UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM S-1

 

REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933

 

_________________

Pioneer Financial Services, Inc.

(Exact name of Registrant as specified in its charter)

 

 

 

4700 BELLEVIEW AVENUE, SUITE 300

KANSAS CITY, MISSOURI 64112

(816) 756-2020

 

(Address, including zip code, and telephone number, including

area code, of registrant's principal executive offices)

 

THOMAS H. HOLCOM

CHIEF EXECUTIVE OFFICER

4700 BELLEVIEW AVENUE, SUITE 300

KANSAS CITY, MISSOURI 64112

(816) 756-2020

 

(Name, address, including zip code, and telephone number, including area code, of agent for service)

_________________

 

COPIES TO:

 

JOHN GRANDA

KENDA K. TOMES

STINSON MORRISON HECKER LLP

1201 WALNUT STREET

KANSAS CITY, MISSOURI 64106

(816) 842-8600

_________________

 

Approximate date of commencement of proposed sale to public:

As soon as practicable after this registration statement becomes effective.

_________________

 

If any of the securities being registered are being offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. x

 

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ]

 

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ]

 

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ]

 

Indicate by a check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accredited filer or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.

 

 

 

 

CALCULATION OF REGISTRATION FEE

 

 

 

 

 

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THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE MAY NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER TO SELL THESE SECURITIES AND IT IS NOT SOLICITING AN OFFER TO BUY THESE SECURITIES IN ANY JURISDICTION WHERE THE OFFER OR SALE IS NOT PERMITTED.

SUBJECT TO COMPLETION

[GRAPHIC OMITTED]

$25,000,000 Investment Notes

Minimum Investment of $10,000

Pioneer Financial Services, Inc. (“PFS”), a Missouri corporation, is a wholly owned subsidiary of MidCountry Financial Corp., a Georgia corporation (“MCFC”). PFS, with its wholly owned subsidiaries (collectively “we,” “us,” “our” or the “company”) is offering up to $25,000,000 in aggregate principal amount of our investment notes ("notes" or "investment notes") on a continuous basis. This offering will terminate on January __, 2012 unless terminated earlier at our discretion. The notes will be offered in maturities ranging from 12 to 120 months, in increments of $10,000.

We are offering the notes through our officers and employees without an underwriter and on a continuous basis. We do not have to sell any minimum amount of notes to accept and use the proceeds of this offering. There is no assurance that all or any portion of the notes we are offering will be sold. We have not made any arrangement to place any of the proceeds from this offering in an escrow, trust or similar account, and thus you will not be entitled to the return of your investment. There is no public trading market for the notes and it is very unlikely that any trading market will develop, and no assurance can be given that the notes may be resold at any price. We have the right to reject any subscription, in whole or in part.

We will disclose the interest rates at which notes will be offered, from time to time, in supplements to this prospectus. However, any such change will not affect the interest rate of any notes purchased prior to the effective date of the change. We will pay or compound interest on the notes annually. Holders of notes may elect to receive monthly interest payments in return for a ½% reduction in the interest rate of the note. Qualified investors may establish individual retirement accounts, simplified employee pension accounts, Roth IRAs and Coverdell education savings accounts with us in which to hold their notes.

You should read this prospectus and the applicable prospectus supplement carefully before you invest in the notes.

These notes are our unsecured, subordinated obligations. Payment of the notes is not insured or guaranteed by the Federal Deposit Insurance Corporation, any governmental or private insurance fund, or any other entity. We do not contribute funds to a separate account such as a sinking fund to repay the notes upon maturity. We may redeem the notes in whole or in part any time prior to maturity at a price equal to the principal amount thereof plus accrued interest to the purchase date.

See "Risk Factors" beginning on page 6 for certain factors you should consider before buying the notes.

These securities have not been approved or disapproved by the Securities and Exchange Commission or any state securities commission nor has the Securities and Exchange Commission or any state securities passed upon the accuracy or adequacy of this prospectus. Any representation to the contrary is a criminal offense.

 

 

 

 

 

The date of this Prospectus is January __, 2010

 

TABLE OF CONTENTS

Page

 

 

 

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You should rely only upon the information contained in this prospectus. We have not authorized anyone to provide you with information different from that contained in this prospectus. We are offering to sell notes only in jurisdictions where offers and sales are permitted. The information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of the prospectus or of any sale of the notes.

 

 

PROSPECTUS SUMMARY

This summary highlights selected information and does not contain all the information that may be important to you. You should carefully read this prospectus, any related prospectus supplement and the documents we have referred you to in "Where You Can Find More Information" on page 42 before making an investment in the notes, including the “Risk Factors” section beginning on page 6. In this prospectus, references to "Pioneer," "we," "us" and "our" refer to Pioneer Financial Services, Inc. and our subsidiaries.

Our Company

On a worldwide basis, we purchase consumer loans made exclusively to active-duty or retired career U.S. military personnel or U.S. Department of Defense employees. We purchase primarily from two different types of sources. Our largest source of military loans is the Military Banking Division of MidCountry Bank (“MCB”) (a wholly-owned subsidiary of our parent and referred to throughout as “MBD"), an affiliate who originates direct loans through a network of loan production offices and via the Internet; military families use these loan proceeds to purchase goods and services. We also purchase retail installment contracts from retail merchants that sell consumer goods to active-duty or retired career U.S. military personnel or U.S. Department of Defense employees. We plan to hold these military loans and retail installment contracts until repaid.

Finance receivables, whether originated or purchased, are effectively unsecured and consist of loans originated by us or purchased from MBD and retail merchants. All finance receivables have fixed interest rates and typically have a maturity of less than 48 months. At acquisition, the size of the average finance receivable that we own was approximately $3,065 during fiscal year 2009. A large portion of our customers are unable to obtain financing from traditional sources due to factors such as age, frequent relocations and lack of credit history. These factors may not allow them to build relationships with traditional sources of financing.

We were incorporated in Missouri in 1932, and our principal corporate office is located at 4700 Belleview, Suite 300, Kansas City, Missouri 64112-1359. The telephone number at that address is (816) 756-2020. Information about us can be found at www.investpioneer.com. We do not intend for the information contained on this website to be a part of this prospectus.

The Offering

 

 

 

 

 

 

Summary Consolidated Financial Data

The following table summarizes the financial data of our business. You should also read "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our audited consolidated financial statements and related notes included elsewhere in this prospectus. The data as of, and for the fiscal years ended September 30, 2009 and 2008, as of and for the periods ended September 30 and May 31, 2007, and the fiscal years ended September 30, 2006 and 2005 has been derived from our audited consolidated financial statements and related notes.

 

 

 

 

RISK FACTORS

Our operations and your investment in the notes are subject to a number of risks, including but not limited to those described below. If any of the following risks actually occur, our business, financial condition or operating results and our ability to repay the notes could be materially adversely affected.

Risk Factors Related to the Investment Notes

Our investment notes are not insured or guaranteed by any third party, and we are not subject to regulatory requirements designed to protect investors.

Our investment notes are not insured or guaranteed by the FDIC, any governmental agency or any other public or private entity as are certificates of deposit or other accounts offered by banks, savings and loan associations or credit unions. You are dependent upon our ability to effectively manage our business to generate sufficient cash flow, including cash flow from our financing activities, for the repayment of principal at maturity and the ongoing payment of interest on the investment notes. If these sources are inadequate, you could lose your entire investment.

