Attached files
file | filename |
---|---|
EX-32 - EX-32 - CAPITAL CROSSING PREFERRED CORP | b84091exv32.htm |
EX-31.2 - EX-31.2 - CAPITAL CROSSING PREFERRED CORP | b84091exv31w2.htm |
EX-12.1 - EX-12.1 - CAPITAL CROSSING PREFERRED CORP | b84091exv12w1.htm |
EX-31.1 - EX-31.1 - CAPITAL CROSSING PREFERRED CORP | b84091exv31w1.htm |
EX-23.1 - EX-23.1 - CAPITAL CROSSING PREFERRED CORP | b84091exv23w1.htm |
Table of Contents
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
þ | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Fiscal Year Ended December 31, 2010
or
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
Commission File Number 000-25193
EOS PREFERRED CORPORATION
(Exact name of registrant as specified in its charter)
Massachusetts | 04-3439366 | |
(State of incorporation) | (IRS Employer Identification No.) |
1271 Avenue of the Americas, 46th Floor New York, New York (Address of principal executive offices) |
10020 (Zip code) |
Registrants telephone number, including area code:
(212) 377-1503
(212) 377-1503
Securities registered pursuant to Section 12(b) of the Act:
8.50% Non-Cumulative Exchangeable Preferred Stock, Series D
(Title of Class)
8.50% Non-Cumulative Exchangeable Preferred Stock, Series D
(Title of Class)
Securities registered pursuant to Section 12(g) of the Act:
None
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule
405 of the Securities Act. Yes o No þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section
13 or Section 15(d) of the Act. Yes o No þ
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 þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period
that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best of registrants
knowledge, in definitive proxy or information statement incorporated by reference in Part III of
this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated 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. (Check one):
Large accelerated filer o | Accelerated filer o | Non-accelerated filer þ (Do not check if a smaller reporting company) | Smaller reporting company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes o No þ
The number of shares outstanding of the registrants sole class of common stock was 100
shares, $.01 par value per share, as of March 31, 2011. No common stock was held by non-affiliates
of the registrant.
TABLE OF CONTENTS
Table of Contents
PART I
ITEM 1. BUSINESS |
This report contains, and from time to time EOS Preferred Corporation (EOS, the Company,
we, us or our) may make, certain statements that constitute forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995. Words such as
expects, anticipates, believes, estimates, and other similar expressions or future or
conditional verbs such as will, should, would, and could are intended to identify such
forward-looking statements. These statements are not historical facts, but instead represent the
Companys current expectations, plans or forecasts of its future results, growth opportunities,
business outlook, loan growth, credit losses, liquidity position, and other similar matters,
including, but not limited to, the requirement that Aurora Bank FSB (Aurora Bank) be sold or
dissolved as an asset purchased by its parent within defined time frames, the ability to pay
dividends with respect to the Series D preferred stock, future bank regulatory actions that may
impact the Company, and the effect of the bankruptcy of Lehman Brothers Holdings Inc. (LBHI; LBHI
with its subsidiaries, Lehman Brothers) on the Company. These statements are not guarantees of
future results or performance and involve certain risks, uncertainties, and assumptions that are
difficult to predict and often are beyond the Companys control. Actual outcomes and results may
differ materially from those expressed in, or implied by, the Companys forward-looking statements.
You should not place undue reliance on any forward-looking statement and should consider all
uncertainties and risks, including, among other things, the risks set forth under Item 1A. Risk
Factors, as well as those discussed in any of the Companys other subsequent Securities and
Exchange Commission (SEC) filings. Forward-looking statements speak only as of the date they are
made, and the Company undertakes no obligation to update any forward-looking statement to reflect
the impact of circumstances or events that arise after the date the forward-looking statement was
made.
Possible events or factors could cause results or performance to differ materially from what
is expressed in our forward-looking statements. These possible events or factors include, but are
not limited to, those risk factors discussed under Item 1A. Risk Factors in this report and the
following: limitations by regulatory authorities on the Companys ability to implement its business
plan and restrictions on its ability to pay dividends; further regulatory limitations on the
business of Aurora Bank that are applicable to the Company; the requirement that Aurora Bank be
sold or dissolved within defined time frames; negative economic conditions that adversely affect
the general economy, housing prices, the job market, consumer confidence, and spending habits which
may affect, among other things, the credit quality of our loan portfolio (the degree of the impact
of which is dependent upon the duration and severity of these conditions); the level and volatility
of interest rates; changes in consumer, investor, and counterparty confidence in, and the related
impact on, financial markets and institutions; legislative and regulatory actions which may
adversely affect the Companys business and economic conditions as a whole; the impact of
litigation and regulatory investigations; various monetary and fiscal policies and regulations;
changes in accounting standards, rules and interpretations and the impact on the Companys
financial statements; and changes in the nature and quality of the types of loans held by the
Company.
General
EOS is a Massachusetts corporation organized on March 20, 1998, with the principal business
objective to hold mortgage assets that will generate net income for distribution to stockholders.
We may acquire additional mortgage assets in the future. Aurora Bank, an indirect subsidiary of
LBHI, owns all of our common stock. Prior to the merger with Aurora Bank (discussed below), we were
a subsidiary of Capital Crossing Bank (Capital Crossing Bank), a federally insured Massachusetts
trust company, our corporate name was Capital Crossing Preferred Corporation, and Capital Crossing
Bank owned all of our common stock. Effective June 21, 2010, we changed our corporate name to EOS
Preferred Corporation.
We operate in a manner intended to allow us to be taxed as a real estate investment trust, or
a REIT, under the Internal Revenue Code of 1986, as amended. As a REIT, EOS will not be required
to pay federal income tax if we distribute our earnings to our shareholders and continue to meet a
number of other requirements.
In order to qualify as a REIT, we are generally required each year to distribute to our
stockholders at least 90% of our net taxable income, excluding net capital gains. We may retain the
remainder of REIT taxable income or all or part of our net capital gain, but will be subject to tax
at regular corporate rates on such income. In addition, we
1
Table of Contents
are subject to a 4% nondeductible excise tax on the amount, if any, by which certain
distributions considered as paid by us with respect to any calendar year are less than the sum of
(1) 85% of our ordinary income for the calendar year, (2) 95% of our capital gains net income for
the calendar year, and (3) 100% of any undistributed income from prior periods.
Our Series D preferred stock is publicly traded on the National Association of Securities
Dealers Automated Quotation System (NASDAQ) stock exchange under the ticker symbol EOSPN.
At December 31, 2010, we had total assets of $87.2 million, including cash and cash
equivalents of $62.6 million, and total liabilities of $1.9 million.
Aurora Bank
Aurora Bank, which holds all of the common stock of EOS, is an indirect subsidiary of Lehman
Brothers with its home office located in Wilmington, Delaware. Aurora Bank is a member of the
Federal Home Loan Bank System and its deposits are insured by the Deposit Insurance Fund, which is
administered by the Federal Deposit Insurance Corporation (FDIC). Its primary federal banking
regulator is the Office of Thrift Supervision (OTS).
As an operating subsidiary of Aurora Bank, the assets and liabilities and results of
operations of EOS are consolidated with those of Aurora Bank for Aurora Banks financial reporting
and regulatory capital purposes. Any loans that may in the future be acquired by EOS, therefore,
will be treated as assets of Aurora Bank for purposes of compliance by Aurora Bank with OTS
regulatory capital requirements and reported in Aurora Banks consolidated financial statements.
Interest income on such loans will be reported as interest income of Aurora Bank in Aurora Banks
consolidated financial statements.
Aurora Bank is involved in virtually every aspect of our operations and is able to approve
unilaterally almost all corporate actions of EOS as our sole common shareholder. The officers of
EOS are also officers of Aurora Bank. EOS has retained Aurora Bank to be responsible for the
administration of the day-to-day activities of EOS in its roles as servicer under a master service
agreement between Aurora Bank and EOS (the Master Service Agreement or MSA) and as advisor
under an advisory agreement (the Advisory Agreement or AA). These agreements were amended
effective as of January 1, 2010.
Under the AA, Aurora Bank is responsible for administering the day-to-day activities,
including monitoring of our loan portfolios credit quality and advising us with respect to the
acquisition, management, financing and disposition of mortgage assets, and our operations
generally. Under the MSA, Aurora Bank services our commercial loans and oversees the servicing of
the residential loan portfolio. Aurora Bank may subcontract all or a portion of its obligations
under the AA to its affiliates or, with the approval of a majority of the Board of Directors
including a majority of our independent directors, subcontract its obligations under the AA to
unrelated third parties. Aurora Bank will not, in connection with the subcontracting of any of its
obligations under the AA, be discharged or relieved from its obligations under the AA.
Bankruptcy of Lehman Brothers Holdings Inc.
On September 15, 2008, LBHI, the indirect parent company of Aurora Bank, filed a voluntary
petition under Chapter 11 of the U.S. Bankruptcy Code. The bankruptcy filing of LBHI has led to
increased regulatory constraints being placed on Aurora Bank by its bank regulatory authorities,
primarily the OTS. These constraints affect Aurora Banks subsidiaries, including EOS, as
applicable.
Pursuant to a Settlement Agreement (Settlement Agreement) approved by the bankruptcy court
and executed on November 30, 2010 (Execution Date), LBHI agreed to terms of a Capital Maintenance
Agreement (CMA) in which, among other things, LBHI agreed that it will seek to sell Aurora Bank
within eighteen (18) months from Execution Date. If after a period of fifteen (15) months following
the Execution Date, the OTS concludes that a sale of Aurora Bank will not be consummated by the end
of the eighteen (18) month period, Aurora Bank will prepare and submit to the OTS a plan for
dissolution. The bankruptcy court will have the final review and approval of any proposed agreement
for the sale or dissolution of Aurora Bank. There can be no assurance that a
2
Table of Contents
sale or dissolution of Aurora Bank will be consummated within the specified time frames or at
all. We also cannot predict the effect any such sale or dissolution of Aurora Bank would have on
the business, financial condition and results of operations of EOS.
Regulatory Actions Involving Aurora Bank
Following execution of the Settlement Agreement, Aurora Bank entered into a Stipulation and
Consent to Issuance of Amended Order to Cease and Desist with the OTS whereby Aurora Bank consented
to the issuance of an Amended Order to Cease and Desist (Amended Order) issued by the OTS, which
amended the Original Cease and Desist Order issued on January 26, 2009 (Original Order, and
together with the Amended Order, Order). The Amended Order amended certain requirements for
Aurora Bank contained in the Original Order. The provisions in the Original Order that require
Aurora Bank to ensure that each of its subsidiaries, including EOS, comply with the Original Order
were not amended. These operating restrictions, among other things, restrict transactions with
affiliates, capital distributions to shareholders (including redemptions), contracts outside the
ordinary course of business, and changes in senior executive officers, board members or their
employment arrangements without prior written notice to the OTS.
Under the Order, EOS must continue to seek and receive approval or non-objection from the OTS
for the declaration and payment of dividends to our preferred and common shareholders. There is no
assurance that the OTS will approve any future request for the declaration or payment of dividends.
As an operating subsidiary of Aurora Bank, EOS remains subject to all of the terms and conditions
of the Order which apply to such operating subsidiaries. The Order was still effective as of the
date of issuance of this annual report.
On November 30, 2010, and effective on the same date, the OTS issued an order terminating the
Prompt Correction Action Directive (PCA) issued on February 4, 2009.
More detailed information can be found in the Original Order, the Amended Order, the PCA, and
the termination of the PCA themselves, copies of which are available on the OTS website
(www.ots.treas.gov).
Capital of Aurora Bank
Under the CMA LBHI agreed for the duration of LBHIs ownership of Aurora Bank that, in the
event Aurora Banks capital levels fall below levels specified in the agreement, LBHI will promptly
make capital contributions to Aurora Bank sufficient to maintain the specified levels. The
specified capital levels in the CMA are greater than the thresholds required to achieve the
well-capitalized designation under OTS regulations.
As of December 31, 2010, as set forth in a public filing with the OTS, Aurora Banks capital
ratios were above the thresholds required under the CMA. The classification of Aurora Banks
capitalization level is subject to review and acceptance by the OTS.
OTS Approval of Dividends
On June 26, 2009, the OTS notified Aurora Bank that, as a result of the Original Order and the
PCA, the approval of the OTS would be required prior to declaration and payment of dividends by
EOS. The OTS required Aurora Bank to submit a formal request for non-objection determination to
permit the payment of dividends. A formal request was submitted to the OTS on July 28, 2009.
As a result of the notice from the OTS, our Board of Directors (the Board of Directors) did
not declare or pay the Series B and Series D preferred stock dividends that would have been payable
for the second, third and fourth quarters of 2009 and the first and second quarters of 2010. The
Board of Directors also did not declare or pay dividends on the common stock that would have been
payable for fiscal 2009.
On September 9, 2010, the OTS provided a non-objection determination for the declaration of
dividends by September 14, 2010 and the payment of these dividends between December 15, 2010 and
December 31, 2010 in an amount sufficient to maintain qualification as a REIT for the 2009 tax
year. The Board of Directors of EOS declared
3
Table of Contents
such dividends on September 13, 2010, for the quarter ended September 30, 2010, consistent
with the OTS non-objection determination. The dividends were payable to shareholders of record as
of October 29, 2010 and included cumulative dividends on the Series B preferred stock of $120.00
per share, non-cumulative dividends on the Series D preferred stock of $0.53125 per share and
dividends on our common stock of $1,467,000.
An additional formal request to declare dividends was submitted to the OTS on December 17,
2010 and on December 30, 2010, the OTS provided a non-objection determination for the declaration
of dividends in an amount sufficient to maintain qualification as a REIT and avoid excise tax for
the 2010 tax year. The non-objection determination did not provide any restriction as to the timing
of declaration or payment. The Board of Directors of EOS declared such dividends on December 31,
2010, for the quarter ended December 31, 2010, consistent with the OTS non-objection determination.
The dividends were payable to shareholders of record as of December 31, 2010 and included dividends
on the Series B preferred stock of $20.00 per share, non-cumulative dividends on the Series D
preferred stock of $0.53125 per share and dividends on our common stock in the amount of $884,000.
These dividends were paid in 2011. At December 31, 2010, there were no dividends in arrears related
to our Series B preferred stock. Dividends on the Series D preferred stock are non-cumulative and
as such, there were no dividends in arrears.
The OTS has not approved or provided a non-objection to any further dividend distributions.
There can be no assurance that such approval will be received from the OTS or when or if such OTS
approval requirement will be removed. Failure to permit the distribution of sufficient dividends in
future years will cause EOS to fail to qualify as a REIT. If EOS no longer qualifies as a REIT, we
will be subject to federal and state income taxes in the tax year when loss of REIT status occurs
and in years thereafter. Furthermore, even if approval is received from the OTS, any future
dividends on the preferred stock will be payable only when, as and if declared by the Board of
Directors. Aurora Bank and EOS will continue to work with the OTS regarding the resumption of
normal payment of dividends. There can be no assurance that the OTS will grant any future
non-objection request, nor can there be any assurance that any further dividends will be paid or
that EOS will continue to qualify as a REIT.
Business Strategies and Operations
Our principal business objective is to hold mortgage assets that will generate net income for
distribution to stockholders. We may acquire additional mortgage assets in the future. All of the
mortgage assets in our loan portfolio at December 31, 2010 were acquired from Capital Crossing Bank
or Aurora Bank and it is anticipated that substantially all additional mortgage assets, if any are
acquired in the future, will be acquired from Aurora Bank. Our loan portfolio at December 31, 2010
consisted of mortgage assets secured by residential, multi-family and commercial properties.
Aurora Bank is responsible for the administration of the day-to-day activities of EOS in its
roles as servicer under the MSA and advisor under the AA. EOS paid Aurora Bank fees for services
provided under the MSA and AA. Aurora Bank and its affiliates have interests that are not identical
to those of EOS. Consequently, conflicts of interest may arise with respect to transactions,
including, without limitation:
| future acquisitions of mortgage assets from Aurora Bank or its affiliates; | ||
| servicing of mortgage assets, particularly with respect to mortgage assets that become non-accrual; and | ||
| the modification of the AA and the MSA. |
Both the AA and the MSA as amended were effective as of January 1, 2010. The amended AA and the
amended MSA change the fees paid by us. It is our intention that any agreements and transactions
between EOS and Aurora Bank are fair to all parties and consistent with market terms, including the
price paid and received for mortgage assets on their acquisition or disposition by EOS or in
connection with the servicing of such mortgage assets. However, there can be no assurance that such
agreements or transactions will be on terms as favorable to us as those that could have been
obtained from unaffiliated third parties.
4
Table of Contents
Management Policies and Programs
In order to preserve our status as a REIT under the Internal Revenue Code, substantially all
of the assets of EOS must consist of mortgage loans and other qualified assets of the type set
forth in Section 856(c)(4)(A) of the Internal Revenue Code. Such other qualifying assets include
cash, cash equivalents and securities, including shares or interests in other REITs, although we do
not currently intend to invest in shares or interests in other REITs.
