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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31,2005
|_| Transition report pursuant to Section 13 or 15(d) of the Securities Exchange
For the transition period from ________ to ___________ Act of 1934
Commission file number 0-17771
FRANKLIN CREDIT MANAGEMENT CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 75-2243266
(State or other jurisdiction of (I.R.S. Employer identification No.)
incorporation or organization)
Six Harrison Street
New York, New York 10013
(212) 925-8745
(Address of principal executive offices)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|.
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes |_| No |X|.
As of May 16, 2005 the issuer had 6,102,295 of shares of Common Stock, par value
$0.01 per share, outstanding.
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FRANKLIN CREDIT MANAGEMENT CORPORATION
FORM 10-Q
INDEX
C O N T E N T S
PART I. FINANCIAL INFORMATION Page
----
Item 1. Financial Statements (unaudited)
Consolidated Balance Sheets at March 31, 2005 and
December 31, 2004 3
Consolidated Statements of Income for the three months ended
March 31, 2005 and March 31, 2004 4
Consolidated Statement of Changes in Stockholders' Equity for the three months ended
March 31, 2005 5
Consolidated Statements of Cash Flows for the three months ended
March 31, 2005 and March 31, 2004 6
Notes to Consolidated Financial Statements 7-14
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 15-24
Item 3. Quantitative and Qualitative Disclosures about Market Risk 24-25
Item 4. Controls and Procedures 26
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 26
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 26
Item 3. Defaults Upon Senior Securities 26
Item 4. Submission of Matters to a Vote of Security Holders 26
Item 5. Other Information 26-28
Item 6. Exhibits and Reports on Form 8-K 28
SIGNATURES 29
CERTIFICATIONS 30-33
FRANKLIN CREDIT MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (Unaudited)
- --------------------------------------------------------------------------------
ASSETS March 31, 2005 December 31, 2004
CASH AND CASH EQUIVALENTS $ 24,333,579 $ 19,519,659
RESTRICTED CASH 143,831 128,612
NOTES RECEIVABLE:
Principal 837,706,645 811,885,856
Purchase discount (29,388,621) (32,293,669)
Allowance for loan losses (83,919,665) (89,628,299)
------------- -------------
Net notes receivable 724,398,359 689,963,888
ORIGINATED LOANS HELD FOR SALE 17,666,811 16,851,041
ORIGINATED LOANS HELD FOR INVESTMENT 171,237,420 110,496,274
ACCRUED INTEREST RECEIVABLE 9,949,260 8,506,252
OTHER REAL ESTATE OWNED 21,492,219 20,626,156
OTHER RECEIVABLES 7,102,014 5,366,500
DEFERRED TAX ASSET 301,073 583,644
OTHER ASSETS 9,422,222 10,577,344
BUILDING, FURNITURE AND EQUIPMENT - Net 1,336,823 1,290,442
DEFERRED FINANCING COSTS- Net 8,726,573 7,600,942
------------- -------------
TOTAL ASSETS $ 996,110,184 $ 891,510,754
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
ACCOUNTS PAYABLE AND ACCRUED EXPENSES $ 11,971,286 $ 11,572,764
FINANCING AGREEMENTS 31,518,801 39,540,205
NOTES PAYABLE 916,186,427 807,718,038
INCOME TAX LIABILITY
CURRENT --
DEFERRED 3,783,964 3,123,865
------------- -------------
TOTAL LIABILITIES 963,460,478 861,954,872
------------- -------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value per share; authorized 3,000,000; issued-none
Common stock, $.01 par value, 22,000,000 authorized shares;
issued and outstanding: 6,082,295 in 2005 and 6,062,295 in 2004 60,823 60,623
Additional paid-in capital 7,377,578 7,354,778
Retained earnings 25,211,305 22,140,481
------------- -------------
TOTAL STOCKHOLDERS' EQUITY 32,649,706 29,555,882
------------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 996,110,184 $ 891,510,754
============= =============
See notes to consolidated financial statements.
Page 3
FRANKLIN CREDIT MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
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Three months ended March 31,
2005 2004
REVENUES:
Interest income $22,877,198 $10,636,341
Purchase discount earned 2,251,481 1,341,397
Gain on sale of notes receivable -- 844,902
Gain on sale of originated loans held for sale 663,704 892,955
Gain on sale of other real estate owned 255,981 231,246
Prepayment penalties and other income 1,842,916 1,112,924
----------- -----------
Total revenues 27,891,280 15,059,765
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OPERATING EXPENSES:
Interest expense 13,018,345 5,313,075
Collection, general and administrative 7,089,544 4,446,182
Provision for loan losses 1,198,218 895,876
Amortization of deferred financing costs 692,987 592,901
Depreciation 205,474 113,382
----------- -----------
Total operating expenses 22,204,568 11,361,416
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INCOME BEFORE PROVISION FOR INCOME TAXES 5,686,712 3,698,349
PROVISION FOR INCOME TAXES 2,615,888 1,665,000
----------- -----------
NET INCOME $ 3,070,824 $ 2,033,349
=========== ===========
NET INCOME PER COMMON SHARE:
Basic $ 0.51 $ 0.34
=========== ===========
Diluted $ 0.45 $ 0.30
=========== ===========
WEIGHTED AVERAGE NUMBER OF COMMON SHARES
OUTSTANDING:
Basic 6,072,295 5,916,527
=========== ===========
Diluted 6,870,616 6,690,627
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See notes to consolidated financial statements.
Page 4
FRANKLIN CREDIT MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
THREE MONTHS ENDED MARCH 31, 2005 (Unaudited)
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Common Stock Additional
--------------------------- Paid-In Retained
Shares Amount Capital Earnings Total
- --------------------------------------------------------------------------------------------------------------------------
January 1, 2005 6,062,295 $60,623 $7,354,778 $22,140,481 $29,555,882
Exercise of options 20,000 200 22,800 23,000
Net income 3,070,824 3,070,824
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March 31, 2005 6,082,295 $60,823 $7,377,578 $25,211,305 $32,649,706
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See notes to consolidated financial statements.
Page 5
FRANKLIN CREDIT MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
- --------------------------------------------------------------------------------
Three Months Ended March 31,
2005 2004
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 3,070,824 $ 2,033,349
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Gain on sale of notes receivable -- (844,902)
Gain on sale of other real estate owned (255,981) (231,246)
Gain on sale of originated loans held for sale (663,704) (892,955)
Depreciation 205,474 113,382
Amortization of deferred financing costs 692,987 592,901
Origination of loans held for sale (14,269,650) (33,358,278)
Proceeds from the sale of and principal collections on loans held for sale 14,117,584 20,639,137
Purchase discount earned (2,251,481) (1,341,397)
Provision for loan losses 1,198,218 895,876
Changes in operating assets and liabilities:
Accrued interest receivable (1,443,008) 81,360
Other receivables (1,735,514) 66,662
Deferred income tax asset 282,571 198,829
Other assets 1,155,122 (277,251)
Current income tax liability 265,565
Deferred income tax liability 660,099 545,643
Accounts payable and accrued expenses 398,522 (302,627)
------------- -------------
Net cash provided by /(used) in operating activities 1,162,063 (11,815,952)
------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Increase in restricted cash (15,219) (15,484)
Purchase of notes receivable (98,522,946) (38,432,630)
Principal collections on notes receivable 57,046,430 40,504,391
Principal collections on loans held for investment 12,394,909 3,933,731
Originations of loans held for investment-net (73,463,873) --
Acquisition and loan fees (1,040,368) (449,595)
Proceeds from sale of other real estate owned 7,034,795 4,955,454
Proceeds from sale of notes receivable -- 6,556,853
Purchase of building, furniture and equipment (251,856) (73,481)
------------- -------------
Net cash (used in)/ provided by investing activities (96,818,128) 16,979,239
------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from notes payable 183,247,345 49,771,473
Principal payments of notes payable (74,778,956) (60,395,200)
Proceeds from financing agreements 87,195,847 34,052,232
Principal payments of financing agreements (95,217,251) (27,681,774)
Exercise of options 23,000 --
------------- -------------
Net cash provided by/ (used in) financing activities 100,469,985 (4,253,269)
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NET CHANGE IN CASH AND CASH EQUIVALENTS 4,813,920 910,018
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 19,519,659 14,418,876
------------- -------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 24,333,579 $ 15,328,894
============= =============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash payments for interest $ 12,654,694 $ 5,436,345
============= =============
Cash payments for taxes $ 228,872 $ 636,800
============= =============
See notes to consolidated financial statements.