Because the investment notes are not secured by any collateral, you are dependent upon our successful operations to service the interest and principal payments on the investment notes.

Substantially all of our assets have been pledged to our lenders to secure our borrowings under our Senior Secured Lending Agreement (“SSLA”). Accordingly, in the event of a default under our SSLA, it is likely that our assets would be liquidated to repay our senior debt. Therefore, repayment of the investment notes is dependent on our continued successful operations. There can be no assurance that we will continue to operate successfully in the future.

Payment on the investment notes is subordinate to the payment of all outstanding senior indebtedness, and the investment notes do not limit the amount of senior indebtedness, additional junior subordinated indebtedness or other indebtedness we may incur.

The investment notes are subordinate and junior to any and all senior indebtedness (defined generally as any debt or liability for money borrowed, regardless of when incurred or created, that is not expressly subordinate or equal in right of payment to the investment notes, including senior debt), and will rank equal in payment priority with all junior subordinated investment notes we issue in the future. There are no restrictions in the investment notes regarding the amount of senior indebtedness, junior subordinated indebtedness, or other indebtedness that we or our subsidiaries may incur. We intend to incur additional senior indebtedness and junior subordinated indebtedness in the future. Upon the maturity of our senior indebtedness, by lapse of time, acceleration or otherwise, the holders of our senior indebtedness have first right to receive payment in full prior to any payments being made to any note holders. Therefore, you would only be repaid if funds remain after the repayment of our senior indebtedness. As of September 30, 2009, we had approximately $242.0 million of senior indebtedness outstanding.

Payment of interest and principal on the investment notes is effectively subordinate to the payment of the unsecured creditors of our subsidiaries.

Substantially all of the assets we use in our business are held by our subsidiaries. Any indebtedness of our subsidiaries will have rights upon liquidation or dissolution of the particular subsidiary prior to payment being made to any note holders. As a result, in the event of the liquidation of any of our subsidiaries, all the creditors of our subsidiaries would be paid prior to the subsidiary distributing any amounts to us. While our senior loan agreement limits the amount of debt that our subsidiaries may incur, if our subsidiaries did not have sufficient funds to pay their debts, our ability to pay interest and principal on the investment notes would be impaired.

The investment notes do not contain any restrictive covenants or other provisions to protect your investment.

The investment notes do not have the benefit of any restrictive covenants. Therefore, your investment is not protected if there is a material adverse change in our financial condition or results of operations. For example, the investment notes do not contain any restrictions on our ability to pay dividends or to create or incur senior indebtedness or indebtedness which is junior or subordinate to or has the same rights and obligations as the investment notes. In addition, the investment notes do not contain covenants specifically designed to protect note holders if we engage in a highly leveraged transaction such as a requirement that we redeem the investment notes if there is a takeover, recapitalization or similar restructuring.

 

Furthermore, the investment notes do not contain a provision permitting an individual, unless such individual is a majority holder, to accelerate the indebtedness in the event of a default on the note.

Your investment in the investment notes is illiquid.

The investment notes are not listed on a national or other securities exchange. Further, it is very unlikely that any trading market for the investment notes will develop. You have no right to require redemption of the investment notes, and there is no assurance that the investment notes will be accepted as collateral for loans. Due to the lack of a market for the investment notes, we cannot assure you that you would be able to sell the investment notes.

There is no sinking fund to ensure repayment of the investment notes on maturity.

We do not contribute funds to a separate account, commonly known as a “sinking fund,” to repay the investment notes upon maturity. Because funds are not set aside periodically for the repayment of the investment notes over their term, note holders must rely on our cash flow from operations and other sources of financing for repayment, such as funds from bank loans, the sale of investment notes and other credit facilities. To the extent cash flow from operations and other sources are not sufficient to repay the investment notes, you may lose all or a part of your investment.

The investment notes contain a renewal feature which could result in the extension of the maturity of the notes and a lower interest rate being paid.

The investment notes contain a renewal provision that allows us to extend the maturity date of the notes and to reset the interest rate to the then current rate unless you provide us with written notice that you want your note paid within 20 days after the maturity date of the note. The principal amount of the renewed note will equal the principal amount of the note on the most recent maturity date, plus all accrued and unpaid interest. The term of the renewed note will be equal to the original term of the note, and the interest rate on the note will be equal to the interest rate we are then paying on notes of a like term and principal amount. Therefore, if you fail to take action, you will be required to maintain your investment in us beyond the original maturity date of the note. Further, because the interest rate we pay on notes depends on a number of factors, the interest rate on a renewed note may be lower than the interest rate on the original note.

If we redeem or fail to renew the notes, you may not be able to reinvest the proceeds at comparable rates.

We, at our option, may at any time redeem all or a portion of the outstanding notes for payment prior to their maturity. We may, in our discretion, purchase fewer than all of the outstanding notes. The notes will be purchased at a purchase price equal to 100% of the principal amount plus any accrued but unpaid interest. We will pay no premium upon redemption of the notes. In addition, while we have the right to renew the notes if you fail to timely provide us with written notice that you want your note paid, we may elect to repay your note in full upon maturity. In the event we redeem or fail to renew your notes, you would have the risk of reinvesting the proceeds at the then-current market rates, which may be lower than the rates paid on the original notes.

We face risks of interest rate fluctuations and if we are not able to adequately protect our portfolio from changes in interest rates, our results of operations could be adversely affected and impair our ability to pay interest and principal on the investment notes.

Interest rates are currently at historic lows. Our earnings are significantly dependent on our net interest income, as we realize income primarily from the difference between the rate of interest we receive on the loans we own and the interest rate we must pay on our outstanding senior debt and investment notes. We are unable to predict future fluctuations in market interest rates, which are affected by many factors, including inflation, economic growth, employment rates, fiscal and monetary policy and disorder and instability in domestic and foreign financial markets. Sustained, significant increases in market rates could unfavorably impact our liquidity and profitability. Any significant reduction in our profitability would have a material adverse impact on our business, results of operation, financial condition and cash flow which diminish our ability to pay interest and principal on the investment notes.

We purchase loans made exclusively to the military market, which traditionally has higher delinquencies than customers in other markets, resulting in higher charge-offs, a reduction in profitability and impairment of our ability to pay interest and principal on the investment notes.

A large portion of our loan customers are unable to obtain financing from traditional sources, due to factors such as their age, frequent relocations and lack of credit history. Historically, we have experienced higher delinquency rates than

 

traditional financial institutions. When we purchase loans, we depend on underwriting standards and collection procedures designed to mitigate the higher credit risk associated with lending to these borrowers. However, these standards and procedures may not offer adequate protection against risks of default. Higher than anticipated delinquencies, foreclosures or losses on the loans we own could reduce our profitability and have a material adverse impact on our business, financial condition and results of operations which restricts our ability to pay interest and principal on the investment notes.

Risk Factors Related to the Business

We may experience limited availability of financing and variation in our funding costs, which may materially impact our results of operations, profits and ability to grow.