The administration of EOS has been significantly impacted by regulatory orders issued to
Aurora Bank by the OTS. The Order requires Aurora Bank to ensure that each of its subsidiaries,
including EOS, be in compliance with provisions, including the operating restrictions contained
therein. These operating restrictions, among other things, restrict transactions with affiliates,
capital distributions to shareholders (including redemptions), contracts outside the ordinary
course of business, and changes in senior executive officers, board members or their employment
arrangements without prior written notice to the OTS. Until the termination of the Order,
effectively, any cash or in-kind distribution, any asset acquisition or disposition, or any
significant change in the business of operations of EOS will be subject to prior approval of the
OTS.
The OTS has informed Aurora Bank, our parent, that approval of the OTS is required prior to
declaration and payment of dividends to our preferred and common shareholders. To date, the OTS has
issued non-objection determinations for the formal requests submitted by Aurora Bank for the
declaration and payment of dividends. However, there can be no assurance that such approvals will
be received in the future from the OTS or when or if the OTS will release Aurora Bank from the
Order. Furthermore, any future dividends will be payable only when, as and if declared by the Board
of Directors.
Asset Acquisition and Disposition Policies. Subject to prior approval by the OTS, we may,
from time to time, purchase additional mortgage assets. To the extent any acquisitions are made, we
intend to acquire all or substantially all of any such mortgage assets from Aurora Bank on terms
that are comparable to those that could be obtained by us if such mortgage assets were purchased
from unrelated third parties. We intend generally to acquire only accrual loans from Aurora Bank.
We may also acquire mortgage assets from unrelated third parties. To date, we have not adopted any
arrangements or procedures by which we would purchase mortgage assets from unrelated third parties,
and we have not entered into any agreements with any third parties with respect to the purchase of
mortgage assets. We anticipate that we will purchase mortgage assets from unrelated third parties
only if neither Aurora Bank nor any of its affiliates had an amount or type of mortgage asset
sufficient to meet our requirements. We currently anticipate that the mortgage assets that we may
purchase will primarily include residential, multi-family, and commercial mortgage loans, although
if Aurora Bank develops an expertise in additional mortgage asset products, we may purchase such
additional types of qualified mortgage assets. In addition, we may also acquire limited amounts of
other assets eligible to be held by REITs.
Capital and Leverage Policies. To the extent that the Board of Directors determines, subject
to regulatory approval, that additional funding is required, we may raise such funds through
additional equity offerings, debt financing or retention of cash flow (after consideration of
provisions of the Internal Revenue Code requiring the distribution by a REIT of not less than 90%
of our REIT taxable income and taking into account taxes that would be imposed on undistributed
taxable income), or a combination of these methods.
EOS has no debt outstanding, and we currently do not intend to incur any indebtedness. The
organizational documents of EOS limit the amount of indebtedness which we are permitted to incur
without approval of the Series D preferred stockholders to no more than 100% of our total
stockholders equity. Any such debt incurred may include intercompany advances made by Aurora Bank
to EOS.
EOS, subject to regulatory approval, may also issue additional series of preferred stock.
However, it may not issue additional shares of preferred stock ranking senior to the Series D
preferred stock without consent of holders of at least two-thirds of the outstanding Series D
preferred stock. Although our charter does not prohibit or otherwise restrict Aurora Bank or its
affiliates from owning or voting shares of Series D preferred stock, to our knowledge, as of
December 31, 2010, Aurora Bank held no shares of Series D preferred stock. Similarly, EOS may not
issue additional shares of preferred stock ranking on parity with the Series D preferred stock
without the approval of a majority of our independent directors (as defined in the EOS charter).
Prior to any future issuance of additional shares of preferred stock, EOS will take into consideration Aurora Banks
regulatory capital requirements and the cost of raising and maintaining that capital at the time.
5
Table of Contents
Conflicts of Interest Policies. Because of the nature of our relationship with Aurora Bank
and its affiliates, conflicts of interest may arise with respect to certain transactions, including
without limitation, our acquisition of mortgage assets from, or return of mortgage assets to Aurora
Bank, or disposition of mortgage assets or foreclosed property to, Aurora Bank or its affiliates,
and the modification of the MSA and AA. It is our policy that the terms of any financial dealings
with Aurora Bank and its affiliates will be consistent with those available from unaffiliated third
parties in the mortgage lending industry. In addition, EOS maintains an Audit Committee of the
Board of Directors, which is comprised solely of independent directors who satisfy the standards
for independence promulgated by the NASDAQ Stock Market, Inc. Among other functions, the Audit
Committee (or the Board of Directors as a whole) will review transactions between EOS and Aurora
Bank and its affiliates. Furthermore, under the terms of the AA, Aurora Bank provides advice and
recommendations with respect to all aspects of our business and operations, subject to the control
and discretion of the Board of Directors.
Conflicts of interest between EOS and Aurora Bank and its affiliates may also arise in
connection with decisions bearing upon the credit arrangements that Aurora Bank or one of its
affiliates may have with a borrower. Conflicts could also arise in connection with actions taken by
Aurora Bank as the controlling person of EOS. It is the intention of EOS and Aurora Bank that any
agreements and transactions between EOS and Aurora Bank or its affiliates are fair to all parties
and are consistent with market terms for such types of transactions. The MSA provides that
foreclosures and dispositions of the mortgage assets are to be performed in a manner substantially
the same as for similar work performed by Aurora Bank for transactions on its own behalf. However,
there can be no assurance that any such agreement or transaction will be on terms as favorable to
us as would have been obtained from unaffiliated third parties.
There are no provisions in our charter limiting any officer, director, security holder or
affiliate of EOS from having any direct or indirect pecuniary interest in any mortgage asset to be
acquired or disposed of by EOS or in any transaction in which we have an interest or from engaging
in acquiring and holding mortgage assets. As described herein, it is expected that Aurora Bank and
its affiliates may have direct interests in transactions with EOS (including, without limitation,
the sale of mortgage assets to EOS). It is not currently anticipated, however, that any of our
officers or directors will have any interests in such mortgage assets.
Other Policies. We intend to operate in a manner that will not subject us to regulation under
the Investment Company Act of 1940, as amended. We do not intend to:
| invest in the securities of other issuers for the purpose of exercising control over such issuers; | ||
| underwrite securities of other issuers; | ||
| actively trade in loans or other investments; | ||
| offer securities in exchange for property; or | ||
| make loans to third parties, including without limitation our officers or directors and any affiliates of EOS. |
We may, under certain circumstances, and subject to applicable federal and state laws and the
requirements for qualifying as a REIT, purchase Series D preferred stock in the open market or
otherwise, for redemption by us. Any such redemption may only be effected with the prior approval
of the OTS while the Original Order and Amended Order are in place.
We currently intend to make investments and operate our business at all times in such a manner
as to be consistent with the requirements of the Internal Revenue Code to qualify as a REIT.
However, future economic, market, legal, regulatory, tax or other considerations may cause the
Board of Directors to determine that it is in the best interests of EOS and our stockholders to
revoke our REIT status which would have the immediate result of subjecting EOS to federal and state
income tax at regular corporate rates.
6
Table of Contents
Under the AA, Aurora Bank monitors and reviews our compliance with the requirements of the
Internal Revenue Code regarding our qualification as a REIT on a quarterly basis and has an
independent public accounting firm, selected by the Board of Directors, annually review the results
of the analysis.
Servicing
Our loan portfolio is serviced by Aurora Bank pursuant to the terms of the MSA. The MSA as
amended was effective as of January 1, 2010. The amended MSA changed the fees paid by EOS to
reflect the fees payable to each sub-servicer. Through December 31, 2009, Aurora Bank in its role
as servicer under the terms of the MSA received an annual servicing fee equal to 0.20%, payable
monthly, on the gross average unpaid principal balances of loans serviced for the immediately
preceding month. Additionally, loan servicing expense includes third party expenses associated with
the collection of certain non-accrual loans.
The MSA requires Aurora Bank to service the loan portfolio in a manner substantially the same
as for similar work performed by Aurora Bank for transactions on its own behalf. Aurora Bank
collects and remits principal and interest payments on at least a monthly basis; maintains
perfected collateral positions; submits and pursues insurance claims; and initiates and supervises
foreclosure proceedings on the loan portfolio it services. Aurora Bank also provides accounting and
reporting services for the loan portfolio as required by EOS. We may also direct Aurora Bank to
dispose of any loans placed on non-accrual status, or are modified due to financial deterioration
of the borrower. Aurora Bank may facilitate loan modifications and short sales where circumstances
are so warranted. Aurora Bank may institute foreclosure proceedings and foreclose, manage and
protect the mortgaged premises, including exercising any power of sale contained in any mortgage or
deed of trust, obtaining a deed-in-lieu-of-foreclosure, or otherwise acquiring title to a mortgaged
property underlying a mortgage loan by operation of law or otherwise in accordance with the terms
of the MSA.
The MSA may be terminated on thirty days notice pursuant to agreement between the parties. The
MSA will automatically terminate if EOS ceases to be a subsidiary of Aurora Bank.
When any mortgaged property underlying a mortgage loan is conveyed by a mortgagor, Aurora Bank
generally, upon notice of the conveyance, will enforce any due-on-sale clause contained in the
mortgage loan, to the extent permitted under applicable law and governmental regulations. The terms
of a particular mortgage loan or applicable law, however, may prohibit Aurora Bank from exercising
the due-on-sale clause under certain circumstances related to the collateral underlying the
mortgage loan and the borrowers ability to fulfill the obligations under the related mortgage
note.
Advisory Services
EOS has entered into the AA pursuant to which Aurora Bank administers our day-to-day
operations. The AA as amended was effective as of January 1, 2010. The amended AA changed the fees
paid by EOS. Through December 31, 2009, Aurora Bank was paid an annual advisory fee equal to 0.05%,
payable monthly, of the gross average unpaid principal balances of our loans for the immediately
preceding month, plus reimbursement for certain expenses incurred by Aurora Bank as advisor. During
2010, the amended agreement, among other things, changed the management fee to a flat $25,000 per
month. As advisor, Aurora Bank is responsible for:
| monitoring the credit quality of our loan portfolio; | ||
| advising us with respect to the acquisition, management, financing, and disposition of our loans and other assets; and | ||
| maintaining our corporate and shareholder records. |
Aurora Bank may, from time to time, subcontract all or a portion of its obligations under the
AA to one or more of its affiliates involved in the business of managing mortgage assets or, with
the approval of a majority of Board of Directors as well as a majority of its independent
directors, subcontract all or a portion of its obligations under the AA to unrelated third parties.
Aurora Bank will not, in connection with the subcontracting of any of its obligations under the AA,
be discharged or relieved in any respect from its obligations under the AA.
7
Table of Contents
The AA has a term of one year, renewable annually for an additional one-year period unless EOS
delivers notice of nonrenewal to Aurora Bank. We may terminate the AA at any time upon ninety days
prior notice. As long as any Series D preferred stock remains outstanding, any decision by us
either not to renew the AA or to terminate the AA must be approved by a majority of our Board of
Directors, as well as by a majority of our independent directors. Other than the servicing fee and
the advisory fee, Aurora Bank is not entitled to a fee for providing advisory and management
services to EOS.
Description of Loan Portfolio
To date, all of our mortgage loans have been acquired or were contributed from Capital
Crossing Bank or Aurora Bank. It is anticipated that substantially all additional mortgage assets,
if any additional assets are acquired in the future, will be acquired or contributed from Aurora
Bank. The characteristics of our loan portfolio described below may or may not exist at future
dates.
Loans Held For Sale. On February 5, 2009, EOS and Aurora Bank entered into an Asset Exchange
Agreement (the February Asset Exchange) pursuant to which we agreed to transfer loans secured
primarily by commercial real estate and multi-family residential real estate in exchange for loans
secured primarily by residential real estate. As a result of entering into the February Asset
Exchange, we reclassified all of our loan assets as held for sale. On July 20, 2009, EOS and Aurora
Bank mutually agreed to terminate the February Asset Exchange following the OTS failing to grant
Aurora Banks requests for non-objection with respect to the February Asset Exchange. We continue
to carry these loan assets at the lower of their accreted cost or market value. Prior to February
5, 2009, our loan assets were considered held for investment and recorded at accreted cost. On
November 18, 2009, EOS and Aurora Bank entered into an Asset Exchange Agreement (the November
Asset Exchange) pursuant to which Aurora Bank agreed to assign various single family residential
mortgage loans to EOS in exchange for EOS assigning certain commercial and multi-family mortgage
loans to Aurora Bank. From the November Asset Exchange, we received residential mortgage loans,
including jumbo mortgage loans, in exchange for commercial and multi-family loans transferred to
Aurora Bank. The residential mortgage loans received were recorded at their fair value and
currently are presented at fair value.
Fair value is defined as the price at which an asset or liability could be exchanged in a
current transaction between knowledgeable, willing parties. Where available, fair value is based on
observable market prices or parameters or derived from such prices or parameters. Where observable
prices or inputs are not available, valuation models are applied. Various cash flow
models are used to derive fair value estimates. These models consider significant inputs such as
loan type, loan age, loan to value ratio, payment history, and property location, as well as
significant assumptions such as estimated rates of loan delinquency, potential recovery, discount
rate, and the impact of interest rate reset. Recent trade quotes or prices are identified in
estimating the amount at which a third party might purchase the loans and their yield requirements.
Management also considers market information and quotes received from third parties, when
available. The valuation of the loan portfolio involves some estimation and judgment, the degree of
which is dependent on the terms of the loans and the availability of market prices and inputs.
We use the term carrying value to reflect loans valued at the lower of their accreted cost
or market value, or at their fair value, as applicable to the individual loans valuation method as
selected by us in accordance with accounting standards.
8
Table of Contents
A summary of the carrying value and unpaid principal balance (UPB) of loans by valuation
method and in total is as follows:
December 31, | ||||||||||||||||
2010 | 2009 | |||||||||||||||
Unpaid Principal | Unpaid Principal | |||||||||||||||
Carrying Value | Balance | Carrying Value | Balance | |||||||||||||
(Dollars In Thousands) | ||||||||||||||||
Total mortgage loans, held for sale: |
||||||||||||||||
Commercial real estate |
$ | 6,866 | $ | 9,504 | $ | 6,380 | $ | 11,324 | ||||||||
Multi-family residential |
850 | 1,034 | 693 | 1,203 | ||||||||||||
One-to-four family residential |
16,724 | 22,320 | 22,750 | 32,386 | ||||||||||||
Total |
$ | 24,440 | $ | 32,858 | $ | 29,823 | $ | 44,913 | ||||||||
Portion carried at fair value: |
||||||||||||||||
Commercial real estate |
$ | | $ | | $ | | $ | | ||||||||
Multi-family residential |
| | | | ||||||||||||
One-to-four family residential |
16,505 | 22,048 | 22,531 | 32,007 | ||||||||||||
Total |
$ | 16,505 | $ | 22,048 | $ | 22,531 | $ | 32,007 | ||||||||
Portion carried at lower of accreted cost or market value (1): |
||||||||||||||||
Commercial real estate |
$ | 6,866 | $ | 9,504 | $ | 6,380 | $ | 11,324 | ||||||||
Multi-family residential |
850 | 1,034 | 693 | 1,203 | ||||||||||||
One-to-four family residential |
219 | 272 | 219 | 379 | ||||||||||||
Total |
$ | 7,935 | $ | 10,810 | $ | 7,292 | $ | 12,906 | ||||||||
(1) | Though the table compares the carrying value of these loans against UPB, these loans are carried at the lower of accreted cost or market value and the carrying value cannot exceed the cost of these loans which for all loans is less than UPB. |
The following table sets forth certain information regarding the geographic location of
properties securing the mortgage loans in the loan portfolio at December 31, 2010:
Percentage of | ||||||||||||
Total | ||||||||||||
Number of | Carrying | Carrying | ||||||||||
Location | Loans | Value | Value | |||||||||
(Dollars In Thousands) | ||||||||||||
California |
44 | $ | 9,758 | 40.0 | % | |||||||
Maryland |
5 | 1,533 | 6.3 | |||||||||
Washington |
4 | 1,404 | 5.8 | |||||||||
Virginia |
4 | 1,233 | 5.1 | |||||||||
Massachusetts |
12 | 1,142 | 4.7 | |||||||||
Michigan |
3 | 952 | 3.9 | |||||||||
Texas |
3 | 930 | 3.8 | |||||||||
Florida |
9 | 924 | 3.8 | |||||||||
North Dakota |
4 | 792 | 3.2 | |||||||||
Colorado |
2 | 663 | 2.7 | |||||||||
Kentucky |
2 | 608 | 2.5 | |||||||||
All others |
41 | 4,501 | 18.2 | |||||||||
133 | $ | 24,440 | 100.0 | % | ||||||||
9
Table of Contents
The following tables set forth information regarding maturity, contractual interest rate,
contractual interest rate structure, and UPB of all loans in the loan portfolio at December 31,
2010:
Percentage of | ||||||||||||
Number of | Carrying | Total Carrying | ||||||||||
Period Until Maturity | Loans | Value | Value | |||||||||
(Dollars In Thousands) | ||||||||||||
Six months or less |
5 | $ | 476 | 1.9 | % | |||||||
Greater than six months to one year |
5 | 188 | 0.8 | |||||||||
Greater than one year to three years |
9 | 366 | 1.5 | |||||||||
Greater than three years to five years |
10 | 783 | 3.2 | |||||||||
Greater than five years to ten years |
10 | 927 | 3.8 | |||||||||
Greater than ten years |
94 | 21,700 | 88.8 | |||||||||
133 | $ | 24,440 | 100.0 | % | ||||||||
Percentage of | ||||||||||||
Number of | Carrying | Total Carrying | ||||||||||
Contractual Interest Rate | Loans | Value | Value | |||||||||
(Dollars In Thousands) | ||||||||||||
Less than 4.00% |
10 | $ | 438 | 1.8 | % | |||||||
4.00 to 4.49 |
52 | 7,304 | 29.8 | |||||||||
4.50 to 4.99 |
21 | 5,337 | 21.9 | |||||||||
5.00 to 5.49 |
27 | 8,186 | 33.5 | |||||||||
5.50 to 5.99 |
6 | 1,205 | 4.9 | |||||||||
6.00 to 7.99 |
8 | 806 | 3.3 | |||||||||
8.00 to 9.99 |
5 | 808 | 3.3 | |||||||||
10.00% and above |
4 | 356 | 1.5 | |||||||||
133 | $ | 24,440 | 100.0 | % | ||||||||
Percentage of | ||||||||||||
Number of | Carrying | Total Carrying | ||||||||||
Contractual Interest Structure | Loans | Value | Value | |||||||||
(Dollars In Thousands) | ||||||||||||
Fixed Interest Rate |
75 | $ | 7,755 | 31.7 | % | |||||||
Variable Interest Rate |
58 | 16,685 | 68.3 | |||||||||
133 | $ | 24,440 | 100.0 | % | ||||||||
Percentage of | ||||||||||||
Number of | Carrying | Total Carrying | ||||||||||
Unpaid Principal Balance | Loans | Value | Value | |||||||||
(Dollars In Thousands) | ||||||||||||
$50,000 and less |
29 | $ | 571 | 2.3 | % | |||||||
Greater than $50,000 to $100,000 |
15 | 795 | 3.2 | |||||||||
Greater than $100,000 to $250,000 |
31 | 4,005 | 16.4 | |||||||||
Greater than $250,000 to $500,000 |
42 | 11,283 | 46.2 | |||||||||
Greater than $500,000 to $1,000,000 |
16 | 7,786 | 31.9 | |||||||||
133 | $ | 24,440 | 100.0 | % | ||||||||
10
Table of Contents
Loan Purchasing Activities. All of our commercial loans and multi-family residential loans
were purchased or contributed from Capital Crossing Bank who originally purchased such loans from
third parties. All of our residential loans were acquired from Aurora Bank. It is anticipated that
substantially all additional loans, if any loans are acquired by us in the future, will be acquired
from Aurora Bank. Existing loans primarily are secured by commercial, multi-family residential, or
one-to-four family residential real estate located throughout the United States. Aurora Bank does
not intend to utilize any specific threshold underwriting criteria in evaluating individual loans
or pools of loans for purchase, but rather anticipates that it will evaluate each individual loan,
if it is purchasing an individual loan, or pool of loans, if it is purchasing a pool of loans, on a
case by case basis in making a purchase decision as described in more detail below.
