $ 399,197,450
Consumer unsecured 8,382,427 19,345,544
Mobile homes 14,871,762 12,091,393
Other 5,551,070 4,625,007
------------- -------------
465,553,870 435,259,394
Less:
Purchase discount (25,678,165) (22,974,310)
Allowance for loan losses (46,247,230) (45,841,651)
------------- -------------
Balance $ 393,628,475 $ 366,443,433
============= =============
Originated loans held for sale at December 31, 2003 and 2002 represent real
estate mortgages.
44
2003
Real estate secured $ 9,575,896
Consumer unsecured 53,816
Mobile homes 85,240
-----------
9,714,952
Less:
Allowance for loan losses (178,283)
-----------
Balance, December 31, 2003 $ 9,536,669
===========
As of December 31, 2003, contractual maturities of notes receivable,
originated loans held for sale and originated loans held for investment net
of the allowance for loan losses if any, were as follows:
ORIGINATED ORIGINATED
YEAR ENDING NOTES LOANS HELD LOANS HELD
DECEMBER 31, RECEIVABLE FOR SALE FOR INVESTMENT
2004 $ 18,210,384 $ 370,120 $ 512,561
2005 16,949,622 391,782 522,065
2006 16,006,666 415,052 533,284
2007 14,965,218 440,057 545,355
2008 20,321,242 407,462 152,368
Thereafter 332,853,508 25,348,306 7,271,036
------------ ------------ ------------
Balance, December 31, 2003 $419,306,640 $ 27,372,779 $ 9,536,669
============ ============ ============
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, 2003, 2002 and 2001,
cash collections of principal amounts totaled approximately $157,000,000,
$120,000,000 and $ 72,900,000 respectively, and the ratios of these cash
collections to average $73,000,000 principal balances were approximately
33%, 29% and 23% respectively.
45
Changes in the allowance of loan losses on notes receivable for the years
ended December 31, 2003, 2002 and 2001 are as follows:
2003 2002 2001
Balance, beginning $ 45,841,651 $ 33,490,456 $ 24,086,322
Allowance allocated on purchased portfolio 11,413,944 15,551,056 9,198,705
Loans charged to allowance (14,172,468) (5,913,725) (1,982,024)
Provision for loan losses 3,164,103 2,713,864 2,187,453
------------ ------------ ------------
Balance, ending $ 46,247,230 $ 45,841,651 $ 33,490,456
============ ============ ============
At December 31, 2003, 2002 and 2001, principal amounts of notes receivable
included approximately $126,000,000, $119,000,000 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 years ended December 31,
2003, 2002 and 2001:
2003 2002 2001
Total impaired notes receivable $126,341,722 $119,134,128 $ 74,563,057
============ ============ ============
Allowance for loan losses related to impaired
notes receivable $ 30,111,278 $ 32,809,607 $ 24,810,426
============ ============ ============
Average balance of impaired notes receivable
during the year $122,737,925 $ 96,848,593 $ 64,049,206
============ ============ ============
Interest income recognized $ 2,196,003 $ 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.
46
4. BUILDING, FURNITURE AND EQUIPMENT
At December 31, 2003 and 2002, building, furniture and equipment consisted
of the following:
2003 2002
Building and improvements $1,094,336 $1,060,359
Furniture and equipment 1,871,925 1,255,044
---------- ----------
2,966,261 2,315,403
Less accumulated depreciation 1,713,550 1,208,538
---------- ----------
$1,252,711 $1,106,865
========== ==========
5. 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 March 19, 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%. As of December 31, 2003
and 2002, the Company had several loans outstanding to its Senior Debt
Lender with an aggregate principal balance of $427,213,039 and $395,011,306
respectively. 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, 2003, approximately $
35,071,944 of borrowings accrues interest at a rate of prime plus a margin
of 0% to 1.75%. The remaining $392,141,095 accrues interest at the FHLB 30
day advance rate plus 3.50%. The remaining $234,805 accrues interest at
8.93%. The above loans requires all cash collections received on the notes
receivable to be paid to the Senior Debt Lender and the Company is provided
with $1,912,500 monthly, to fund operations.
At December 31, 2003 and 2002, the weighted average interest rate on the
Senior Debt was 4.82% and 4.85%, respectively.
The above loans also require additional monthly principal reductions based
on cash collections received by the Company.