We currently fund our operations primarily through senior debt. The profitability and growth of our business and our ability to purchase loans currently depends on our ability to access senior debt at competitive rates, and we cannot guarantee that such financing will be available in the future. Our senior debt is comprised of individual loans from lenders, which are party to our SSLA. The SSLA is an uncommitted facility that provides common terms and conditions pursuant to which individual banks that are a party to this agreement may choose to make loans to us in the future. No lender has an obligation to make any additional future loans to us. As of September 30, 2009, we could request up to $27.8 million in additional funds and remain in compliance with the terms of the SSLA. No lender has a contractual obligation to lend us these additional funds. In addition, we have borrowings of $53 million from withdrawing banks who had previously participated in our credit facility; this capacity needs to be replaced to fund purchasing of additional finance receivables. If we are unable to renew or replace the senior debt or find alternative financing at reasonable rates, we will be forced to reduce our loan acquisition. If we are forced to reduce the number of loans we acquire, there can be no assurance that we will be able to pay the interest and principal on the investment notes. With the ongoing strains in the financial markets, we see liquidity, capital and earnings challenges for some banks in our credit group that reduce their ability to participate in the credit or may cause a decrease in their willingness to lend at the current levels. In an effort to conserve our funding resources, we have reduced the number of loans we acquire.

Recent Supreme Court ruling may expose national banks and thrifts to state enforcement of state consumer protection laws and bring into question federal preemption.

Recently, the United States Supreme Court invalidated a regulation of the Office of the Comptroller of the Currency (the “OCC”) that purported to preempt enforcement of state consumer protection laws.  Although the Supreme Court's holding does not allow a state to exercise visitorial powers over an OCC-chartered institution, it does allow state attorneys general to bring judicially enforced actions against OCC-chartered institutions to enforce state consumer protection laws. The Supreme Court’s holding addresses OCC regulations, not the regulations of the Office of Thrift Supervision (“OTS”) that govern our operations, as well as the operations of MCB and MCFC.  However, courts may interpret the holding as permitting state attorneys general to enforce state consumer protection laws against all lending institutions, including OTS-chartered institutions.  Further, the Secretary of the Treasury and others submitted to Congress various pieces of legislation that propose to combine responsibilities of the OCC and the OTS into the National Bank Supervisor (“Proposed Legislation”). If courts conclude that the Supreme Court's recent holding applies to federal savings banks, or if Congress adopts these proposed changes and effects the combination of the responsibilities of the OTS and OCC, we may be exposed to increased state enforcement of consumer protection laws.  An increase in state enforcement actions could have an affect on our business, in which case we might need to amend our business model to comply with the consumer protection laws of each state in which MBD originates and services loans.

Potential regulatory changes may impact the lending practices of our vendors requiring us to make changes to our business model.

Under the Proposed Legislation, a new federal government agency, the National Bank Supervisor (“NBS”) would be created, that would charter and supervise all federally-chartered depository institutions, and all federal branches and agencies of foreign banks. It is proposed that the NBS take over the responsibilities of the OCC, which currently charters and supervises nationally chartered banks, and the responsibility for the institutions currently supervised by the OTS, which supervises federally chartered thrifts and thrift holding companies, such as MCFC, MCB and us. Some of the Proposed Legislation would implement the combination of the responsibilities of the OCC and the OTS, if adopted in its current form. In addition, under the administration’s proposal, the thrift charter, under which MCB is organized, could be eliminated. If the administration’s proposal is finalized, MCB may be subject to a new charter mandated by the NBS. There is no assurance as to how this new charter, or the supervision by the NBS, will affect MCB’s operations going forward.

 

The administration’s proposal also includes the creation of a new federal agency designed to enforce consumer protection laws. The Consumer Financial Protection Agency (“CFPA”) would have the authority to protect consumers of financial products and services and to regulate all providers (bank and non-bank) of such services. The CFPA would be authorized to adopt rules for all providers of consumer financial services, supervise and examine such institutions for compliance and enforce compliance through orders, fines and penalties. The rules of the CFPA could serve as a “floor” and individual states would be permitted to adopt and enforce stronger consumer protection laws. If adopted as proposed, we, along with MCFC, MCB and our vendors of loans, could become subject to multiple laws affecting the provision of loans and other credit services to consumers, which may substantially increase the cost of providing such services.

At this time, we do not know whether the administration’s proposal for regulatory reform will be adopted and if so, the final form of such enactment, and what the full impact on us may be. There is no assurance whether this new charter, the supervision by the NBS or the creation of the CFPA will affect our operations and the operations of our vendors going forward. We might need to amend our business model to comply with these changes and ensure that our vendors have complied with these changes. Nevertheless, any changes as to how we are regulated may adversely affect our business, financial condition and results of operations.

We are dependent on our key officers and the loss of services of any member of our team may have an adverse effect on our operations.

Our success depends in large part on the retention of a limited number of key officers, including: Thomas H. Holcom, Jr., our Chief Executive Officer, Joe B. Freeman, our Chief Operating Officer and Laura V. Stack, our Chief Financial Officer. The loss of the services of any of our key officers may have a material adverse effect on us. Each of these key personnel also has a key role with MBD and the loss of one or more such persons and our ability to find suitable successors for such individuals could have a material adverse impact on us and could cause us to undergo a difficult transition period. There is no assurance that we will be able to retain our current key officers or attract additional officers as needed.

MBD may modify underwriting and servicing standards and does not have to lend to the traditional customers who meet our business model and lending guidelines, which may materially adversely affect our business, results of operations and financial condition.

Except as permitted by the SSLA, we are obligated to purchase generally all the loans made to U.S. military personnel and U.S. Defense Department employees that are originated by MBD and that meet our business systems and model, including our lending guidelines existing prior to our acquisition by MCFC (“Transaction”). In addition, we have retained MBD to service all loans we own. However, MBD is not obligated to continue to use these underwriting and servicing systems and models indefinitely. MBD does have the right to modify these systems and models. MBD may also originate for its own account loans that are not deemed to be military loans made in the ordinary course of business as previously conducted by us. If MBD does modify the systems and models significantly, we may not be willing to purchase such loans. No assurance can be given that if MBD does modify the underwriting and servicing standards that these modifications would be successful and such modifications may have a material adverse impact on our business, financial condition and results of operations.

MCB and MCFC have entered into confidential Memorandums of Understanding (MOU) with the OTS, which MOUs contains requirements that MCB and MCFC may not be able to continue to satisfy.

MCB and MCFC entered into separate confidential MOUs with the OTS.  The MOUs are each effective as of February 26, 2009. The MOUs are informal agreements and are not available to the public.  Among other things, MCB’s MOU requires it to closely monitor its capital levels, allowance for loan and lease losses, risks and problem assets as well as to obtain the approval of the OTS to pay dividends and to increase brokered deposits above levels existing as of the date of the MOU. MCFC’s MOU requires it, among other things, to closely monitor its liquidity and to obtain approval of OTS to conduct certain activities, including payment of dividends and increasing debt levels above that existing as of the effective date of the MOU. The provisions of the MOU may limit funds available to MCB to originate loans. Our vendor, MBD, is a division of MCB. Non-compliance with the MOUs could result in formal enforcement actions and could limit MBD’s ability to originate military loans.  This would have a materially adverse impact on the business, results of operations, financial condition and cash flow that would require us to change our business model.