The estimated value of the real property collateralizing a loan will be determined by
considering, among other factors, the type of property, its condition and location, and its highest
and best use in its marketplace. In many cases, real estate brokers and/or appraisers with specific
knowledge of the local real estate market will be consulted. For larger commercial loans, typically
a site inspection of the real property collateralizing the loan and an internal rental analysis of
similar commercial properties in the local area is undertaken. An analysis of the current and
likely future cash flows generated by the collateral to repay the loan and consideration of minimum
debt service coverage ratios, consisting of the ratio of net operating income to total principal
and interest payments will be made. New tax and title searches may also be obtained to verify the
status of any prior liens on the collateral. Additionally, if necessary, environmental specialists
will review available information with respect to each property collateralizing a loan to assess
potential environmental risk.
In order to determine the amount that we are willing to bid to acquire individual loans or
loan pools, we will consider, among other factors:
| the collateral securing the loan; | ||
| the financial resources of the borrowers or guarantors, if any; | ||
| the recourse nature of the loan; | ||
| the age and performance of the loan; | ||
| the length of time during which the loan has performed in accordance with its repayment terms; | ||
| geographic location; | ||
| the yield expected to be earned; and | ||
| servicing restrictions, if any. |
In addition to the factors listed above, we will also consider the amount it may realize
through collection efforts or foreclosure and sale of the collateral, net of expenses, and the
length of time and costs required to complete the collection or foreclosure process in the event a
loan becomes non-accrual or is a non-accrual loan at the purchase date.
Loan Servicing and Asset Resolution. In the event that a purchased loan becomes delinquent,
or if it is delinquent at the time of purchase, Aurora Bank, as servicer, promptly initiates
collection activities. If a delinquent loan is placed in non-accrual status, Aurora Bank may pursue
a number of alternatives with the goal of maximizing the overall return on each loan in a timely
manner. In instances when a loan is not returned to accrual status, Aurora Bank may seek
resolution through negotiating a discounted pay-off with borrowers, which may be accomplished
through refinancing by the borrower with another lender, restructuring the loan to a level that is
supported by existing collateral and debt service capabilities, foreclosure, sale of the
collateral, or other loss mitigation activities.
11
Table of Contents
Asset Quality
Payment Status of Loan Portfolio. The following table sets forth certain information relating
to the payment status of loans, net in the loan portfolio at the dates indicated:
Carrying Value at | ||||||||
December 31, | ||||||||
2010 | 2009 | |||||||
(Dollars In Thousands) | ||||||||
Current |
$ | 23,514 | $ | 29,353 | ||||
Past due (over thirty days to eighty-nine days) |
10 | 152 | ||||||
Total loans in accrual status |
23,524 | 29,505 | ||||||
Non-accrual loans (ninety days or more past due) |
916 | 318 | ||||||
Total |
$ | 24,440 | $ | 29,823 | ||||
As servicing agent for our commercial loan portfolio, Aurora Bank monitors our loans through
its review procedures and updated appraisals. Additionally, in order to monitor the adequacy of
cash flows on income-producing properties, Aurora Bank may obtain financial statements and other
information from the borrower and the guarantor, including, but not limited to, information
relating to rental rates and income, maintenance costs, and an update of real estate property tax
payments.
Non-Accrual Loans. The performance of our loan portfolio is evaluated regularly by Aurora
Bank. Management generally classifies a loan as non-accrual and the accrual of interest on loans is
discontinued when the collectability of principal and interest is not probable or estimable which
generally occurs when the loan is ninety days or more past due as to either principal or interest.
Unpaid interest income previously accrued on such loans is reversed against current period interest
income. Interest payments received on non-accrual loans are recorded as interest income. A loan is
returned to accrual status when it is brought current. Loans are charged off when they are
determined to be uncollectible.
A summary of the loans on non-accrual status is as follows:
December 31, | ||||||||||||||||
2010 | 2009 | |||||||||||||||
Unpaid Principal | Unpaid Principal | |||||||||||||||
Carrying Value | Balance | Carrying Value | Balance | |||||||||||||
(Dollars In | ||||||||||||||||
Thousands) | ||||||||||||||||
Mortgage loans on real estate on non-accrual status: |
||||||||||||||||
Commercial real estate |
$ | 692 | $ | 802 | $ | 318 | $ | 792 | ||||||||
Multi-family residential |
| | | | ||||||||||||
One-to-four family residential |
224 | 337 | | | ||||||||||||
Total loans on non-accrual status |
$ | 916 | $ | 1,139 | $ | 318 | $ | 792 | ||||||||
Number of loans on non-accrual status |
8 | 7 | ||||||||||||||
Number of borrowers with loans on non-accrual status |
8 | 5 | ||||||||||||||
Non-accrual loans, net, as a percent of loans |
3.75 | % | 1.07 | % | ||||||||||||
Non-accrual loans, net, as a percent of total assets |
1.05 | % | 0.39 | % |
Non-accrual loans increased as of December 31, 2010 as compared to December 31, 2009. During
2010, four loans became non-accrual and three loans were written off. The carrying value increased
from December 31, 2009 to December 31, 2010 due to unrealized gains resulting from increases in the
fair market value of the loans held for sale and the residential loan that became non-accrual
during 2010.
Discount and Allowance for Loan Losses
Discounts on Acquired Loans. Prior to February 5, 2009, our loan assets were considered held
for investment and recorded at accreted cost which accounts for the amortization of any purchase
discount and deferred
12
Table of Contents
fees less an allowance for loan losses. We reviewed acquired loans for differences between
contractual cash flows and cash flows expected to be collected from our initial investment in the
acquired loans to determine if those differences were attributable, at least in part, to credit
quality. If those differences were attributable to credit quality, the loans contractually
required payments receivable in excess of the amount of its cash flows expected at acquisition, or
nonaccretable discount, was not accreted into income. Prior to February 5, 2009, we recognized the
excess of all cash flows expected at acquisition over our initial investment in the loan as
interest income using the interest method over the term of the loan.
Prior to February 5, 2009, for loans at acquisition which did not have evidence of
deterioration of credit quality since origination, the discount, representing the excess of the
amount of reasonably estimable and probable discounted future cash collections over the purchase
price, was accreted into interest income using the interest method over the term of the loan.
Prepayments were not considered in the calculation of accretion income. Additionally, discount was
not accreted on non-accrual loans. If cash flows could not be reasonably estimated for any loan,
and collection was not probable, the cost recovery method of accounting was used. Under the cost
recovery method, any amounts received were applied against the recorded amount of the loan.
Nonaccretable discount was generally offset against the related unpaid principal balance when the
amount at which a loan was resolved or restructured. There was no effect on the income statement as
a result of these reductions. Subsequent to acquisition, if cash flow projections improved, and it
was determined that the amount and timing of the cash flows related to the nonaccretable discount
were reasonably estimable and collection was probable, the corresponding decrease in the
nonaccretable discount was transferred to the accretable discount and was accreted into interest
income over the remaining life of the loan on the interest method. If cash flow projections
deteriorated subsequent to acquisition, the decline was accounted for through a provision for loan
losses included in earnings.
Allowance for Loan Losses. Prior to February 5, 2009, our loan assets were considered held
for investment and recorded at accreted cost, which accounts for the amortization of any purchase
discount and deferred fees, less an allowance for loan losses. The allowance for loan losses was
increased or decreased through a provision for loan losses or a reduction in the allowance for loan
losses included in earnings.
Employees
EOS has four employees, including the President and Chief Financial Officer. EOS employees
currently are also officers of Aurora Bank and do not receive separate compensation from EOS. EOS
maintains corporate records and audited financial statements that are separate from those of Aurora
Bank. We do not have any other employees because we have retained Aurora Bank to perform all
necessary functions pursuant to the AA and the MSA. There are no provisions in our charter limiting
any of the officers or directors from having any direct or indirect pecuniary interest in any
mortgage asset to be acquired or disposed of by us or in any transaction in which we have an
interest or from engaging in acquiring and holding mortgage assets. None of the officers or
directors currently has, nor is it anticipated that they will have, any such interest in our
mortgage assets.
Competition
Numerous banks and non-bank financial institutions have historically competed with Aurora Bank
for deposit accounts and the acquisition of loans. The primary factors in competing for deposit
accounts include interest rates and the quality and range of financial services offered. The
primary factor in competing for purchased loans is price. Aurora Bank continues to be subject to
restrictions imposed by the Order. With respect to deposits, additional significant competition may
arise from corporate and government debt securities, as well as money market mutual funds.
We do not anticipate that we will engage in the business of originating mortgage loans.
Subject to prior approval by the OTS, we may acquire mortgage assets in addition to those in the
loan portfolio and anticipate that substantially all these mortgage assets, if any assets are
acquired in the future, will be acquired from Aurora Bank. Accordingly, we do not expect to compete
with mortgage conduit programs, investment banking firms, savings and loan associations, banks,
thrift and loan associations, finance companies, mortgage bankers, or insurance companies in
acquiring our mortgage assets from Aurora Bank. Aurora Bank, however, may face significant
competition in the purchase of mortgage loans, which could have an adverse effect on our ability to
acquire mortgage loans. If Aurora
13
Table of Contents
Bank does not successfully compete in the purchase and origination of mortgage loans, there
could be an adverse effect on our business, financial condition and results of operations.
The banking industry in the United States is part of the broader financial services industry
which also includes insurance companies, mutual funds, consumer finance companies, and securities
brokerage firms. In recent years, intense market demands, technological and regulatory changes, and
economic pressures have eroded industry classifications which were once clearly defined. Continuing
realignment within the financial services sector could eliminate some competitors or introduce new
ones. Likewise, government programs aimed at addressing the current credit crisis could facilitate
additional companies and government sponsored entities to compete with Aurora Bank for attractive
investments.
Environmental Matters
In the course of our business, we may acquire through foreclosure, properties securing loans
we have purchased which are in default and involve environmental matters. With respect to other
real estate owned, there is a risk that hazardous substances or wastes, contaminants or pollutants
could be discovered on such properties after acquisition. In such event, we may be required to
remove such substances from the affected properties at our sole cost and expense and may not be
able to recoup any of such costs from any third party.
Available Information
We file an annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form
8-K, and all amendments to these reports with the SEC. You may read and copy any document filed by
us at the SECs Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549 on official
business days during the hours of 10:00 a.m. to 3:00 p.m. Please call the SEC at 1-800-SEC-0330 for
information on the Public Reference Room. We do not maintain an internet website, but the SEC
maintains a website that contains annual, quarterly, and current reports, proxy statements, and
other information that issuers (including us) file electronically with the SEC. The SECs website
address is http://www.sec.gov.
14
Table of Contents
ITEM 1A. RISK FACTORS
A number of risk factors, including, without limitation, the risks factors set forth below,
may cause our actual results to differ materially from anticipated future results, performance or
achievements expressed or implied in any forward-looking statements contained in this Annual Report
on Form 10-K. All of these factors should be carefully reviewed, and the reader of this Annual
Report on Form 10-K should be aware that there may be other factors that could cause difference in
future results, performance or achievements.
Risks Related to the LBHI Bankruptcy, Settlement Agreement and Regulatory Oversight of Aurora Bank
EOS is dependent in virtually every phase of its operations on the diligence and skill of the
management of Aurora Bank. The Settlement Agreement requires LBHI to either sell or dissolve Aurora
Bank within defined time frames.
Aurora Bank, which holds all of the common stock of EOS, is involved in every aspect of our
operations and is able to approve unilaterally almost all of our corporate actions as its sole
common shareholder. We have four employees and the employees of EOS currently are also officers of
Aurora Bank. EOS does not have any other employees because we have retained Aurora Bank to perform
all necessary functions pursuant to the AA and the MSA.
Under the AA between EOS and Aurora Bank, Aurora Bank is responsible for administering the
day-to-day activities, including monitoring of our credit quality and advising it with respect to
the acquisition, management, financing and disposition of mortgage assets, and our operations
generally. Under the MSA between EOS and Aurora Bank, Aurora Bank services our commercial loans and
oversees the servicing of the residential loan portfolio.
Pursuant to the CMA, LBHI agreed that it will seek to sell Aurora Bank within eighteen (18)
months from Execution Date. If after a period of fifteen (15) months following the Execution Date,
the OTS concludes that a sale of Aurora Bank will not be consummated by the end of the eighteen
(18) month period, Aurora Bank will prepare and submit to the OTS a plan for dissolution. The
bankruptcy court will have the final review and approval of any proposed agreement for the sale of
Aurora Bank.
The loss of the services of Aurora Bank, or the inability of Aurora Bank to effectively
provide such services whether as a result of the loss of key members of Aurora Banks management,
early termination of the agreements or otherwise, and our inability to replace such services on
favorable terms, or at all, could adversely affect our ability to conduct our operations and our
results of operations.
Failure to honor the Capital Maintenance Agreement may result in an automatic exchange directive.
On September 15, 2008, LBHI filed a voluntary petition for relief under Chapter 11 of Title 11
of the United States Code in the United States Bankruptcy Court for the Southern District of New
York. Aurora Bank is an indirect subsidiary of LBHI and EOS is an operating subsidiary of Aurora
Bank. Aurora Bank has not been placed into bankruptcy, reorganization, conservatorship, or
receivership and EOS has not filed for bankruptcy protection.
On the Execution Date, LBHI agreed to enter into the CMA with Aurora Bank and the OTS.
Pursuant to the CMA, LBHI agreed for the duration of LBHIs ownership of Aurora Bank to maintain
Aurora Banks tier 1 risk based capital ratios at levels greater than the thresholds required to
achieve a well-capitalized designation under OTS regulations. As of December 31, 2010, as set
forth in a public filing with the OTS, Aurora Banks capital ratios were above the thresholds
required under the CMA. The classification of Aurora Banks capitalization level is subject to
review and acceptance by the OTS.
