UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

 

First Investors Financial Services Group, Inc.

(Exact Name of Registrant as Specified in its Charter)

 

Texas		76-0465087
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)
675 Bering Drive, Suite 710 Houston, Texas		77057
(Address of Principal Executive Offices)		(Zip Code)
(713) 977-2600
(Registrant’s Telephone Number, Including Area Code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o.

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes o No ý.

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Class		Shares Outstanding At September 13, 2004
Common Stock-$.001 Par Value		5,000,269

 

 

FIRST INVESTORS FINANCIAL SERVICES GROUP, INC.

AND SUBSIDIARIES

 

FORM 10-Q

 

JULY 31, 2004

 

TABLE OF CONTENTS

 

Part I	Financial Information
	Item 1.	Financial Statements
		Consolidated Balance Sheets as of April 30, 2003 and July 31, 2004
		Consolidated Statements of Operations for the Three Months Ended July 31, 2003 and 2004
		Consolidated Statement of Shareholders’ Equity for the Three Months Ended July 31, 2004
		Consolidated Statements of Cash Flows for the Three Months Ended July 31, 2003 and 2004
		Notes to Unaudited Consolidated Financial Statements
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk
	Item 4.	Controls and Procedures
Part II	Other Information
	Item 6.	Exhibits and Reports On Form 8-K
Signatures

 

2

 

FIRST INVESTORS FINANCIAL SERVICES GROUP, INC. AND SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS — APRIL 30, 2004 AND JULY 31, 2004

 

		April 30, 2004			July 31, 2004
		(Audited)			(Unaudited)
ASSETS
Receivables Held for Investment, net		$	209,777,347		$	210,122,864
Receivables Acquired for Investment, net		1,190,230			992,072
Cash and Short-Term Investments, including restricted cash of $19,036,747 and $18,290,223		21,055,237			18,530,633
Accrued Interest Receivable		2,576,023			2,462,772
Assets Held for Sale		851,426			888,690
Other Assets:
Funds held under reinsurance agreement		4,182,134			4,377,302
Deferred financing costs and other assets, net of accumulated amortization and depreciation of $5,759,477 and $6,154,746		6,115,203			5,717,133
Current income taxes receivable		8,212			8,212
Interest rate derivative positions		—			115,344
Total assets		$	245,755,812		$	243,215,022
LIABILITIES AND SHAREHOLDERS’ EQUITY
Debt:
Warehouse credit facilities		$	42,705,810		$	61,670,082
Term Notes		164,718,190			142,966,523
Working capital facility		8,761,143			8,759,543
Other Liabilities:
Accounts payable and accrued liabilities		1,708,984			1,847,414
Current income taxes payable		—			22,822
Deferred income taxes payable		558,000			558,000
Total liabilities		218,452,127			215,824,384
Commitments and Contingencies		—			—
Shareholders’ Equity:
Common stock, $0.001 par value, 10,000,000 shares authorized, 5,583,669 issued; 5,000,269 outstanding at April 30, 2004 and at July 31, 2004		5,584			5,584
Additional paid-in capital		18,754,608			18,754,608
Retained earnings		10,515,258			10,602,211
Less, treasury stock, at cost, 583,400 and 583,400 shares		(1,971,765		)	(1,971,765		)
Total shareholders’ equity		27,303,685			27,390,638
Total liabilities and shareholders’ equity		$	245,755,812		$	243,215,022

 

The accompanying notes are an integral part of these consolidated financial statements.

 

3

 

FIRST INVESTORS FINANCIAL SERVICES GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

For the Three Months Ended July 31, 2003 and 2004

(Unaudited)

 

		For the Three Months Ended July 31,
		2003			2004
Interest Income		$	8,070,436		$	6,952,179
Interest Expense		2,017,971			1,776,773
Net interest income		6,052,465			5,175,406
Provision for Credit Losses		3,391,963			2,442,105
Net Interest Income After Provision for Credit Losses		2,660,502			2,733,301
Other Income:
Servicing revenue		1,274,632			969,955
Late fees and other		379,561			630,553
Income from investment		247,869			193,706
Other interest income		47,279			74,132
Unrealized gain/(loss) on interest rate derivative positions		142,757			(67,657		)
Total other income		2,092,098			1,800,689
Operating Expenses:
Salaries and benefits		2,218,389			2,063,445
Operating expense		1,072,374			1,298,790
General and administrative		995,283			922,821
Other interest expense		129,140			112,000
Total operating expenses		4,415,186			4,397,056
Income Before Provision for Income Taxes and Minority Interest		337,414			136,934
Provision (Benefit) for Income Taxes:
Current		(2,302		)	49,981
Deferred		128,804			—
Total provision for income taxes		126,502			49,981
Minority Interest		(9,167		)	—
Net Income		$	220,079		$	86,953
Basic and Diluted Net Income per Common Share		$	0.04		$	0.02

 

The accompanying notes are an integral part of these consolidated financial statements.

 

4

 

FIRST INVESTORS FINANCIAL SERVICES GROUP, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY

 

For the Three Months Ended July 31, 2004

(Unaudited)

 

		Common Stock			Additional Paid-In Capital			Retained Earnings			Treasury Stock, at cost			Total
Balance at April 30, 2004		$	5,584		$	18,754,608		$	10,515,258		$	(1,971,765	)	$	27,303,685
Net income		—			—			86,953			—			86,953
Balance at July 31, 2004		$	5,584		$	18,754,608		$	10,602,211		$	(1,971,765	)	$	27,390,638

 

The accompanying notes are an integral part of these consolidated financial statements.

 

5

 

FIRST INVESTORS FINANCIAL SERVICES GROUP, INC. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Three Months Ended July 31, 2003 and 2004

(Unaudited)

 

		2003			2004
Cash Flows From Operating Activities:
Net income		$	220,079		$	86,953
Adjustments to reconcile net income to net cash provided by operating activities —
Depreciation and amortization expense		944,893			1,002,154
Provision for credit losses		3,391,963			2,442,105
Minority interest		(9,167		)	—
(Increase) decrease in:
Accrued interest receivable		156,124			113,251
Restricted cash		298,799			746,524
Deferred financing costs and other assets		(52,116		)	(153,978		)
Funds held under reinsurance agreement		(328,008		)	(195,168		)
Current income tax receivable		(4,461		)	—
Interest rate derivative positions		1,011,996			(115,344		)
Increase (decrease) in:
Accounts payable and accrued liabilities		(30,761		)	138,430
Deferred income taxes payable		257,673			—
Current income taxes payable		—			22,822
Interest rate derivative positions		(1,283,184		)	—
Net cash provided by operating activities		4,573,830			4,087,749
Cash Flows From Investing Activities:
Origination of Receivables Held for Investment		(29,201,027		)	(29,210,448		)
Principal payments from Receivables Held for Investment		20,240,718			24,158,794
Principal payments from Receivables Acquired for Investment		339,463			198,158
Payments received on Assets Held for Sale		1,774,160			1,651,565
(Purchase) sale of furniture and equipment		(3,361		)	125,097
Net cash used in investing activities		(6,850,047		)	(3,076,834		)
Cash Flows From Financing Activities:
Proceeds from advances on—
Warehouse credit facilities		50,364,471			32,703,706
Principal payments made on—
Warehouse credit facilities		(35,932,938		)	(13,739,434		)
Term Notes		(11,488,004		)	(21,751,667		)
Working capital facility		(868,561		)	(1,600		)
Treasury stock purchased		(84,630		)	—
Net cash provided by (used in) financing activities		1,990,338			(2,788,995		)
Decrease in Cash and Short-Term Investments		(285,879		)	(1,778,080		)
Cash and Short-Term Investments at Beginning of Period		2,617,680			2,018,490
Cash and Short-Term Investments at End of Period		$	2,331,801		$	240,410
Supplemental Disclosures of Cash Flow Information:
Cash paid during the period for—
Interest		$	1,890,571		$	1,543,921
Income Taxes		2,158			—

 

The accompanying notes are an integral part of these consolidated financial statements

 

6

 

FIRST INVESTORS FINANCIAL SERVICES GROUP, INC. AND SUBSIDIARIES

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

July 31, 2004

1.              The Company

 

Organization.  First Investors Financial Services Group, Inc. (First Investors) was established to serve as a holding company for First Investors Financial Services, Inc. (FIFS) and FIFS’s wholly-owned subsidiaries, First Investors Insurance Company (FIIC), First Investors Auto Receivables Corporation (FIARC), F.I.R.C., Inc. (FIRC), First Investors Servicing Corporation (FISC), formerly known as Auto Lenders Acceptance Corporation (ALAC), FIFS Acquisition Funding Corp. LLC, Farragut Financial Corporation, and First Investors Auto Funding Corporation. First Investors, together with its wholly- and majority-owned subsidiaries, is hereinafter referred to as the Company.

 

FIFS began operations in May 1989 and is principally involved in the business of originating and holding for investment retail installment contracts and promissory notes secured by new and used automobiles originated by factory authorized franchised dealers or directly through consumers. As of July 31, 2004, approximately 28%, 19%, and 13% of receivables held for investment had been originated in Texas, Georgia, and Ohio, respectively. The Company currently operates in 28 states.

 

FIIC was organized under the captive insurance company laws of the state of Vermont for the purpose of reinsuring certain credit enhancement insurance policies that have been written by unrelated third party insurance companies.

 

On October 2, 1998, the Company completed the acquisition of FISC and the operations of FISC are included in the consolidated results of the Company since the date of acquisition. Headquartered in Atlanta, Georgia, FISC performed servicing and collection activities on a portfolio of receivables originated for investment as well as on a portfolio of receivables originated and sold pursuant to two asset securitizations. As a result of the acquisition, the Company increased the total dollar value on its balance sheet of receivables, acquired an interest in certain trust certificates related to the asset securitizations and acquired certain servicing rights along with furniture, fixtures, equipment and technology to perform the servicing and collection functions for the portfolio of receivables under management.

 

On August 8, 2000, the Company entered into a partnership agreement whereby a subsidiary of the Company was the general partner owning 70% of the partnership interests and First Union Investors, Inc. served as the limited partner and owned 30% of the partnership interests.  On September 19, 2003, First Investors Financial Services, Inc. purchased the limited partnership interests previously held by First Union Investors, Inc.  The Partnership consists primarily of a portfolio of loans previously owned or securitized by FISC and certain other financial assets including charged-off accounts owned by FISC.

 

On December 24, 2002, the Company purchased 40% of common stock and an investment in the junior mezzanine debt of First Auto Receivables Corporation (“FARC”).  FARC purchased an approximately $197.5 million portfolio of installment loan receivables from a subsidiary of Union Acceptance Corporation.  FISC performs ongoing servicing and collection activities on the portfolio.

 

On March 19, 2003, FISC entered into a servicing agreement with an unrelated third party to service an approximately $300 million portfolio of installment loan receivables purchased from a subsidiary of Union Acceptance Corporation.