Page 6
FRANKLIN CREDIT MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
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1. Organizations and Business.
We are a specialty consumer finance company primarily engaged in two
related lines of business, the acquisition, servicing and resolution of
performing and nonperforming residential mortgage loans and the origination of
non-prime mortgage loans for our portfolio and for sale into the secondary
market. We focus on acquiring and originating loans that involve an elevated
credit risk as a result of the nature or absence of income documentation,
limited credit histories, high levels of consumer debt or past credit
difficulties. We typically purchase loan portfolios at a discount and originate
loans with interest rates and fees calculated to provide us with a rate of
return adjusted to reflect the elevated credit risk inherent in these types of
loans. We originate non-prime loans through our wholly-owned subsidiary, Tribeca
Lending Corp. We generally hold for investment the loans we acquire and a
significant portion of the loans we originate.
From inception through March 31, 2005, we had purchased and originated in excess
of $2.4 billion in mortgage loans. As of March 31, 2005, we had total assets of
$996.1 million face value, our portfolios of notes receivable and loans held for
investment and sale, net, totaled $913.3 million, and our stockholders' equity
was $32.6 million.
Loan Acquisitions
Since commencing operations in 1989, we have become a nationally
recognized buyer of portfolios of residential mortgage loans from a variety of
financial institutions in the United States, including mortgage banks,
commercial banks and thrifts, other traditional financial institutions and other
specialty finance companies. These portfolios generally consist of one or more
of the following types of mortgage loans which we sometimes refer to
collectively as scratch and dent, or S&D loans:
performing loans - loans that are contractually current, although they may
have been delinquent in the past.
reperforming loans - loans that are not contractually current but that
have made regular payments recently, and there is a good possibility they
will become current and/or be paid off in full.
nonperforming loans - loans that are seriously delinquent, generally not
expected to cure, and for which the primary avenue of recovery is through
the sale of the property securing the loan.
We have developed a specialized expertise at risk-based pricing, credit
evaluation and loan servicing that allows us to effectively evaluate and manage
the potentially higher risks associated with this segment of the residential
mortgage industry, including the rehabilitation or resolution of nonperforming
or reperforming loans.
We refer to the loans we acquire as "notes receivable." In 2004, we purchased
notes receivable with an aggregate unpaid principal balance of $652 million at
an aggregate price equal to 84% of the face amount of the notes. These purchases
included our largest portfolio acquisition to date, which was comprised of loans
with an unpaid principal amount of approximately $310 million. During the first
quarter of 2005, we purchased $111.8 million of notes receivable at an
aggregated price of 88% of the face value.
Page 7
Loan Originations
We conduct our loan origination business through our wholly owned
subsidiary, Tribeca Lending Corp., or Tribeca, which we formed in 1997 in order
to leverage our experience in evaluating and managing scratch and dent
residential mortgage loans and our loan servicing capabilities. We originate
primarily non-prime residential mortgage loans to individuals whose
documentation, credit histories, income and other factors cause them to be
classified as non-prime borrowers and to whom, as a result, conventional
mortgage lenders will often not make loans. Our loans carry interest rates that
are typically significantly higher than those of prime loans. We have chosen to
focus our marketing efforts on this segment of the residential mortgage market
in order to capitalize on the knowledge we have developed through our extensive
experience in acquiring and servicing scratch and dent loans. Our infrastructure
is well-suited for the more intensive monitoring and servicing associated with
these types of loans due to our experience with servicing purchased loans with
similar characteristics.
In 2004, we originated $200 million in non-prime mortgage loans, 27% of which
were adjustable rate mortgages. We originated approximately 65% of our mortgage
loans on a retail basis and the remainder through our network of mortgage
brokers. During the first quarter of 2005, the Company originated $87.9 million
in non-prime mortgage loans. We hold the mortgages we originate for our
portfolio or sell them for cash in the whole loan market, depending on market
conditions and our own portfolio goals.
Loan Servicing
Because we expect to experience above average delinquencies, defaults and
erratic payment patterns on the loans we purchase and originate, we believe our
ability to service our loans internally and our focus on collection, default
management and loss mitigation are key elements of our success. In general,
after we acquire or originate loans our servicing department seeks to ensure
that the loans are repaid in accordance with their terms or according to amended
repayment terms negotiated with the borrowers.
The condensed consolidated financial statements (unaudited) should be read in
conjunction with our Company's consolidated financial statements and notes
thereto included in the Company's Annual Report on Form 10-K for the year ended
December 31, 2004. The condensed consolidated financial statements reflect all
adjustments (consisting only of normal recurring adjustments) that are, in the
opinion of management, necessary for the fair statement of the results for the
interim period. The results of operations for interim periods are not
necessarily indicative of results for the entire year.
Business Segments- The Company has two reportable operating segments: (i)
portfolio asset acquisition and resolution; and (ii) mortgage banking. The
portfolio asset acquisition and resolution segment acquires performing,
reperforming or nonperforming notes receivable and promissory notes from
financial institutions, mortgage and finance companies, and services and
collects such notes receivable through enforcement of terms of the original
note, modification of original note terms and, if necessary, liquidation of the
underlying collateral. The mortgage-banking segment originates or purchases, sub
prime residential mortgage loans from individuals whose credit histories, income
and other factors cause them to be classified as nonconforming borrowers.
The Company's management evaluates the performance of each segment based
on profit or loss from operations before unusual and extraordinary items and
income taxes. The accounting policies of the segments are the same as those
described in the summary of significant accounting policies. [OBJECT OMITTED]
Three Months Ended March 31,
2005 2004
CONSOLIDATED REVENUE
Portfolio asset acquisition and resolution $22,477,726 $12,797,836
Mortgage banking 5,413,554 2,261,929
----------- -----------
Consolidated Revenue $27,891,280 $15,059,765
=========== ===========
CONSOLIDATED INCOME BEFORE INCOME TAXES
Portfolio asset acquisition and resolution $ 4,214,686 $ 3,271,347
Mortgage banking 1,472,026 427,002
----------- -----------
Consolidated Income before income taxes $ 5,686,712 $ 3,698,349
=========== ===========
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation - The consolidated financial statements include the
accounts of the Company and its wholly owned subsidiaries. All significant
intercompany accounts and transactions have been eliminated in consolidation.
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
The most significant estimates of the Company are allowance for loan losses and
purchase discount. The Company's estimates and assumptions primarily arise from
risks and uncertainties associated with interest rate volatility and credit
exposure. Although management is not currently aware of any factors that would
significantly change its estimates and assumptions in the near term, future
changes in market trends and conditions may occur which could cause actual
results to differ materially.
Page 8
Reclassification- Certain prior year quarterly amounts have been reclassified to
conform to current quarterly presentation.
Operating Segments- Statement of Financial Accounting Standards ("SFAS") No.
131, Disclosures about Segments of an Enterprise and Related Information
requires companies to report financial and descriptive information about their
reportable operating segments, including segment profit or loss, certain
specific revenue and expense items, and segment assets. The Company is currently
operating in two business segments: (i) portfolio asset acquisition and
resolution; and (ii) mortgage banking.
Earnings per share - Basic earnings per share is calculated by dividing net
income by the weighted average number of common shares outstanding during the
year. Diluted earnings per share is calculated by dividing net income by the
weighted average number of common shares outstanding, including the dilutive
effect, if any, of outstanding stock options and warrants, calculated under the
treasury stock method.
Cash and Cash Equivalents - Cash and cash equivalents includes cash and
investments with original maturities of three months or less, with the exception
of restricted cash. The Company maintains accounts at banks, which at times may
exceed federally insured limits. The Company has not experienced any losses from
such concentrations.
Notes Receivable and Income Recognition - The notes receivable portfolio
consists primarily of secured real estate mortgage loans purchased from
financial institutions, mortgage banks and finance companies. Such notes
receivable are performing, reperforming or nonperforming at the time of purchase
and are usually purchased at a discount from the principal balance remaining.