Notwithstanding the Settlement Agreement, the bankruptcy or other factors may limit the
ability of LBHI to contribute capital to Aurora Bank now or in the future. The potential inability
of LBHI to contribute capital to Aurora Bank increases the risk that the OTS may direct the
automatic exchange of the Series D preferred stock of EOS for preferred shares of Aurora Bank at a
ratio of one Series D preferred share for one-hundredth of one
15
Table of Contents
preferred share of Aurora Bank. Should that automatic exchange occur the Series D shareholders
may hold bank stock for an institution that has inadequate capital, and whose stock is not listed
and therefore possess an asset that is not liquid.
EOS is subject to extensive government regulation and supervision.
EOS, as an operating subsidiary of Aurora Bank, is subject to extensive federal regulation and
supervision. Banking regulations are primarily intended to protect depositors funds, federal
deposit insurance funds, and the banking system as a whole, not shareholders. These regulations
have an effect on our capital structure, dividend policy, and growth, among other things. Congress
and federal regulatory agencies continually review and revise banking laws, regulations, and
policies to enhance the safety and soundness of the banking system. Changes to statutes,
regulations or regulatory policies, including changes in interpretation or implementation of
statutes, regulations or policies, could affect us in substantial and unpredictable ways. Failure
to comply with laws, regulations or policies could result in, among other things, sanctions by
regulatory agencies, civil money penalties, and/or reputation damage, which could have a material
adverse effect on our business, financial condition, and results of operations.
On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (Act) was
signed into law. Under the Act financial institutions, including Aurora Bank will be subject to
significant new conditions and limitations. In addition, Aurora Banks primary federal regulator,
the OTS, will be dissolved with supervision and enforcement powers being transferred to the Office
of the Comptroller of the Currency (OCC). This transfer of supervisory and enforcement powers
will directly impact EOS. The OCC will become the administrator of the Order, as well as be the
agency empowered with approving dividend declaration requests and other actions impacting the
capital and/or assets of EOS. There can be no assurance that the OCC will approve any dividend
declaration request, or any other requests impacting the capital and/or assets of EOS.
The failure of Aurora Bank could result in the loss of our funds on deposit with Aurora Bank, which
could reduce the amount of cash available to pay distributions, including dividends on the Series D
preferred stock.
As of December 31, 2010, the FDIC, will only insure amounts up to $250,000 per depositor in
any particular bank. As of December 31, 2010, we had approximately $62.4 million of interest
bearing deposits with Aurora Bank, which is significantly in excess of federally-insured levels. If
Aurora Bank were to fail or be placed into receivership, we may lose any amount of deposit value
over federally-insured amounts. The loss of deposit value could reduce the amount of cash we have
available to pay distributions, including dividends on the Series D preferred stock.
16
Table of Contents
Risks Related to our Loan Portfolio
Fluctuations in interest rates could reduce our earnings and affect our ability to pay dividends.
Our income consists primarily of interest earned on our mortgage assets and cash deposits.
Approximately 68% of our accrual mortgage assets bear interest at adjustable rates. If there is a
decline in interest rates, we will experience a decrease in income available to be distributed to
our stockholders. If interest rates decline, we may also experience an increase in prepayments on
our mortgage assets and may find it difficult to purchase additional mortgage assets bearing rates
sufficient to support the payment of dividends. Conversely, an increase in mortgage rates could
result in decreased interest income and increased non-interest expense related to workouts and
other collection efforts. An increase in interest rates that adversely affects the ability of
borrowers to pay the principal or interest on our loans may lead to an increase in non-accrual
loans, which could have a material adverse effect on our results of operations.
The realizable value of our loan portfolio may differ from fair value.
The fair value of our loan portfolio is estimated based upon various cash flow
models. These models consider significant inputs such as loan type, loan age, loan to value ratio,
payment history, and property location, as well as significant assumptions such as estimated rates
of loan delinquency, potential recovery, discount rate, and the impact of interest rate reset.
Recent trade quotes or prices are identified in estimating the amount at which a third party might
purchase the loans and their yield requirements. Management also considers market information and
quotes received from third parties, when available. The valuation of the loan portfolio involves a
significant level of management estimation and judgment, the degree of which is dependent on the
terms of the loans and the availability of market prices and inputs. The realizable value of the
loan portfolio may differ from fair value and actual losses could materially and adversely affect
our results of operations.
Continued declines in home prices would negatively impact the performance of residential mortgages.
Beginning in 2007, there has been a steep decline in the national housing market with home
prices falling dramatically and increases in foreclosures. The global recession has brought
increased levels of unemployment and underemployment. If housing prices continue to fall and
unemployment and underemployment continue to rise, the number of defaults, and related
foreclosures, on residential mortgages will remain at their current elevated levels or possibly
increase. In addition, governmental initiatives could impact the ability of lenders to foreclose on
residential properties and realize the value of the collateral for residential loans that are in
default. These factors could have a material adverse effect on a portfolio of loans secured
primarily by residential real estate such as ours, which could result in a material adverse effect
on our financial condition and results of operations.
Loans in our portfolio will most likely be originated by other parties.
EOS does not originate mortgage loans but rather purchases mortgage loans originated by third
parties. It is anticipated that additional mortgage assets would be acquired from Aurora Bank.
Loans purchased by Aurora Bank would likely consist of loans originated by third parties which may
not be subject to the same level of due diligence that Aurora Bank would have conducted had it
originated the loans and may lack current financial information. In addition, such loans may have
incomplete legal documentation and outdated appraisals. Although it is anticipated that Aurora Bank
would conduct a comprehensive acquisition review, it also may rely on certain information provided
by the parties that originated the loans, who may have substantially different underwriting
standards. These differences may include less rigorous appraisal requirements and debt service
coverage ratios, and less rigorous analysis of property location and environmental factors,
building condition and age, tenant quality, compliance with zoning regulations, any use
restrictions, easements or rights of ways that may impact the property value, and the borrowers
ability to manage the property and service the mortgage. As a result, we may not have information
with respect to an acquired loan which, if known at the time of acquisition, would have caused it
to reduce its bid price or not bid for the loan at all. This may adversely affect our yield on
loans. Loans such as these could have a higher risk of becoming non-accrual loans in the future and
adversely affect our results of operations.
17
Table of Contents
The loans in our portfolio are concentrated in California and adverse conditions in that market
could adversely affect our financial results.
Properties underlying the current mortgage assets of EOS are concentrated in California. As of
December 31, 2010, approximately 40% of the carrying value of our mortgage loans were secured by
properties located in California. Adverse economic, political or business developments or natural
hazards may affect this area and the ability of property owners in this area to make payments of
principal and interest on the underlying mortgages. Beginning in 2007 and throughout the following
years, the housing and real estate sectors in California were particularly hard hit by the
recession with higher overall foreclosure rates than the national average. If California
experiences further adverse economic, political or business conditions, or natural hazards, we will
likely experience higher rates of loss and delinquency on our mortgage loans than if our loans were
more geographically diverse.
A portion of our loan portfolio is made up of commercial mortgage loans, which are generally
riskier than other types of loans.
Commercial mortgage loans constituted approximately 28% of the carrying value of our loan
portfolio at December 31, 2010. Commercial mortgage loans are generally subject to greater risks
than other types of loans. Our commercial mortgage loans, like most commercial mortgage loans,
generally lack standardized terms, may have shorter maturities than other mortgage loans and may
not be fully amortizing, meaning that they have an unpaid principal balance or balloon payment
due on maturity. The commercial real estate properties underlying our commercial mortgage loans
also tend to be unique and are more difficult to value than other real estate properties. They are
also subject to relatively greater environmental risks than other types of loans and to the
corresponding burdens and costs of compliance with environmental laws and regulations. Because of
these risks related to commercial mortgage loans, we may experience higher rates of default on our
mortgage loans than we would if our loan portfolio was more diversified and included a greater
number of owner-occupied residential or other mortgage loans. Higher rates of default will cause
the level of impaired loans to increase, which may have a material adverse effect on our results of
operations.
We may not be able to purchase loans at the same volume or with the same yields as purchased in the
past.
Future loan purchases, if any, will depend on the availability of pools of loans offered for
sale and Aurora Banks ability to submit successful bids or negotiate satisfactory purchase prices.
Historically, the acquisition of loans has been highly competitive and there can be no assurance
that Aurora Bank will be able to purchase loans at the same volume or with the same yields as we
have historically purchased or that we will acquire any loans from Aurora Bank or at all. This may
interfere with our ability to maintain the requisite level of mortgage assets to maintain our
qualification as a REIT. If volumes of loans owned by us decline or the yields on these loans
decline, we could experience a material adverse effect on our financial condition.
We could be held responsible for environmental liabilities of properties it acquires through
foreclosure.
If we choose to foreclose on a defaulted mortgage loan to recover our investment, we may be
subject to environmental liabilities related to the underlying real property. Approximately 28% of
the carrying value in our portfolio at December 31, 2010, was for commercial mortgage loans, which
generally are subject to relatively greater environmental risks than other types of loans.
Hazardous substances or wastes, contaminants, pollutants or sources thereof may be discovered on
properties during our ownership or after a sale to a third party. The amount of environmental
liability could exceed the value of the real property. There can be no assurance that we would not
be fully liable for the entire cost of any removal and clean-up on an acquired property, that the
cost of removal and clean-up would not exceed the value of the property, or that we could recoup
any of the costs from any third party. In addition, we may find it difficult or impossible to sell
the property prior to or following any such remediation. The incurrence of any significant
environmental liabilities with respect to a property securing a mortgage loan could have a material
adverse effect on our financial condition.
18
Table of Contents
Risks Related to Tax Status as a REIT
Our qualification as a REIT requires us to satisfy numerous requirements (some on an annual
and quarterly basis) established under the highly technical and complex Internal Revenue Code
provisions, including share ownership tests, organizational requirements, distribution tests, gross
income tests, and asset tests.
If we fail to qualify as a REIT, we will be subject to federal and state income tax at regular
corporate rates.
If we fail to qualify as a REIT for any taxable year, we will be subject to federal income
tax, including any applicable alternative minimum tax, on our taxable income at regular corporate
rates. As a result, the amount available for distribution to our stockholders would be reduced for
the year or years involved. In addition, unless entitled to relief under statutory provisions, we
would be disqualified from treatment as a REIT for the four taxable years following the year which
qualification was lost. The failure to qualify as a REIT would reduce our net earnings available
for distribution to our stockholders because of the additional tax liability for the year or years
involved.
Although we currently intend to operate in a manner designed to qualify as a REIT, future
economic, market, legal, regulatory, tax or other considerations may cause EOS directors to revoke our REIT election. The tax law prohibits us from electing treatment as a REIT
for the four taxable years following the year of any such revocation.
If we do not distribute 90% of our net taxable income, we may not qualify as a REIT.
We generally are required each year to distribute to our stockholders at least 90% of our net
taxable income, excluding net capital gains. We may retain the remainder of REIT taxable income or
all or part of our net capital gain, but will be subject to tax at regular corporate rates on such
income. In addition, we are subject to a 4% nondeductible excise tax on the amount, if any, by
which certain distributions considered as paid with respect to any calendar year are less than the
sum of (1) 85% of our ordinary income for the calendar year, (2) 95% of our capital gains net
income for the calendar year, and (3) 100% of any undistributed income from prior periods. In order
to qualify as a REIT, distributions must be declared by September 15th of the following
fiscal year and paid by December 31st.
Restrictions on our ability to declare and pay dividends contained in the Order could result
in EOS failing to qualify as a REIT. Futhermore, to the extent our REIT taxable income may exceed
the actual cash received for a particular period, we may not have sufficient liquidity to make
distributions necessary to retain our REIT qualification.
If ownership of the stock of EOS becomes concentrated in a small number of individuals, EOS may
fail to qualify as a REIT.
Not more than 50% in value of a companys outstanding shares may be owned, directly or
indirectly, by five or fewer individuals, as defined in the Internal Revenue Code to include
certain entities, during the last half of each taxable year. We monitor EOS ownership, however, it
is possible that the ownership of our preferred stock might become sufficiently concentrated in the
future such that five or fewer individuals would be treated as having constructive ownership of
more than 50% of the value of our stock. Also, difficulty monitoring the ownership and constructive
ownership of our outstanding shares could evolve and, therefore, there can be no assurance that we
will continue to meet the share ownership requirement.
If we do not meet certain gross income tests, we may not qualify as a REIT.
We are required to satisfy two gross income tests for each taxable year. At least 75% of our
gross income must be derived directly or indirectly from rents from real property, investments in
real estate and/or real estate mortgages, dividends paid by another REIT, and from some types of
temporary investments. Additionally at least 95% of our gross income must be derived from any
combination of income qualifying under the 75% test and dividends, non-real estate mortgage
interest, and gain from the sale or disposition of stock or securities. If we fail to
19
Table of Contents
satisfy one or both of the gross income tests for any taxable year, we may nevertheless
qualify as a REIT for the year if we are entitled to relief under certain provision of the Internal
Revenue Code. In this case, a penalty tax would still be applicable.
If we do not meet certain asset tests, we may not qualify as a REIT.
We are required to meet four asset tests at the close of each quarter of our taxable year.
First, at least 75% of the value of our total assets must be represented by real estate assets
(which include other real estate investment trusts) and certain cash related items. Second, not
more than 25% of the value of our total assets may be represented by securities other than those in
the 75% asset class. Third, except for securities included in the first test, we may not own more
than 5% of the value of our total assets in any one equity investment in other REITs, qualified
REIT subsidiary, or taxable REIT subsidiary and we may not own securities representing more than
10% of the voting power or value in any of those investments. Fourth, not more than 25% of the
value of our total assets may be represented by securities of one or more taxable REIT
subsidiaries. There are certain exceptions to these tests. If we fail to satisfy the 5% or 10%
asset tests described after a 30-day cure period provided by the Internal Revenue Code and the
non-qualifying asset is the lesser of less than 1% of the total value of our assets at the end of
the applicable quarter or $10,000,000 and we dispose of the non-qualifying assets within six months
after the last day of the applicable quarter in which the failure to satisfy the asset test is
discovered, we will be deemed to have meet such tests. For violations due to reasonable cause and
not willful neglect, we may avoid disqualification as a REIT by disposing of sufficient assets to
meet the asset test within such six month period, paying a tax equal to the greater of $50,000 or
the highest corporate tax rate multiplied by the net income generated by the non-qualifying assets
and disclosing certain information to the Internal Revenue Service. If we cannot avail ourselves of
these relief provisions, or if we fail to timely cure any noncompliance with the asset tests, we
would cease to qualify as a REIT.
20
Table of Contents
Risks Related to future dividends and the Potential for Exchange or Redemption of Preferred Stock
Bank regulators may continue to limit the ability of EOS to declare and pay dividends.
Because EOS is an operating subsidiary of Aurora Bank, the OTS and FDIC have the right to
examine EOS and our activities and to impose restrictions on Aurora Bank or EOS which impacts our
ability to conduct business according to our business objectives, which could materially adversely
affect the financial condition and results of operations of EOS.
Following execution of the Settlement Agreement, on November 30, 2010, the OTS issued the
Amended Order, which amended the Original Order. However, the provisions in the Original Order that
require Aurora Bank to ensure that each of its subsidiaries, including EOS, comply with the
Original Order were not amended. These operating restrictions, amount other things, restrict
transactions with affiliates, capital distributions to shareholders, (including redemptions),
contracts outside the ordinary course of business, and changes in senior executive officers, board
members or their employment arrangements without prior written notice to the OTS.
Under the Order, EOS must continue to seek and receive approval or non-objection from the OTS
for the declaration, payment, and distribution of dividends to our preferred and common
shareholders. There is no assurance that the OTS will approve any request for the declaration or
payment of dividends.
Furthermore, any future dividends on the Series D preferred stock will be payable only when,
as and if declared by the Board of Directors.
Changes in the performance of Aurora Bank may result in the Series D preferred stock being subject
to automatic exchange into preferred shares of Aurora Bank at any time.
The returns from an investment in the Series D preferred stock will depend to a significant
extent on the performance and capital of Aurora Bank. If (i) Aurora Bank is undercapitalized, (ii)
or if the OTS anticipates that Aurora Bank will become undercapitalized, (iii) or if Aurora Bank is
placed into bankruptcy, reorganization, conservatorship or receivership, the OTS may direct the
automatic exchange of the preferred shares of EOS for preferred shares of Aurora Bank, which would
represent an investment in Aurora Bank and not in EOS. Under these circumstances:
| a holder of Series D preferred stock would be a preferred stockholder of Aurora Bank if Aurora Bank becomes undercapitalized, if Aurora Bank is placed into bankruptcy, reorganization, conservatorship, or receivership, or if the OTS, in its sole discretion, anticipates Aurora Bank becoming undercapitalized. The conversion ratio is one Series D preferred share for one-hundredth of one preferred share of Aurora Bank. An investment in Aurora Bank is also subject to risks that are distinct from the risks associated with an investment in EOS. For example, an investment in Aurora Bank would involve risks relating to the capital levels of, and other federal regulatory requirements applicable to, Aurora Bank and the performance of Aurora Banks loan portfolio, other assets, and other business lines. Aurora Bank stock is not listed. Aurora Bank also has significantly greater liabilities than does EOS; | ||
| if a liquidation of Aurora Bank occurs, the claims of depositors and creditors of Aurora Bank and/or the OTS would have priority over the claims of holders of the preferred shares of Aurora Bank, and therefore, a holder of Series D preferred stock likely would receive, if anything, substantially less than such holder would receive had the Series D preferred stock not been exchanged for preferred shares of Aurora Bank; and | ||
| the exchange of the Series D preferred stock for preferred shares of Aurora Bank would be a taxable event to a holder of Series D preferred stock under the Internal Revenue Code, and such holder would incur a gain or a loss, as the case may be, measured by the difference between such holders basis in the Series D preferred stock and the fair market value of Aurora Bank preferred shares received in the exchange. |
21
Table of Contents
General Business Risks
Our business and financial results are significantly affected by general business and economic
conditions.