 

In total, at July 31, 2004, FISC performs servicing and collection functions on a managed receivables portfolio of approximately $466 million.

 

7

 

2.              Interim Financial Information

 

Basis of Presentation.  The consolidated financial statements include the accounts of First Investors and its wholly-owned and majority-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. Investments in which the Company exercises significant influence, but which it does not control (generally a 20% to 50% ownership interest), are accounted for under the equity method of accounting, except for variable interest entities for which the Company is considered the primary beneficiary under Financial Accounting Standards Board (“FASB”) Interpretation No. 46, Consolidation of Variable Interest Entities, an interpretation of ARB No. 51, as amended in December 2003 by Interpretation 46R.  As of July 31, 2004, the Company does not have any entities under FIN 46 as amended by Interpretation 46R.

 

The results for the interim periods are not necessarily indicative of the results of operations that may be expected for the fiscal year. In the opinion of management, the information furnished reflects all adjustments which are of a normal recurring nature and are necessary for a fair presentation of the Company’s financial position as of July 31, 2004, and the results of its operations for the three months ended July 31, 2003 and 2004, and its cash flows for the three months ended July 31, 2003 and 2004.

 

The consolidated financial statements for the interim periods have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to make the information not misleading. These financial statements should be read in conjunction with the audited consolidated financial statements included in the Company’s 2004 Annual Report on Form 10-K filed July 26, 2004.

 

Receivables Held for Investment.  Receivables Held for Investment represents the aggregate outstanding balance of installment sales contracts and promissory notes originated by the Company through its automobile dealer relationships or directly with consumers.  The Company accrues interest income monthly using the effective interest method. Interest income also includes additional amounts received upon early payoffs of certain receivables attributable to the difference between the principal balance of the receivables calculated using the Rule of 78’s method and the principal balance of the receivables calculated using the effective interest method. When a receivable becomes 90 days past due, the income accrual is suspended until the payments become current. When a loan is charged off or the collateral is repossessed, the remaining income accrual is written off.

 

Receivables Acquired for Investment.  In connection with loans that were acquired in a portfolio purchase by the Partnership, the Company estimates the amount and timing of undiscounted expected future principal and interest cash flows. For certain purchased loans, the amount paid for a loan reflects the Company’s determination that it is probable the Company will be unable to collect all amounts due according to the loan’s contractual terms. Accordingly, at acquisition, the Company recognizes the excess of the loan’s scheduled contractual principal and contractual interest payments over its expected cash flows as an amount that should not be accreted. The remaining amount, representing the excess of the loan’s expected cash flows over the amount paid, is accreted into interest income over the remaining life of the loan.  As a result of the amortization of the outstanding principal balance of the receivables portfolio, the majority of the remaining cash flows projected constitute default collections from obligors.  Given the nature of the remaining cash flows of individual loans, the Company determined that the timing of collections on these assets are much more unpredictable than contractual cash flows from non-defaulted receivables, therefore in the periods subsequent to September 30, 2003 the Company follows the guidance provided by Practice Bulletin 6, Amortization of Discounts on Certain Acquired Loans, and accounts for these assets utilizing the cost-recovery method.  Under this method, cash proceeds from collections are applied to first reduce the Company’s basis in the assets.  Cash collected in excess of this cost basis is recognized as income when received.

 

Other Income.  Other Income consists of income received from servicing activities, late fees and other loan-related fees, income from investments, reinvestment revenue and unrealized gain or loss on interest rate derivative positions.  Servicing revenue is accrued as services are rendered. Late fees and other loan-related fees are

 

8

 

recognized when received.  Income from investments and reinvestment revenue are accrued based on the respective interest rate of such investment and unrealized gain or loss on interest rate derivatives is recognized as changes occur in the derivatives fair value.

 

Allowance for Credit Losses.  The Company calculates the allowance for credit losses in accordance with SFAS No. 5, Accounting for Contingencies.   SFAS No. 114, Accounting for Creditors for Impairment of a Loan does not apply to loans currently held by the Company because they are comprised of a large group of smaller balance homogenous loans that are evaluated collectively for impairment.

 

The Company initiates efforts to make customer contact when the customer is one day past due and becomes more aggressive as the loan becomes more delinquent.  Management reviews past due loans and considers various factors including payment history, job status and any events that may have occurred that prevent the customer from making a payment.  Through the evaluation, if it is determined that the loan is uncollectible, the collateral is typically repossessed.  Generally this occurs at 90 to 120 days past due.  Upon repossession, the uncollectible portion of the loan and 100% of accrued interest is written off.  The fair value of the collateral is recorded in Assets Held for Sale.  In the event the collateral is unable to be located, the Company will write off the entire balance after exhausting all collection efforts.

 

The Company applies a systematic methodology in order to determine the amount of the allowance for credit losses.  The specific methodology utilized is a six-month migration analysis whereby the Company compares the aging status of each loan from six months prior to the aging loan status as of the reporting date.  These factors are then applied to the aging status of each loan at the reporting date in order to calculate the number of loans that are expected to migrate to impaired status.  The estimated number of impairments is then multiplied by estimated loss per loan, which is based on historical information.  The computed reserve is then compared to the amount recorded for adequacy.  The Company compares the six-month result to prior six-month periods to compare trends and evaluate any other internal or external factors that may affect collectibility. The allowance for credit losses is based on estimates and qualitative evaluations, and ultimate losses will vary from current estimates. These estimates are reviewed periodically and as adjustments, either positive or negative, become necessary, are reported in earnings in the period they become known.

 

Stock-Based Compensation.  The Company has an employee stock option plan and a non-employee director stock option plan, which are described more fully in Note 9.  The Company has adopted the disclosure provisions of SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure, an amendment of FASB Statement No. 123. This pronouncement requires prominent disclosures in both annual and interim financial statements regarding the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company accounts for stock compensation awards under the intrinsic value method of Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees which requires compensation cost to be recognized based on the excess, if any, between the quoted market price of the stock at the date of grant and the amount an employee must pay to acquire the stock. All options awarded under the Company’s plan are granted with an exercise price equal to or greater than the fair market value on the date of the grant.

 

9

 

The following table presents the Company’s net income per share had the Company adopted the fair value method of accounting for stock-based compensation under SFAS No. 123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148.

 

		For the Three Months Ended July 31,
		2003			2004
Net Income as reported		$	220,079		$	86,953
Deduct: Total stock option plan compensation expense determined under fair value based method for awards granted, modified or settled, net of taxes		(10,504		)	(36,339		)
Pro Forma Net Income		$	209,575		$	50,614
Basic and Diluted Net Income per Common Share, as reported		$	0.04		$	.02
Basic and Diluted Net Income per Common Share, pro forma		$	0.04		$	.01

 

Reclassifications. Certain reclassifications have been made to the fiscal 2003 amounts to conform with the fiscal 2004 presentation.

 

3.              Receivables Held for Investment

 

The receivables generally have terms between 48 and 72 months and are collateralized by the underlying vehicles.  Net receivable balances consisted of the following at April 30, 2004 and July 31, 2004:

 

		April 30, 2004			July 31, 2004
Receivables		$	207,489,339		$	207,741,744
Unamortized premium and deferred fees (1)		4,487,394			4,583,182
Allowance for credit losses		(2,199,386		)	(2,202,062		)
Net receivables		$	209,777,347		$	210,122,864

 

(1)  Includes premium and discounts paid to dealer plus deferred acquisition cost.

 

Activity in the allowance for credit losses for the periods ended July 31, 2003 and 2004 was as follows:

 

		For the Three Months Ended July 31,
		2003			2004
Balance, beginning of period		$	2,397,216		$	2,199,386
Provision for credit losses		3,391,963			2,442,105
Charge-offs, net of recoveries		(3,362,057		)	(2,439,429		)
Balance, end of period		$	2,427,122		$	2,202,062

 

4.              Receivables Acquired for Investment

 

Receivables Acquired for Investment comprise loans previously originated by Auto Lenders Acceptance Corporation and other third parties.  Loans originated by Auto Lenders Acceptance Corporation include a portfolio of warehouse loans and a portfolio of loans that were previously securitized.  The securitized loans were subsequently redeemed and funded through one of the Company’s credit facilities.  Receivables Acquired for Investment previously originated by Auto Lenders Acceptance Corporation were purchased at a discount relating to credit quality.  As a result of the amortization of the outstanding principal balance of the receivables portfolio, the majority of the remaining cash flows projected constitute default collections from obligors.  Given the nature

 

10

 

of the remaining cash flows of individual loans, the Company determined that the timing of collections on Receivables Acquired for Investment was much more unpredictable than contractual cash flows from non-defaulted receivables.  Therefore, under the guidance provided by Practice Bulletin 6, Amortization of Discounts on Certain Acquired Loans, Receivables Acquired for Investment will be accounted for under the cost-recovery method beginning September 30, 2003.  Under this method, cash proceeds from collections are applied to first reduce the Company’s basis in the assets.  Cash collected in excess of this cost basis is recognized as income when received. Receivables Acquired for Investment previously originated by Auto Lenders Acceptance Corporation were $979,496 and $870,766 as of April 30, 2004 and July 31, 2004, respectively.

 

On September 30, 2003 the Company purchased $9.4 million of defaulted auto loan receivables from an unrelated third party.  These loans of $210,735 and $121,306 are included in Receivables Acquired for Investment on the balance sheet as of April 30, 2004 and July 31, 2004 respectively, and are accounted for using the cost-recovery method.  The Company may, from time to time, consider similar acquisitions in the future.

 

5.              Debt

 

The Company finances its loan origination through two warehouse credit facilities. The Company’s credit facilities provide for one-year terms and have been renewed annually. Management of the Company believes that the credit facilities will continue to be renewed or extended or that it would be able to secure alternate financing on satisfactory terms; however, there can be no assurance that it will be able to do so. In January 2002 the Company issued $159 million in asset-backed notes (“Term Notes”) secured by a discrete pool of receivables. On November 20, 2003, the Company issued $140 million in Term Notes secured by a discrete pool of receivables.  Substantially all receivables retained by the Company are pledged as collateral for the credit facilities and the Term Notes. The weighted average interest rate for the Company’s secured borrowings including the effect of program fees, dealer fees, and other comprehensive income (loss) amortization was 3.5% and 2.8% for the periods ended July 31, 2003 and 2004, respectively.

 

Warehouse Facilities as of July 31, 2004

 

Facility		Capacity			Outstanding			Interest Rate		Fees		Insurance		Borrowing Rate At July 31, 2004
FIARC		$	150,000,000		$	9,175,344		Commercial paper rate plus .3%		.25% of Unused Facility		.35	%	1.37	%
FIRC		$	65,000,000	(1)	$	52,494,738		Option of a) Base Rate, which is the higher of prime rate or fed funds plus .5% or b) LIBOR plus .5%		.25% of Unused Facility		See below		1.96	%

 

(1)                                  Increased from $50 million to $65 million in June, 2004, to allow for an increase in new loan originations.  Facility is scheduled to revert to $50 million on September 13, 2004.