47
Aggregate contractual maturities of all notes payable at December 31, 2003
are as follows:
2004 $ 42,947,946
2005 42,148,523
2006 40,903,803
2007 39,013,137
2008 35,966,791
Thereafter 226,467,644
------------
$427,447,844
============
6. FINANCING AGREEMENTS
The Company has the following financing agreements with 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 $30,000,000 at a rate equal to the bank's prime rate or
a floor of 5%, if prime is lower than 5%. This credit facility is to be
utilized for the purpose of originating mortgage loans. As of December 31,
2003 and 2002, $22,646,114 and $10,196,976, respectively, are outstanding
on the warehouse financing agreement and are secured by originated loans
held for sale. The prime rate at December 31, 2003 was 4%.
The credit facility provides the Company with the ability to borrow a
maximum of $2,500,000 at a rate equal to the bank's prime rate plus two
percent per annum. The credit facility 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, 2003 and 2002, $569,451 and
$1,250,451, 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, 2003, and 2002, $99,736 and $109,942,
respectively, are outstanding on the line of credit. The bank's prime rate
at December 31, 2003 was 4%.
48
7. INCOME TAX MATTERS
The components of the income tax provision for the years ended December
31, 2003, 2002 and 2001 are as follows:
2003 2002 2001
Current provision:
Federal $ 4,131,000 $ 3,317,000 $ 146,000
State and local 1,036,000 1,043,000 79,000
----------- ----------- -----------
5,167,000 4,360,000 225,000
----------- ----------- -----------
Deferred provision:
Federal 422,000 945,000 671,000
State and local 106,000 209,000 588,000
----------- ----------- -----------
528,000 1,154,000 1,259,000
----------- ----------- -----------
Decrease in valuation allowance - - (1,040,000)
----------- ----------- -----------
Provision $ 5,695,000 $ 5,514,000 $ 444,000
=========== =========== ===========
A reconciliation of the anticipated income tax expense (computed by
applying the Federal statutory income tax rate of 34% to income before
income tax expense) to the provision for income taxes in the
accompanying consolidated statements of income for the years ended
December 31, 2003, 2002, and 2001 are as follows:
2003 2002 2001
Tax determined by applying U.S. statutory rate
to income $ 4,546,000 $ 4,262,000 $ 1,164,000
Increase in taxes resulting from:
State and local income taxes, net of Federal benefit 1,142,000 1,252,000 331,000
Meals and entertainment (net of adjustments) 7,000 - 5,000
Decrease in valuation allowance - - (1,040,000)
Other items, net - - (16,000)
----------- ----------- -----------
$ 5,695,000 $ 5,514,000 $ 444,000
=========== =========== ===========
49
The tax effects of temporary differences that give rise to significant
components of deferred tax assets and deferred tax liabilities at
December 31, 2003, and 2002 are presented below:
2003 2002
Deferred liabilities:
Purchase discount $ 926,596 $ 783,115
Deferred cost $ 384,493 -
----------- ----------
- -
Deferred tax liabilities $ 1,311,089 $ 783,115
=========== ==========
Deferred tax assets:
Inventory, repossessed collateral $ 681,398 $ 387,767
----------- ----------
Deferred tax assets $ 681,398 $ 387,767
=========== ==========
The Company has not recorded an evaluation allowance, as the Company
believes all of the deferred tax assets will be realized.
8. STOCK OPTION PLAN
During 1996, the Company adopted an incentive stock option plan for
certain of its officers and directors. Under the terms of the Plan,
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.
The Company granted 39,000 options to five members of the Board of
Directors during 2003. The weighted average fair value of options
granted during the year was $2.41. The fair value of the options
granted was estimated using the Black-Scholes option-pricing model.
During 2002, the Company granted 121,000 options to members of the
Board of Directors and 275,000 options to various management employees.
Also during 2002, 130,000 options were forfeited by former Company
officers. There were no options granted during 2001.
50
Transactions in stock options under the plan are summarized as follows:
WEIGHTED
AVERAGE
EXERCISE
SHARES PRICE
Options outstanding at January 1, 2001 712,500 $ 1.00
Granted - -
Forfeited - -
--------- --------
Options outstanding at December 31, 2001 712,500 $ 1.00
--------- --------
Granted 396,000 0.75
Forfeited (130,000) 1.00
--------- --------
Options outstanding at December 31, 2002 978,500 $ 0.90
Granted 39,000 2.25
Expired - -
--------- --------
Options outstanding at December 31, 2003 1,017,500 $ 0.95
========= ========
As of December 31, 2003, 2002, and 2001, there were 1,017,500, 978,500,
and 712,500 options 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.