Since 2007, the U.S. economy has experienced a severe economic downturn. Business activity
across a wide range of industries and regions has suffered significant declines with many showing
reduced earnings or, in some cases, losses. The U.S. economy has seen increased levels of
commercial and consumer delinquencies and defaults, lack of consumer confidence and spending,
reduced availability of commercial credit, and increased unemployment and underemployment.
We do not expect that these difficult conditions are likely to improve significantly in the
near future. A worsening of these conditions would likely exacerbate the adverse effects of these
difficult market conditions and lead to additional foreclosures, delinquencies, and bankruptcies,
which could have a negative impact on our financial condition and results of operations.
Our results will be affected by factors beyond our control.
Our mortgage loan portfolio is subject to local economic conditions which could affect the
value of the real estate assets underlying our loans and therefore our results of operations will
be affected by various conditions in the real estate market, all of which are beyond our control,
such as:
| local and other economic conditions affecting real estate values; | ||
| the continued financial stability of a borrower and the borrowers ability to make mortgage payments; | ||
| the ability of tenants to make lease payments; | ||
| the ability of a property to attract and retain tenants, which may in turn be affected by local conditions, such as oversupply of space or a reduction in demand for rental space in the area; | ||
| regional experiences of adverse business conditions or natural disasters; | ||
| interest rate levels and the availability of credit to refinance mortgage loans at or prior to maturity; and | ||
| increased operating costs, including energy costs, real estate taxes and costs of compliance with environmental controls and regulations. |
The relationship between EOS and Aurora Bank may create conflicts of interest.
Aurora Bank and its affiliates may have interests which are not identical to those of EOS and
conflicts of interest have arisen and may arise in the future with respect to transactions between
us and Aurora Bank such as:
Acquisition of mortgage assets. Subject to prior approval by the OTS, we may from time to time purchase additional mortgage assets. If we acquire any additional mortgage assets, it is anticipated that substantially all of such mortgage assets will be acquired from Aurora Bank on terms that are comparable to those that could be obtained by us if such mortgage assets were purchased from unrelated third parties. Although any purchases will be structured to take advantage of the underwriting procedures of Aurora Bank, and while we believe that any agreements and transactions between us and Aurora Bank and/or its affiliates, will be fair to all parties and consistent with market terms, neither EOS nor Aurora Bank are required to obtain a third-party valuation to confirm that we are paying fair market value. Additionally, through limiting our source of purchased mortgage assets solely to those originated or purchased by Aurora Bank, our portfolio will generally reflect the nature, scope, and risk of Aurora Banks portfolio rather than a more diverse portfolio composed of mortgage loans also purchased from other lenders. |
22
Table of Contents
Servicing of mortgage assets by Aurora Bank. Aurora Bank in its role as servicer under the terms of the MSA received an annual servicing fee on the gross average unpaid principal balances of loans serviced for the immediately preceding month. The MSA requires Aurora Bank to service the loan portfolio in a manner substantially the same as for similar work performed by Aurora Bank for transactions on its own behalf. While we believe that Aurora Bank will diligently pursue collection of any non-accrual loans, there can be no assurance that this will be the case. Our ability to make timely payments of dividends will depend in part upon Aurora Banks prompt collection efforts on behalf of EOS. | |||
Future dispositions of mortgage assets to Aurora Bank or its affiliates. The MSA provides that foreclosures and dispositions of the mortgage assets are to be performed in a manner substantially the same as for similar work performed by Aurora Bank on its own behalf. However, there can be no assurance that any such agreement or transaction will be on terms as favorable to it as would have been obtained from unaffiliated third parties. Aurora Bank may seek to exercise its influence on our affairs so as to cause the sale of the mortgage assets owned by EOS and their replacement by lesser quality loans purchased from Aurora Bank or elsewhere which could adversely affect our business and our ability to make timely payments of dividends. |
The controls and procedures of EOS may fail or be circumvented.
Management is responsible for our internal controls, disclosure controls and procedures, and
corporate governance policies and procedures. Any system of controls, however well designed and
operated, is based in part on certain assumptions and can provide only reasonable, not absolute,
assurances that the objectives of the system are met. Any failure or circumvention of our controls
and procedures or failure to comply with regulations related to controls and procedures could have
a material adverse effect on our business, results of operations, and financial condition.
The Board of Directors has broad discretion to revise the strategies of EOS.
The Board of Directors establishes our investment and operating strategies. These strategies
may be revised from time to time at the discretion of the Board of Directors without a vote of the
EOS stockholders. Changes in our strategies could have a negative effect on shareholders.
EOS is subject to the risk of litigation, and the outcome of proceedings it may become involved in
could materially adversely affect our business.
From time to time, we may be involved in litigation incidental to our business, including
without limitation, a variety of legal proceedings with borrowers. Although we intend to vigorously
defend against all potential actions, there can be no assurance that the ultimate outcome of any
actions will not cause a loss or materially adversely affect our business or results of operations.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
We conduct all of our business out of offices maintained by Aurora Bank. The mailing address
is 1271 Avenue of the Americas, 46th Floor, New York, NY 10020. EOS does not directly reimburse
Aurora Bank for the use of such space.
ITEM 3. LEGAL PROCEEDINGS
From time to time, we may be involved in routine litigation incidental to our business,
including a variety of legal proceedings with borrowers, which could contribute to the Companys
expenses, including the costs of carrying non-accrual loans.
23
Table of Contents
ITEM 4. (REMOVED AND RESERVED).
Not applicable.
PART II
ITEM 5. | MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES. |
Common Stock
In connection with our formation on March 20, 1998, we issued 100 shares of our common stock
to Capital Crossing Bank. These shares of common stock were issued in reliance upon the exemption
from registration under Section 4(2) of the Securities Act of 1933, as amended. There is no
established public trading market for the common stock. As of March 31, 2011, there were 100 issued
and outstanding shares of common stock, all of which were held by Aurora Bank.
On February 14, 2007, Capital Crossing Bank was acquired by Aurora Bank through a two step
merger transaction. An interim thrift subsidiary of Aurora Bank was merged into Capital Crossing
Bank. Immediately following such merger, Capital Crossing Bank was merged into Aurora Bank. Under
the terms of the agreement, Lehman Brothers paid $30.00 per share in cash in exchange for each
outstanding share of Capital Crossing Bank. Effective as of April 27, 2009, Lehman Brothers Bank,
FSB, the owner of all of our common stock, formally changed its name to Aurora Bank FSB.
During 2010, dividends of $2.4 million were declared to the common stockholder and no returns
of capital were paid to the common stock holder. During 2009, no dividends or returns of capital
were declared or paid to the common shareholder. During 2008, dividends of $2.8 million were
declared to the common stockholder and returns of capital totaling $20.2 million were paid to the
common stockholder.
Preferred Stock
On March 31, 1998, Capital Crossing Bank capitalized EOS by transferring mortgage loans valued
at $140.7 million in exchange for 1,000 shares of EOS 8% Cumulative Non-Convertible Preferred
Stock, Series B, valued at $1.0 million and 100 shares of EOS common stock valued at $139.7
million. The carrying value of these loans approximated their fair values at the date of
contribution.
On May 11, 2004, we closed our public offering of 1,500,000 shares of our 8.50% Non-cumulative
exchangeable preferred stock, Series D. The net proceeds to EOS from the sale of Series D preferred
stock was $35.3 million. The Series D preferred stock became redeemable at the option of EOS at a
redemption price of $25.00 per share plus accrued and unpaid dividends, effective July 15, 2009,
with the prior approval of the OTS and the FDIC. The Series D preferred stock has a liquidation
amount of $25.00 per share plus any accrued and unpaid dividends for the quarter in which the
liquidation occurs.
All shares of EOS 9.75% Non-cumulative exchangeable preferred stock, Series A, and 10.25%
Non-cumulative exchangeable preferred stock, Series C, were redeemed on March 23, 2007. The Series
B preferred stock and Series D preferred stock remain outstanding and subject to their existing
terms and conditions, including the call feature with respect to the Series D preferred stock. At
any time following the occurrence of certain changes in the tax laws or regulations concerning
REITs, EOS will have the right to redeem the Series D preferred stock in whole, subject to the
prior written approval of the OTS. We would have the right to redeem the Series D preferred stock
if we received an opinion of counsel to the effect that, as a result of changes to the tax laws or
regulations:
| dividends paid or to be paid by us with respect to our capital stock are not, or will not be, fully deductible by us for income tax purposes; or | ||
| we are otherwise unable to qualify as a REIT. |
24
Table of Contents
The occurrence of such changes in the tax laws or regulations will not, however, give the
holders of the Series D preferred stock any right to have their shares redeemed.
In accordance with the Series D registration statement, the OTS may direct in writing the
automatic exchange of the Series D preferred stock for preferred shares of Aurora Bank at a ratio
of one Series D preferred share for one hundredth of one preferred share of Aurora Bank if Aurora
Bank becomes undercapitalized under prompt corrective action regulations, if Aurora Bank is placed
into bankruptcy, reorganization, conservatorship or receivership, or if the OTS, in its sole
discretion, anticipates Aurora Bank will become undercapitalized in the near term (Exchange
Event).
Dividend Policy
Until the second quarter of 2009, we historically paid an aggregate amount of dividends with
respect to our outstanding shares of capital stock equal to substantially all of our REIT taxable
income. We, subject to directives of the OTS, intend to pay dividends on our preferred stock and
common stock in amounts necessary to continue to preserve our status as a REIT under the Internal
Revenue Code. In order to remain qualified as a REIT, we must distribute annually at least 90% of
our REIT taxable income, excluding capital gains, to stockholders. Because in general it will be in
our interest, and in the interests of our stockholders, to remain qualified as a REIT, this tax
requirement creates a significant incentive to declare and pay dividends when we have sufficient
resources and ability to do so. We anticipate that none of the dividends on outstanding preferred
shares will constitute non-taxable returns of capital.
Dividends will be declared at the discretion of the Board of Directors after considering our
distributable funds, financial requirements, tax considerations, regulatory, and other factors. Our
distributable funds will consist primarily of interest and principal payments on the mortgage
assets, interest on deposits, and we anticipate that a significant portion of such assets will earn
interest at adjustable rates. Accordingly, if there is a decline in interest rates, we will
experience a decrease in income available to be distributed to our stockholders. In a period of
declining interest rates, we also may find it difficult to purchase additional mortgage assets
bearing rates sufficient for us to be able to pay dividends on the Series D preferred stock.
The Order requires Aurora Bank and each of its subsidiaries, including EOS, to comply with the
operating restrictions contained in the Order. These operating restrictions, among other things,
restrict transactions with affiliates, capital distributions to shareholders (including
redemptions), transfers or exchanges of assets, contracts outside the ordinary course of business,
and changes in senior executive officers, board members or their employment arrangements without
prior written notice to the OTS.
The OTS has informed Aurora Bank that prior approval of the OTS is required for payment by EOS
of dividends on the Series D preferred stock. There can be no assurance, that future dividends on
the Series D preferred stock will receive approval from the OTS. Furthermore, any future dividends
on the Series D preferred stock will be payable only when, as and if declared by the Board of
Directors.
The OTS may direct in writing upon the occurrence of an Exchange Event the automatic exchange
of the Series D preferred stock for preferred shares of Aurora Bank. If the OTS directs the
automatic exchange of the Series D preferred stock for Aurora Bank preferred shares at this time,
holders of the Series D preferred stock would become holders of Aurora Bank preferred stock at a
time when Aurora Bank is subject to the Order. Thus, Aurora Bank would likely be prohibited from
paying dividends on its preferred shares, including its preferred shares issued in exchange for the
EOS Series D preferred stock. Further, Aurora Banks ability to pay dividends on its preferred
shares following the automatic exchange also would be subject to various restrictions under OTS
regulations and would be payable only when, as and if declared by Aurora Banks board of directors.
Any such dividends would be paid out of Aurora Banks capital surplus.
25
Table of Contents
ITEM 6. SELECTED FINANCIAL DATA
As of and for the Year Ended December 31, | ||||||||||||||||||||
2010 | 2009 | 2008 | 2007 | 2006 | ||||||||||||||||
(Dollars In Thousands) | ||||||||||||||||||||
Financial condition data: |
||||||||||||||||||||
Total assets |
$ | 87,222 | $ | 82,039 | $ | 96,067 | $ | 116,358 | $ | 173,903 | ||||||||||
Loans held for sale, at fair value |
16,505 | 22,531 | | | | |||||||||||||||
Loans held for sale, at lower of
accreted cost or market value |
7,935 | 7,292 | | | | |||||||||||||||
Loans held for investment, net |
| | 53,025 | 66,686 | 90,957 | |||||||||||||||
Allowance for loan losses |
| | (915 | ) | (1,180 | ) | (1,519 | ) | ||||||||||||
Deferred loan fees |
| | (27 | ) | (32 | ) | (47 | ) | ||||||||||||
Loans, net |
$ | 24,440 | $ | 29,823 | $ | 52,083 | $ | 65,474 | $ | 89,391 | ||||||||||
Cash and cash equivalents |
$ | 62,569 | $ | 51,823 | $ | 43,757 | $ | 50,581 | $ | 83,900 | ||||||||||
Stockholders equity |
85,276 | 81,695 | 95,136 | 115,369 | 172,687 | |||||||||||||||
Non-accrual loans, net |
916 | 318 | 1,596 | | 416 | |||||||||||||||
Operations data: |
||||||||||||||||||||
Total interest income |
$ | 2,194 | $ | 3,564 | $ | 6,175 | $ | 8,133 | $ | 10,920 | ||||||||||
Reduction in allowance for loan losses |
| 915 | 265 | 339 | 406 | |||||||||||||||
Gain (loss) on loans held for sale |
6,498 | (16,263 | ) | | | | ||||||||||||||
Other income |
| | | 76 | 1,120 | |||||||||||||||
Operating expenses |
(1,035 | ) | (1,040 | ) | (410 | ) | (299 | ) | (326 | ) | ||||||||||
Net income (loss) |
7,657 | (12,824 | ) | 6,030 | 8,249 | 12,120 | ||||||||||||||
Preferred stock dividends declared |
(1,725 | ) | (816 | ) | (3,262 | ) | (4,006 | ) | (6,529 | ) | ||||||||||
Net income (loss) available to common
shareholder |
$ | 5,932 | $ | (13,640 | ) | $ | 2,768 | $ | 4,243 | $ | 5,591 | |||||||||
Ratio of earnings to fixed charges
and preferred stock dividends |
4.44X | N/A | 1.85X | 2.06X | 1.86X | |||||||||||||||
Selected other information: |
||||||||||||||||||||
Non-accrual loans, net, as a percent
of total assets (1) |
1.05 | % | 0.39 | % | 1.66 | % | 0.00 | % | 0.24 | % | ||||||||||
Non-accrual loans, net, as a
percentage of loans, net of discount
and deferred loan income (1) |
3.75 | 1.07 | 3.01 | 0.00 | 0.46 | |||||||||||||||
Allowance for loan losses as a
percent of total loans, net of
discount and deferred loan fees (2) |
| | 1.73 | 1.77 | 1.67 | |||||||||||||||
Allowance for loan losses as a
percent of non-accrual loans, net (2) |
| | 57.33 | 0.00 | 365.14 |
(1) | The calculated percentage was impacted by the change in the composition of our portfolio of loans resulting from the exchange with Aurora Bank during 2009. | |
(2) | Concurrent with the February Asset Exchange Agreement for the exchange of loans with Aurora Bank, during the first quarter of 2009, we reclassified all of our loan assets as held for sale and recorded a valuation allowance to reflect these loan assets at the lower of their accreted cost or market value. Additionally, concurrent with the November Asset Exchange, loan assets were acquired that are recorded at their fair value. |
26
Table of Contents
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This report contains certain statements that constitute forward-looking statements within
the meaning of the Private Securities Litigation Reform Act of 1995. Words such as expects,
anticipates, believes, estimates and other similar expressions or future or conditional verbs
such as will, should, would, and could are intended to identify such forward-looking
statements. These statements are not historical facts, but instead represent the Companys current
expectations, plans or forecasts of its future results, growth opportunities, business outlook,
loan growth, credit losses, liquidity position, and other similar matters, including, but not
limited to, the requirement that Aurora Bank be sold or dissolved as an asset purchased by its
parent company within defined time frames, the ability to pay dividends with respect to the Series
D preferred stock, future bank regulatory actions that may impact the Company and the effect of the
bankruptcy of LBHI on the Company. These statements are not guarantees of future results or
performance and involve certain risks, uncertainties, and assumptions that are difficult to predict
and often are beyond the Companys control. Actual outcomes and results may differ materially from
those expressed in, or implied by, the Companys forward-looking statements. You should not place
undue reliance on any forward-looking statement and should consider all uncertainties and risks,
including, among other things, the risks set forth under Item 1A Risk Factors, as well as those
discussed in any of the Companys other subsequent Securities and Exchange Commission filings.