 

11

 

Warehouse Facilities – Credit Enhancement as of July 31, 2004

 

Facility		Cash Reserve		Advance Rate		Insurance
FIARC		1% of outstanding receivables		94	%	Surety Bond
FIRC		1% of borrowings		100	%	Default Insurance (ALPI)

 

FIRC - In order to obtain a lower cost of funding, the Company has agreed to maintain credit enhancement insurance covering the receivables pledged as collateral under the FIRC credit facility. The facility lenders are named as additional insureds under these policies. The coverages are obtained on each receivable at the time it is purchased by the Company, and the applicable premiums are prepaid for the life of the receivable. Each receivable is covered by three separate credit insurance policies, consisting of basic default insurance under a standard auto loan protection policy (known as “ALPI” insurance) together with certain supplemental coverages relating to physical damage and other risks. Solely at its expense, the Company carries these coverages and neither the vehicle purchasers nor the dealers are charged for the coverages, nor are they usually unaware of their existence. The Company’s ALPI insurance policy is written by National Union Fire Insurance Company of Pittsburgh (“National Union”), which is a wholly-owned subsidiary of American International Group.

 

The premiums that the Company paid during the three months ended July 31, 2004 for its three credit enhancement insurance coverages, of which the largest component is basic ALPI insurance, represented approximately 3.7% of the principal amount of the receivables originated during the year. Aggregate premiums paid for ALPI coverage alone during the three months ended July 31, 2003 and 2004 were $714,470 and $1,071,409, respectively, and accounted for 2.4% and 3.7% of the aggregate principal balance of the receivables originated during such respective periods.

 

In April 1994, the Company organized First Investors Insurance Company (the “Insurance Subsidiary”) under the captive insurance company laws of the State of Vermont. The Insurance Subsidiary is an indirect wholly-owned subsidiary of the Company and is a party to a reinsurance agreement whereby the Insurance Subsidiary reinsures 100% of the risk under the Company’s ALPI insurance policy. At the time each receivable is insured by National Union, the risk is automatically reinsured to its full extent and approximately 96% of the premium paid by the Company to National Union with respect to such receivable is ceded to the Insurance Subsidiary. When a loss covered by the ALPI policy occurs, National Union pays it after the claim is processed, and National Union is then reimbursed in full by the Insurance Subsidiary.  In addition to the monthly premiums and liquidity reserves of the Insurance Subsidiary, a trust account is maintained by National Union to secure the Insurance Subsidiary’s obligations for losses it has reinsured.

 

The result of the foregoing reinsurance structure is that National Union, as the “fronting” insurer under the captive arrangement, is unconditionally obligated to the Company’s credit facility lenders for all losses covered by the ALPI policy, and the Company, through its Insurance Subsidiary, is obligated to indemnify National Union for all such losses. As of July 31, 2004, the Insurance Subsidiary had capital and surplus of $2,612,455 and unencumbered cash reserves of $1,383,013 in addition to the $3,274,011 trust account.

 

The ALPI coverage as well as the Insurance Subsidiary’s liability under the Reinsurance Agreement, remains in effect for each receivable that is pledged as collateral under the warehouse credit facility. Once receivables are transferred from FIRC to FIARC and financed under the commercial paper facility, ALPI coverage and the Insurance Subsidiary’s liability under the Reinsurance Agreement is cancelled with respect to the transferred receivables. Any unearned premium associated with the transferred receivables is returned to the Company. The Company believes the losses its Insurance Subsidiary will be required to indemnify will be less than the premiums ceded to it. However, there can be no assurance that losses will not exceed the premiums ceded and the capital and surplus of the Insurance Subsidiary.

 

12

 

FIARC – Credit Enhancement for the FIARC warehouse facility is provided to the commercial paper investors by a cash reserve account equal to 1% of the receivables held by FIARC and, additionally, a surety bond issued by MBIA. The Company is not a guarantor of, or otherwise a party to, such commercial paper.

 

Warehouse Facilities – Agents and Expirations

 

Facility		Agent		Expiration		Event if not Renewed
FIARC		Wachovia		December 2, 2004		Receivables pledged would be allowed to amortize; however, no new receivables would be allowed to transfer from the FIRC facility
FIRC		Wachovia		December 2, 2004		Convert to a term loan which would mature six months thereafter and amortize monthly in accordance with the borrowing base with the remaining balance due at maturity

 

On December 4, 2003, the FIRC facility was renewed, under similar terms and conditions, at the $50 million commitment level until December 2, 2004.  On June 15, 2004, the FIRC facility was extended to $65 million,  reverting back to $50 million on September 13, 2004.  On January 29, 2004, following a short-term extension of the original maturity date, the FIARC facility was renewed, under similar terms and conditions, to December 2, 2004.  As of April 30, 2004 and July 31, 2004, there was $0 and $9.2 million, respectively outstanding.

 

Management presently intends to seek further extensions to these warehouse facilities prior to the current expiration dates.  Management further considers its relationship with its lenders to be satisfactory and has no reason to believe that the FIRC and FIARC facilities will not be renewed at each of their respective expiration dates.

 

The following table contains pertinent information on the Term Notes as of July 31, 2004.

 

Term Notes		Issuance Date		Issuance Amount			Maturity Date		Outstanding			Interest Rate
2002-A		January 29, 2002		$	159,036,000		December 15, 2008		$	36,395,776		3.46	%
2003-A		November 11, 2003		$	139,661,000		April 20, 2011		$	106,570,747		2.58	%

 

Credit enhancement on the two Term Notes is as follows:

 

Facility		Cash Reserve		Advance Rate		Insurance
2002-A		2% of Initial Pool Balance including Pre-Funding Amount		99% initial advance decreasing to 97%		Surety Bond
2003-A		0.5% of Initial Pool Balance increasing to 2% of Initial Pool Balance including Pre-Funding Amount		96.5% initial advance decreasing to 96.1%		Surety Bond

 

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Term Notes - - On January 29, 2002, the Company, through its indirect, wholly-owned subsidiary First Investors Auto Owner Trust 2002-A (“2002 Auto Trust”) completed the issuance of $159,036,000 of 3.46% Class A asset-backed notes (“2002-A Term Notes”). The initial pool of automobile receivables transferred to the 2002 Auto Trust totaled $135,643,109, which was previously owned by FIRC and FIARC, secure the 2002-A Term Notes.  In addition to the issuance of the Class A Notes, the 2002 Auto Trust also issued $4,819,000 in Class B Notes that were retained by the Company and pledged to secure the Working Capital Facility as further described below.  Proceeds from the issuance, which totaled $159,033,471 were used to (i) fund a $25,000,000 pre-funding account to be used for future loan originations; (ii) repay all outstanding borrowings under the FIARC commercial paper facility, (iii) reduce the outstanding borrowings under the FIRC credit facility, (iv) pay transaction fees related to the 2002-A Term Note issuance, and (v) fund a cash reserve account of 2% or $2,712,862 of the initial receivables pledged which will serve as a portion of the credit enhancement for the transaction. The Class A Term Notes bear interest at 3.46% and requires monthly principal reductions sufficient to reduce the balance of the Class A Term Notes to 97% of the outstanding balance of the underlying receivables pool. The final maturity of the 2002-A Term Notes is December 15, 2008.    The Class B Notes do not bear interest but require principal reductions sufficient to reduce the balance of the Class B Notes to 3% of the outstanding balance of the underlying receivables pool.  A surety bond issued by MBIA Insurance Corporation provides credit enhancement for the Class A Notes.  In the event that certain asset quality covenants are not met, the reserve account target level will increase to 6% of the then current principal balance of the receivables pool.  As of April 30, 2004 and July 31, 2004, the outstanding principal balances on the 2002-A Term Notes were $44,335,659 and $36,395,776 respectively.

 

On November 20, 2003, the Company, through its indirect, wholly-owned subsidiary First Investors Auto Owner Trust 2003-A (“2003 Auto Trust”) completed the issuance of $139,661,000 of 2.58% Class A asset-backed notes (“2003-A Term Notes”). The initial pool of automobile receivables transferred to the 2003 Auto Trust totaled $114,726,891, which was previously owned by FIRC and FIARC, secure the 2003-A Term Notes.  In addition to the issuance of the Class A Notes, the 2003 Auto Trust also issued $5,065,891 in Class B Notes that were retained by the Company and pledged to secure the Working Capital Facility as further described below.  Proceeds from the issuance, which totaled $139,656,629 were used to (i) fund a $30,000,000 pre-funding account to be used for future loan originations; (ii) repay all outstanding borrowings under the FIARC commercial paper facility, (iii) reduce the outstanding borrowings under the FIRC credit facility, (iv) pay transaction fees related to the 2003-A Term Note issuance, and (v) fund an initial cash reserve account of 0.5% or $573,635 of the initial receivables pledged.  The Class A Term Notes bear interest at 2.58% and requires monthly principal reductions sufficient to reduce the balance of the Class A Term Notes to 96.1% of the outstanding balance of the underlying receivables pool. The final maturity of the 2003-A Term Notes is April 20, 2011.  The Class B Notes do not bear interest but require principal reductions sufficient to reduce the balance of the Class B Notes to 3.9% of the outstanding balance of the underlying receivables pool.  A surety bond issued by MBIA Insurance Corporation provides credit enhancement for the Class A Notes.  In the event that certain asset quality covenants are not met, the reserve account target level will increase to 6% of the then current principal balance of the receivables pool.  As of April 30, 2004 and July 31, 2004, the outstanding principal balances on the 2003-A Term notes were $120,382,531 and $106,570,747 respectively.

 

Working Capital Facility.  On December 6, 2001, the Company entered into an agreement with Wachovia Securities to refinance the $11,175,000 outstanding balance of the working capital term loan previously provided by Bank of America and Wachovia and increase the size of the facility to $13.5 million.  The renewal facility was provided to a special-purpose, wholly-owned subsidiary of the Company, First Investors Residual Funding LP.   The facility originally consisted of a $9 million revolving tranche and a $4.5 million term loan tranche which amortizes monthly.  The term loan tranche of this working capital facility was evidenced by the Class B Notes issued in conjunction with the 2002 Auto Trust financing. The remaining $9 million of the $13.5 million working capital facility revolves monthly in accordance with a borrowing base consisting of the over-collateralization amount and reserve accounts for each of the Company’s other credit facilities.  The facility is secured solely by the residual cash flow and cash reserve accounts related to the Company’s warehouse credit facilities, the acquisition facility and the existing and future term note facilities.  During 2002, the facility was modified to increase the interest rate from LIBOR plus 1.5% to LIBOR plus 2.25%.  The commitment fee paid on the total available amount of the facility was maintained at 1.5%.    In addition, the monthly principal amortization under

 

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the term loan tranche was increased to the greater of $250,000 or the principal distributions made under the Class B Notes issued under the 2002 Auto Trust financing.  On December 4, 2003, the Working Capital Facility was extended to December 2, 2004.  Under the terms of the extension, the monthly amortization requirement was replaced with the requirement that outstandings under the facility could not exceed the lesser of a borrowing base or the $9 million facility limit.  At April 30, 2004 and July 31, 2004, there was $8,761,143 and $8,759,543 respectively, outstanding under this facility.