Notes receivable are stated at the amount of unpaid principal, reduced by
purchase discount and allowance for loan losses. Notes purchased after December
31, 2004, under SOP No.03-3 are stated at amortized cost. The Company has the
ability and intent to hold these notes until maturity, payoff or liquidation of
the collateral. Impaired notes receivable are measured based on the present
value of expected future cash flows discounted at the note's effective interest
rate or, as a practical expedient, at the observable market price of the note
receivable or the fair value of the collateral if the note is collateral
dependent. The Company periodically evaluates the collectability of both
interest and principal of its notes receivable to determine whether they are
impaired. A note receivable is considered impaired when it is probable the
Company will be unable to collect all contractual principal and interest
payments due in accordance with the terms of the note agreement.
In general, interest on the notes receivable is calculated based on contractual
interest rates applied to daily balances of the principal amount outstanding
using the accrual method. Accrual of interest on notes receivable, including
impaired notes receivable, is discontinued when management believes, after
considering economic and business conditions and collection efforts, that the
borrowers' financial condition is such that collection of interest is doubtful.
When interest accrual is discontinued, all unpaid accrued interest is reversed.
Subsequent recognition of income occurs only to the extent payment is received,
subject to management's assessment of the collectability of the remaining
interest and principal. A non-accrual note is restored to an accrual status when
it is no longer delinquent and collectability of interest and principal is no
longer in doubt and past due interest is recognized at that time.
Page 9
Discounts on Acquired Loans
Effective January 1, 2005, as a result of the required adoption of AICPA
Statement of Position SOP No. 03-3, "Accounting for Certain Loans of Debt
Securities Acquired in a Transfer", the Company is required to change its
accounting as it relates to loans which are acquired subsequent to December 31,
2004, and which have evidence of deterioration of credit quality since
origination and, for which it is probable, at acquisition, that the Company will
be unable to collect all contractually required payments. For such loans, the
excess of the undiscounted contractual cash flows over the undiscounted cash
flows estimated at the time of acquisition is not accreted into income
(nonaccretable discount). The remaining amount, representing the excess of the
loan's estimated cash flows over the purchase price, is accreted into income
over the life of the loan (accretable discount).
For all other loans acquired subsequent to December 31, 2004, the
discount, which represents the excess of the amount of reasonably estimable and
probable discounted future cash collections over the purchase price is accreted
into purchase discount using the interest method over the term of the loans and
is not accreted on nonperforming loans. This is consistent with the method the
Company utilizes for its accounting for loans purchased prior to January 1,
2005, except an allowance allocation was also made at the time of acquisition.
The Company no longer increases the allowance through allocations from purchase
discount for loans acquired after December 31, 2004.
There is judgment involved in estimating the amount of the Company's future cash
flows. The amount and timing of actual cash flows could differ materially from
management's estimates, which could materially affect the Company's financial
condition and results of operations. Depending on the timing of an acquisition,
a preliminary allocation may be utilized until a final allocation is
established. Generally, the allocation will be finalized no later than ninety
days from the date of purchase.
The nonaccretable discount is not accreted into income until it is determined
that the amount and timing of the related cash flows are reasonably estimable
and collection is probable. If cash flows cannot be reasonably estimated for any
loan, and collection is not probable, the cost recovery method of accounting is
used. Under the cost recovery method, any amounts received are applied against
the recorded amount of the loan.
Subsequent to acquisition, if cash flow projections improve, and it is
determined that the amount and timing of the cash flows related to the
nonaccretable discount are reasonably estimable and collection is probable, the
corresponding decrease in the nonaccretable discount is transferred to the
accretable discount and is accreted into interest income over the remaining life
of the loan on the interest method. If cash flow projections deteriorate
subsequent to acquisition, the decline is accounted for through the allowance
for loan losses. The application of the requirement of SOP 03-3 did not have a
material effect on the Company's consolidated financial statements during the
three months ended March 31, 2005.
Allowance for Loan Losses - The Company performs reviews of its loan portfolio
upon purchase, at loan boarding, and on a frequent basis thereafter to segment
impaired loans under Statement of Financial Accounting Standards ("SFAS") No.
114. A loan is considered impaired when it is probable the Company will be
unable to collect all contractual principal and interest payments due in
accordance with the terms of the note agreement. An allowance for loan losses is
estimated based on the Company's impairment analysis. Management's judgment in
determining the adequacy of the allowance for loan losses is based on the
evaluation of individual loans within the portfolios, the known and inherent
risk characteristics and size of the portfolio, the assessment of current
economic and real estate market conditions, estimates of the current value of
underlying collateral, past loan loss experience and other relevant factors. In
connection with the determination of the allowance for loan losses, management
obtains independent appraisals for the underlying collateral when considered
necessary. Management believes that the allowance for loan losses is adequate.
The allowance for loan losses is a material estimate, which could change
significantly, in the near term.
Page 10
Effective January 1, 2005, and as a result of the required adoption of SOP No.
03-3, additions to the valuation allowances relating to newly acquired loans
reflect only those losses incurred by the Company subsequent to acquisition. The
Company no longer increases the allowances through allocations from purchase
discount. Additionally, general risk allocations are no longer applied to loans
purchased subsequent to December 31, 2004. Consequently, the allowance for loan
losses has declined since the adoption of SOP No. 03-3, and it is anticipated
that the allowance will continue to decline as credits for loan losses may
continue to be recorded if loans pay off and allowance related to these loans
are not required or additions due to loan impairment are not required.
Originated Loans Held for Sale - The loans held for sale consists primarily of
secured real estate first and second mortgages originated by the Company. Such
loans held for sale are principally performing and are carried at the lower of
cost or market. The Company records a sale upon settlement and when the title
transfers to the buyer. The gain or loss on sale is recorded as the difference
between the carrying amount of the loan and the proceeds from sale on a
loan-by-loan basis.
Originated Loans Held for Investment - Originated loans held for investment
consists primarily of secured real estate first and second mortgages originated
by the Company. Such loans are principally performing and are carried at the
amortized cost of the loan.
Other Real Estate Owned - Other real estate owned ("OREO") consists of
properties acquired through, or in lieu of, foreclosure or other proceedings and
are held for sale and carried at the lower of cost or fair value less estimated
costs to sell. Any write-down to fair value, less cost to sell, at the time of
acquisition is charged to purchase discount. Subsequent write-downs are charged
to operations based upon management's continuing assessment of the fair value of
the underlying collateral. Property is evaluated periodically to ensure that the
recorded amount is supported by current fair values and write downs are recorded
as necessary to reduce the carrying amount to fair value less estimated cost to
sell. Revenue and expenses from the operation of OREO and changes in the
valuation allowance are included in operations. Direct costs relating to the
development and improvement of the property are capitalized, subject to the
limit of fair value of the collateral, while costs related to holding the
property are expensed. Gains or losses are included in operations upon
disposition.
Building, Furniture and Equipment - Building, furniture and equipment is
recorded at cost net of accumulated depreciation. Depreciation is computed using
the straight-line method over the estimated useful lives of the assets, which
range from 3 to 40 years. Maintenance and repairs are expensed as incurred.
Deferred Financing Costs - Deferred financing costs include origination fees
incurred in connection with obtaining financing, which are deferred and
amortized over the terms of the related loans.
Retirement Plan - The Company maintains a savings plan, which is intended to
qualify under Section 401(k) of the Internal Revenue Code. All employees are
eligible to be a participant in the plan. The plan provides for voluntary
contributions by participating employees in amounts up to 20% of their annual
compensation, subject to certain limitations. Currently, the Company matches 50%
of the first 3% of the employee's contribution.
Page 11
Income Taxes - Income taxes are accounted for under SFAS No. 109 Accounting for
Income Taxes which requires an asset and liability approach in accounting for
income taxes. This method provides for deferred income tax assets or liabilities
based on the temporary difference between the income tax basis of assets and
liabilities and their carrying amount in the consolidated financial statements.
Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. Deferred tax assets are
reduced by a valuation allowance when management determines that it is more
likely than not that some portion or all of the deferred tax assets will not be
realized. Deferred tax assets and liabilities are adjusted for the effects of
changes in tax laws and rates on the date of the enactment of the changes.
Prepayments and other income - Prepayments and other income consists of
prepayment penalties on mortgage loans paid off, application fees on originated
loans, late charges, and other miscellaneous income. Such income is recognized
on a cash basis.