Forward-looking statements speak only as of the date they are made, and the Company undertakes no
obligation to update any forward-looking statement to reflect the impact of circumstances or events
that arise after the date the forward-looking statement was made.
Possible events or factors could cause results or performance to differ materially from what
is expressed in our forward-looking statements. These possible events or factors include, but are
not limited to, those risk factors discussed under Item 1A Risk Factors in this report and the
following: limitations by regulatory authorities on the Companys ability to implement its business
plan and restrictions on its ability to pay dividends; further regulatory limitations on the
business of Aurora Bank that are applicable to the Company; the requirement that Aurora Bank be
sold or dissolved within defined time frames; negative economic conditions that adversely affect
the general economy, housing prices, the job market, consumer confidence and spending habits which
may affect, among other things, the credit quality of our loan portfolios (the degree of the impact
of which is dependent upon the duration and severity of these conditions); the level and volatility
of interest rates; changes in consumer, investor and counterparty confidence in, and the related
impact on, financial markets and institutions; legislative and regulatory actions which may
adversely affect the Companys business and economic conditions as a whole; the impact of
litigation and regulatory investigations; various monetary and fiscal policies and regulations;
changes in accounting standards, rules and interpretations and the impact on the Companys
financial statements; and changes in the nature and quality of the types of loans held by the
Company.
Executive Level Overview
Aurora Bank, an indirect wholly-owned subsidiary of LBHI, owns all of our common stock.
Capital Crossing Bank was the sole common stockholder of EOS until February 14, 2007. The Series B
preferred stock and Series D preferred stock remain outstanding and remain subject to their
existing terms and conditions, including the call feature with respect to the Series D preferred
stock.
All of the mortgage assets in our loan portfolio at December 31, 2010 were acquired from
Capital Crossing Bank or Aurora Bank and it is anticipated that substantially all additional
mortgage assets, if any are acquired in the future, will be acquired from Aurora Bank. As of
December 31, 2010, we held loans acquired from Capital Crossing Bank and Aurora Bank with a
carrying value of $24.4 million and an unpaid principal balance of $32.9 million.
Residential loans constituted approximately 72% of the total loans in our loan portfolio at
December 31, 2010. Commercial mortgage loans constituted approximately 28% of the total loans in
our loan portfolio at December 31, 2010. Commercial mortgage loans are generally subject to greater
risks than other types of loans. Our commercial mortgage loans, like most commercial mortgage
loans, generally lack standardized terms, tend to have shorter maturities than other mortgage loans
and may not be fully amortizing. As of December 31, 2010, 96.2% of the carrying value of all loans
was classified as accrual.
27
Table of Contents
Properties underlying our current mortgage assets are concentrated primarily in California and
comprised approximately 40% of the total carrying value of the loan portfolio as of December 31,
2010. Beginning in 2007 and through the present time, the housing and real estate sectors in
California were hit particularly hard by the recession with higher overall foreclosure rates than
the national average. If California experiences continued or further adverse economic, political or
business conditions, or natural hazards, we will likely experience higher rates of loss and
delinquency on our mortgage loans than if our loans were more geographically diverse.
Decisions regarding the utilization of our cash are based, in large part, on our future
commitments to pay dividends. Future decisions regarding mortgage asset acquisitions and returns of
capital will be based on the level of preferred stock dividends at the time and the required level
of income necessary to generate adequate dividend coverage and other factors determined to be
relevant at the time.
Net income (loss) available to common shareholder increased $19.5 million to net income of
$5.9 million in 2010 compared to $13.6 million in net loss in 2009. The increase in 2010 over 2009
was primarily the result of the increase in the gain (loss) on loans held for sale of $22.8
million, partially offset by decreases of $1.4 million in interest income, decreases of $0.9
million reduction in allowance for loan losses and $0.9 million in increases of declared dividends
to preferred stockholders.
Net income (loss) available to common shareholder decreased $16.4 million to a net loss of
$13.6 million in 2009 compared to $2.8 million in net income in 2008. The decrease from 2008 to
2009 was primarily the result of the $16.3 million fair value adjustment established upon
reclassifying the loans to held for sale and recording these loans at fair value. Fair value at
December 31, 2009 was 30.0% below the net investment balance of these loans and reflects the impact
that adverse economic conditions have had on the fair value of these loans. Additionally, total
interest income decreased $2.6 million and operating expenses increased $0.6 million offset by an
increase in the reduction in the allowance for loan losses of $0.7 million and a reduction in
preferred stock declared dividends of $2.5 million compared to 2008.
Aurora Bank
Aurora Bank is involved in virtually every aspect of our operations and is able to approve
unilaterally almost all corporate actions of EOS as our sole common shareholder. EOS does not have
any independent corporate infrastructure. The officers of EOS are also officers of Aurora Bank. EOS
has retained Aurora Bank to be responsible for the administration of the day-to-day activities of
EOS in its roles as servicer under the MSA and as advisor under the AA. Both of these agreements
were amended effective as of January 1, 2010. The AA has a term of one year with an automatic
renewal feature. The MSA does not have a defined term but is subject to termination upon thirty
days notice. The MSA will automatically terminate if EOS ceases to be a subsidiary of Aurora Bank.
Under the AA, Aurora Bank is responsible for administering the day-to-day activities,
including monitoring of our loan portfolios credit quality and advising us with respect to the
acquisition, management, financing, and disposition of mortgage assets and our operations
generally. Under the MSA, Aurora Bank services our held for sale loans and oversees the servicing
of the residential loan portfolio acquired in the November Asset Exchange. Aurora Bank may
subcontract all or a portion of its obligations under the AA to its affiliates or, with the
approval of a majority of the Board of Directors including a majority of our independent directors,
subcontract its obligations under the AA to unrelated third parties. Aurora Bank will not, in
connection with the subcontracting of any of its obligations under the AA, be discharged or
relieved from its obligations under the AA.
The amended AA changes the fees paid by EOS. Through December 31, 2009, Aurora Bank was paid
an annual advisory fee equal to 0.05%, payable monthly, of the gross average unpaid principal
balances of our loans for the immediately preceding month, plus reimbursement for certain expenses
incurred by Aurora Bank as advisor. During 2010, the amended agreement, among other things, changed
the management fee to $25,000 per month. For the years ended December 31, 2010, 2009, and 2008, we
incurred $300,000, $25,000, and $34,000, respectively, in advisory fees.
Our loan portfolio is serviced by Aurora Bank pursuant to the terms of the MSA. The amended
MSA changed the fees paid by EOS to reflect the fees payable to each sub-servicer. Through December
31, 2009, Aurora Bank in its role as servicer under the terms of the MSA received an annual
servicing fee equal to 0.20%, payable
28
Table of Contents
monthly, on the gross average unpaid principal balances of loans serviced for the immediately
preceding month. For the years ended December 31, 2010, 2009, and 2008, we incurred $170,000,
$102,000, and $158,000, respectively, in servicing fees. Additionally, loan servicing expense
includes third party expenses associated with the collection of certain non-accrual loans.
In 2008, there was a return of capital to Aurora Bank of $20.2 million. There were no returns
of capital to Aurora Bank in 2010 or 2009.
Dividends
On June 26, 2009, the OTS notified Aurora Bank that, as a result of the Original Order and the
PCA, the approval of the OTS would be required prior to declaration and payment of dividends by
EOS. The OTS required Aurora Bank to submit a formal request for non-objection determination to
permit the payment of dividends. A formal request was submitted to the OTS on July 28, 2009.
As a result of the notice from the OTS, our Board of Directors did not declare or pay the
Series B and Series D preferred stock dividends that would have been payable for the second, third
and fourth quarters of 2009 and the first and second quarters of 2010. The Board of Directors also
did not declare or pay dividends on the common stock that would have been payable for fiscal 2009.
On September 9, 2010, the OTS provided a non-objection determination for the declaration of
dividends by September 14, 2010 and the payment of these dividends between December 15, 2010 and
December 31, 2010 in an amount sufficient to maintain qualification as a REIT for the 2009 tax
year. The Board of Directors of EOS declared such dividends on September 13, 2010, for the quarter
ended September 30, 2010, consistent with the OTS non-objection determination. The dividends were
payable to shareholders of record as of October 29, 2010 and include cumulative dividends on the
Series B preferred stock of $120.00 per share, non-cumulative dividends on the Series D preferred
stock of $0.53125 per share and dividends on our common stock of $1,467,000 per share.
An additional formal request to declare dividends was submitted to the OTS on December 17,
2010 and on December 30, 2010, the OTS provided a non-objection determination for the declaration
of dividends in an amount sufficient to maintain qualification as a REIT and avoid excise tax for
the 2010 tax year. The non-objection determination did not provide any restriction as to the timing
of declaration or payment. The Board of Directors of EOS declared such dividends on December 31,
2010, for the quarter ended December 31, 2010, consistent with the OTS non-objection determination.
The dividends are payable to shareholders of record as of December 31, 2010 and include dividends
on the Series B preferred stock of $20.00 per share, non-cumulative dividends on the Series D
preferred stock of $0.53125 per share and dividends on our common stock in the amount of $884,000.
These dividends were paid in 2011. At December 31, 2010, there were no dividends in arrears
related to our Series B preferred stock. Dividends on the Series D preferred stock are
non-cumulative and as such, there were no dividends in arrears.
The OTS has not approved any further dividend distributions. There can be no assurance that
such approval will be received from the OTS or when or if such OTS approval requirement will be
removed. In the prior formal requests, Aurora Bank and EOS informed the OTS that failure to permit
the distribution of sufficient dividends in future years will cause EOS to fail to qualify as a
REIT. If EOS no longer qualifies as a REIT, we will be subject to federal and state income taxes in
the tax year when loss of REIT status occurs and in years thereafter. Furthermore, even if approval
is received from the OTS, any future dividends on the preferred stock will be payable only when, as
and if declared by the Board of Directors. Aurora Bank and EOS will continue to work with the OTS
regarding the resumption of normal payment of dividends. There can be no assurance that the OTS
will grant any future dividend declaration request, nor can there be any assurance that any further
dividends will be paid or that EOS will continue to qualify as a REIT.
29
Table of Contents
The following table summarizes the dividends which were declared and paid by class:
Total Amount | Amount to Parent | |||||||||||||||||||
Year | Declared | Paid | Declared | Paid | ||||||||||||||||
(Dollars In Thousands) | ||||||||||||||||||||
Series B |
2010 | $ | 131 | $ | 112 | $ | 126 | $ | 108 | |||||||||||
Series D |
2010 | 1,594 | 797 | | | |||||||||||||||
Common Stock |
2010 | 2,351 | 1,467 | 2,351 | 1,467 | |||||||||||||||
Series B |
2009 | 19 | 38 | 18 | 36 | |||||||||||||||
Series D |
2009 | 797 | 1,593 | | | |||||||||||||||
Common Stock |
2009 | | | | | |||||||||||||||
Series B |
2008 | 75 | 75 | 72 | 72 | |||||||||||||||
Series D |
2008 | 3,187 | 3,187 | | | |||||||||||||||
Common Stock |
2008 | 2,768 | 2,768 | 2,768 | 2,768 |
Impact of Economic Downturn
The U.S. economy has been in an economic downturn since 2007 which has dramatically impacted
the housing market with falling home prices and increasing foreclosures. Combined with high levels
of unemployment and underemployment, these economic forces have negatively impacted the credit
performance of mortgage loans and resulted in significant write-downs of asset values by financial
institutions, including government-sponsored entities as well as major commercial and investment
banks.
Reflecting concern about the strength of counterparties, many lenders and institutional
investors have reduced or ceased providing funding to borrowers, including to other financial
institutions. This market turmoil and tightening of credit have led to an increased level of
delinquencies, decreased consumer spending, lack of confidence, increased market volatility, and
widespread reduction of business activity generally. The resulting economic pressure on borrowers,
negatively impacted the credit quality of our commercial loan portfolio and our residential loan
portfolio. The depth and breadth of the downturn as well as the resulting impacts on the credit
quality of both our commercial and residential loan portfolios remain unclear. We expect, however,
continued market turbulence and economic uncertainty to continue well into 2011.
Bankruptcy of LBHI
On September 15, 2008, LBHI, the indirect parent company of Aurora Bank, filed a voluntary
petition under Chapter 11 of the U.S. Bankruptcy Code. The bankruptcy filing of LBHI has led to
increased regulatory constraints being placed on Aurora Bank by its bank regulatory authorities,
primarily the OTS. Certain of these constraints apply to Aurora Banks subsidiaries, including EOS.
Pursuant to the CMA executed on November 30, 2010, LBHI agreed that it will seek to sell
Aurora Bank within eighteen (18) months from Execution Date. If after a period of fifteen (15)
months following the Execution Date, the OTS concludes that a sale of Aurora Bank will not be
consummated by the end of the eighteen (18) month period, Aurora Bank will prepare and submit to
the OTS a plan for dissolution. The bankruptcy court will have the final review and approval of any
proposed agreement for the sale of Aurora Bank.
There can be no assurance that the sale of Aurora Bank will be consummated within the defined
time frame. There can be no assurance that a potential buyer of Aurora Bank will come forward and
tender an offer acceptable to the bankruptcy court, that the bankruptcy court will approve such
offer, that a potential buyer will have or be able to raise financing for the purchase, and meet
all other conditions necessary to consummate the purchase.
Further, there is complete uncertainty with regards to any and all aspects of a potential
sale. The business strategies of the new owner may not include continued operation of EOS or other
business lines of Aurora Bank.
30
Table of Contents
Further, there is complete uncertainty with regards to any and all aspects of a potential
sale. The business strategies of the new owner may not include continued operation of EOS or other
business lines of Aurora Bank.
Both the bankruptcy filing of LBHI and the increased regulatory constraints placed on Aurora
Bank have negatively impacted the ability of EOS to conduct business according to our business
objectives. Following the execution of the Settlement Agreement, the OTS modified, but did not
remove all of the regulatory constraints on Aurora Bank.
Asset Exchange
On November 18, 2009, EOS and, Aurora Bank, entered into the November Asset Exchange pursuant
to which Aurora Bank agreed to assign various single family residential mortgage loans to EOS in
exchange for EOS assigning certain commercial and multi-family mortgage loans to Aurora Bank. The
November Asset Exchange was effective on November 1, 2009, which resulted in EOS receiving
residential mortgage loans, including jumbo mortgage loans, with a closing value of $199,000
greater than the value of the commercial and multi-family mortgage loans transferred to Aurora
Bank. The November Asset Exchange altered the loan portfolio of EOS to consist primarily of
residential mortgage assets.
Regulatory Actions Involving Aurora Bank
On January 26, 2009, the OTS entered a cease and desist order against Aurora Bank. The
Original Order requires Aurora Bank to ensure that each of its subsidiaries, including EOS, was in
compliance with the Original Order, including the operating restrictions contained therein.
Following execution of the Settlement Agreement, on November 30, 2010, Aurora Bank entered
into a Stipulation and Consent to Issuance of the Amended Order. The Amended Order amended certain
requirements for Aurora Bank contained in the Original Order. The provisions in the Original Order
that require Aurora Bank to ensure that each of its subsidiaries, including EOS, comply with the
Original Order were not amended. These operating restrictions, amount other things, restrict
transactions with affiliates, capital distributions to shareholders (including redemptions),
contracts outside the ordinary course of business, and changes in senior executive officers, board
members or their employment arrangements without prior written notice to the OTS.
Under the Order, EOS must continue to seek and receive approval from the OTS for the
declaration and payment of dividends to our preferred and common shareholders. There is no
assurance that the OTS will approve any request for the declaration or payment of dividends. As an
operating subsidiary of Aurora Bank, EOS remains subject to all of the terms and conditions of the
Order which apply to such operating subsidiaries.
On November 30, 2010, and effective on the same date, the OTS issued an order terminating the
PCA. The Original Order and Amended Order were still effective as of the date of issuance of this
annual report.
More detailed information can be found in the Original Order, the Amended Order, the PCA, and
the termination of the PCA themselves, copies of which are available on the OTS website
(www.ots.treas.gov).