51
PORTFOLIO ASSET ACQUISITION AND RESOLUTION
2003 2002 2001
REVENUES:
Interest income $ 39,472,458 $ 33,435,447 $ 27,065,644
Purchase discount earned 4,912,686 3,841,927 3,986,498
Gain on sale of notes receivable 1,118,239 139,519 986,570
Gain on sale of other real estate owned 995,899 796,562 1,448,548
Rental income 113,255 152,965 330,250
Other 3,567,165 2,402,977 1,327,927
------------ ------------ ------------
50,179,702 40,769,397 35,145,437
------------ ------------ ------------
OPERATING EXPENSES:
Interest expense 20,069,282 17,423,341 20,068,167
Collection, general and administrative 13,741,836 10,646,814 8,894,760
Recovery of a special charge - (1,662,598) -
Provision for loan losses 3,100,524 2,612,361 2,077,588
Amortization of deferred financing costs 1,851,339 1,095,529 996,412
Depreciation 428,906 279,616 179,150
------------ ------------ ------------
39,191,887 30,395,063 32,216,077
------------ ------------ ------------
INCOME BEFORE PROVISION FOR INCOME
TAXES $ 10,987,815 $ 10,374,334 $ 2,929,360
============ ============ ============
52
MORTGAGE BANKING
2003 2002 2001
REVENUES:
Interest income $ 3,227,252 $ 3,293,289 $ 1,758,979
Purchase Discount 241,915 - -
Gain on sale of loans held for sale 3,236,616 2,259,979 842,051
Gain on sale of other real estate owned 31,231 - -
Other 649,843 519,772 216,891
------------- ------------- -------------
7,386,857 6,073,040 2,817,921
------------- ------------- -------------
OPERATING EXPENSES:
Interest expense 1,603,711 1,704,372 686,114
Collection, general and administrative 4,122,950 2,235,321 1,516,252
Provision for loan loss 63,579 101,503 109,865
Amortization of deferred financing costs 127,869 168,583 62,031
Depreciation 76,106 60,145 46,871
------------- ------------- -------------
5,994,215 4,269,924 2,421,133
------------- ------------- -------------
INCOME BEFORE PROVISION FOR INCOME
TAXES $ 1,392,642 $ 1,803,116 $ 396,788
============= ============= =============
CONSOLIDATED ASSETS:
Portfolio asset acquisition and resolution assets $ 428,436,923 $ 400,088,702 $ 303,705,008
Mortgage banking assets 48,296,423 24,330,332 29,520,868
------------- ------------- -------------
Consolidated assets $ 476,733,346 $ 424,419,034 $ 333,225,876
============= ============= =============
TOTAL ADDITIONS TO BUILDING, FURNITURE
AND FIXTURES:
Portfolio asset acquisition and resolution assets $ 503,221 $ 253,140 $ 471,402
Mortgage banking assets 147,637 42,314 37,320
------------- ------------- -------------
Consolidated additions to building,
furniture and fixtures $ 650,858 $ 295,455 $ 508,722
============= ============= =============
CONSOLIDATED REVENUE:
Portfolio asset acquisition and resolution $ 50,179,702 $ 40,769,397 $ 35,145,437
Mortgage banking 7,386,857 6,073,040 2,817,921
------------- ------------- -------------
Consolidated Revenue $ 57,566,559 $ 46,842,437 $ 37,963,358
============= ============= =============
CONSOLIDATED NET INCOME :
Portfolio asset acquisition and resolution $ 5,933,419 $ 5,671,774 $ 2,485,360
Mortgage banking 752,038 991,676 396,788
------------- ------------- -------------
Consolidated Net Income $ 6,685,457 $ 6,663,450 $ 2,882,148
============= ============= =============
53
10. CERTAIN CONCENTRATIONS
The following table summarizes certain information and locations of
mortgage loans as of December 31, 2003:
California $76,547,084 15.23%
New York 40,180,064 8.00%
Georgia 37,091,524 7.38%
Florida 34,664,408 6.90%
Texas 23,957,617 4.77%
Michigan 18,565,089 3.69%
Pennsylvania 18,239,588 3.63%
New Jersey 17,939,188 3.57%
Ohio 17,746,000 3.53%
Illinois 17,257,437 3.43%
Maryland 13,859,712 2.76%
North Carolina 13,122,603 2.61%
Arizona 10,390,790 2.07%
All others 162,999,602 32.43%
------------ ------
Total $502,560,706 100.00%
============ ======
Such real estate notes receivable and loans held are collateralized by
real estate with a concentration in these regions. Accordingly, the
collateral value of a substantial portion of the Company's real estate
notes receivable and real estate acquired through foreclosure is
susceptible to changes in market conditions in these regions. In the
event of sustained adverse economic conditions, it is possible that the
Company could experience a negative impact in its ability to collect on
existing loans, or liquidate foreclosed assets in these regions, which
could impact the Company's related loan loss estimates.