Fair Value of Financial Instruments - SFAS No. 107, Disclosures About Fair Value
of Financial Instruments, requires disclosure of fair value information of
financial instruments, whether or not recognized in the balance sheets, for
which it is practicable to estimate that value. In cases where quoted market
prices are not available, fair values are based on estimates using present value
or other valuation techniques. Those techniques are significantly affected by
the assumptions used, including the discount rate and estimates of future cash
flows. In that regard, the derived fair value estimates cannot be substantiated
by comparison to independent markets and, in many cases, could not be realized
in immediate settlement of the instruments. Statement No. 107 excludes certain
financial instruments and all non-financial assets and liabilities from its
disclosure requirements. Accordingly, the aggregate fair value amounts do not
represent the underlying value of the Company.
The following methods and assumptions were used by the Company in estimating the
fair value of its financial instruments:
a. Cash and Cash Equivalents, Restricted Cash, Accrued Interest Receivable,
Other Receivables and Accrued Interest Payable - The carrying values
reported in the consolidated balance sheets are a reasonable estimate of
fair value.
b. Notes Receivable - Fair value of the net notes receivable portfolio is
estimated by discounting the estimated future cash flows using the
interest method. The fair value of notes receivable at March 31, 2005 and
December 31, 2004 was equivalent to their carrying value of $724,398,359
and $689,963,888, respectively.
c. Loans held for Investment, Loans held for sale- the carrying values
reported in the consolidated balance sheets are a reasonable estimate of
fair value.
d. Short-Term Borrowings - The interest rates on financing agreements and
other short-term borrowings reset on a monthly basis; therefore, the
carrying amounts of these liabilities approximate their fair value. The
fair value at March 31, 2005 and December 31, 2004 was $31,518,801 and
$39,540,205, respectively.
Page 12
e. Long-Term Debt - The interest rates on the Company's long-term debt (notes
payable) are variable rates that reset monthly; therefore, the carrying
value reported in the balance sheet approximates fair value at
$916,186,427 and $807,718,038 at March 31, 2005 and December 31, 2004,
respectively.
Comprehensive Income - SFAS No. 130, Reporting Comprehensive Income defines
comprehensive income as the change in equity of a business enterprise during a
period from transactions and other events and circumstances, excluding those
resulting from investments by and distributions to stockholders. The Company had
no items of other comprehensive income during the quarter, presented; therefore
net income was the same as its comprehensive income.
Accounting for Stock Options- We have adopted the disclosure requirements of
SFAS No. 148, Accounting for Stock-Based Compensation--Transition and Disclosure
effective December 2002. SFAS 148 amends SFAS Statement 123, Accounting for
Stock-Based Compensation to provide alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-based
compensation and also amends the disclosure requirements of SFAS 123 to require
prominent disclosures in both annual and interim financial statements about the
methods of accounting for stock based employee compensation and the effect of
the method used on reported results. As permitted by SFAS 148 and SFAS 123, we
continue to apply the accounting provisions of Accounting Principles Board
Opinion Number 25, "Accounting for stock Issued to Employees," and related
interpretations, with regard to the measurement of compensation cost for options
granted under our Stock Option Plans. SFAS No. 123 and APB Opinion No. 25
require only that the expense relating to employee stock options be disclosed in
the footnotes to the consolidated financial statements.
The "Stock Incentive Plan" is accounted for under the recognition and
measurement principles of Accounting Principles Board (APB) Opinion 25,
Accounting for Stock Issued to Employees and related interpretations. The
following table illustrates the effect on net income and earnings per share if
the fair value based method had been applied to all awards:
3/31/2005 3/31/2004
Net income - as reported $3,070,824 $2,033,349
Stock based compensation expense actual
Stock based compensation expense
determined under fair value method, net
of related tax effects $ (4,442) $ (7,125)
Net income - pro forma $3,066,382 $2,026,224
========== ==========
Earnings per share:
Net income per common share - basic - as reported $ 0.51 $ 0.34
Net income per common share - basic - pro forma $ 0.50 $ 0.34
Net income per common share - diluted - as reported $ 0.45 $ 0.30
Net income per common share - diluted - pro forma $ 0.45 $ 0.30
There were no options granted during the three months ended March 31, 2005 and
2004.
Page 13
Recent Accounting Pronouncements
In December 2004, the FASB issued SFAS No. 123(R), a revision of FASB No. 123,
"Accounting for Stock-Based Compensation. SFAS No. 123(R) requires that the
compensation cost relating to share-based payment transaction, including
employee stock options, restricted share plans, performance-based awards, share
appreciation rights, and employee share purchase plans, be recognized as an
expense in the Company's consolidated financial statements. Under SFAS No.
123(R), the related compensation cost will be measured based on the fair value
of the award at the time of grant.
SFAS No. 123(R) is effective for the first interim or annual reporting period
that begins after December 15, 2005 and will replace SFAS No. 123 and supersede
APB Opinion No. 25 at that time. Accordingly, the Company will adopt SFAS No.
123(R) on December 31,, 2005. The Company is currently evaluating the
prospective effect of SFAS No. 123(R) on its results of operations.
Page 14
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
General
Safe Harbor Statement. Statements contained herein that are not historical fact
may be forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the Securities Exchange
Act of 1934, as amended, that are subject to a variety of risks and
uncertainties. There are a number of important factors that could cause actual
results to differ materially from those projected or suggested in
forward-looking statements made by the Company. These factors include, but are
not limited to: (i) unanticipated changes in the U.S economy, including changes
in business conditions such as interest rates, and changes in the level of
growth in the finance and housing markets; (ii) the status of relations between
the Company and a bank as its "Senior Debt Lender" and the Senior Debt Lender's
willingness to extend additional credit to the Company; (iii) the availability
for purchase of additional loans; (iv) the status of relations between the
Company and its sources for loan purchases; (v) unanticipated difficulties in
collections under loans in the Company's portfolio; and (vi) other risks
detailed from time to time in the Company's SEC reports. Additional factors that
would cause actual results to differ materially from those projected or
suggested in any forward-looking statements are contained in the Company's
filings with the Securities and Exchange Commission, including, but not limited
to, those factors discussed under the caption "Real Estate Risk" in the
Company's Annual Report on Form 10-K and Quarterly Reports on Form 10-Q, which
the Company urges investors to consider. The Company undertakes no obligation to
publicly release the revisions to such forward-looking statements that may be
made to reflect events or circumstances after the date hereof or to reflect the
occurrences of unanticipated events, except as other wise required by
securities, and other applicable laws. Readers are cautioned not to place undue
reliance on these forward-looking statements, which speak only as of the date
thereof. The Company undertakes no obligation to release publicly the results on
any events or circumstances after the date hereof or to reflect the occurrence
of unanticipated events.
Overview
Net income totaled $3.1 million for the first quarter of 2005 and $2.0 million
for the first quarter 2004. Earnings per common share for 2005 was $.45 on a
diluted basis and $.51 on a basic basis, compared to $.30 and $.34 for 2004,
respectively. Our first quarter revenues increased by 85% to $27.9 million, from
last years first quarter revenues of $15.1 million. Net income increased 51% to
$3.1 million in the first quarter 2005, from net income of $2.0 million in the
first quarter of 2004. The increase in net income was driven largely by the near
doubling of net interest income, which was the result of significant additions
to the portfolio of notes receivable and loans held for investment during the
second half of 2004 and in the first quarter of 2005, from both loan portfolio
acquisitions and originated loans. During the first quarter, we closed
acquisitions of S&D assets with an aggregate face amount of $111.8 million and
we originated over $87.9 million of sub-prime loans. We increased the size of
our total portfolio of net notes receivable, loans held for sale, loans held for
investment and OREO at the end of the first quarter 2005 to $934.8 million from
$837.9 million at the end of 2004. Our total debt outstanding, including notes
payable and financing agreements, grew to $947.7 million at March 31, 2005 from
$847.3 million at the end of 2004. Our weighted average cost of funds during the
first quarter 2005 increased to 5.8% from 5.0% during the fourth quarter of
2004.