Application of Critical Accounting Policies and Estimates
Our discussion and analysis of financial condition and results of operations are based upon
our financial statements, which have been prepared in accordance with U.S. generally accepted
accounting principles, or GAAP. The preparation of these financial statements in conformity with
GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and
liabilities at the date of the financial statements and the reported amount of revenues and
expenses in the reporting period. Our actual results may differ from these estimates. We have
provided a summary of our significant accounting policies in Note 2 to our financial statements
included elsewhere in this report. We describe below those accounting policies that require
material subjective or complex judgments and that have the most significant impact on our financial
condition and results of operations. Our management evaluates these estimates on an ongoing basis,
based upon information currently available and on various assumptions management believes are
reasonable as of the date on the front cover of this report.
31
Table of Contents
Loans Held for Sale. On February 5, 2009, EOS and Aurora Bank entered into the February Asset
Exchange pursuant to which EOS agreed to transfer the entire loan portfolio secured primarily by
commercial real estate and multi-family residential real estate to Aurora Bank in exchange for
loans secured primarily by residential real estate. As a result, during the first quarter of 2009
we reclassified all of our loan assets as held for sale and recorded a fair value adjustment. On
July 20, 2009, EOS and Aurora Bank mutually agreed to terminate the February Asset. We continue to
carry these loan assets at the lower of their accreted cost or market value. On November 18, 2009,
EOS and Aurora Bank entered into the November Asset Exchange pursuant to which Aurora Bank agreed
to assign various single family residential mortgage loans to EOS in exchange for EOS assigning
certain commercial and multi-family mortgage loans to Aurora Bank. The residential mortgage loans
received were recorded at their value and currently are presented at fair value.
Fair value is defined as the price at which an asset or liability could be exchanged in a
current transaction between knowledgeable, willing parties. Where available, fair value is based on
observable market prices or parameters or derived from such prices or parameters. Where observable
prices or inputs are not available, valuation models are applied. Fair value of our loan portfolio
was estimated based upon cash flow models to derive its fair value estimates. These
models consider significant inputs such as loan type, loan age, loan to value ratio, payment
history, and property location, as well as significant assumptions such as estimated rates of loan
delinquency, potential recovery, discount rate, and the impact of interest rate reset. Recent trade
quotes or prices are identified in estimating the amount at which a third party might purchase the
loans and their yield requirements. Management also considers market information and quotes
received from third parties, when available. The valuation of the loan portfolio involves
managements use of estimates and judgment, the degree of which is dependent on the terms of the
loans and the availability of market prices and inputs.
The amount by which the carrying value of our loan assets changes as a result of an updated
valuation is recorded as an unrealized gain or loss and is included in the determination of net
income in the period in which the change occurs.
Discounts on Acquired Loans. Prior to February 5, 2009 (when we reclassified the loans as
held for sale), our loan assets were considered held for investment and we reviewed acquired loans
for differences between contractual cash flows and cash flows expected to be collected from our
initial investment in the acquired loans to determine if those differences were attributable, at
least in part, to credit quality. If those differences were attributable to credit quality, the
loans contractually required payments receivable in excess of the amount of its cash flows
expected at acquisition, or nonaccretable discount, was not accreted into income. We recognized the
excess of all cash flows expected at acquisition over our initial investment in the loan as
interest income using the interest method over the term of the loan.
There was judgment involved in estimating the amount of our future cash flows on acquired
loans. The amount and timing of actual cash flows could differ materially from managements
estimates, which could have materially affect our financial condition and results of operations.
Depending on the timing of an acquisition of loans, a preliminary allocation may have been utilized
until a final allocation was established. Generally, the allocation was finalized no later than
ninety days from the date of purchase.
Subsequent to acquisition, if cash flow projections improved, and it was determined that the
amount and timing of the cash flows related to the nonaccretable discount were reasonably estimable
and collection was probable, the corresponding decrease in the nonaccretable discount was
transferred to the accretable discount and was accreted into interest income over the remaining
life of the loan on the interest method. If cash flow projections deteriorated subsequent to
acquisition, the decline was accounted for through a provision for loan losses included in
earnings.
Allowance for Loan Losses. Prior to February 5, 2009, our loan assets were considered held
for investment and recorded at accreted cost, which accounts for the amortization of any purchase
discount and deferred fees, less an allowance for loan losses. Since the loan portfolio is now
classified as held for sale, we no longer maintain an allowance for loan losses. In prior periods,
arriving at an appropriate level of allowance for loan losses required a high degree of judgment.
The allowance for loan losses was increased or decreased through a provision for loan losses.
32
Table of Contents
In determining the adequacy of the allowance for loan losses, management made significant
judgments. We reviewed our loan portfolio to identify loans for which specific allocations were
considered prudent. Specific allocations included the results of measuring impaired loans. Next,
management considered the level of loan allowances deemed appropriate for loans determined not to
be impaired. The allowance for these loans was determined by a formula whereby the portfolio was
stratified by type and internal risk rating categories. Loss factors were then applied to each
strata based on various considerations including collateral type, loss experience, delinquency
trends, current economic conditions, and industry standards. The allowance for loan losses was
managements estimate of the probable loan losses incurred as of the balance sheet date.
The determination of the allowance for loan losses required our use of significant estimates
and judgments. In making this determination, we considered known information relative to specific
loans, as well as collateral type, loss experience, delinquency trends, current economic
conditions, and industry trends, generally. Based on these factors, we estimated the probable loan
losses incurred as of the reporting date and increased or decreased the allowance through a change
in the provision for loan losses. Loan losses were charged against the allowance when we believed
the net investment of the loan, or a portion thereof, was uncollectible. Subsequent recoveries, if
any, were credited to the allowance when cash payments were received.
Gains and losses on sales of loans are determined using the specific identification method.
The excess (deficiency) of any cash received as compared to the net investment is recorded as gain
(loss) on sales of loans.
Recent Accounting Pronouncements. There were no recent accounting pronouncements issued as
of December 31, 2010 that will have a significant impact to our financial statements or disclosures
for the year ended December 31, 2011.
Results of Operations for the Years Ended December 31, 2010, 2009, and 2008
Interest income
The yields on our interest-earning assets are summarized as follows:
Years Ended December 31, | ||||||||||||||||||||||||||||||||||||
2010 | 2009 | 2008 | ||||||||||||||||||||||||||||||||||
Average | Average | Average | ||||||||||||||||||||||||||||||||||
Balance | Interest | Yield | Balance | Interest | Yield | Balance | Interest | Yield | ||||||||||||||||||||||||||||
(Dollars In Thousands) | ||||||||||||||||||||||||||||||||||||
Loans, net(1) |
$ | 37,774 | $ | 2,022 | 5.35 | % | $ | 46,167 | $ | 3,057 | 6.62 | % | $ | 58,937 | $ | 5,152 | 8.74 | % | ||||||||||||||||||
Interest-bearing deposits |
57,620 | 172 | .30 | 47,455 | 507 | 1.07 | 58,438 | 1,023 | 1.75 | |||||||||||||||||||||||||||
Total interest-earning assets |
$ | 95,394 | $ | 2,194 | 2.30 | % | $ | 93,622 | $ | 3,564 | 3.81 | % | $ | 117,375 | $ | 6,175 | 5.26 | % | ||||||||||||||||||
(1) | For purposes of providing a meaningful yield comparison, the foregoing table reflects the average accreted cost of the loans, net of discounts, or alternatively, the unpaid principal balance for loans acquired in the November Asset Exchange, and not the fair value of the loan portfolio. Non-accrual loans are excluded from average balance calculations. |
The decrease in interest income from 2010 to 2009 is a result of a decrease in the average
balance of loans and a decrease in the yield of loans. The average balance of our loans for 2010
(as defined above) totaled $37.8 million compared to $46.2 million for 2009. This decrease is
primarily attributable to loan payments. For the year ended December 31, 2010, the yield on our
loan portfolio decreased to 5.35% compared to 6.62% for 2009. For the year ended December 31, 2010,
interest and fee income recognized on loan payoffs decreased $171,000, or 50%, to $173,000 from
$344,000 for 2009. The level of interest and fee income recognized on loan payoffs varies for
numerous reasons, as further discussed below. The yield from regularly scheduled interest and
accretion income decreased to 4.89% for the year ended December 31, 2010 from 5.87% for the same
period in 2009 primarily due to a reduction in average balances.
The average balance of our interest-bearing deposits increased $10.1 million or 21.4% to $57.6
million for the year ended December 31, 2010, compared to $47.5 million for 2009. The changes in
the average balances of interest-bearing deposits are the result of dividend payments offset by
cash flows from loan repayments. The rate earned on interest-bearing deposits has remained unchanged since its decrease in July 2009 from 1.75% to
0.30%, resulting in a decrease in interest income and yield for the year ended December 31, 2010.
33
Table of Contents
The decline in interest income from 2008 to 2009 is a result of a decrease in the average
balance of loans and a decrease in the yield on loans. The average balance of the loans for 2009
(as defined above) totaled $46.2 million compared to $58.9 million for 2008. This decrease is
primarily attributable to loan payments. For the year ended December 31, 2009, the yield on the
loan portfolio decreased to 6.62% compared to 8.74% for 2008. For the year ended December 31, 2009,
interest and fee income recognized on loan payoffs decreased $536,000, or 61%, to $344,000 from
$880,000 for 2008. The level of interest and fee income recognized on loan payoffs varies for
numerous reasons, as further discussed below. The yield from regularly scheduled interest and
accretion income decreased to 5.87% for the year ended December 31, 2009 from 7.25% for the same
period in 2008 primarily due to a $739,000 reduction in interest income resulting from the
discontinuance of the amortization of purchase discount and fees on loans as a result of the loans
being reclassified to held for sale during the first quarter of 2009, a reduction in average
balances and decreases in market interest rates.
The average balance of our interest-bearing deposits decreased $10.9 million or 18.6% to $47.5
million for the year ended December 31, 2009, compared to $58.4 million for 2008. The changes in
the average balances of interest-bearing deposits are the result of dividend payments and returns
of capital partially offset by cash flows from loan repayments. In July 2009, the rate earned on
interest-bearing deposits decreased from 1.75% to 0.30%, resulting in a decrease in interest income
and yield for the year ended December 31, 2009.
Prior to February 5, 2009, when a loan was paid off, the excess of any cash received over the
net investment was recorded as interest income. In addition to the amount of purchase discount that
was recognized at that time, income may also have included interest owed by the borrower prior to
our acquisition of the loan, interest collected if on non-accrual status, prepayment fees and other
loan fees. For periods after February 5, 2009, when a loan is paid off, the excess of any cash
received over the net investment is considered in the assessment of the valuation allowance. The
following table sets forth, for the periods indicated, the components of interest and fees on
loans. There can be no assurance regarding future interest income, including the yields and related
level of such income, or the relative portion attributable to loan payoffs as compared to other
sources.
Years Ended December 31, | ||||||||||||||||||||||||
2010 | 2009 | 2008 | ||||||||||||||||||||||
Interest | Interest | Interest | ||||||||||||||||||||||
Income | Yield | Income | Yield | Income | Yield | |||||||||||||||||||
(Dollars In Thousands) | ||||||||||||||||||||||||
Regularly scheduled interest and accretion income |
$ | 1,849 | 4.89 | % | $ | 2,713 | 5.87 | % | $ | 4,272 | 7.25 | % | ||||||||||||
Interest and fee income recognized on loan pay-offs: |
||||||||||||||||||||||||
Accretable discount |
173 | 0.46 | 309 | 0.67 | 818 | 1.39 | ||||||||||||||||||
Other interest and fee income |
| | 35 | 0.08 | 62 | 0.10 | ||||||||||||||||||
173 | 0.46 | 344 | 0.75 | 880 | 1.49 | |||||||||||||||||||
Total interest from loans |
$ | 2,022 | 5.35 | % | $ | 3,057 | 6.62 | % | $ | 5,152 | 8.74 | % | ||||||||||||
The amount of loan pay-offs and related discount income is influenced by several factors,
including the interest rate environment, the real estate market in particular areas, the timing of
transactions, and circumstances related to individual borrowers and loans. The amount of individual
loan payoffs is often a result of negotiations between us and the borrower. Based upon credit risk
analysis and other factors, we will, in certain instances, accept less than the full amount
contractually due in accordance with the loan terms.
Allowance for loan losses
Following the reclassification of the loan portfolio as held for sale in February 2009, we no
longer maintain an allowance for loan losses. We recorded reductions in the allowance for loan
losses of $915,000 and $265,000, for the years ended December 31, 2009 and 2008, respectively, to
reflect the reclassification of loans held for sale in 2009 and, in prior years, to reverse unused
loss reserves related to loans that had been paid off. The allowance for loan losses was based on
the size of the portfolio and its historical performance. The determination of the allowance
required managements use of estimates and assumptions regarding the risks inherent in
individual loans and the loan portfolio in its entirety.
34
Table of Contents
Operating expenses
Loan servicing and advisory expenses increased $188,000, or 66.7%, to $470,000 in 2010 from
$282,000 in 2009 and increased $53,000, or 23.1%, from $229,000 in 2008. The increase in 2010 was
primarily due to the Amended MSA and the Amended AA with Aurora Bank which changed the fee
structure. The increase in 2009 was primarily due to legal fees incurred in collection efforts on
loans serviced.
Other general and administrative expenses decreased $193,000, or 25.5% to $565,000 in 2010
from $758,000 in 2009 and increased 318.8% from $181,000 in 2008. The decrease in 2010 was
primarily attributable to decreases in legal fees and external audit expenses. The increase in 2009
was primarily attributable to an increase in legal fees, excise tax, external audit expenses and
printing costs.
Preferred stock dividends declared
Preferred stock dividends declared were $1,725,000 for the year ended December 31, 2010
compared to $816,000 in 2009. On September 9, 2010, the OTS provided non-objection for the
declaration and payment of dividends in an amount sufficient to maintain qualification as a REIT
for the 2009 tax year. The Board of Directors of EOS declared such dividends on September 13, 2010,
for the quarter ended September 30, 2010, consistent with the OTS non-objection determination. The
dividends included dividends on the Series B and Series D preferred stock for the third quarter of
2010 and along with cumulative dividends in arrears on the Series B preferred stock for the second,
third and fourth quarters of 2009 and the first and second quarters of 2010.
An additional formal request to declare dividends was submitted to the OTS on December 17,
2010 and on December 30, 2010, the OTS provided a non-objection determination for the declaration
of dividends in an amount sufficient to maintain qualification as a REIT and avoid excise tax for
the 2010 tax year. The non-objection determination did not provide any restriction as to the timing
of declaration or payment. The Board of Directors of EOS declared such dividends on December 31,
2010, for the quarter ended December 31, 2010, consistent with the OTS non-objection determination.
The dividends are payable to shareholders of record as of December 31, 2010 and include dividends
on the Series B and Series D preferred stock and dividends on our common stock. These dividends
were paid in 2011.
At December 31, 2010, there were no dividends in arrears related to our Series B preferred
stock. Dividends on the Series D preferred stock are non-cumulative and as such, there were no
dividends in arrears. The OTS has not approved any further dividend distributions. Additionally,
any future dividends on the preferred stock will be payable only when, as and if declared by the
Board of Directors.
Preferred stock dividends declared decreased in 2009 compared to 2008 because the dividends
that would have been payable on July 15 and October 15, 2009 were not declared or paid as noted
earlier.
Financial Condition
Interest-bearing Deposits with Parent
Interest-bearing deposits with parent consist entirely of money market accounts. The balance
of interest-bearing deposits increased $10.8 million to $62.4 million at December 31, 2010 compared
to $51.6 million at December 31, 2009. The increase in the balance of interest-bearing deposits is
the result of cash flows from loan repayments offset by preferred stock and common stock dividend
payments.
35
Table of Contents
Loan Portfolio
The loan portfolio is summarized as follows:
December 31, | ||||||||||||||||
2010 | 2009 | |||||||||||||||
Carrying | Percentage | Carrying | Percentage | |||||||||||||
Value | of Total | Value | of Total | |||||||||||||
(Dollars In Thousands) | ||||||||||||||||
Mortgage loans on real estate: |
||||||||||||||||
Commercial real estate |
$ | 6,866 | 28.09 | % | $ | 6,380 | 21.40 | % | ||||||||
Multi-family residential |
850 | 3.48 | 693 | 2.32 | ||||||||||||
One-to-four family residential |
16,724 | 68.43 | 22,750 | 76.28 | ||||||||||||
Total |
$ | 24,440 | 100.00 | % | $ | 29,823 | 100.00 | % | ||||||||
We have historically acquired primarily commercial real estate and multi-family residential
mortgage loans in accrual status. On November 18, 2009, we and our parent, Aurora Bank, entered
into the November Asset Exchange pursuant to which Aurora Bank agreed to assign various single
family residential mortgage loans to EOS in exchange for EOS assigning certain commercial and
multi-family mortgage loans to Aurora Bank. The November Asset Exchange has altered the loan
portfolio of EOS to consist primarily of residential mortgage assets. During 2008, EOS did not
acquire any loans from Capital Crossing Bank or Aurora Bank.