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 Agreements - Effective April 1, 2002, the Company entered
into a three-year employment agreement with its Chief Operating
Officer. The agreement provides for, among other things, a stipulated
base salary, and share in a bonus pool of up to 10.0% of the Company's
net income in excess of $500,000.
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 share
in a bonus pool of up to 10% 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 at
December 31, 2003 are as follows:
54
YEAR ENDED AMOUNT
2004 $ 514,269
2005 535,056
2006 547,888
2007 483,697
2008 208,456
Thereafter 37,800
-----------
$ 2,327,166
===========
Capital Leases - Certain office equipment is leased under capital
leases. The combined future minimum lease payments at December 31, 2003
are as follows:
YEAR ENDED AMOUNT
2004 $ 162,859
2005 162,859
2006 154,609
-----------
$ 480,327
===========
Legal Actions - The Company is involved in legal proceedings and
litigation arising in the ordinary course of business. In the opinion
of management, the outcome of such proceedings and litigation currently
pending will not materially affect the Company's financial statements.
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
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, 2003 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, 2003 the remaining
obligation under the recourse provision was approximately $28,938.
During the year the Company sold $2,730,605 of loans to one investor
and retained the servicing rights. SFAS 140 requires that entities that
acquire servicing assets through either purchase or origination of
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loans and sell or securitize those loans with servicing assets retained
must allocate the total costs of the loans to the servicing assets and
the loans (without the servicing assets) based on their relative fair
values. The amount attributable to the servicing assets was determined
to be $20,480 and is capitalized as a servicing asset in other assets
in the consolidated balance sheet.
As of December 31, 2003 the unpaid balances of the above mortgage loans
being serviced by the Company were $3,574,724. Mortgage loans serviced
for others are not included in the Company's consolidated balance
sheet.
12. RELATED PARTY TRANSACTIONS
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, 2004. The Company and Mr. Axon extended the note
until April 2004. 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 and was extended until April 2004.
At December 31, 2003, the Company is due a receivable from an
affiliate, RMTS Associates, of $62,481. This receivable represents
various shared operating expenses that are paid for by the Company and
then reimbursed by RMTS.
On March 31, 1999, Mr. Steven W. Leftkowitz, a board member and
stockholder, purchased from the Company without recourse a note held by
the Company. The consideration given included a note for $270,000 of
indebtedness to the Company. The note bears interest at a rate of 8%
per annum payable monthly and is secured by a mortgage on real estate.
This note was paid of on March 31, 2004.
13. SUMMARY OF QUARTERLY RESULTS (UNAUDITED)
The table below sets forth selected unaudited financial information for
each quarter of the last two fiscal years. 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.
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2003
Revenue $ 13,939,228 $ 13,957,953 $ 14,057,724 $ 15,611,654
Operating expenses 10,517,883 11,246,377 11,386,400 12,035,442
------------ ------------ ------------ ------------
Income before income taxes $ 3,421,345 $ 2,711,576 $ 2,671,324 $ 3,576,212
------------ ------------ ------------ ------------
Provision for Income taxes 1,573,800 1,282,500 1,215,900 1,622,800
------------ ------------ ------------ ------------
Net Income $ 1,847,545 $ 1,429,076 $ 1,455,424 $ 1,953,412
============ ============ ============ ============
Income per common share
Basic $ 0.31 $ 0.24 $ 0.25 $ 0.33
============ ============ ============ ============
Diluted $ 0.30 $ 0.22 $ 0.22 $ 0.30
============ ============ ============ ============
2002
Revenue $ 10,671,461 $ 11,306,298 $ 12,220,502 $ 12,644,176
Recovery of a special charge - 1,662,598 - -
Operating expenses $ 7,758,575 $ 8,848,584 $ 9,374,722 $ 10,345,704
------------ ------------ ------------ ------------
Income before income income taxes 2,912,886 4,120,312 2,845,780 2,298,472
Provision for Income taxes 1,354,500 1,854,250 1,280,601 1,024,649
------------ ------------ ------------ ------------
Net Income $ 1,558,386 $ 2,266,062 $ 1,565,179 $ 1,273,823
============ ============ ============ ============
Income per common share
Basic $ 0.26 $ 0.38 $ 0.26 $ 0.22
============ ============ ============ ============
Diluted $ 0.26 $ 0.36 $ 0.25 $ 0.20
============ ============ ============ ============
14. SUBSEQUENT EVENTS
The credit facility with the Senior Debt Lender was amended on February
28, 2004 and provides the Company with the ability to borrow up to an
aggregate of $550,000,000 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 $2,075,000 monthly, to fund
operations.
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