Critical Accounting Policies. The following management's discussion and analysis
of financial condition and results of operations is based on the amounts
reported in the Company's consolidated financial statements. In preparing the
consolidated financial statements in conformity with accounting principles
generally accepted in the United States of America ("GAAP"), management is
required to make estimates and assumptions that affect the financial statements
and disclosures. These estimates require management's most difficult, complex or
subjective judgments. The Company's critical accounting policies are described
in its Form 10-K for the year ended December 31, 2004, and have not changed in
2005, except for the adoption of SOP 03-03 as described below; such adoption had
no immediate impact on our consolidated statements of income.
Page 15
Discounts on Acquired Loans- Effective January 1, 2005, as a result of the
required adoption of AICPA Statement of Position No. 03-3, Accounting for
Certain Loans of Debt Securities Acquired in a Transfer, the Company is required
to change its accounting as it relates to loans which are acquired subsequent to
December 31, 2004 and which have evidence of deterioration of credit quality
since origination and, for which it is probable, at acquisition, that the
Company will be unable to collect all contractually required payments. For such
loans, the excess of the undiscounted contractual cash flows over the
undiscounted cash flows estimated at the time of acquisition is not accreted
into income (nonaccretable discount). The remaining amount, representing the
excess of the loan's estimated cash flows over the purchase price, is accreted
into income over the life of the loan (accretable discount).
For all other loans acquired subsequent to December 31, 2004, the discount,
which represents the excess of the amount of reasonably estimable and probable
discounted future cash collections over the purchase price is accreted into
income using the interest method over the term of the loans and is not accreted
on non-performing loans. This is consistent with the method the Company utilizes
for its accounting for loans purchased prior to January 1, 2005, except an
allowance allocation was also made at the time of acquisition. The Company no
longer increases the allowance through allocations from purchase discount.
There is judgment involved in estimating the amount of the Company's future cash
flows. The amount and timing of actual cash flows could differ materially from
management's estimates, which could materially affect the Company's financial
condition and results of operations. Depending on the timing of an acquisition,
a preliminary allocation may be utilized until a final allocation is
established. Generally, the allocation will be finalized no later than ninety
days from the date of purchase.
The nonaccretable discount is not accreted into income until it is determined
that the amount and timing of the related cash flows are reasonably estimable
and collection is probable. If cash flows cannot be reasonably estimated for any
loan, and collection is not probable, the cost recovery method of accounting is
used. Under the cost recovery method, any amounts received are applied against
the recorded amount of the loan.
Subsequent to acquisition, if cash flow projections improve, and it is
determined that the amount and timing of the cash flows related to the
nonaccretable discount are reasonably estimable and collection is probable, the
corresponding decrease in the nonaccretable discount is transferred to the
accretable discount and is accreted into interest income over the remaining life
of the loan on the interest method. If cash flow projections deteriorate
subsequent to acquisition, the decline is accounted for through the allowance
for loan losses.
Allowance for Loan Losses - The Company performs reviews of its loan portfolio
upon purchase, at loan boarding, and on a frequent basis thereafter to segment
impaired loans under Statement of Financial Accounting Standards ("SFAS") No.
114. A loan is considered impaired when it is probable the Company will be
unable to collect all contractual principal and interest payments due in
accordance with the terms of the note agreement. An allowance for loan losses is
estimated based on the Company's impairment analysis. Management's judgment in
determining the adequacy of the allowance for loan losses is based on the
evaluation of individual loans within the portfolios, the known and inherent
risk characteristics and size of the portfolio, the assessment of current
economic and real estate market conditions, estimates of the current value of
underlying collateral, past loan loss experience and other relevant factors. In
connection with the determination of the allowance for loan losses, management
obtains independent appraisals for the underlying collateral when considered
necessary. Management believes that the allowance for loan losses is adequate.
The allowance for loan losses is a material estimate, which could change
significantly, in the near term.
Page 16
Portfolio Activity. We purchased over $111.8 million in loans during the first
quarter of 2005 as compared with approximately $47.3 million in loans during the
first quarter 2004. The following table sets forth the number of loans, unpaid
principal balance at acquisition, purchase price and purchase price as a
percentage of unpaid principal balance for the Company's loan acquisitions
during the three-month periods ended March 31, 2005 and 2004:
Three Months ended March 31,
2005 2004
---- ----
Number of Loans 4,116 1,655
Unpaid Principal Balance at Acquisition $ 111,775,289 $ 47,282,162
Purchase Price $ 98,522,946 $ 38,432,630
Purchase Price Percentage 88% 81%
During the first quarter of 2004, we also purchased a pool of $4.1 million of
non-performing credit card assets for an aggregate purchase price of
approximately $.3 million.
Loan Origination Activity -Loan originations increased 164% to $87.9 million for
the three months ended March 31, 2005 as compared to the same period last year.
The increase in volume reflects growth due to the success or our Liberty loan
product. The following table sets forth the number of loans and original
aggregate principal balance of loans originated during the three-month periods
ended March 31, 2005 and March 31, 2004:
Three months ended March 31,
2005 2004
---- ----
Number of Loans 389 223
Original Principal Balance $ 87,924,216 $ 33,358,278
Average Balance of loans originated $ 226,026 $ 149,589
During the three months ended March 31, 2005, Tribeca's income before taxes was
$1.5 million as compared to $427,000 during the three months ended March 31,
2004. This increase in income reflected the increased volume of loans originated
and retained, which increased the portfolio of loans held for investment
significantly since March 31, 2004. This increase in loans held for investment
resulted in increased net interest income of 226%, to $1.9 million in the first
quarter of 2005 as compared to $599,000 for the quarter ended March 31, 2004.
As of March 31, 2005, we had approximately $17.7 million face value of loans
held for sale and $171.2 million held for investment, as compared to $16.9
million and $ 110.5 million as of March 31, 2004. The increase in loans held for
investment reflects the retention of $60.8 million of loans originated by
Tribeca, substantially all of which have adjustable rates.
Page 17
Loan Sales of Originated Loans
In the ordinary course of business, Tribeca typically sells loans on a
whole loan servicing released basis, which means that we sell all right, title
and interest in and to a loan or pools of loans for cash. The following table
sets forth our loans sales of originated loans during the quarters ended March
31, 2005 and March 31, 2004:
2005 2004
---- ----
Aggregate Face Value $13,411,176 $19,301,203
Number of Loans Sold 71 107
Gain on Sale $ 663,704 $ 892,955
Gain on Sale/Loans Sold 4.95% 4.63%
Cost of Funds. As of March 31, 2005, the Company had an aggregate of $916.2
million of senior debt owed to Sky Bank ("our lender"), which was incurred in
connection with the purchase of, and is collateralized by, the Company's loan
and OREO portfolios. The Company's senior debt incurred after March 1, 2001,
accrues interest at the Federal Home Loan Bank of Cincinnati ("FHLB") thirty-day
advance rate (the "Index") plus a margin of 3.25%. Senior debt incurred before
March 1, 2001 accrues interest at the prime rate plus a margin of between 0% and
1.75%. At March 31, 2005, approximately $18 million the of the senior debt
incurred before March 1, 2001 remained outstanding and will continue to accrue
interest at the prime rate plus a margin of between 0% and 1.75%. At March 31,
2005, the weighted average interest rate on senior debt was 6.05%.
As of March 31, 2005, we had $31.5 million of debt outstanding under a warehouse
line with our lender, which carried an interest rate of prime, for loans
originated by our Tribeca subsidiary pending sale to others or transfer to held
for investment
Inflation. The impact of inflation on the Company's operations during the
periods presented was immaterial.
Page 18
Results of Operations
Three Months Ended March 31, 2005 Compared to Three Months Ended March 31, 2004.
Total revenue, comprised of interest income, purchase discount earned,
gains on the sales of notes receivable, gain on sale of originated loans held
for sale, gain on sale of OREO, prepayment penalties and other income, increased
by $12.8 million or 85%, to $27.9 million during the three months ended March
31, 2005 from $15.0 million during the three months ended March 31, 2004.
Interest income increased by $12.2 million or 115%, to $22.9 million
during the three months ended March 31, 2005 from $10.6 million during the three
months ended March 31, 2004. The increase in interest income reflected a 103%
increase in the average balances of gross notes receivable, loans held for
investment and loans held for sale during the quarter ended March 31, 2005
compared to the quarter ended March 31, 2004.