 

We, MBD and our retail merchants are subject to extensive laws, regulations and governmental supervision by federal and state agencies in the conduct of our business operations, which regulations are costly, time consuming and intended to protect depositors; failure to comply with regulatory policies and rules could result in further restrictions on our business and reputation.

We, as a wholly owned subsidiary of a thrift holding company, and MBD, as a division of a federal savings bank, are regulated by the Office of Thrift Supervision. Our loan purchasing operations, MBD’s lending operations as well as our retail merchants are also subject to regulation by federal and state finance and consumer protection authorities and various laws and judicial and administrative decisions imposing various requirements and restrictions on our operations, including the requirement to obtain and maintain certain licenses and qualifications. These regulations are primarily designed to protect depositors, borrowers and the financial system as a whole. We are also regulated by state and federal securities regulators as long as the investment notes are outstanding. These regulations are designed to protect investors in securities (such as the investment notes), which we sold and may sell in the future.

Changes to statutes, regulations or regulatory policies, including interpretation or implementation of statutes, regulations or policies, could affect us in substantial and unpredictable ways, including limiting the types of financial services and products we may offer and increasing the ability of competitors to offer competing financial services and products. Compliance with these statutes, regulations and policies is expensive and requires the time and attention of management. These costs divert capital and focus away from efforts intended to grow our business. If we do not successfully comply with laws, regulations or policies, our compliance costs could increase, our operations could be limited and we may suffer damage to our reputation.

As long as the investment notes are outstanding, we are subject to federal and state securities laws and regulations and failure to comply with or changes in such laws and regulations may adversely affect us or increase substantially the disclosure required by us.

 

We are also regulated by state and federal securities regulators. These regulations are designed to protect investors in securities (such as the investment notes) which we sold and may sell in the future. Congress and state legislatures and foreign, federal and state regulatory agencies continually review laws, regulations and policies for possible changes. Changes to statutes, regulations or regulatory policies, including interpretation or implementation of statutes, regulations or policies, could affect us in substantial and unpredictable ways including limiting the types of securities we may issue or increasing substantially the disclosure required by us.

We have limited restrictions on the payments we may make to our parent, MidCountry Financial Corp. (“MCFC”).

As of September 30, 2009, our sole shareholder, MCFC, owned the outstanding share of our common stock. Accordingly, MCFC is able to exercise significant control over our affairs including, but not limited to, the election of directors, operational decisions and decisions regarding the investment notes. The SSLA, among other things, limits the amounts that we can pay to MCFC each year. In fiscal 2009, the SSLA prohibits us from paying MCFC more than $735,000 for strategic planning services, professional services, product identification and branding and service charges. Other than the covenants contained in the SSLA, there are no significant contractual limits on the amounts we can pay to our parent or other affiliates.

A significant portion of MBD’s loan customers are active-duty military or federal government employees who could be instructed not to do business with MBD or us, or access to the Government Allotment System could be denied.

When they deem it to be in the best interest of their personnel, military commanders and supervisors of federal employees may instruct their personnel, formally or informally, not to patronize a business. If military commanders or federal employee supervisors at any given level determine one or more of MBD's loan production offices or its Internet site to be off limits, MBD and we would be unable to do new business with the potential customers they command or supervise. Additionally, approximately 60% of our borrowers make their monthly loan payments through the Government Allotment System. Military commanders or federal employee supervisors could deny those they command or supervise access to these programs, increasing the credit risk of loans we own. Without access to sufficient new customers or to the Government Allotment System, we may be forced to discontinue lending and liquidate our portfolio of military loans and retail installment contracts.

 

If a customer leaves the military prior to repaying the military loan, there is an increased risk that loan will not be repaid.

The terms of repayment on the loans we purchase are generally structured so the entire loan amount is repaid prior to the customer's estimated separation from the military. If, however, a customer unexpectedly leaves the military or other events occur that result in the loan not being repaid prior to the customer's departure from the military, there is an increased chance that the loan will not be repaid. Because we do not know whether or when a customer will leave the military early, we cannot institute policies or procedures to ensure that the entire loan is repaid before the customer leaves the military. As of September 30, 2009, we had approximately 3,300 customers, which represented 2.2% of our total customers, who separated from the military prior to repaying their loan and who in the aggregate owed us approximately $6.2 million. Based on historical charge-off models, management believes this could result in approximately $3.8 million in charge-offs. If that amount increases or the number of customers who separate from the military prior to their scheduled separation date materially increases, our charge-offs will increase. This will have a materially adverse effect on our business, cash flow, results of operations and financial condition.

If a large number of borrowers are wounded in combat, our profits may be adversely affected.

Our wholly owned subsidiary reinsures generally all of the credit life and credit accident and health insurance policies sold by us and MBD on the borrowers for the loans we own. These policies pay the loan payments as they become due during a customer's disability due to illness or injury, including war-related injuries, and pay the balance in the event of death including war-related fatalities. Therefore, if a large number of borrowers are injured and disabled in combat, the profitability of our reinsurance subsidiary would be impaired, which could have a material adverse impact on our business, results of operation, financial condition and cash flow and may impair our ability to pay interest and principal on the investment notes.

 

FORWARD-LOOKING STATEMENTS

This prospectus and related prospectus supplements contains forward-looking statements within the meaning of federal securities law. Words such as "may," "will," "expect," "anticipate," "believe," "estimate," "continue," "predict," or other similar words, identify forward-looking statements. Forward-looking statements appear in a number of places in this prospectus and include statements regarding our intent, belief or current expectation about, among other things, trends affecting the markets in which we operate, our business, financial condition, results of operations, cash flow and growth strategies. Although we believe that the expectations reflected in these forward-looking statements are based on reasonable assumptions, forward-looking statements are not guarantees of future performance and involve risks and uncertainties. Actual results may differ materially from those predicted in the forward-looking statements as a result of various factors, including those set forth in the "Risk Factors" section of this prospectus. If any of the events described in "Risk Factors" occur, they could have an adverse effect on our business, financial condition and results of operation, cash flow, and growth strategies. When considering forward-looking statements, you should keep these factors in mind as well as the other cautionary statements in this prospectus. You should not place undue reliance on any forward-looking statement. We are not obligated to update forward-looking statements.

 

USE OF PROCEEDS

Use of Proceeds

If we sell all of the notes offered by this prospectus, we estimate that the net proceeds will be approximately $24,375,000 after deduction of estimated offering expenses of $625,000. We will pay all of the expenses related to this offering. Some of the notes covered by this prospectus will be issued to renew notes which mature within 24 months of the date of this prospectus, and we will not receive any additional cash proceeds upon the issuance of those notes.

The cash proceeds of this offering will be received in varying amounts from time to time over the remaining life of the offering. We expect to use the net cash proceeds from the sale of the notes first to fund the origination of consumer loans, second to fund the purchase of retail installment contracts, and third for working capital and other general corporation purposes. While the precise amounts and timing of the application of such proceeds depends upon many factors, including, but not limited to, the amount of any such proceeds and actual funding requirements, we do not anticipate using more than 15% of the aggregate net proceeds from the offering for working capital and other general corporate purposes.