 

The Company presently intends to seek a renewal of the working capital facility from its lender prior to maturity.  Should the facility not be renewed, the outstanding balance of the receivables would be amortized in accordance with the borrowing base.  Management considers its relationship with its lenders to be satisfactory and has no reason to believe that this credit facility will not be renewed.  If the facility is not renewed, however, or if material changes are made to its terms and conditions, it could have a material adverse effect on the Company.

 

Shareholder Loans.  On December 3, 2001 the Company entered into an agreement with one of its shareholders who is a member of its Board of Directors under which the Company may, from time to time, borrow up to $2.5 million.  The proceeds of the borrowings will be utilized to fund certain private and open market purchases of the Company’s common stock pursuant to a Stock Repurchase Plan authorized by the Board of Directors and for general corporate purposes.  Borrowings under the facility bear interest at a fixed rate of 10% per annum.  The facility is unsecured and expressly subordinated to the Company’s senior credit facilities. The facility matures on December 3, 2008 but may be repaid at any time unless the Company is in default on one of its other credit facilities.  There were no amounts outstanding under this facility as of April 30, 2004 and July 31, 2004 respectively.

 

Loan Covenants.  The documentation governing these credit facilities and Term Notes contains numerous covenants relating to the Company’s business, the maintenance of credit enhancement insurance covering the receivables (if applicable), the observance of certain financial covenants, the avoidance of certain levels of delinquency experience and other matters. The breach of these covenants, if not cured within the time limits specified, could precipitate events of default that might result in the acceleration of the FIRC credit facility, the Term Notes and the working capital facility or the termination of the commercial paper facilities. The Company was not in default with respect to any financial covenants governing these financing arrangements at July 31, 2004.

 

Interest Rate Management.  The Company’s warehouse credit facilities and working capital facilities bear interest at floating interest rates which are reset on a short-term basis while the secured Term Notes bear interest at a fixed rate of interest. The Company’s receivables bear interest at fixed rates that do not generally vary with a change in market interest rates. Since a primary contributor to the Company’s profitability is its ability to manage its net interest spread, the Company seeks to maximize the net interest spread while minimizing exposure to changes in interest rates. In connection with managing the net interest spread, the Company may periodically enter into interest rate swaps or caps to minimize the effects of market interest rate fluctuations on the net interest spread. To the extent that the Company has outstanding floating rate borrowings or has elected to convert a portion of its borrowings from fixed rates to floating rates, the Company will be exposed to fluctuations in short-term interest rates.

 

During June 2004, as a requirement of the FIARC commercial paper facility, the Company entered into an interest rate cap transaction with a rate cap of 5%, with a notional balance that amortizes over six years, for a total purchase price of $183,000.  The interest rate cap was not designated as a hedge, and accordingly, changes in the fair value of the interest rate caps are recorded as unrealized gains or losses and reflected in net income.  As of July 31, 2004, the value of the interest rate cap is $115,343 and is recorded under other assets as interest rate derivative positions.  During the quarter ended July 31, 2004, the Company recorded an unrealized loss of $67,657 that is included as a separate caption of other income.

 

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During fiscal year 2004, as a requirement of the FIARC commercial paper facility, the Company entered into various interest rate cap transactions at cap rates ranging from 6.5% to 7.5% with a notional balance that amortized over five to six year periods. The interest rate caps were not designated as hedges and, accordingly, changes in the fair value of the interest rate caps are recorded as unrealized gains or losses and reflected in net income.  On December 2, 2003, the Company terminated all interest rate caps outstanding in exchange for proceeds of $356,000.  The caps were terminated following the repayment of all outstandings under the FIARC facility following the issuance of the 2003-A Term Notes.  As a result, a realized loss of $14,000 was incurred relative to the aggregate market value of the interest rate caps.

 

On June 1, 2001, the Company entered into interest rate swaps with an aggregate notional amount of $100 million and a maturity date of April 15, 2004.  Under the terms of these swaps, the Company will pay a floating rate based on one month LIBOR and receive a fixed rate of 5.025%.  Management elected to enter into these swap agreements to offset the uneconomical position of the existing pay fixed swap created by rapidly declining market interest rates.  In connection with the decision to enter into the $100 million floating rate swap, the Company elected to change the designation of the $100 million fixed rate swap from a cash flow hedge and not account for the instrument as a hedge under SFAS No. 133.   As a result, the change in fair value of the swaps is reflected in net income for periods subsequent to May 31, 2001.

 

6.              Earnings Per Share

 

Earnings per share amounts are based on the weighted average number of shares of common stock and potential dilutive common shares outstanding during the period. The weighted average number of shares used to compute basic and diluted earnings per share for the three months ended July 31, 2003 and 2004, are as follows:

 

		For the Three Months Ended July 31,
		2003		2004
Weighted average shares:
Weighted average shares outstanding for basic earnings per share		5,023,758		5,000,269
Effect of dilutive stock options and warrants		47,238		147,989
Weighted average shares outstanding for diluted earnings per share		5,070,996		5,148,258

 

For the three months ended July 31, 2003 and 2004, the Company had 575,987 and 838,998 respectively, of stock options and stock warrants which were not included in the computation of diluted earnings per share because to do so would have been antidilutive for the period presented.

 

7.              Investment in First Auto Receivables Corporation

 

On December 24, 2002, the Company invested $475,061 for a 40% ownership interest in First Auto Receivables Corporation (“FARC”) and $712,591 for junior mezzanine investments of FARC.  FARC purchased a $197.5 million automobile loan portfolio from UAFC-2 Corporation, a subsidiary of Union Acceptance Corporation, with proceeds from $186 million in senior bridge debt, $8.9 million of senior mezzanine debt, $1.8 million of junior mezzanine debt and $1.2 million of equity.   The bridge debt interest rate is LIBOR plus 1%, the senior mezzanine interest rate is 22.5% and the junior mezzanine interest rate is 25%.

 

The Company accounts for its ownership investment in FARC using the equity method in accordance with APB Opinion 18.  In addition to the equity and debt investments, the Company performs loan servicing and collection activities on the portfolio.  For the three months ended July 31, 2003 and 2004, the Company recognized $371,803 and $263,087 respectively of servicing revenue, $0 and $27,473 of interest income respectively, and $247,869 and $193,706 respectively of equity in the income from investment in FARC.  For the

 

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three months ended July 31, 2004, the equity investment in FARC of $968,327 and junior mezzanine debt of $716,675 are included in Deferred Financing Costs and Other Assets on the balance sheet.

 

8.              New Accounting Pronouncements

 

In December 2003, the American Institute of Certified Public Accountants issued Statement of Position (SOP) 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer. SOP 03-3 addresses the accounting for loans acquired through a transfer (including a business combination) that have differences between their expected cash flows and their contractual cash flows, due in part to credit quality. The SOP requires that the excess of the expected cash flows at acquisition to be collected over the acquirer’s initial investment be recognized on a level-yield basis over the loan’s life. Any future excess of contractual cash flows over the original expected cash flows is recognized as a future yield adjustment. Future decreases in actual cash flows over the original expected cash flows are recognized as impairment and expensed immediately. Valuation allowances can not be created or “carried over” in the initial accounting for loans acquired that are within the scope of the SOP. SOP 03-3 is effective for loans acquired in fiscal years beginning after December 15, 2004.  The Company does not anticipate SOP 03-3 will have a material effect on its financial statements.

 

9.              Shareholders’ Equity

 

Preferred Stock.  The Company has authorized 1,000,000 shares of preferred stock with a $1.00 par value.  As of July 31, 2004, no shares have been issued.

 

Employee Stock Option Plan. In June 1995, the Board of Directors adopted the Company’s 1995 Employee Stock Option Plan (the Plan). The Plan is administered by the Compensation Committee of the Board of Directors and provides that options may be granted to officers and other key employees for the purchase of up to 300,000 shares of common stock, subject to adjustment in the event of certain changes in capitalization. On September 10, 2002, the number of shares of common stock available for issuance was increased to 500,000. Options may be granted either as incentive stock options (which are intended to qualify for certain favorable tax treatment) or as non-qualified stock options.  The Compensation Committee selects the persons to receive options and determines the exercise price, the duration, any conditions on exercise and other terms of the options. In the case of options intended to be incentive stock options, the exercise price may not be less than 100% of the fair market value per share of common stock on the date of grant. With respect to non-qualified stock options, the exercise price may be fixed as low as 50% of the fair market value per share at the time of grant. In no event may the duration of an option exceed 10 years and no option may be granted after the expiration of 10 years from the adoption of the Plan. As of April 30, 2004 and July 31, 2004, a total of 282,500 and 373,000, respectively, options had been issued and remained outstanding leaving a remaining 217,500 and 127,000, respectively, available under the plan.

 

The exercise price of the option is payable in full upon exercise and payment may be in cash, by delivery of shares of common stock (valued at their fair market value at the time of exercise), or by a combination of cash and shares. At the discretion of the Compensation Committee, options may be issued in tandem with stock appreciation rights entitling the option holder to receive an amount in cash or in shares of common stock, or a combination thereof, equal in value to any increase since the date of grant in the fair market value of the common stock covered by the option.

 

Non-Employee Director Stock Option Plan - In September 2002, the Non-Employee Stock Option Plan was established to further align the interests of the Company’s directors with the interests of the shareholders, as well as attracting and retaining qualified directors.   The Board of Directors administers the plan and the options will not be qualified as incentive stock options.  A total of 500,000 shares of common stock are available for issuance.  Option types will be automatic and discretionary.   Automatic grants of 20,000 shares for each non-employee director, or 100,000 shares total, were approved in September 2002.  Subsequent automatic grants of an option to purchase 20,000 shares shall be made to each non-employee director on July 15^th each year, beginning July 15, 2003. The plan also gives the Board of Directors discretionary authority to provide for additional option grants if the Company’s annual financial performance exceeds parameters established by the Board.  No discretionary grants have been awarded.  As of April 30, 2004 and July 31, 2004, a total of 270,000 and 390,000, respectively,

 

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options had been issued under the plan, leaving a remaining 230,000 and 110,000, respectively, available for issuance.  In addition to the options granted above, there were an additional 20,000 options granted to a director in 1995, before the adoption of the Non-Employee Stock Option Plan.

 

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ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Critical Accounting Policies

 

Financial Reporting Release No. 60, which was issued by the Securities and Exchange Commission (“SEC”), requires all registrants to discuss critical accounting policies or methods used in the preparation of financial statements.  Note 2 to the consolidated financial statements includes a summary of the significant accounting policies and methods used in the preparation of the Company’s consolidated financial statements.

 

The preparation of financial statements includes the use of estimates and assumptions that affect the reported amounts of assets and liabilities and the reported amounts of net revenues and expenses during the reporting periods. The following is a review of the more significant assumptions and estimates, as well as the accounting policies and methods used in the preparation of the consolidated financial statements.