Purchase discount earned increased by $.9 million or 68%, to $2.2 million
during the three months ended March 31, 2005 from $1.3 million during the three
months ended March 31, 2004. This increase resulted primarily from a 95%
increase in gross notes receivable, and increased prepayments during the first
quarter of 2005, which accelerated income recognition of the associated purchase
discount compared with the same quarter in 2004. The Company received $57.0
million of principal repayments during the three months ended March 31, 2005
compared with $40.5 million during the three months ended March 31, 2004.
There were no sales of notes receivable during the three months ended
March 31, 2005. During the three months ended March 31, 2004 we sold $6.6
million of notes receivable and recognized a gain of $ .8 million.
Gain on sale of originated loans decreased by $229,000 or 26% to $.7
million during the three months ended March 31, 2005, from $.9 million during
the three months ended March 31, 2004. This decrease reflected a decrease in the
volume of originated loans sold during the three months ended March 31, 2005, as
compared to the three months ended March 31, 2004. Tribeca sold $13.4 million
and $19.3 million in loans, respectively, during the three months ended March
31, 2005 and March 31, 2004.
Prepayment penalties and other income increased by $.7 million or 66%, to
$1.8 million during the three months ended March 31, 2005 from $1.1 million
during the three months ended March 31, 2004. The increase was due primarily to
increases in prepayment penalties received as a result of an increase in loan
pay offs during the three months ended March 31, 2005 compared with the same
period in 2004. Increased late charges resulting primarily from the growth in
the size of the notes receivable portfolio and increased loan application fees
due to the growth in volume of our non-prime loan originations also contributed
to the increase in prepayment penalties and other income.
Total Operating expenses increased by $10.8 million or 95% to $22.2
million during the three months ended March 31, 2005, from $11.4 million during
the three months ended March 31, 2004. Total operating expenses includes
interest expense, collection, general and administrative expenses, provisions
for loan losses, amortization of deferred financing costs and depreciation
expense.
Interest expense increased by $7.7 million or 145% to $13.0 million during
the three months ended March 31, 2005, from $5.3 million during the three months
ended March 31, 2004. This increase reflected the significant increase in the
balance of total debt used to fund the growth in total assets during the period,
including senior debt and financing agreements, which increased by 112% to
$947.7 million as of March 31, 2005 as compared with $446.0 million as of March
31, 2004. In addition, the weighted average cost of funds during the three
months ended March 31, 2005 and March 31, 2004 increased to 5.84% from 4.78%,
reflecting the rise in short-term market interest rates during the past twelve
months.
Page 19
Collection, general and administrative expenses increased by $2.6 million or 59%
to $7.1 million during the three months ended March 31, 2005 from $4.4 million
during the three months ended March 31, 2004. Personnel expenses increased by
$.9 million or 37% and reflected increase in personnel in all areas to meet the
demands of growth in our business. We ended the first quarter of 2005 with 204
employees as compared to 146 at the end of the first quarter of 2004.
Professional and legal fees increased by $.8 million or 129% to $1.4 million and
reflects higher tax, audit and recruiting fees as well as higher legal fees
relating to increased activity with respect to foreclosures, disposition of OREO
and corporate governance initiatives. All other expenses increased $1.0 million
or 66% to $2.5 million from $1.5 million, which is attributed to the overall
increase in our business activity.
Provisions for loan losses increased by $302,000 or 34% to $1.2 million
during the three months ended March 31, 2005 from $.9 million during the three
months ended March 31, 2004. This increase was primarily due to reserve
increases in specific portfolios of notes receivable in accordance with our
periodic evaluation of our allowance for loan losses as result of increased
impairment.
Amortization of deferred financing costs increased by $100,000 or 17%, to
$.7 million during the three months ended March 31, 2005 from $.6 million during
the three months ended March 31, 2004. This increase resulted primarily from the
growth in outstanding debt under our master credit facility and the increased
pace of prepayments, which caused a corresponding increase in the pay down of
senior debt, both of which resulted in increased amortization of the deferred
fee paid to our lender.
During the three months ended March 31, 2005 the Company had a provision
for income taxes of $2.6 million as compared to $1.7 million during the three
months ended March 31, 2004. The effective tax rate for the three months ended
March 31, 2005 and March 31, 2004 was 46% and 45% respectively.
The Company's net income increased by $1.1 million or 51% to $ 3.1 million
from $2.0 million during the three months ended March 31, 2005 for the reasons
set forth above.
Page 20
Notes Receivable Portfolio
As of March 31, 2005, our notes receivable portfolio, which consists of
purchased loans, included 24,869 loans with an aggregate face value of $837.7
million and a net carrying value of $753.8 million (after allowance for loan
losses), compared with 10,685 loans with an aggregate face value of $459.4
million and a net balance of $408.6 million (after allowance for loan losses) as
of March 31, 2004. The following table provides a breakdown of the portfolio as
of March 31, 2005, December 31, 2004 and March 31, 2004, respectively:
March 31, 2005 December 31, 2004 March 31, 2004
-------------- ----------------- --------------
Performing loans $449,684,130 $436,366,894 $309,620,865
Allowance for loan losses 19,727,338 19,154,311 14,666,990
------------ ------------ ------------
Total performing loans
net of allowance for loan losses $429,956,792 $417,212,583 $294,953,875
------------ ------------ ------------
Impaired loans $248,729,295 $280,078,060 $123,614,554
Allowance for loan losses 53,214,855 57,889,091 31,689,950
------------ ------------ ------------
Total impaired loans
net of allowance for loan losses $195,514,440 $222,188,969 $ 91,924,604
------------ ------------ ------------
Loans not recorded onto servicing system $139,293,220 $ 95,440,903 $ 26,146,744
Allowance for loan losses 10,977,472 12,584,898 4,432,875
------------ ------------ ------------
Loans not recorded onto servicing system,
net of allowance for loan losses $128,315,748 $ 82,856,005 $ 21,713,869
------------ ------------ ------------
Notes receivable, net of allowance for
loan losses $753,786,980 $722,257,557 $408,592,348
============ ============ ============
The following table provides a breakdown of the balance of the Company's
portfolio of notes receivable by coupon type, net of allowance for loan losses
and excluding loans purchased but not recorded onto the Company's servicing
system:
Page 21
March 31, 2005 December 31, 2004 March 31, 2004
-------------- ----------------- --------------
Performing loans:
Fixed rate performing loans $312,347,389 $300,286,566 $188,979,199
Adjustable rate performing loans 117,609,403 116,926,017 105,974,676
------------ ------------ ------------
Total performing loans $429,956,792 $417,212,583 $294,953,875
============ ============ ============
Impaired loans:
Fixed rate impaired loans $163,206,209 $184,312,204 $ 56,076,397
Adjustable rate impaired loans 32,308,231 37,876,765 35,848,207
------------ ------------ ------------
Total impaired loans $195,514,440 $222,188,969 $ 91,924,604
============ ============ ============
Total notes receivable, net of allowance for
loan losses $625,471,232 $639,401,552 $386,878,479
============ ============ ============
The increase in the amount of impaired loans from March 31, 2004 to March 31,
2005 reflects the acquisition of two large portfolios, which were purchased at
discounts to their face value, during 2004 with a sizeable portion of impaired
loans at the time of purchase. These portfolios included loans in bankruptcy and
foreclosure that are classified as impaired. We received payments on a portion
of these impaired loans even though they are contractually delinquent.
Liquidity and Capital Resources
The Company has one principal source of external funding to meet its liquidity
requirements, in addition to the cash flow provided from borrower payments of
interest and principal on mortgage loans. (See" Senior Debt" below). In
addition, the Company sells pools of mortgage loans from time to time and
regularly sells loans that it originates specifically for sale into the
secondary market.
During the quarter ended March 31, 2005 the Company purchased 4,116 loans,
consisting primarily of first and second mortgages, with an aggregate face value
of $111.8 million at an aggregate purchase price of $98.5 million, or 88% of the
face value. These acquisitions were funded with senior debt in the amount equal
to the purchase price of the mortgages plus a 1% loan origination fee.