There is no minimum number or amount of notes that we must sell to receive and use the proceeds from the sale of any notes, and there can be no assurance that the total principal amount of the notes will be sold. If we receive substantially less than the estimated amount of net proceeds, we will pursue alternative sources of capital, including the securitization of our finance receivable portfolio or a private placement of debt. If we are unable to find alternative sources of capital, we will not be able to grow our business in accordance with our business plan. Currently, however, our management believes that our business will not be materially and adversely affected if we do not sell any of the notes offered by his prospectus for approximately the next 12 months.

 

SELECTED CONSOLIDATED FINANCIAL DATA

The following selected consolidated financial data should be read in conjunction with our audited consolidated financial statements and the related notes, with other financial data included in this prospectus and with "Management's Discussion and Analysis of Financial Condition and Results of Operation". The data as of, and for the fiscal years ended September 30, 2009 and 2008, as of and for the periods ended September 30 and May 31, 2007, and fiscal years ended September 30, 2006 and 2005 has been derived from our audited consolidated financial statements and related notes.

 

 

 

 

MANAGEMENT'S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATION

Overview

On a worldwide basis, we purchase consumer loans made exclusively to active-duty or retired career U.S. military personnel or U.S. Department of Defense employees. We purchase primarily from two different types of sources. Our largest source of military loans is MBD, an affiliate who originates direct loans through a network of loan production offices and via the Internet; military families use these loan proceeds to purchase goods and services. We also purchase retail installment contracts from retail merchants that sell consumer goods to active-duty or retired career U.S. military personnel or U.S. Department of Defense employees. We plan to hold these military loans and retail installment contracts until repaid.

Finance receivables, whether originated or purchased, are effectively unsecured and consist of loans originated by us or purchased from MBD and retail merchants. All finance receivables have fixed interest rates and typically have a maturity of less than 48 months. At acquisition, the size of the average finance receivable that we own was approximately $3,065 during fiscal year 2009. A large portion of our customers are unable to obtain financing from traditional sources due to factors such as age, frequent relocations and lack of credit history. These factors may not allow them to build relationships with traditional sources of financing.

Improvement of our profitability is dependent upon the growth in amount of aggregate finance receivables we are able to acquire from MBD and retail merchants, as well as the maintenance of loan quality.

Sources of Income

Currently we generate revenues primarily from interest earned on the military loans purchased from MBD, loans previously originated by us and retail installment contracts purchased from retail merchants. We also earn revenues from credit reinsurance premiums. For purposes of the following discussion, “revenues” means the sum of our finance income and reinsurance premiums.

Prior to June 1, 2007, our revenues and resulting income came from interest income derived from direct consumer lending ("military loans") and retail installment contracts purchased, sale of credit insurance products, credit reinsurance premiums, and commissions earned on the sale of ancillary products and services.

Finance Income. Finance income consists of interest and origination revenue earned on the military loans and retail installment contracts we own (referred to throughout individually as “loan” or collectively as “loans” or “finance receivables”). Our interest revenue is based on the risk adjusted interest rates charged customers for loans that we purchase. Interest rates vary from loan to loan based on many factors, including the overall degree of credit risk assumed and the interest rates allowed in the state where the loan is originated. Prior to June 1, 2007, we also earned fee income from these loans. Finance income comprised approximately 95.8% of our total revenues in fiscal 2009.

Credit Insurance Commissions. Prior to June 1, 2007, we offered payment protection plans in the form of credit life and credit accident and health insurance to our customers. Customers were not obligated to purchase plans but purchased them at the customers’ discretion. We received a commission when a customer purchased a plan. These commissions were recognized ratably over the life of the policy. Credit insurance commission income comprised approximately 1.75% of our total revenues on fiscal 2007. As of June 1, 2007, we no longer sell these plans and have no commission income.

Credit Reinsurance Premiums. We have a wholly-owned insurance subsidiary that reinsures substantially all of the credit life, credit accident and health insurance sold by us and MBD. Our subsidiary assumes these reinsurance policies on behalf of an unaffiliated insurance company, providing us with an additional source of revenue. Net credit reinsurance premiums comprised approximately 4.2% of our total revenues in fiscal 2009.

Ancillary Products and Services. Prior to June 1, 2007, we sold non-loan related products and services, including roadside assistance programs and discount cards. Our revenues from the sale of these products and services consisted of commissions paid by an unaffiliated company. These sales commissions comprised approximately 1.3% of our total revenues in fiscal 2007. We discontinued the selling of ancillary products and services as of June 1, 2007.

 

Finance Receivables

Our finance receivables are comprised of loans previously originated by us or purchased from MBD (collectively referred to below as "military loans") and retail installment contracts. The following table sets forth certain information about the components of our finance receivables as of the end of the periods presented:

 

 

Net Interest Margin

The principal component of our profitability is net interest margin, which is the difference between the interest earned on our finance receivables and the interest paid on borrowed funds. Some states and federal statutes regulate the interest rates that may be charged to our customers. In addition, competitive market conditions also impact the interest rates.

 

Our interest expense is sensitive to general market interest rate fluctuations. These general market fluctuations directly impact our cost of funds. General inability to increase the interest rates earned on new and existing finance receivables restricts our ability to react to increases in cost of funds. Accordingly, increases in market interest rates generally will narrow interest rate spreads and lower profitability, while decreases in market interest rates generally will widen interest rate spreads and increase profitability. The following table presents a five-year history of data relating to our net interest margin as of, and for the fiscal years ended September 30, 2009 and 2008, the periods ended September 30 and May 31, 2007, and the fiscal years ended September 30, 2006 and 2005:

 

 

 

Results of Operations

Year Ended September 30, 2009 Compared to Year Ended September 30, 2008

Total Finance Receivables. Our aggregate finance receivables increased 14.2% to $364.8 million on September 30, 2009 from $319.3 million on September 30, 2008. Our primary supplier of loans, MBD, saw a 7.8% increase in its originations of military loans during fiscal 2009 over the same period in fiscal 2008, thus increasing the availability of loans for us to purchase in fiscal 2009. Our acquisitions from retail merchants increased by 103.6% during this same period. The increase in the acquisitions of retail installment contracts from retail merchants is due to an increase in our network of retail merchants as well as new relationships with larger regional merchants. See further discussion in the section entitled “Loan Acquisition/Origination.” Our aggregate average finance receivables also increased during this period to $349.5 million in fiscal 2009 from $295.5 million in fiscal 2008, an increase of $54.0 million or 18.3%.

Total Interest Income and Fees. Total interest income and fees in fiscal 2009 increased to $99.7 million from $83.8 million in fiscal 2008, an increase of $15.9 million or 19.0%. This increase is primarily due to an increase in aggregate average finance receivables of $54.0 million or 18.3%.

Interest Expense. Interest expense in fiscal 2009 increased to $17.9 million from $16.4 million in fiscal 2008, an increase of $1.5 million or 9.1%. Our average interest bearing liabilities increased to $234.3 in fiscal 2009 from $230.6 in fiscal 2008, an increase of $3.7 million or 1.6%. In January 2009, we started paying our lenders a minimum interest rate per annum of 5.00% for our revolving facility and 6.25% per annum for our amortizing notes. In addition, we are paying our lenders a quarterly uncommitted availability fee in an amount equal to ten basis points multiplied by the average, aggregate outstanding principal amount of all amortizing notes held by the lenders. As of September 30, 2009, we paid our lenders $0.5 million in uncommitted availability fees. The addition of the floor interest rates and uncommitted availability fee increased our cost of funds to 7.6% in fiscal 2009 compared to the cost of funds of 7.1% in fiscal 2008.