 

Receivables Held for Investment.  The Company accrues interest income monthly using the effective interest method. Interest income also includes additional amounts received upon early payoffs of certain receivables attributable to the difference between the principal balance of the receivables calculated using the Rule of 78’s method and the principal balance of the receivables calculated using the effective interest method. When a receivable becomes 90 days past due, the income accrual is suspended until the payments become current. When a loan is charged off or the collateral is repossessed, the remaining income accrual is written off.

 

Receivables Acquired for Investment.  The Company estimates the amount and timing of undiscounted expected future principal and interest cash flows. For certain purchased loans, the amount paid for a loan reflects the Company’s determination that it is probable the Company will be unable to collect all amounts due according to the loan’s contractual terms. Accordingly, at acquisition, the Company recognizes the excess of the loan’s scheduled contractual principal and contractual interest payments over its expected cash flows as an amount that should not be accreted. The remaining amount, representing the excess of the loan’s expected cash flows over the amount paid, is accreted into interest income over the remaining life of the loan.  As a result of the amortization of the outstanding principal balance of the receivables portfolio, the majority of the remaining cash flows projected constitute default collections from obligors.  Given the nature of the remaining cash flows, the Company determined that the timing of collections on these assets are much more unpredictable than contractual cash flows from non-defaulted receivables, therefore; in the periods subsequent to September 30, 2003 the Company follows the guidance provided by Practice Bulletin 6, Amortization of Discounts on Certain Acquired Loans, and accounts for these assets utilizing the cost-recovery method.  Under this method, cash proceeds from collections are applied to first reduce the Company’s basis in the assets.  Cash collected in excess of this cost basis is recognized as income when received.

 

Other Income.  Other Income consists of income received from servicing activities, late fees and other loan-related fees, income from investments, reinvestment revenue and unrealized loss on interest rate derivative positions.  Servicing revenue is accrued as services are rendered. Late fees and other loan-related fees are recognized when received.  Income from investments and reinvestment revenue are accrued based on the respective interest rate of such investment and unrealized loss on interest rate derivatives is recognized when incurred.

 

Allowance for Credit Losses.  The Company calculates the allowance for credit losses in accordance with SFAS No. 5, Accounting for Contingencies.   SFAS No. 114, Accounting for Creditors for Impairment of a Loan does not apply to loans currently held by the Company because they are composed of a large group of smaller balance homogenous loans that are evaluated collectively for impairment.

 

The Company initiates efforts to make customer contact when the customer is one day past due and become more aggressive as the loan becomes further past due.  Management reviews past due loans and considers various factors including payment history, job status and any events that may have occurred that prevent the customer from making a payment.  Through the evaluation, if it is determined that the loan is uncollectible, the collateral is typically repossessed.  Generally this occurs when a loan is 90 to 120 days past due.   Upon repossession, the

 

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uncollectible portion of the loan and 100% of accrued interest is written off.  The fair value of the collateral is recorded as an Assets Held for Sale.  Fair value is determined by estimating the proceeds of the collateral, which primarily are composed of auction proceeds on the sale of the automobile less selling related expenses.  After collection of all proceeds, the Company records an adjustment, positive or negative, based on the difference between the fair value estimate and the true proceeds received.   In the event the collateral is unable to be located, the Company will write off the entire balance after exhausting all collection efforts.

 

The Company applies a systematic methodology in order to determine the amount of the allowance for credit losses.  The specific methodology utilized is a six-month migration analysis whereby the Company compares the aging status of each loan from six months prior to the aging loan status as of the reporting date.  These factors are then applied to the aging status of each loan at the reporting date in order to calculate the number of loans that are expected to migrate to impaired status.  The estimated number of impairments is then multiplied by the estimated loss per loan, which is based on historical information.  The computed reserve is then compared to the amount recorded for adequacy.  The Company compares the six-month result to prior six-month periods to compare trends and evaluate any other internal or external factors that may affect collectibility. The allowance for credit losses is based on estimates and qualitative evaluations and ultimate losses will vary from current estimates. These estimates are reviewed periodically and as adjustments, either positive or negative, become necessary, are reported in earnings in the period they become known.

 

Stock-Based Compensation.  The Company has an employee stock option plan and a non employee director stock option plan. The Company has adopted the disclosure provisions of SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure, an amendment of FASB Statement No. 123. This pronouncement requires prominent disclosures in both annual and interim financial statements regarding the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company accounts for stock compensation awards under the intrinsic value method of Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees which requires compensation cost to be recognized based on the excess, if any, between the quoted market price of the stock at the date of grant and the amount an employee must pay to acquire the stock. All options awarded under the Company’s plan are granted with an exercise price equal to or greater than the fair market value on the date of the grant.

 

Managed Receivables

 

The Company’s managed receivables are (dollars in thousands):

 

		As of or for the Three Months Ended July 31,
		2003			2004
Receivables Held for Investment:
Number		18,497			16,226
Principal balance		$	228,973		$	207,742
Average principal balance of receivables outstanding during the three-month period		$	227,982		$	206,950
Receivables Acquired for Investment:
Number		250			654
Principal balance		$	499		$	992
Other Servicing:
Number		24,135			17,363
Principal balance		$	388,956		$	257,164
Total Managed Receivables Portfolio:
Number		42,882			34,243
Principal balance		$	618,429		$	465,898
Average principal balance of receivables outstanding during the three-month period		$	639,301		$	478,580

 

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The following table sets forth information with regard to the Company’s net interest spread, which represents the difference between the effective yield on Receivables Held for Investment and the Company’s average cost of debt utilized to fund these receivables, and its net interest margin (averages based on month-end balances):

 

		Three Months Ended July 31,
		2003		2004
Receivables Held for Investment:
Effective yield on Receivables Held for Investment (1)		14.2	%	13.4	%
Average cost of debt (2)		3.5	%	3.4	%
Net interest spread (3)		10.7	%	10.0	%
Net interest margin (4)		10.6	%	10.0	%

 

(1)                                  Represents interest income as a percentage of average Receivables Held for Investment outstanding.

 

(2)                                  Represents interest expense as a percentage of average debt outstanding.

 

(3)                                  Represents yield on Receivables Held for Investment less average cost of debt.

 

(4)                                  Represents net interest income as a percentage of average Receivables Held for Investment outstanding.

 

Net interest income is the difference between interest earned from the receivables portfolio and interest expense incurred on the credit facilities used to acquire the receivables. Net interest income was $5.2 million for the three months ended July 31, 2004, a decrease of 14% when compared to amounts reported for the three months ended July 31, 2003.

 

The amount of net interest income is the result of the relationship between the average principal amount of receivables held and average rate earned thereon and the average principal amount of debt incurred to finance such receivables and the average rates paid thereon. Changes in the principal amount and rate components associated with the receivables and debt can be segregated to analyze the periodic changes in net interest income. The following table analyzes the changes attributable to the principal amount and rate components of net interest income (dollars in thousands):

 

		Three Months Ended July 31, 2003 to 2004
		Increase (Decrease) Due to Change in
		Average Principal Amount			Average Rate			Total Net Increase (Decrease)
Receivables Held for Investment:
Interest income		$	(382	)	$	(745	)	$	(1,127	)
Interest expense		(26		)	(215		)	(241		)
Net interest income		$	(356	)	$	(530	)	$	(886	)

 

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Results of Operations

 

Three Months Ended July 31, 2004 and 2003 (dollars in thousands)

 

Key Factors. The critical factors affecting the Company’s profitability during any period are (i) loan origination volume and the corresponding growth in Receivables Held For Investment; (2) the level of net interest spread, which is defined as the difference between the effective yield on receivables held for investment and the cost of funds under the Company’s credit facilities and securitizations utilized to finance these receivables; (3) the level of provision for credit losses; (4) the amount of income derived from other activities; and (5) the ability of the Company to control operating expenses relative to the total amount of the managed portfolio.

 

Executive Summary.  Net income for the three months ended July 31, 2004 was $87 compared to $220 for year the three months ended July 31, 2003.  Basic and diluted earnings per common share were $0.02 and $0.04 for the three months ended July 31, 2004 and July 31, 2003, respectively.  The decline in net income for the three months ended July 31, 2004 compared to July 31, 2003 is due to several factors including (i) a decline in effective yields, (ii) a decline in Receivables Held for Investment, (iii) a decline in loan servicing income and (iv) an unrealized gain on interest rate derivatives for the three months ended July 31, 2003 versus an unrealized loss for the three months ended July 31, 2004.

 

Interest Income. Interest income for the three months ended July 31, 2004 decreased to $6,952 compared to $8,070 for the three months ended July 31, 2003.

 

The level of interest income, a primary driver of financial results, is impacted by the average outstanding balance of the portfolio of Receivables Held for Investment, the weighted average interest rate on receivables originated by the Company, the mix of direct and indirect lending activities and the level of early prepayments and charge-offs.  Interest income on Receivables Held for Investment decreased 14% for the three months ended July 31, 2004 compared to the three months ended July 31, 2003.  The reduction in yield for the three months ended July 31, 2004 is due to (i) an increase in interest written-off for impaired loans (ii) a decrease of 63 basis points in the weighted average interest rate on the performing portfolio which reflects the Company’s increased focus on receivables originated directly to consumers which typically carry lower interest rates and (iii) a 9% decrease in the average portfolio outstanding for the period ended July 31, 2004 compared the period ended July 31, 2003.

 

Interest Expense. Interest expense for the three months ended July 31, 2004 decreased to $1,777 compared to $2,018 for the three months ended July 31, 2003. Interest expense on Receivables Held for Investment decreased 12% for the three months ended July 31, 2004.  The reduction in interest expense is primarily due to (i) the average debt outstanding decreased $24,686 or 11% for the three months ended July 31, 2004 compared to the three months ended July 31, 2003 as a result of a 9% decrease in the average portfolio of Receivables Held for Investment and (ii) the termination of swap agreements in April 2004. These events were partially offset by (i) the Company’s decision to lock in interest rates on $140 million of debt in November 2003 through the issuance of Term Notes to minimize the risk of future interest rate increases as longer term fixed rate Term Notes typically carry higher interest rates than shorter term floating rate debt and (ii) an increase in overall market interest rates as a result of the current economic environment and market rate increases adopted by the Federal Reserve System.

 

Provision for Credit Losses. The provision for credit losses for the three months ended July 31, 2004 decreased to $2,442 as compared to $3,392 for the three months ended July 31, 2003. The decrease in provision for credit losses is primarily due to (i) the Company’s assessment of economic conditions and the ability of customers to maintain comparable employment (ii) the decrease in the average Receivables Held for Investment of 9% and (iii) the increase in recovery rates on repossessions and defaults.