Cash Flow From Operating, Investing and Financing Activities
As of March 31, 2005, we had cash and cash equivalents of approximately $24.3
million compared to approximately $19.5 million at December 31, 2004. The
increase was primarily due to an increase in collections on purchased notes
receivable and originated loans held for investment, caused primarily by an
increase in the portfolio of purchased notes receivable and loans held for
investment during 2004 and in the first quarter of 2005 due to increased
acquisitions and originations. The primary source of cash from operations is
interest income received on purchased notes receivable and loans held for
investment and sale.
Substantially all of the assets of the Company are invested in its portfolios of
notes receivable, loans held for investment, OREO and loans held for sale. The
only significant external source of the Company's funding for investing
activities is borrowings under its senior debt facility. Primary uses of cash
include purchases of notes receivable and origination of loans. We rely
significantly upon our lender to provide the funds necessary for the purchase of
notes receivable portfolios and the origination of loans. While we have
historically been able to finance these purchases and originations, we do not
currently have committed loan facilities in significant excess of the amount we
currently have outstanding under our debt facilities, described below.
Page 22
Net cash provided by operating activities was $1.2 million during the quarter,
compared to approximately $11.8 million used during the first quarter of 2004.
The decrease in cash used was primarily due to a decrease in the volume of loans
originated for sale, due to the Company's changed strategy of holding a
significant portion of originated loans.
Net cash used in investing activities was approximately $96.8 million in the
quarter, compared to approximately $17.0 million provided in the first quarter
2004. The increase in cash used was primarily due to increases in originations
of loans held for investment of $73.5 million, the purchase of notes receivable,
which constituted approximately $98.5 million in the first quarter of 2005,
which was partially offset by principal collections of notes receivable and
loans held for investment of $69.4 million and sales of OREO of $7.0 million in
the quarter.
Net cash provided by financing activities increased to approximately $100.5
million in the quarter, from $4.3 million used during the first quarter 2004.
The increase resulted primarily from a net increase in senior debt of $108.5
million.
Senior Debt
As of March 31, 2005, the Company owed its lender $916.2 million under its
master credit and security agreement and $31.5 million under its warehousing
credit and security agreement.
During the three months ended March 31, 2005, the Company amortized as
additional interest expense $150,000 of success fee paid to its lender under the
master credit facility. The amortization amount was derived using the
straight-lined method based on the estimated weighted average life of the
relevant term loans and the related success fee payments. The unamortized amount
will be re-evaluated each reporting period for changes in assumptions.
Financing Activities and Contractual Obligations
Below is a schedule of the Company's contractual obligations and commitments at
March 31, 2005:
Weighted Average Weighted Average
Interest Rate Interest Rate
Contractual Obligation Schedule As of 3/31/05 As of 12/31/04
Contractual Obligations
Notes Payable 6.05% 5.73%
Warehouse Line 5.75% 5.25%
Minimum Contractual Obligations
(excluding interest)
Contractual Obligation Schedule Total Less Than 1 yr 1-3 yrs 3-5 yrs Thereafter
Contractual Obligations
Notes Payable 916,186,427 117,102,921 615,903,401 181,854,412 1,325,693
Warehouse Line 31,518,801 31,518,801 -- -- --
Rent Obligations 9,258,980 760,447 2,686,130 2,139,549 3,672,854
Capital Lease Obligations 563,324 170,610 255,631 137,083 --
Employment Agreements 1,590,500 453,000 650,000 487,500 --
------------ ------------ ------------ ------------ ------------
Total Contractual Cash Obligations $959,118,032 $150,005,779 $619,495,162 $184,618,544 $ 4,998,547
============ ============ ============ ============ ============
The interest rates on the Notes Payable and the Warehouse Line are indexed to
the monthly Federal Home Loan Bank of Cincinnati 30 day LIBOR advance rate and
Prime as more fully described herein, and will increase or decrease over time.
Minimum contractual obligations are based on minimum required principal payments
including balloon maturities of the notes payable and warehouse line. Actual
payments will vary depending on cash collections and loan sales as described
herein. Historically, the Company and the Bank have extended the maturities and
balloon payments.
Page 23
Certain Concentrations- The following table summarizes geographic locations of
mortgage loans held as of March 31, 2005:
Percentage of Total
Location Principal Balance
- -------- -----------------
New York 8.47%
Ohio 8.04%
California 7.46%
Florida 6.97%
New Jersey 6.95%
Georgia 4.55%
Pennsylvania 4.35%
Texas 4.07%
Michigan 3.94%
North Carolina 3.77%
All Others 41.43%
------------------
100.00%
==================
Such real estate mortgage loans held are collateralized by real estate with a
concentration in these regions. Accordingly, the collateral value of a
substantial portion of the Company's real estate mortgage loans held and real
estate acquired through foreclosure is susceptible to changes in market
conditions in these regions. In the event of sustained adverse economic
conditions, it is possible that the Company could experience a negative impact
in its ability to collect on existing real estate mortgage loans held, or
liquidate foreclosed assets in these regions, which could impact the Company's
related loan loss estimates.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to various types of market risk in the normal course of business,
including the impact of interest rate changes and changes in corporate tax
rates. A material change in these rates could adversely affect our operating
results and cash flows.
Interest Rate Risk
Interest rate fluctuations can adversely affect the Company's operating results
and present a variety of risks, including the risk of a the mismatch between the
repricing of interest-earning assets and borrowings, variances in the yield
curve and changing prepayment rates.
Interest rates are highly sensitive to many factors, including governmental
monetary policies and domestic and international economic and political
conditions. Conditions such as inflation, recession, unemployment, money supply
and other factors beyond the Company's control may also affect interest rates.
Fluctuations in market interest rates are neither predictable nor controllable
and may have a material adverse effect on the Company's business, financial
condition and results of operations.
Page 24
The Company's operating results will depend in large part on differences between
the interest from its assets and its borrowings. Most of the Company's assets,
consisting primarily of mortgage notes receivable and loans held for investment,
generate fixed returns and have terms in excess of five years. The Company funds
the origination and acquisition of a significant portion of these assets with
borrowings, which have interest rates that are based on the monthly Federal Home
Loan Bank of Cincinnati ("FHLB") 30-day advance rate. In most cases, the
interest income from assets will respond more slowly to interest rate
fluctuations than the cost of borrowings, creating a mismatch between interest
yielding assets and borrowings. Consequently, changes in interest rates,
particularly short-term rates, will significantly impact the Company's net
interest income and, therefore, net income. The Company's borrowing under
agreements with its senior debt lender bear interest at rates that fluctuate
with the FHLB rate of Cincinnati and the prime rate. Based on approximately
$916.2 million of borrowings outstanding at March 31, 2005, a 1% increase in
both FHLB and prime rates would increase quarterly interest expense by
approximately $2.3 million, pre tax, which would negatively impact the Company's
quarterly net income by approximately $1.2 million after tax. Due to the
Company's liability sensitive balance sheet, increases in these rates will
decrease net income and market value of the Company's net assets.
The value of the Company's assets may be affected by prepayment rates on
investments. Prepayments rates are influenced by changes in current interest
rates and a variety of economic, geographic and other factors beyond the
Company's control, and consequently, such prepayment rates cannot be predicted
with certainty. When the Company originates and purchases mortgage loans, it
expects that such mortgage loans will have a measure of protection from
prepayment in the form of prepayments lockout periods or prepayment penalties.
In periods of declining mortgage interest rates, prepayments on mortgages
generally increase. If general interest rates decline as well, the proceeds of
such prepayments received during such periods are likely to be reinvested by the
Company in assets yielding less than the yields on the investments that were
prepaid. In addition, the market value of mortgage investments may, because of
the risk of prepayment, benefit less from declining interest rates than other
fixed-income securities. Conversely, in periods of rising interest rates,
prepayments on mortgage generally decrease, in which case the Company would not
have the prepayment proceeds available to invest in assets with higher yields.
Under certain interest rate and prepayment scenarios the Company may fail to
recoup fully its cost of acquisition of certain investments.
Real Estate Risk
Residential property values and operating income derived from such properties
are subject to volatility and may be affected adversely by number of factors,
including, but not limited to, national, regional and local economic conditions,
which may be adversely affected by industry slowdowns and other factors; local
real estate conditions (such as the supply of housing or the rapid increase in
home values). In the event operating income decreases, a borrower may have
difficultly paying the Company's mortgage loan, which could result in losses to
the Company. In addition, decreases in property values reduce the value of the
collateral and the potential proceeds available to a borrower to repay the
Company's mortgage loans, which could also cause the Company to suffer losses.