Provision for Credit Losses. The provision for credit losses in fiscal 2009 increased to $23.5 million from $21.9 million in fiscal 2008, an increase of $1.6 million or 7.3%. While the provision increased, we saw a decline in our net charge-offs as a percentage of our average total finance receivables to 6.24% compared to 6.96% in fiscal 2008. Loans that are 60 days or more delinquent have also increased to $10.8 million at September 30, 2009 from $9.7 million at September 30, 2008, an increase of $1.1 million or 11.3%; however, loans that are 60 days or more delinquent as a percentage of total loans has decreased to 2.97% in fiscal 2009 compared to 3.02% in fiscal 2008. See further discussion in “Allowance for Credit Losses” section.

 

Noninterest Income. Noninterest income consists of revenue from credit reinsurance premiums which increased to $4.4 million from $3.9 million in fiscal 2008, an increase of $0.5 million or 12.8%. The increase in credit reinsurance premiums is directly related to the increase in our loan acquisitions.

Noninterest Expenses. Noninterest expenses in fiscal 2009 increased to $42.0 million compared to $36.4 million in fiscal 2008, an increase of $5.6 million or 15.4%. The increase was primarily due to the increase in our management and record keeping services fees for the year. Management and record keeping services fees in fiscal 2009 increased by $6.6 million from fiscal 2008 due to a 14.2% increase in our aggregate finance receivables and an increase in the CPI for which these fees are based.

Year Ended September 30, 2008 Compared to September 30, 2007 Combined Period.

Our accounting for the Transaction required that purchase accounting treatment of the Transaction be “pushed down,” resulting in the adjustment of all of our net assets to their respective fair values as of the Transaction date.  Although we continued as the same legal entity after the Transaction, the application of push down accounting represents the termination of the old accounting entity and the creation of a new one.  As a result, our consolidated financial statements are presented for two periods:  Predecessor and Successor, which relate to the period preceding the Transaction and the period succeeding the Transaction, respectively.  We have prepared our discussion of the results of operations by comparing the mathematical combination of the Predecessor Period from October 1, 2006 to May 31, 2007, and the Successor Period from June 1, 2007 to September 30, 2007. We refer to the twelve months ended September 30, 2007 as the 2007 Combined Period.  Although this presentation does not comply with generally accepted accounting principals (“GAAP”), we believe the combination of the 2007 periods provides a meaningful comparison to the 2008 period.  The combined operating results have not been prepared as pro forma results under applicable regulations and may not reflect the actual results we would have achieved absent the Transaction and may not be predictive of future results of operations.

There are significant differences in the way we operated in the Predecessor Period to the Successor Period. Certain fees and revenue we earned in the Predecessor Period are not collected in the Successor Period from our loans. We outsource origination of military loans and servicing of all loans and pay a fee to MBD in the Successor Period for these activities. Our expenses include amortization of our intangible assets in the Successor Period. Comparisons to prior periods are relevant, and changes have a material effect on our financial condition, results of operations and cash flow.

 

 

 

Total Finance Receivables. Our aggregate finance receivables increased 14.1% during fiscal 2008 to $319.3 million on September 30, 2008 from $279.8 million on September 30, 2007. Our primary supplier of loans, MBD, saw an increase in its originations of military loans during fiscal 2008 over the same period in fiscal 2007, thus increasing our ability to acquire more loans in fiscal 2008. Now that we acquire loans that are originated by a federally-chartered financial institution we have the opportunity to reach more customers than we have in years past. Our aggregate average finance receivables also increased during this period to $295.5 million in fiscal 2008 from $277.2 million in the successor period of June 1 to September 30, 2007, an increase of $18.3 million or 6.6%.

Total Interest Income and Fees. Total interest income and fees in fiscal 2008 increased to $83.8 million from $78.5 million in the 2007 Combined Period, an increase of $5.3 million or 6.8%. This increase is primarily due to an increase in

 

aggregate average finance receivables of $18.3 million or 6.6%. This increase was in part offset by reduced fees as MBD now retains certain fees related to military loans as part of the Transaction. These fees amounted to approximately $4.9 million in the 2007 Combined Period.

Interest Expense. Interest expense in fiscal 2008 increased to $16.4 million from $16.0 million in the 2007 Combined Period, an increase of $.4 million or 2.5%. The weighted average interest rate on our debt remained constant at 6.6% in fiscal 2008 and in the 2007 Combined Period.

Provision for Credit Losses. The provision for credit losses in fiscal 2008 decreased to $21.9 million from $32.5 million in the 2007 Combined Period, a decrease of $10.6 million or 32.6%. This decrease is primarily due to positive trends in net charge offs and delinquency, as well as increased collection efforts during fiscal 2008. During fiscal 2007, we began experiencing an increase in our net charge-offs, from 6.0% of our average finance receivables in fiscal 2006 to 9.7% in fiscal 2007. This increase was due in part to the more frequent and longer term deployments of our military customers, as well as other economic conditions at that time. As a result, management increased the allowance for credit losses during the 2007 Combined Period. During fiscal 2008, we saw a decline in our net charge-offs to 7.0%. Loans that are 60 days or more delinquent have also decreased to $9.7 million at September 30, 2008 from $11.7 million at September 30, 2007, a decrease of $2.0 million or 17.1%. See further discussion in “Allowance for Credit Losses” section.

Noninterest Income. Total noninterest income in fiscal 2008 decreased to $3.9 million from $5.9 million in the 2007 Combined Period, a decrease of $2.0 million or 33.9%. Prior to June 1, 2007, we sold non-loan related products and services, including roadside assistance programs and discount cards. We discontinued the selling of these products and services as of June 1, 2007. Revenue from these programs during the 2007 Combined Period was $1.1 million. In addition, as of June 1 2007, we no longer sell credit insurance policies and have no commission income. Revenue from these commissions during the 2007 Combined Period was $1.5 million.

Noninterest Expenses. Noninterest expenses in fiscal 2008 increased to $36.4 million compared to $32.2 million in the 2007 Combined Period, an increase of $4.2 million or 13.0%. The increase in non-interest expense is due in part to the increase in the amortization of intangibles from $5.3 million to $2.0 million for fiscal 2008 and the 2007 Combined Period, respectively.

Delinquency Experience

Our customers are required to make monthly payments of interest and principal. Our servicer, MBD, under our supervision, analyzes our delinquencies on a recency delinquency basis utilizing our guidelines. A loan is delinquent under the recency method when a full payment (95% or more of the contracted payment amount) has not been received for 30 days after the last full payment. We rarely grant extensions or deferments, or allow account revision, rewriting, renewal or rescheduling in order to bring otherwise delinquent accounts current.

Prior to June 1, 2007, finance receivables were charged-off when management deemed them to be uncollectible through normal collection procedures on or before they become 270 days past due or earlier. Further, our SSLA requires us to charge-off finance receivables if they are 270 days past due or earlier if deemed appropriate. In connection with the Transaction, we changed our charge-off methodology (effective June 1, 2007) to coordinate it with MCFC’s charge-off methodology. Accordingly, we now charge-off finance receivables at 180 days past due or earlier if management deems it appropriate.