 

Net charge-offs for the three months ended July 31, 2004 decreased to $2,439 compared to $3,362 for the three months ended July 31, 2003.  The decrease in net charge-offs for the three months ended July 31, 2004 is primarily due to (i) a 9% decrease in the average Receivables Held for Investment (ii) a decrease in loss frequency and severity from repossessions and (iii) an increase in recoveries from defaulted loans.

 

The level of provision for credit losses is a key driver of overall financial performance and should be positively impacted by improvement in general economic conditions, improvements in wholesale used car prices and lower net losses resulting from stricter underwriting controls adopted by the Company during 2000 and 2001.

 

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Any additional economic deterioration or further decline in wholesale used car prices will negatively impact provision expense as will increases in the outstanding balance of receivables held for investment.

 

Servicing Revenue.  Servicing revenue decreased to $970 for the three months ended July 31, 2004 compared to $1.275 for three months ended July 31, 2003.  The decrease in servicing revenue for the three months ended July 31, 2004 is due to the decrease in principal balance of the servicing portfolio, partially offset by revenues related to an incentive servicing fee that were not present in 2003. Revenue derived from servicing activities will increase or decrease in direct proportion to the average outstanding balance of serviced receivables.

 

Late Fees and Other Income. Late fees and other income increased to $631 for the three months ended July 31, 2004, compared to $380 for the three months ended July 31, 2003.  The increase is attributable to (i) an increase in loans originated for a third party (ii) income received related to GAP insurance and extended service contracts sold to consumers in connection with the Company’s direct lending activities that were not present during the three months ended July 31, 2003, (iii) an increase in collection efforts and (iv) interest income from FARC which was not present during the three months ended July 31, 2003.

 

Late fees and other income are driven by a number of factors including overall delinquency rates, the percentage of customers utilizing electronic payment products and growth rates in the Company’s direct lending business which will affect the ability of the Company to generate fee income from marketing insurance and warranty products.

 

Unrealized (Loss)/Gain on Interest Rate Derivative Positions.  In conjunction with the adoption of SFAS 133, the Company is required to report the fair value of interest rate derivative positions.  An unrealized loss of $(68) for the three months ended July 31, 2004, compared to an unrealized gain of $143 for the three months ended July 31, 2003 are principally due to changes in the fair value of the Company’s derivative position.

 

Salaries and Benefit Expenses. Salaries and benefit expense decreased to $2,063 for the three months ended July 31, 2004, compared to $2,218 for the three months ended July 31, 2003.  The decrease is primarily due to (i) a decrease in staff associated with a decrease in the Company’s serviced portfolio, (ii) a decrease in overtime as the Company is maintaining a lower level of delinquent loans and (iii) a decrease in costs associated with new hires.

 

Operating Expenses. Operating expenses increased to $1,299 for the three months ended July 31, 2004, compared to $1,072 for the three months ended July 31, 2003.  An increase in printing, credit bureau and postage costs is due to the Company’s decision to grow the direct lending business in fiscal year 2005.  Overall operating expenses are generally correlated to the total number of receivables managed by the Company.

 

General and Administrative. General and administrative expenses decreased to $923 for the three months ended July 31, 2004, compared to $995 for the three months ended July 31, 2003.  The three months ended July 31, 2004 experienced a general decline in occupancy, travel, depreciation and amortization expense.  General and administrative costs tend to be more fixed in nature and not as dependent on the overall level of managed receivables.

 

Other Interest Expense. Other interest expense, related to working capital, decreased to $112 for the three months ended July 31, 2004, compared to $129 for the three months ended July 31, 2003. The decrease was primarily due to the shareholder loan having a $0 outstanding balance for the three months ended July 31, 2004, while there was an average balance of $747 outstanding for the three months ended July 31, 2003.

 

Liquidity and Capital Resources

 

Sources and Uses of Cash Flows.  The Company’s business requires significant cash flow to support its operating activities. The principal cash requirements include (i) amounts necessary to acquire receivables from dealers and fund required reserve accounts, (ii) amounts necessary to fund premiums for credit enhancement insurance or other credit enhancement required by the Company’s financing programs, and (iii) amounts necessary to fund costs to retain receivables, primarily interest expense. The Company also requires a significant amount of cash flow for working capital to fund fixed operating expenses, primarily salaries and benefits.

 

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The Company’s most significant cash flow requirement is for the origination of receivables. The Company originated $29.2 million of receivables to be held for investment for the three months ended July 31, 2004 compared to $29.2 million for the three months ended July 31, 2003.

 

The Company funds loan originations through a combination of two warehouse credit facilities. The FIRC credit facility generally permits the Company to borrow up to the outstanding principal balance of qualified receivables, not to exceed $65 million.  Receivables that have accumulated in the FIRC credit facility may be transferred to the FIARC commercial paper facility at the option of the Company. The FIARC commercial paper facility provides an additional financing source of up to $150 million. Additionally, the Company has transferred receivables from the warehouse credit facilities and issued term notes. Substantially all of the Company’s receivables are pledged to collateralize these credit facilities and term notes.  The Company is obligated to meet certain financial covenants.  Noncompliance may significantly affect cash flow.

 

The Company’s most significant source of cash flow is the principal and interest payments received from its receivables portfolios. The Company received such payments in the amount of $24.2 million during the three months ended July 31, 2004 and $20.2 million during the three months ended July 31, 2003.  Such cash flow funds were used to repay amounts borrowed under the Company’s credit facilities and other holding costs, primarily interest expense, and servicing and custodial fees.  During the three months ended July 31, 2004 and 2003, the Company required net cash of $3.1 million and $6.7 million, respectively, as the receivables originated exceeded portfolio collections.  The Company relies on borrowed funds to provide cash flow in periods of growth.  As of July 31, 2004, the Company had $153.3 million of available capacity in the FIRC and FIARC credit facilities to fund future growth.

 

In addition to the cash flow generated from the principal and interest collections on its receivables portfolio, the Company collects servicing fees funded from each of the credit facilities.  Servicing fees range from 1.4% to 2.5% of the outstanding principal balance of the loans in the portfolio.  Cash flow and servicing fees are received after month end, but relate to the prior month activity.  Thus upon filing of the monthly servicing statements, a portion of the restricted cash is converted to cash available to fund operations.   At July 31, 2004 and 2003, the Company’s unencumbered cash was $240,410 and $2,331,800 respectively.  The decrease in available cash is primarily due to an increase in expenditures related to the Company’s direct lending business.  Management believes the unencumbered cash and cash inflows and amounts available under the working capital facility are adequate to fund cash requirements for operations.  In addition, as of July 31, 2004, the Company had $140.8 million available under the FIARC warehouse facility.

 

Capitalization. The Company expects to rely primarily on its credit facilities and the issuance of secured term notes to acquire and retain receivables. The Company believes its existing credit facilities have adequate capacity to fund the increase of the receivables portfolio expected in the foreseeable future. While the Company has no reason to believe that these facilities will not continue to be available, their termination could have a material adverse effect on the Company’s operations if substitute financing on comparable terms was not obtained.

 

Financing Arrangements.  The Company finances its loan origination through two warehouse credit facilities. The Company’s credit facilities provide for one-year terms and have been renewed annually. Management of the Company believes that the credit facilities will continue to be renewed or extended or that it would be able to secure alternate financing on satisfactory terms; however, there can be no assurance that it will be able to do so. In January 2002 the Company issued $159 million in asset-backed notes (“Term Notes”) secured by a discrete pool of receivables. On November 20, 2003, the Company issued $140 million in Term Notes secured by a discrete pool of receivables.  Substantially all receivables retained by the Company are pledged as collateral for the credit facilities and the Term Notes. The weighted average interest rate for the Company’s secured borrowings including the effect of program fees, dealer fees, and other comprehensive income (loss) amortization was 3.5% and 2.8% for the periods ended July 31, 2003 and 2004, respectively.

 

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Warehouse Facilities as of July 31, 2004

 

Facility		Capacity			Outstanding			Interest Rate		Fees		Insurance		Borrowing Rate At July 31, 2004
FIARC		$	150,000,000		$	9,175,344		Commercial paper rate plus .3%		.25% of Unused Facility		.35	%	1.37	%
FIRC		$	65,000,000	(1)	$	52,494,738		Option of a) Base Rate, which is the higher of prime rate or fed funds plus .5% or b) LIBOR plus .5%		.25% of Unused Facility		See below		1.96	%

 

(1)                                  Increased from $50 million to $65 million in June, 2004, to allow for an increase in new loan originations.  Facility is scheduled to revert to $50 million on September 13, 2004.

 

Warehouse Facilities – Credit Enhancement as of July 31, 2004

 

 

FIRC - In order to obtain a lower cost of funding, the Company has agreed to maintain credit enhancement insurance covering the receivables pledged as collateral under the FIRC credit facility. The facility lenders are named as additional insureds under these policies. The coverages are obtained on each receivable at the time it is purchased by the Company, and the applicable premiums are prepaid for the life of the receivable. Each receivable is covered by three separate credit insurance policies, consisting of basic default insurance under a standard auto loan protection policy (known as “ALPI” insurance) together with certain supplemental coverages relating to physical damage and other risks. Solely at its expense, the Company carries these coverages and neither the vehicle purchasers nor the dealers are charged for the coverages, nor are they usually unaware of their existence. The Company’s ALPI insurance policy is written by National Union Fire Insurance Company of Pittsburgh (“National Union”), which is a wholly-owned subsidiary of American International Group.

 

The premiums that the Company paid during the three months ended July 31, 2004 for its three credit enhancement insurance coverages, of which the largest component is basic ALPI insurance, represented approximately 3.7% of the principal amount of the receivables originated during the year. Aggregate premiums paid for ALPI coverage alone during the three months ended July 31, 2003 and 2004 were $714,470 and $1,071,409, respectively, and accounted for 2.4% and 3.7% of the aggregate principal balance of the receivables originated during such respective periods.

 

In April 1994, the Company organized First Investors Insurance Company (the “Insurance Subsidiary”) under the captive insurance company laws of the State of Vermont. The Insurance Subsidiary is an indirect wholly-owned subsidiary of the Company and is a party to a reinsurance agreement whereby the Insurance Subsidiary reinsures 100% of the risk under the Company’s ALPI insurance policy. At the time each receivable is insured by National Union, the risk is automatically reinsured to its full extent and approximately 96% of the premium paid by the Company to National Union with respect to such receivable is ceded to the Insurance Subsidiary. When a loss covered by the ALPI policy occurs, National Union pays it after the claim is processed, and National Union is then reimbursed in full by the Insurance Subsidiary.  In addition to the monthly premiums and liquidity reserves of the Insurance Subsidiary, a trust account is maintained by National Union to secure the Insurance Subsidiary’s obligations for losses it has reinsured.

 

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The result of the foregoing reinsurance structure is that National Union, as the “fronting” insurer under the captive arrangement, is unconditionally obligated to the Company’s credit facility lenders for all losses covered by the ALPI policy, and the Company, through its Insurance Subsidiary, is obligated to indemnify National Union for all such losses. As of July 31, 2004, the Insurance Subsidiary had capital and surplus of $2,612,455 and unencumbered cash reserves of $1,383,013 in addition to the $3,274,011 trust account.