The Company purchases and originates principally fixed and adjustable rate
residential mortgage loans, which are secured primarily by the underlying
single-family properties. Because the vast majority of the Company's loans are
to non-prime borrowers, delinquencies and foreclosures are substantially higher
than those of prime mortgage loans, and if not serviced properly could result in
an increase in losses on dispositions of properties acquired through
foreclosure. In addition, a decline in real estate values would reduce the value
of the residential properties securing our loans, which could lead to an
increase in borrower defaults and increased losses on the disposition of
foreclosed properties.
Page 25
Item 4. Controls and Procedures.
As of the end of the period covered by this Quarterly Report on Form 10-Q, the
Company carried out an evaluation, under the supervision and with the
participation of senior management, including the Company's Chief Executive
Officer and Chief Financial Officer, of the effectiveness of the design and
operation of its disclosure controls and procedures. Based upon that evaluation,
the Company's Chief Executive Officer and Chief Financial Officer concluded that
the Company's disclosure controls and procedures are effective for gathering,
analyzing and disclosing the information that the Company is required to
disclose in reports filed under the Securities Exchange Act of 1934.
There have been no significant changes in the Company's internal controls over
financial reporting or in other factors during the fiscal quarter ended March
31, 2005 that materially affected, or are reasonably likely to materially
affect, the Company's internal control over financial reporting subsequent to
the date the Company carried out its most recent evaluation.
Part II Other Information
Item 1. Legal Proceedings
None.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
Termination of Six Harrison Sublease
On May 12, 2005, the Company entered into a Termination Agreement (the
"Six Harrison Termination Agreement"), by and among RMTS, LLC, a New York
limited liability company of which Thomas J. Axon, the Company's Chairman, owns
80% (the "Sublessor" ), James Thomas Realty, a New York limited liability
corporation (the "Landlord") of which Mr. Axon owns 90% and Frank B. Evans, Jr.,
a member of the Company's Board of Directors, owns 10%, and the Company.
Under the Six Harrison Termination Agreement, the Landlord and the
Sublessor agreed, in connection with the Company's planned relocation of most of
its offices to Jersey City, New Jersey, to the early termination of the
Company's sublease for approximately 2,500 square feet of office space at Six
Harrison Street in New York, New York, which was due to expire in August 2009,
in consideration of the Company's payment of $125,000 to the Landlord.
Page 26
Pursuant to the Six Harrison Termination Agreement, the Company agreed to
surrender the premises on or before August 31, 2005, provided that it may extend
the scheduled surrender date for all or any portion of the premises by one-month
increments through November 30, 2005, subject to payment of monthly rent, pro
rated to reflect the portion of the premises retained. A copy of the Termination
Agreement is filed herewith as Exhibit 10.3.
Termination of 185 Franklin Lease
On May 12, 2005, the Company entered into a Termination Agreement (the
"185 Franklin Termination Agreement") with 185 Franklin Street Development
Associates L.P., a New York limited partnership (the "185 Franklin Lessor"), the
general partner of which is owned by an entity that is owned by Mr. Axon.
Pursuant to the 185 Franklin Termination Agreement, the 185 Franklin Lessor
agreed, in connection with the Company's planned relocation of its offices to
Jersey City, New Jersey, to the early termination of the Company's leases for
approximately 7,400 square feet of office space at 185 Franklin Street in New
York, New York, which were due to expire on dates ranging from February 2008
through October 2008, in consideration of the Company's payment of $462,859 to
the 185 Franklin Lessor.
Pursuant to the 185 Termination Agreement, the Company agreed to surrender
the premises by August 31, 2005, provided that it may extend the scheduled
surrender date in one-month increments through November 30, 2005, subject to
payment of monthly rent, pro rated to reflect the portion of the premises
retained. A copy of the 185 Franklin Termination Agreement is filed herewith as
Exhibit 10.4.
Sale of Remaining Miramar Oil and Gas Interests
On May 12, 2005, the Company entered into a Purchase Agreement with Mr.
Axon. Under the Purchase Agreement, the Company sold to Mr. Axon certain
interests in oil and gas-related assets remaining from before the merger of
Miramar Resources, Inc. and Franklin Credit Management Corporation in 1994 for a
purchase price of $30,800. The assets sold included (i) 100% of the outstanding
shares of common stock of Rockwell Drilling Company, Inc. and (ii) interests in
certain joint ventures known as the Kingman Energy Minerals Joint Venture, the
Kerrick Energy Minerals Joint Venture and the High Plains Energy Minerals Joint
Venture. A copy of the Purchase Agreement is filed herewith as Exhibit 10.5.
Sale of Tribeca Condominium; Agreement for Hosting
On May 12, 2005, the Company entered into a Contract of Sale with Mr. Axon
and Noreen Axon, Mr. Axon's wife (collectively, the "Axons"). Under the Contract
of Sale, the Company agreed to sell to the Axons a condominium apartment unit at
350 Albany Street in New York, New York (the "350 Albany Condominium") for a
purchase price of $514,000. The closing of the transaction is scheduled to occur
on or about May 31, 2005. A copy of the Contract of Sale is filed herewith as
Exhibit 10.6.
On May 12, 2005, the Company entered into an Agreement for the Use of
Facilities with the Axons. Under the Agreement, the Axons will make the 350
Albany Condominium and another condominium located at 300 Albany Street
available to the Company for up to 240 nights per year for the housing of
employees, prospective employees, out-of-town business associates, guests and
other individuals engaged in business activities related to the Company, in
exchange for which the Company will pay the Axons $4,500 per month commencing
June 1, 2005. Either party may terminate the Agreement upon two months written
notice. A copy of the Agreement for the Use of Facilities is filed herewith as
Exhibit 10.7
Page 27
On August 29, 2005, pursuant to a recommendation of the Compensation
Committee of the Board of Directors of the Company, the Company paid Mr. Axon
$23,322 as compensation for Mr. Axon providing personal guarantees with regard
to certain of the Company's debt outstanding to Sky Bank. The compensation
amount was determined based on the amount of capital at risk, a reasonable
reimbursement rate and the time value of money.
Item 6. Exhibits
Exhibit
Number
- ------
10.1 Employment Agreement, effective as of March 28, 2005, between the
Registrant and Paul D. Colasono.
10.2 Restricted Stock Grant Agreement, dated as of April 13, 2005,
between the Registrant and Paul D. Colasono.
10.3 Termination Agreement, dated as of May 12, 2005, among RMTS, LLC,
James Thomas Realty and the Registrant.
10.4 Termination Agreement, dated as of May 12, 2005, between 184
Franklin Street Development Associates L.P. and the Registrant.
10.5 Purchase Agreement, dated as of May 12, 2005, between Thomas J. Axon
and the Registrant.
10.6 Contract of Sale, dated as of May 12, 2005, between Thomas J. Axon
and Noreen Axon and the Registrant.
10.7 Agreement for Use of Facilities, dated as of May 12, 2005, between
Thomas J. Axon and Noreen Axon and the Registrant.
31.1 Rule 13a-14(a) Certification of Chief Executive Officer of the
Company in accordance with Section 302 of the Sarbanes-Oxley Act of
2002.
31.2 Rule 13a-14(a) Certification of Chief Financial Officer of the
Company in accordance with Section 302 of the Sarbanes-Oxley Act of
2002.
32.1 Certification of Chief Executive Officer of the Company in
accordance with Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer of the Company in
accordance with Section 906 of the Sarbanes-Oxley Act of 2002.
Page 28
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.
May 16, 2005
FRANKLIN CREDIT MANAGEMENT
CORPORATION
By: /s/ JEFFREY R. JOHNSON
---------------------------------
Jeffrey R. Johnson
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act, this report
has been signed below by the following persons on behalf of the registrant and
in the capacity and on the dates indicated.
Signature Title Date
/s/JEFFREY R. JOHNSON Chief Executive Officer May, 16 2005
- -------------------------- and Director ------------
Jeffrey R. Johnson
(Chief Executive Officer)
/s/PAUL D. COLASONO Executive Vice President, May 16, 2005
- ------------------- Chief Financial Officer ------------
Paul D. Colasono
(Principal Financial Officer)
Page 29