 

The following sets forth a pro-forma analysis of the five-year history of our delinquency experience for accounts for which payments are 60 days or more past due and allowance for credit losses for finance receivables. Predecessor Period information has been adjusted to reflect finance receivable balances that would have been delinquent under the current 180 day charge-off policy methodology.

 

 

 

The following sets forth the actual five-year history of our delinquency experience for accounts for which payments are 60 days or more past due and allowance for credit losses for finance receivables. As a result of the change in our charge-off methodology, our total finance receivables balances 60 days or more past due as a percent of total finance receivables appears more favorable in the Successor Period when we charge-off no later than 180 days delinquent compared to the Predecessor Periods when we charged off no later than 270 days past due.

 

 

 

Credit Loss Experience and Provision for Credit Losses

General. The allowance for credit losses is maintained at an amount which management considers sufficient to cover estimated future losses. We utilize a statistical model based on potential credit risk trends incorporating both historical and prospective factors to estimate losses. These results and management's judgment are used to estimate future losses and in establishing the current provision and allowance for credit losses. These estimates are influenced by factors outside our control, such as economic conditions, current or future military deployments and completion of military service prior to repayment of loan. There is uncertainty inherent in these estimates, making it reasonably possible that they could change in the near term. See "Item 1A. Risk Factors—If a customer leaves the military prior to repaying loans, there is an increased risk loans will not be repaid."

 

Military Loans. Our charge-off policy is based on an account-by-account review of delinquent receivables on a recency basis. Our primary sources of charge-offs occur when a customer leaves the military prior to repaying the finance receivable or is subject to longer term and more frequent deployments. Generally, loans purchased or originated by us are structured so that the entire amount is repaid prior to a customer’s estimated separation from the military. When buying loans, however, we cannot predict when or whether a customer may depart from the military early. Accordingly, we cannot implement policies or procedures for MBD to follow to ensure that we will be repaid in full prior to a customer leaving the military. Nor can we predict when a customer may be subject to deployment at a duration or frequency that causes a default on their loans. Another source of loss is when a customer declares bankruptcy. See “Item 7. — Nonearning Assets."

In connection with the Transaction, we implemented a change in our charge-off methodology to charge-off loans no later than 180 days delinquent from 270 days delinquent, which resulted in a one-time charge-off of $4.5 million in June 2007. This change increased our “Loans charged-off” in the Successor Period ending September 30, 2007 from $8.6 million to $13.1 million. The following table shows a five-year historical picture of net charge-offs on military loans and net charge-offs as a percentage of military loans:

 

 

 

 

 

Retail Installment Contracts. Under most of our arrangements with retail merchants, we typically withhold a percentage (usually between five and ten percent) of the principal amount of the retail installment contract purchased. The amounts withheld from a particular retail merchant are recorded in a specific reserve account. As of September 30, 2009, the aggregate amount of retail merchant reserves totaled $4.4 million, an increase of $2.9 million or 206%, from the same period last year. This represents a 12.7% reserve as a percentage of average retail installment contract receivables. Any losses incurred on the retail installment contracts purchased from that retail merchant are charged against its specific reserve account. Upon the retail merchant's request, and no more often than annually, we will pay the retail merchant the amount by which its specific reserve account exceeds 15% of the aggregate outstanding balance on all retail installment contracts purchased from them, less losses we have sustained, or reasonably could sustain, due to debtor defaults, collection expenses, delinquencies and breaches of our agreement with the retail merchant. Our allowance for credit losses is charged only to the extent that the loss on a retail installment contract exceeds the originating retail merchant's specific reserve account at the time of the loss.

 

The following table shows a five-year historical picture of net charge-offs on retail installment contracts and net charge-offs as a percentage of retail installment contracts:

 

 

_______________________

 

 

Allowance for Credit Losses. The following table sets forth the five-year history of our allowance for credit losses:

 

 

_________________________

 

Management increased the allowance for credit losses in fiscal 2009 to $24.6 million from $23.0 million at the end of fiscal 2008, as a result of the increase in aggregate average finance receivables of $54.0 million or 18.3%. In June of fiscal 2007, we took a one-time charge-off of $4.5 million when we implemented the change in our charge-off methodology to follow MCFC’s methodology in connection with the Transaction. The result of this one-time charge-off of loans reduced the number of delinquent loans in our portfolio. As a result, management reduced the allowance for credit losses from $23.3 million at the end of May 2007 to $21.6 million at the end of September 2007.

 

The following table sets forth history of the components of our allowance for credit losses:

 

 

 

Nonearning Assets

In the Predecessor Period, accrual of interest income is suspended when a full payment has not been received for 60 days or more, and the interest due exceeds an amount equal to 60 days of interest charges. The accrual is resumed when a full payment (95% or more of the contracted payment amount) is received. In the Successor Period, we increased our income suspension period to 90 days to conform to that of MCFC. The impact of this change was immaterial to our overall financial statements.

Nonearning assets represent those finance receivables on which both the accrual of interest income has been suspended and for which no full payment of principal or interest has been received for more than 90 days.

 

Loan Acquisition / Origination

Asset growth is the most important factor in determining our future revenues. We are dependent upon MBD and retail merchants to increase their originations for our future growth. In connection with purchasing the loans, we pay MBD a fee in the amount of $35.00 for each military consumer loan originated by MBD and purchased by us. This fee is adjusted annually on the basis of the annual increase or decrease in MBD’s deferred acquisition cost analysis. For fiscal 2009, loans purchased from MBD and retail merchants increased to $395.8 million from $355.3 million in fiscal 2008, an increase of $40.5 million or 11.4%. See "Item 1: Business—General."

 

The following table sets forth the five-year history of overall loan acquisitions / originations and lending activities:

 

 

Based upon the results of a regulatory examination, the Office of Thrift Supervision ("OTS") expressed concerns largely related to asset quality issues at MCB and the need for MCB, along with our parent, MCFC, to develop plans to perform analyses and conduct reviews to reduce problem assets, to improve earnings and to ensure that liquidity, capital and the allowance for loan and lease losses are reasonable and commensurate with our needs and risk profiles consistent with the MCB’s regulatory guidelines. As a result of the concerns noted by the OTS, MCB and MCFC entered into separate confidential Memorandums of Understanding (“MOUs”) with the OTS. The MOUs are informal agreements and are not available to the public. As of September 30, 2009, MCFC and MCB were both in compliance with the MOUs. The asset quality issues raised by OTS did not relate to the military loans originated by MBD and acquired by us.