 

The ALPI coverage as well as the Insurance Subsidiary’s liability under the Reinsurance Agreement, remains in effect for each receivable that is pledged as collateral under the warehouse credit facility. Once receivables are transferred from FIRC to FIARC and financed under the commercial paper facility, ALPI coverage and the Insurance Subsidiary’s liability under the Reinsurance Agreement is cancelled with respect to the transferred receivables. Any unearned premium associated with the transferred receivables is returned to the Company. The Company believes the losses its Insurance Subsidiary will be required to indemnify will be less than the premiums ceded to it. However, there can be no assurance that losses will not exceed the premiums ceded and the capital and surplus of the Insurance Subsidiary.

 

FIARC – Credit Enhancement for the FIARC warehouse facility is provided to the commercial paper investors by a cash reserve account equal to 1% of the receivables held by FIARC and, additionally, a surety bond issued by MBIA. The Company is not a guarantor of, or otherwise a party to, such commercial paper.

 

Warehouse Facilities – Agents and Expirations

 

Facility		Agent		Expiration		Event if not Renewed
FIARC		Wachovia		December 2, 2004		Receivables pledged would be allowed to amortize; however, no new receivables would be allowed to transfer from the FIRC facility
FIRC		Wachovia		December 2, 2004		Convert to a term loan which would mature six months thereafter and amortize monthly in accordance with the borrowing base with the remaining balance due at maturity

 

On December 4, 2003, the FIRC facility was renewed, under similar terms and conditions, at the $50 million commitment level until December 2, 2004.  On June 15, 2004, the FIRC facility was extended to $65 million,  reverting back to $50 million on September 13, 2004.  On January 29, 2004, following a short-term extension of the original maturity date, the FIARC facility was renewed, under similar terms and conditions, to December 2, 2004.  As of April 30, 2004 and July 31, 2004, there was $0 and $9.2 million, respectively outstanding.

 

Management presently intends to seek further extensions to these warehouse facilities prior to the current expiration dates.  Management further considers its relationship with its lenders to be satisfactory and has no reason to believe that the FIRC and FIARC facilities will not be renewed at each of their respective expiration dates.

 

The following table contains pertinent information on the Term Notes as of July 31, 2004.

 

Term Notes		Issuance Date		Issuance Amount			Maturity Date		Outstanding			Interest Rate
2002-A		January 29, 2002		$	159,036,000		December 15, 2008		$	36,395,776		3.46	%
2003-A		November 11, 2003		$	139,661,000		April 20, 2011		$	106,570,747		2.58	%

 

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Credit enhancement on the two Term Notes is as follows:

 

Facility		Cash Reserve		Advance Rate		Insurance
2002-A		2% of Initial Pool Balance including Pre-Funding Amount		99% initial advance decreasing to 97%		Surety Bond
2003-A		0.5% of Initial Pool Balance increasing to 2% of Initial Pool Balance including Pre-Funding Amount		96.5% initial advance decreasing to 96.1%		Surety Bond

 

Term Notes - - On January 29, 2002, the Company, through its indirect, wholly-owned subsidiary First Investors Auto Owner Trust 2002-A (“2002 Auto Trust”) completed the issuance of $159,036,000 of 3.46% Class A asset-backed notes (“2002-A Term Notes”). The initial pool of automobile receivables transferred to the 2002 Auto Trust totaled $135,643,109, which was previously owned by FIRC and FIARC, secure the 2002-A Term Notes.  In addition to the issuance of the Class A Notes, the 2002 Auto Trust also issued $4,819,000 in Class B Notes that were retained by the Company and pledged to secure the Working Capital Facility as further described below.  Proceeds from the issuance, which totaled $159,033,471 were used to (i) fund a $25,000,000 pre-funding account to be used for future loan originations; (ii) repay all outstanding borrowings under the FIARC commercial paper facility, (iii) reduce the outstanding borrowings under the FIRC credit facility, (iv) pay transaction fees related to the 2002-A Term Note issuance, and (v) fund a cash reserve account of 2% or $2,712,862 of the initial receivables pledged which will serve as a portion of the credit enhancement for the transaction. The Class A Term Notes bear interest at 3.46% and requires monthly principal reductions sufficient to reduce the balance of the Class A Term Notes to 97% of the outstanding balance of the underlying receivables pool. The final maturity of the 2002-A Term Notes is December 15, 2008.    The Class B Notes do not bear interest but require principal reductions sufficient to reduce the balance of the Class B Notes to 3% of the outstanding balance of the underlying receivables pool.  A surety bond issued by MBIA Insurance Corporation provides credit enhancement for the Class A Notes.  In the event that certain asset quality covenants are not met, the reserve account target level will increase to 6% of the then current principal balance of the receivables pool.  As of April 30, 2004 and July 31, 2004, the outstanding principal balances on the 2002-A Term Notes were $44,335,659 and $36,395,776 respectively.

 

On November 20, 2003, the Company, through its indirect, wholly-owned subsidiary First Investors Auto Owner Trust 2003-A (“2003 Auto Trust”) completed the issuance of $139,661,000 of 2.58% Class A asset-backed notes (“2003-A Term Notes”). The initial pool of automobile receivables transferred to the 2003 Auto Trust totaled $114,726,891, which was previously owned by FIRC and FIARC, secure the 2003-A Term Notes.  In addition to the issuance of the Class A Notes, the 2003 Auto Trust also issued $5,065,891 in Class B Notes that were retained by the Company and pledged to secure the Working Capital Facility as further described below.  Proceeds from the issuance, which totaled $139,656,629 were used to (i) fund a $30,000,000 pre-funding account to be used for future loan originations; (ii) repay all outstanding borrowings under the FIARC commercial paper facility, (iii) reduce the outstanding borrowings under the FIRC credit facility, (iv) pay transaction fees related to the 2003-A Term Note issuance, and (v) fund an initial cash reserve account of 0.5% or $573,635 of the initial receivables pledged.  The Class A Term Notes bear interest at 2.58% and requires monthly principal reductions sufficient to reduce the balance of the Class A Term Notes to 96.1% of the outstanding balance of the underlying receivables pool. The final maturity of the 2003-A Term Notes is April 20, 2011.  The Class B Notes do not bear interest but require principal reductions sufficient to reduce the balance of the Class B Notes to 3.9% of the outstanding balance of the underlying receivables pool.  A surety bond issued by MBIA Insurance Corporation provides credit enhancement for the Class A Notes.  In the event that certain asset quality covenants are not met, the reserve account target level will increase to 6% of the then current principal balance of the receivables pool.  As of April 30, 2004 and July 31, 2004, the outstanding principal balances on the 2003-A Term notes were $120,382,531 and $106,570,747 respectively.

 

Working Capital Facility.  On December 6, 2001, the Company entered into an agreement with Wachovia Securities to refinance the $11,175,000 outstanding balance of the working capital term loan previously provided

 

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by Bank of America and Wachovia and increase the size of the facility to $13.5 million.  The renewal facility was provided to a special-purpose, wholly-owned subsidiary of the Company, First Investors Residual Funding LP.   The facility originally consisted of a $9 million revolving tranche and a $4.5 million term loan tranche which amortizes monthly.  The term loan tranche of this working capital facility was evidenced by the Class B Notes issued in conjunction with the 2002 Auto Trust financing. The remaining $9 million of the $13.5 million working capital facility revolves monthly in accordance with a borrowing base consisting of the over-collateralization amount and reserve accounts for each of the Company’s other credit facilities.  The facility is secured solely by the residual cash flow and cash reserve accounts related to the Company’s warehouse credit facilities, the acquisition facility and the existing and future term note facilities.  During 2002, the facility was modified to increase the interest rate from LIBOR plus 1.5% to LIBOR plus 2.25%.  The commitment fee paid on the total available amount of the facility was maintained at 1.5%.    In addition, the monthly principal amortization under the term loan tranche was increased to the greater of $250,000 or the principal distributions made under the Class B Notes issued under the 2002 Auto Trust financing.  On December 4, 2003, the Working Capital Facility was extended to December 2, 2004.  Under the terms of the extension, the monthly amortization requirement was replaced with the requirement that outstandings under the facility could not exceed the lesser of a borrowing base or the $9 million facility limit.  At April 30, 2004 and July 31, 2004, there was $8,761,143 and $8,759,543 respectively, outstanding under this facility.

 

The Company presently intends to seek a renewal of the working capital facility from its lender prior to maturity.  Should the facility not be renewed, the outstanding balance of the receivables would be amortized in accordance with the borrowing base.  Management considers its relationship with its lenders to be satisfactory and has no reason to believe that this credit facility will not be renewed.  If the facility is not renewed, however, or if material changes are made to its terms and conditions, it could have a material adverse effect on the Company.

 

Shareholder Loans.  On December 3, 2001 the Company entered into an agreement with one of its shareholders who is a member of its Board of Directors under which the Company may, from time to time, borrow up to $2.5 million.  The proceeds of the borrowings will be utilized to fund certain private and open market purchases of the Company’s common stock pursuant to a Stock Repurchase Plan authorized by the Board of Directors and for general corporate purposes.  Borrowings under the facility bear interest at a fixed rate of 10% per annum.  The facility is unsecured and expressly subordinated to the Company’s senior credit facilities. The facility matures on December 3, 2008 but may be repaid at any time unless the Company is in default on one of its other credit facilities.  There were no amounts outstanding under this facility as of April 30, 2004 and July 31, 2004 respectively.

 

Loan Covenants.  The documentation governing these credit facilities and Term Notes contains numerous covenants relating to the Company’s business, the maintenance of credit enhancement insurance covering the receivables (if applicable), the observance of certain financial covenants, the avoidance of certain levels of delinquency experience and other matters. The breach of these covenants, if not cured within the time limits specified, could precipitate events of default that might result in the acceleration of the FIRC credit facility, the Term Notes and the working capital facility or the termination of the commercial paper facilities. The Company was not in default with respect to any financial covenants governing these financing arrangements at July 31, 2004.

 

Interest Rate Management.  The Company’s warehouse credit facilities and working capital facilities bear interest at floating interest rates which are reset on a short-term basis while the secured Term Notes bear interest at a fixed rate of interest. The Company’s receivables bear interest at fixed rates that do not generally vary with a change in market interest rates. Since a primary contributor to the Company’s profitability is its ability to manage its net interest spread, the Company seeks to maximize the net interest spread while minimizing exposure to changes in interest rates. In connection with managing the net interest spread, the Company may periodically enter into interest rate swaps or caps to minimize the effects of market interest rate fluctuations on the net interest spread. To the extent that the Company has outstanding floating rate borrowings or has elected to convert a portion of its borrowings from fixed rates to floating rates, the Company will be exposed to fluctuations in short-term interest rates.