Liquidity and Capital Resources

A relatively high ratio of borrowings to invested capital is customary in the consumer finance industry. Our principal use of cash is to purchase military loans and retail installment contracts. We use borrowings to fund the difference, if any, between the cash used to purchase military loans and retail installment contracts and operations, and the cash generated from loan repayments and operations. This amount is generally cash used in investing activities. Cash used in investing activities in fiscal 2009 was approximately $70.8 million, which was funded from operating activities of $48.3 million and $13.1 million from financing activities. The increase in our cash used in investing activities and provided by operating activities is primarily attributable to the increase in finance receivables purchased from MBD. Cash used in investing activities in fiscal 2008 was approximately $59.5 million, which was funded from $36.7 million of cash from operating activities and $31.9 million from financing activities. We have not sold any investment notes since December 31, 2006. In the Successor Period, financing activities primarily consist of borrowing and repayments of debt incurred under our SSLA. With ongoing strains in the financial markets, we see liquidity, capital and earnings challenges for some lenders in our credit group which may reduce their ability to participate in our credit facility or may cause a decrease in their willingness to lend at the current levels. In addition, we have borrowings of $53 million from withdrawing banks who previously participated in the Senior Lending Agreement; this capacity needs to be replaced to fund purchases of additional finance receivables. In an effort to conserve our funding resources, we have reduced our loan acquisitions.

 

Senior Indebtedness-Senior debt.

On June 12, 2009, we entered into the SSLA with the lenders listed on the SSLA (“the lenders”) and UMB Bank, N.A. (the “Agent”). The SSLA replaces and supersedes the Senior Lending Agreement, dated as of June 9, 1993, as subsequently amended and restated (the “SLA”). The initial term of the SSLA ends on March 31, 2010 and is automatically extended annually unless any lender gives written notice of its objection by March 1 of each calendar year. Our assets secure the loans extended under the SSLA for the benefit of the lenders and other holders of the notes issued pursuant to the SSLA or the SLA (the “Senior Debt”). The facility is an uncommitted facility that provides common terms and conditions pursuant to which the individual lenders that are a party to the SSLA may choose to make loans to us in the future. Any lender may elect not to participate in any future fundings at any time without penalty. As of September 30, 2009, we could request up to $27.8 million in additional funds and remain in compliance with the terms of the SSLA. No lender, however, has any contractual obligation to lend us these additional funds.

The aggregate notional balance outstanding under amortizing notes was $221.2 million and $198.5 million at September 30, 2009 and 2008, respectively. Interest on the amortizing notes is fixed at 270 basis points over the 90-day moving average of like-term treasury notes when issued. The interest rate may not be less than 6.25%. All amortizing notes have terms not to exceed 48 months, payable in equal monthly principal and interest payments. There were 321 and 330 amortizing term notes outstanding at September 30, 2009 and 2008, respectively, with a weighted-average interest rate of 6.54% and 6.63%, respectively. Interest on amortizing notes is payable monthly. In addition, we are paying our lenders a quarterly uncommitted availability fee in an amount equal to ten basis points multiplied by the average, aggregate outstanding principal amount of all amortizing notes held by the lenders. As of September 30, 2009, we paid our lenders $0.5 million in uncommitted availability fees.

Advances outstanding under the revolving credit line were $20.8 million and $23.6 million at September 30, 2009 and 2008, respectively. When a lender elects not to participate in future fundings, any existing borrowings from that lender under the revolving credit line are payable in 12 equal monthly installments. Interest on borrowings under the revolving credit line is payable monthly and is based on prime or 5.00%, whichever is greater. Interest on borrowings was 5.00% at September 30, 2009 and 2008, respectively.

Substantially all of our assets secure this debt under the SSLA. The SSLA also limits, among other things, our ability to (1) incur additional debt from the lenders beyond that allowed by specific financial ratios and tests, (2) borrow or incur other additional debt except as permitted in the SSLA, (3) pledge assets, (4) pay dividends, (5) consummate certain asset sales and dispositions, (6) merge, consolidate or enter into a business combination with any other person, (7) pay fees to MCFC each year except as provided in the SSLA, (8) purchase, redeem, retire or otherwise acquire any of our outstanding equity interests, (9) issue additional equity interests, (10) guarantee the debt of others without reasonable compensation and only in the ordinary course of business or (11) enter into agreements with our affiliates.

Under the SSLA, we are subject to certain financial covenants that require that we, among other things, maintain specific financial ratios and satisfy certain financial tests. In part, these covenants require us to: (1) maintain an allowance for credit losses equal to or greater than the allowance for credit losses shown on our audited financial statements as of the end of our most recent fiscal year and at no time less than 5.25% of our consolidated net receivables, unless otherwise required by GAAP, (2) limit our senior indebtedness as of the end of each quarter to not greater than four times our tangible net worth, (3) maintain a positive net income in each fiscal year, (4) limit our senior indebtedness as of the end of each quarter to not greater than 80% of our consolidated receivables, and (5) maintain a consolidated total required capital of at least $75 million plus 50% of the cumulative positive net income earned by us during each of our fiscal years ending after September 30, 2008. Any part of the 50% of positive net income not distributed by us as a dividend for any fiscal year within 120 days after the last day of such fiscal year must be added to our consolidated total required capital and may not be distributed as a dividend or otherwise. No part of the consolidated total required may be distributed as a dividend.

We may not make any payment to MCFC in any fiscal year for services performed or reasonable expenses incurred in an aggregate amount greater than $735,000 plus reimbursable expenses. Such amount may be increased on each anniversary of the SSLA by the percentage increase in the CPI published by the United States Bureau of Labor for the calendar year then most recently ended. Except as required by law, we may not stop purchasing small loans to military families from MBD, unless the lenders consent to such action.

 

The breach of any of these covenants could result in a default under the SSLA, in which event the lenders could seek to declare all amounts outstanding to be immediately due and payable. As of September 30, 2009, we were in compliance with all loan covenants.

Once an event of default has occurred, the Agent has the right, on behalf of all holders of the Senior Debt, to immediately take possession and control of the collateral. When the Agent notifies us of an event of default, the interest rate on all Senior Debt will automatically increase to a default rate equal to 2% above the interest rate otherwise payable on such Senior Debt. The default rate will remain in effect so long as any event of default has not been cured.

In connection with the execution of the SSLA, MCFC entered into an Unlimited Continuing Guaranty. MCFC guaranteed the Senior Debt and accrued interest in accordance with the terms of the Unlimited Continuing Guaranty. Under the Unlimited Continuing Guarantee, MCFC also agreed to indemnify the Lenders and the Agent for all reasonable costs and expenses (including reasonable fees of counsel) incurred by the Lenders or the Agent for payments made under the Senior Debt that are rescinded or must be repaid by lenders to us. If MCFC is required to satisfy any of borrowers’ obligations under the Senior Debt, the Lenders and the Agent will assign without recourse the related Senior Debt to MCFC.

Concurrently, in connection with the execution of the SSLA, MCFC entered into a Negative Pledge Agreement in favor of the Agent. Under the Negative Pledge Agreement, MCFC represented that it will not pledge, sell, assign or transfer its ownership of all or any part of the issued and outstanding capital stock of PFS and will not otherwise or further encumber any of such capital stock beyond the currently existing negative pledge thereof in favor of Branch Banking and Trust Company, a North Carolina banking corporation headquartered in Winston-Salem, North Carolina (“BB&T”). Once the pledge of the capital stock of PFS to BB&T is terminated, MCFC will pledge all of its capital stock in PFS to the Agent for the benefit of the lenders to secure payment of all Senior Debt.

As of September 30, 2009, the lenders have indicated a willingness to participate in fundings up to an aggregate of $216 million during the next 12 months, including $189 million which is currently outstanding. In addition, the Company has borrowings of $53 million from withdrawing banks who had previously participated in the SLA.