 

During June 2004, as a requirement of the FIARC commercial paper facility, the Company entered into an interest rate cap transaction with a rate cap of 5%, with a notional balance that amortizes over six years, for a total purchase price of $183,000.  The interest rate cap was not designated as a hedge, and accordingly, changes in the fair value of the interest rate caps are recorded as unrealized gains or losses and reflected in net income.  As of July 31, 2004, the value of the interest rate cap is $115,343 and is recorded under other assets as interest rate derivative positions.  During the quarter ended July 31, 2004, the Company recorded an unrealized loss of $67,657 that is included as a separate caption of other income.

 

During fiscal year 2004, as a requirement of the FIARC commercial paper facility, the Company entered into various interest rate cap transactions at cap rates ranging from 6.5% to 7.5% with a notional balance that amortized over five to six year periods. The interest rate caps were not designated as hedges and, accordingly, changes in the

 

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fair value of the interest rate caps are recorded as unrealized gains or losses and reflected in net income.  On December 2, 2003, the Company terminated all interest rate caps outstanding in exchange for proceeds of $356,000.  The caps were terminated following the repayment of all outstandings under the FIARC facility following the issuance of the 2003-A Term Notes.  As a result, a realized loss of $14,000 was incurred relative to the aggregate market value of the interest rate caps.

 

On June 1, 2001, the Company entered into interest rate swaps with an aggregate notional amount of $100 million and a maturity date of April 15, 2004.  Under the terms of these swaps, the Company will pay a floating rate based on one month LIBOR and receive a fixed rate of 5.025%.  Management elected to enter into these swap agreements to offset the uneconomical position of the existing pay fixed swap created by rapidly declining market interest rates.  In connection with the decision to enter into the $100 million floating rate swap, the Company elected to change the designation of the $100 million fixed rate swap from a cash flow hedge and not account for the instrument as a hedge under SFAS No. 133.   As a result, the change in fair value of the swaps is reflected in net income for periods subsequent to May 31, 2001.

 

Delinquency and Credit Loss Experience

 

The Company’s results of operations, financial condition and liquidity may be adversely affected by nonperforming receivables. The Company seeks to manage its risk of credit loss through (i) prudent credit evaluations, (ii) risk management activities, (iii) effective collection procedures, and (iv) by maximizing recoveries on defaulted loans. The allowance for credit losses of $2,202,062 as of July 31, 2004 and $2,427,122 as of July 31, 2003 as a percentage of Receivables Held for Investment of $207,741,744 as of July 31, 2004 and $207,489,339 as of April 30, 2004 was 1.1% and 1.1% respectively.

 

The Company considers a loan to be delinquent when the borrower fails to make a scheduled payment of principal and interest. Accrual of interest is suspended when the payment from the borrower is over 90 days past due. Generally, repossession procedures are initiated 90 to 120 days after the payment default.

 

The Company retains the credit risk associated with the receivables originated. The Company purchases credit enhancement insurance from third party insurers which covers the risk of loss upon default and certain other risks. The Company established a captive insurance subsidiary to reinsure certain risks under the credit enhancement insurance coverage for all receivables.  In addition, receivables financed under the Auto Trust and FIARC commercial paper facilities do not carry default insurance.  Provisions for credit losses of $2,442,105 and $3,391,963 have been recorded for the three months ended July 31, 2004 and July 31, 2003, respectively.

 

The Company calculates the allowance for credit losses in accordance with SFAS No. 5, Accounting for Contingencies.   SFAS No. 114, Accounting for Creditors for Impairment of a Loan does not apply to loans currently held by the Company because they are comprised of a large group of smaller balance homogenous loans that are evaluated collectively for impairment.

 

The Company applies a systematic methodology in order to determine the amount of the allowance for credit losses.  The specific methodology utilized is a six-month migration analysis whereby the Company compares the aging status of each loan from six months prior to the aging loan status as of the reporting date.  These factors are then applied to the aging status of each loan at the reporting date in order to calculate the number of loans that are expected to migrate to impaired status in the next six months.  The estimated number of impairments is then multiplied by estimated loss per loan, which is based on historical information.  The computed reserve is then compared to the amount recorded for adequacy.  The Company compares the six-month result to prior six-month periods to compare trends and evaluate any other internal or external factors that may affect collectibility. The allowance for credit losses is based on estimates and qualitative evaluations and ultimate losses will vary from

 

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current estimates. These estimates are reviewed periodically and as adjustments, either positive or negative, become necessary, are reported in earnings in the period they become known.

 

The following table sets forth certain information regarding the Company’s delinquency and charge-off experience over its last two fiscal years (dollars in thousands):

 

		For the three months ended July 31,
		2003					2004
		Number of Loans		Amount			Number of Loans		Amount
Receivables Held for Investment:
Delinquent amount outstanding (1):
30 - 59 days		321		$	2,926		318		$	2,753
60 - 89 days		113		1,088			78		669
90 days or more		376		3,709			211		2,167
Total delinquencies		810		$	7,723		607		$	5,589
Total delinquencies as a percentage of outstanding receivables.		4.4	%	3.4		%	3.7	%	2.7		%
Net charge-offs as a percentage of average receivables outstanding during the period (2)				5.9		%			4.7		%

 

(1)                                  Delinquent amounts outstanding do not include loans in bankruptcy status since collection activity is limited and highly regulated for bankrupt accounts.

 

(2)                                  The percentages have been annualized and are not necessarily indicative of the results for a full year.

 

The lower annualized charge-off rate results from an improving economic environment coupled with an increase in the Company’s direct to consumer lending program.

 

As of July 31, 2004, there were 519 accounts totaling $4,793,472 that were in bankruptcy status and were more than 30 days past due.  As of July 31, 2003, there were 712 accounts totaling $6,940,863 that were in bankruptcy status and were more than 30 days past due.  As of July 31, 2004 and 2003, 93% and 88%, respectively, of the bankruptcy delinquencies filed for protection under Chapter 13.

 

New Accounting Pronouncements

 

In December 2003, the American Institute of Certified Public Accountants issued Statement of Position (SOP) 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer. SOP 03-3 addresses the accounting for loans acquired through a transfer (including a business combination) that have differences between their expected cash flows and their contractual cash flows, due in part to credit quality. The SOP requires that the excess of the expected cash flows at acquisition to be collected over the acquirer’s initial investment be recognized on a level-yield basis over the loan’s life. Any future excess of contractual cash flows over the original expected cash flows is recognized as a future yield adjustment. Future decreases in actual cash flows over the original expected cash flows are recognized as impairment and expensed immediately. Valuation allowances can not be created or “carried over” in the initial accounting for loans acquired that are within the scope of the SOP. SOP 03-3 is effective for loans acquired in fiscal years beginning after December 15, 2004.  The Company does not anticipate SOP 03-3 will have a material effect on its financial statements.

 

Forward Looking Information

 

Statements and financial discussion and analysis included in this report that are not historical are considered to be forward-looking in nature. Forward-looking statements involve a number of risks and uncertainties that may

 

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cause actual results to differ materially from anticipated results. Specific factors that could cause such differences include unexpected fluctuations in market interest rates, changes in economic conditions, changes in the competition for loans, or the inability to renew or obtain financing. Further information concerning risks and uncertainties is included in this report and the company’s other reports filed with the Securities and Exchange Commission.

 

The Company believes the factors discussed in its reports are important factors that could cause actual results to differ materially from those expressed in any forward looking statement made herein or elsewhere by the Company or on its behalf.  The factors listed are not necessarily all of the important factors.  Unpredictable or unknown factors not discussed could also have material adverse effects on actual results.  The Company does not intend to update its description of important factors each time a potential important factor arises.  The Company advises its stockholders that they should:  (1) be aware that important factors not described herein could affect the accuracy of our forward looking statements, and (2) use caution and common sense when analyzing our forward looking statements in this document or elsewhere.  All of such forward looking statements are qualified in their entirety by this cautionary statement.

 

ITEM 3.                             QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

The market risk discussion and the estimated amounts generated from the analysis that follows are forward-looking statements of market risk assuming certain adverse market conditions occur. Actual results in the future may differ materially due to changes in the Company’s product and debt mix, developments in the financial markets, and further utilization by the company of risk-mitigating strategies such as hedging.

 

The Company’s operating revenues are derived almost entirely from the collection of interest on the receivables it retains and its primary expense is the interest that it pays on borrowings incurred to purchase and retain such receivables. The Company’s credit facilities bear interest at floating rates which are reset on a short-term basis, whereas its receivables bear interest at fixed rates which do not generally vary with changes in interest rates. The Company is therefore exposed primarily to market risks associated with movements in interest rates on its credit facilities. The Company believes that it takes the necessary steps to appropriately reduce the potential impact of interest rate increases on the Company’s financial position and operating performance.

 

The Company relies almost exclusively on revolving credit facilities to fund its origination of receivables. Periodically, the Company will transfer receivables from a revolving to a term credit facility. Currently all of the Company’s credit facilities in bear interest at floating rates tied to either a commercial paper index or LIBOR.

 

As of July 31, 2004, the Company had $70.4 million of floating rate secured debt outstanding under the FIRC warehouse and working capital facilities.  For every 1% increase in LIBOR annual after-tax earnings would decrease by approximately $.7 million assuming the Company maintains a level amount of floating rate debt and assuming an immediate increase in rates.  As of July 31, 2003, the Company had $164.2 million of floating rate secured debt outstanding net of swap and cap agreements. For every 1% increase in commercial paper rates or LIBOR, annual after-tax earnings would decrease by approximately $1.0 million assuming the Company maintains a level amount of floating rate debt and assuming an immediate increase in rates.

 

ITEM 4.                             CONTROLS AND PROCEDURES

 

In accordance with Exchange Act Rules 13a-15 and 15d-15, we carried out an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report.  Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of July 31, 2004 to provide reasonable assurance that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.

 

There has been no change in our internal controls over financial reporting that occurred during the three months ended July 31, 2004 that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.

 

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PART II

 

OTHER INFORMATION

 

ITEM 6.                             EXHIBITS AND REPORTS ON FORM 8-K

 

(a)          Exhibits

 

31.1            Certification of Chief Executive Officer pursuant to section 302 of the Sarbanes-Oxley Act of 2002.

 

31.2            Certification of Chief Financial Officer pursuant to section 302 of the Sarbanes-Oxley Act of 2002.

 

32.1            Certification of Chief Executive Officer pursuant to section 906 of the Sarbanes-Oxley Act of 2002.

 

32.2            Certification of Chief Financial Officer pursuant to section 906 of the Sarbanes-Oxley Act of 2002.

 

Filed with this 10-Q

 

(b)         Reports on Form 8-K

 

Form 8-K filed July 8, 2004, press release announcing fiscal year end April 30, 2004 financial results.

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

	First Investors Financial Services Group, Inc.
	(Registrant)
Date:  September 13, 2004	By: /s/TOMMY A. MOORE, JR.
	Tommy A. Moore, Jr.
	President and Chief Executive Officer
Date:  September 13, 2004	By: /s/BENNIE H. DUCK
	Bennie H. Duck
	Secretary, Treasurer and Chief Financial Officer

 

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