Non-accrual loans, net of discount, totaled $916,000 at December 31, 2010 representing eight
loans and eight borrowers. Non-accrual loans, net of discount, totaled $318,000 at December 31,
2009 representing seven loans and five borrowers. Loans generally are placed on non-accrual status
and the accrual of interest is generally discontinued when the collectability of principal and
interest is not probable or estimable and generally occurs when the loan is ninety days or more
past due as to either principal or interest. Unpaid interest income previously accrued on such
loans is reversed against current period interest income. Interest payments received on non-accrual
loans are recorded as interest income. A loan is returned to accrual status when it is brought
current. Loans are charged off when they are determined to be uncollectible.
Cash Flows
Years Ended December 31, | ||||||||||||
2010 | 2009 | 2008 | ||||||||||
(Dollars In Thousands) | ||||||||||||
Net cash provided by operating activities |
$ | 11,295 | $ | 2,472 | $ | 5,783 | ||||||
Net cash provided by investing activities |
1,827 | 7,225 | 13,656 | |||||||||
Net cash used in financing activities |
(2,376 | ) | (1,631 | ) | (26,263 | ) | ||||||
Net change in cash and cash equivalents |
$ | 10,746 | $ | 8,066 | $ | (6,824 | ) | |||||
Cash provided by operating activities increased by $8.8 million for 2010 as compared to 2009,
primarily attributable to the loan repayments held for sale at fair value including in operating
activities partially offset by lower interest income. Cash provided by operating activities
decreased by $3.3 million for 2009 as compared to 2008, primarily attributable to lower interest
income.
Cash provided by investing activities decreased by $5.4 million for 2010 as compared to 2009
due to loan repayments from loans held for sale included in operating activities. Conversely, cash
provided by investing activities decreased by $6.4 million for 2009 as compared to 2008 due to
lower loan repayments.
Cash used in financing activities increased $745,000 for 2010 as compared to 2009 due to
increases in dividends paid. Cash used in financing activities decreased $24.6 million for 2009 as
compared to 2008 primarily
attributable to transactions that occurred in 2008 that did not occur in 2009, namely, a
return of capital to common stockholder of $20.2 million and common stock dividends of $2.8
million.
36
Table of Contents
Off-Balance-Sheet Arrangements
We do not have any off-balance-sheet arrangements, other than those currently disclosed that
have or are reasonably likely to have a current or future effect on financial condition, changes in
financial condition, results of operations, liquidity, or capital resources that are material to
investors.
Interest Rate Risk
The majority of our loan portfolio consists of variable rate loans with contractual interest
rates that are affected by changes in market interest rates. In addition, falling interest rates
would tend to reduce the amount of interest earned on our interest bearing cash deposits, which
could negatively impact the amount of cash available to pay dividends on preferred stock and common
stock. We are not able to precisely quantify the potential impact on our operating results or funds
available for distribution to stockholders from material changes in interest rates.
Significant Concentration of Credit Risk
We have cash and cash equivalents of $62.6 million as of December 31, 2010. These funds were
held in interest bearing and non-interest bearing accounts with Aurora Bank. The FDIC provides
coverage on these accounts which as of December 31, 2010 was limited to $250,000. Cash in excess of
FDIC coverage limitations is subject to credit risk.
Concentration of credit risk primarily arises with respect to the geographical distribution of
our loan portfolio. Our balance sheet exposure to geographic concentrations directly affects the
credit risk of the loans within our loan portfolio. At December 31, 2010, 40% of the carrying value
of our mortgage loans consisted of loans collateralized by properties located in California.
Consequently, the portfolio may experience a higher default rate in the event of adverse economic,
political or business developments or natural hazards in California that may affect the ability of
property owners to make payments of principal and interest on the underlying mortgages. The housing
and real estate sectors in California have been particularly impacted by the economic downturn with
higher overall foreclosure rates than the national average. If California experiences further
adverse economic, political or business conditions, or natural hazards, we will likely experience
higher rates of loss and delinquency on our mortgage loans than if our loans were more
geographically diverse.
Liquidity Risk Management
The objective of liquidity management is to ensure the availability of sufficient cash flows
to meet all of our financial commitments. In managing liquidity risk, we take into account various
legal limitations placed on a REIT. Our principal liquidity need is to pay dividends on our
preferred shares and common shares; however, our payment of dividends is currently subject to OTS
approval.
If and to the extent that any additional assets are acquired in the future, such acquisitions
are intended to be funded primarily through repayment of unpaid principal balances of mortgage
assets by individual borrowers and cash on hand. We do not have and does not anticipate having any
material capital expenditures. To the extent that the Board of Directors determines that additional
funding is required, we may raise such funds through additional equity offerings, debt financing or
retention of cash flow (after consideration of provisions of the Internal Revenue Code requiring
the distribution by a REIT of at least 90% of its REIT taxable income and taking into account taxes
that would be imposed on undistributed income), or a combination of these methods. We do not
currently intend to incur any indebtedness. The organizational documents of EOS limit the amount of
indebtedness which it is permitted to incur without the approval of the Series D preferred
stockholders to no more than 100% of the total stockholders equity of EOS. Any such debt may
include intercompany advances made by Aurora Bank to EOS.
We may also issue additional series of preferred stock, subject to OTS approval. However, we
may not issue additional shares of preferred stock ranking senior to the Series D preferred stock
without the consent of
holders of at least two-thirds of the Series D preferred stock outstanding at that time.
Although EOS charter does not prohibit or otherwise restrict Aurora Bank or its affiliates from
holding and voting shares of Series D preferred stock, to our knowledge, there were no shares of
Series D preferred stock held by Aurora Bank or its affiliates as of
37
Table of Contents
December 31, 2010. Additional
shares of preferred stock ranking on parity with the Series D preferred stock may not be issued
without the approval of a majority of our independent directors.
There are no known material trends, demands, commitments, events or uncertainties at the
present time that are reasonably likely to result in our liquidity increasing or decreasing in any
material way.
Impact of Inflation and Changing Prices
Our asset and liability structure is substantially different from that of an industrial
company in that virtually all of our assets are monetary in nature. Management believes the impact
of inflation on financial results depends upon our ability to react to changes in interest rates
and by such reaction, reduce the inflationary impact on performance. Interest rates do not
necessarily move in the same direction, or at the same magnitude, as the prices of other goods and
services.
Various information shown elsewhere in this annual report will assist the reader in
understanding how EOS is positioned to react to changing interest rates and inflationary trends. In
particular, the discussion of market risk and other maturity and repricing information of our
assets is contained in Item 7A, Quantitative and Qualitative Disclosure About Market Risk, of this
annual report.
38
Table of Contents
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of loss from adverse changes in market prices and interest rates. It
is our objective to attempt to manage risks associated with interest rate movements. Negative
fluctuations in interest rates could reduce the amount of interest paid on our interest bearing
cash deposits. Our market risk arises primarily from interest rate risk inherent in holding loans
and interest-earning deposits. A period of rising interest rates would tend to result in an
increase in net interest income and conversely, a period of falling interest rates would tend to
adversely affect net interest income.
Aurora Bank actively monitors our interest rate risk exposure pursuant to the AA. Aurora Bank
reviews, among other things, the sensitivity of our assets to interest rate changes, the book and
market values of assets, any purchase and sale activity, and anticipated loan pay-offs. Aurora
Banks senior management also approves and establishes pricing and funding decisions with respect
to our overall asset and liability composition.
Our methods for evaluating interest rate risk include an analysis of our interest-earning
assets maturing or repricing within a given time period. As of December 31, 2010, only
interest-earning assets were evaluated as we have no interest-bearing liabilities.
The following table sets forth our interest-rate-sensitive assets categorized by repricing
dates and weighted average yields at December 31, 2010. For fixed rate instruments, the repricing
date is the maturity date. For adjustable-rate instruments, the repricing date is deemed to be the
earliest possible interest rate adjustment date. Assets that are subject to immediate repricing are
placed in the overnight column.
December 31, 2010 | ||||||||||||||||||||||||||||||||||||
Over One | Over Two | Over Three | Over Four | |||||||||||||||||||||||||||||||||
Within | to Two | to Three | to Four | to Five | Over Five | |||||||||||||||||||||||||||||||
Overnight | One Year | Years | Years | Years | Years | Years | Total | Fair Value | ||||||||||||||||||||||||||||
(Dollars In Thousands) | ||||||||||||||||||||||||||||||||||||
Interest-bearing deposits |
$ | 62,385 | $ | | $ | | $ | | $ | | $ | | $ | | $ | 62,385 | $ | 62,385 | ||||||||||||||||||
Weighted average yield |
.30 | % | ||||||||||||||||||||||||||||||||||
Fixed-rate loans(1) |
| 1,193 | 628 | 839 | 616 | 634 | 5,848 | 9,758 | 7,064 | |||||||||||||||||||||||||||
Weighted average yield |
6.18 | % | 4.57 | % | 4.96 | % | 5.11 | % | 5.43 | % | 4.39 | % | ||||||||||||||||||||||||
Adjustable-rate loans(1) |
| 21,962 | | | | | | 21,962 | 16,460 | |||||||||||||||||||||||||||
Weighted average yield |
4.97 | % | ||||||||||||||||||||||||||||||||||
Total rate-sensitive assets |
$ | 62,385 | $ | 23,155 | $ | 628 | $ | 839 | $ | 616 | $ | 634 | $ | 5,848 | $ | 94,105 | $ | 85,909 | ||||||||||||||||||
(1) | Loans are presented at unpaid principal balance and exclude non-accrual loans. |
At December 31, 2010, the fair value of our loans in accrual status was $23.5 million with an
unpaid principal balance of $32.9 million and approximately 70% of the fair value of loans in
accrual status our portfolio were floating rate loans with contractual interest rates that may
fluctuate based on changes in market interest rates. Based on our experience, management applies
the assumption that, on average, approximately 33.3% and 6.9% of residential and commercial loans,
respectively, will prepay annually. The fair value of interest-bearing deposits approximates
carrying value.
39
Table of Contents
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Page | ||||
41 | ||||
43 | ||||
44 | ||||
45 | ||||
46 | ||||
47 |
40
Table of Contents
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders of
EOS Preferred Corporation
EOS Preferred Corporation
We have audited the accompanying balance sheet of EOS Preferred Corporation (a Massachusetts
corporation) (the Company) as of December 31, 2010, and the related statement of operations,
changes in stockholders equity, and cash flows for the year ended December 31, 2010. These
financial statements are the responsibility of the Companys management. Our responsibility is to
express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement. The
Company is not required to have, nor were we engaged to perform an audit of its internal control
over financial reporting. Our audit included consideration of internal control over financial
reporting as a basis for designing audit procedures that are appropriate in the circumstances, but
not for the purpose of expressing an opinion on the effectiveness of the Companys internal control
over financial reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates made by management,
as well as evaluating the overall financial statement presentation. We believe that our audit
provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material
respects, the financial position of EOS Preferred Corporation at December 31, 2010, and the results
of its operations and its cash flows for the year ended December 31, 2010 in conformity with U.S.
generally accepted accounting principles.
As discussed in Note 3 to the financial statements, on September 15, 2008, Lehman Brothers Holdings
Inc. (Lehman Brothers), indirect parent company of the Aurora Bank FSB (the Bank), and ultimate
parent company of the Company, filed a voluntary petition under Chapter 11 of the U.S. Bankruptcy
Code. On January 6, 2009, the Bank filed a Proof of Claim in the Lehman Brothers Chapter 11
proceedings in the amount of $2.2 billion relating to Lehman Brothers default on amounts due to
the Bank. On November 30, 2010 the Bank settled these claims. Also, as described in Note 3 to the
financial statements, the Bank is subject to an Amended Order to Cease and Desist, dated November
30, 2010, issued by the Office of Thrift Supervision, which imposes restrictions on certain
activities of the Bank and the Company.
/s/ GRANT THORNTON LLP
Dallas, Texas
March 31, 2011
March 31, 2011
Table of Contents
REPORT OF INDEPENDENT REGISTERED ACCOUNTING FIRM
The Board of Directors and Stockholders of
EOS Preferred Corporation (formerly Capital Crossing Preferred Corporation):
EOS Preferred Corporation (formerly Capital Crossing Preferred Corporation):
We have audited the accompanying balance sheet of EOS Preferred Corporation (the Company),
formerly Capital Crossing Preferred Corporation, as of December 31, 2009, and the related
statements of operations, stockholders equity, and cash flows for the years ended December 31,
2009 and 2008. These financial statements are the responsibility of the Companys management. Our
responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of material
misstatement. We were not engaged to perform an audit of the Companys internal control over
financial reporting. Our audits included consideration of internal control over financial reporting
as a basis for designing audit procedures that are appropriate in the circumstances, but not for
the purpose of expressing an opinion on the effectiveness of the Companys internal control over
financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on
a test basis, evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material
respects, the financial position of EOS Preferred Corporation at December 31, 2009, and the results
of its operations and its cash flows for the years ended December 31, 2009 and 2008, in conformity
with U.S. generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that EOS Preferred
Corporation will continue as a going concern. As more fully described in Note 3, on September 15,
2008, Lehman Brothers Holdings Inc. (Lehman Brothers), indirect parent company to Aurora Bank FSB
(Aurora Bank), and ultimate parent company of EOS Preferred Corporation, filed a voluntary
petition under Chapter 11 of the U.S. Bankruptcy Code. As further described in Note 3 to the
financial statements, Aurora Bank, the sole owner of the common stock of EOS Preferred Corporation,
is subject to a Cease and Desist Order, dated January 26, 2009, and a Prompt Corrective Action
Directive, dated February 4, 2009, issued by the Office of Thrift Supervision (the OTS),
requiring Aurora Bank, among other matters, to submit a capital restoration plan and a liquidity
management plan, and imposing restrictions on certain activities of Aurora Bank and EOS Preferred
Corporation. The bankruptcy of Lehman Brothers and the ability of the OTS to regulate and restrict
the business and operations of EOS Preferred Corporation, in light of the Cease and Desist Order
and the Prompt Corrective Action Directive, raise substantial doubt about EOS Preferred
Corporations ability to continue as a going concern. The 2009 financial statements do not include
any adjustments that might result from the outcome of this uncertainty.
/s/ Ernst & Young LLP
New York, New York
March 31, 2010
March 31, 2010
Table of Contents
EOS PREFERRED CORPORATION
(f/k/a Capital Crossing Preferred Corporation)
(f/k/a Capital Crossing Preferred Corporation)
BALANCE SHEETS
(Dollars In Thousands, except share data)
December 31, | ||||||||
2010 | 2009 | |||||||
ASSETS |
||||||||
Cash account with parent |
$ | 184 | $ | 184 | ||||
Interest-bearing deposits with parent |
62,385 | 51,639 | ||||||
Total cash and cash equivalents |
62,569 | 51,823 | ||||||
Loans held for sale, at fair value |
16,505 | 22,531 | ||||||
Loans held for sale, at lower of accreted cost or market value |
7,935 | 7,292 | ||||||
Loans |
24,440 | 29,823 | ||||||
Accrued interest receivable |
213 | 393 | ||||||
Total assets |
$ | 87,222 | $ | 82,039 | ||||
LIABILITIES AND STOCKHOLDERS EQUITY |
||||||||
Accrued expenses |
$ | 159 | $ | 275 | ||||
Accounts payable to parent |
87 | 69 | ||||||
Dividends payable |
798 | | ||||||
Dividends payable to parent |
902 | | ||||||
Total liabilities |
1,946 | 344 | ||||||
Stockholders equity: |
||||||||
Preferred stock, Series B,
8% cumulative, non-convertible; $.01 par value; $1,000 liquidation value
per share plus accrued dividends; 1,000 shares authorized, 937 shares
issued and outstanding |
| | ||||||
Preferred stock, Series D,
8.50% non-cumulative, exchangeable; $.01 par value; $25 liquidation value
per share; 1,725,000 shares authorized, 1,500,000 issued and outstanding |
15 | 15 | ||||||
Common stock, $.01 par value, 100 shares authorized, issued and outstanding |
| | ||||||
Additional paid-in capital |
95,320 | 95,320 | ||||||
Accumulated deficit less dividends |
(10,059 | ) | (13,640 | ) | ||||
Total stockholders equity |
85,276 | 81,695 | ||||||
Total liabilities and stockholders equity |
$ | 87,222 | $ | 82,039 | ||||
See accompanying notes to financial statements.
43
Table of Contents
EOS PREFERRED CORPORATION
(f/k/a Capital Crossing Preferred Corporation)
(f/k/a Capital Crossing Preferred Corporation)
STATEMENTS OF OPERATIONS
Years Ended December 31, | ||||||||||||
2010 | 2009 | 2008 | ||||||||||
(Dollars In Thousands) | ||||||||||||
Interest income: |
||||||||||||
Interest and fees on loans |
$ | 2,022 | $ | 3,057 | $ | 5,152 | ||||||
Interest on interest-bearing deposits |
172 | 507 | 1,023 | |||||||||
Total interest income |
2,194 | 3,564 | 6,175 | |||||||||
Gain (loss) on loans held for sale |
6,498 | (16,263 | ) | | ||||||||
Reduction in allowance for loan losses |
| 915 | 265 | |||||||||
Net revenue (loss) |
8,692 | (11,784 | ) | 6,440 | ||||||||
Operating expenses: |
||||||||||||
Loan servicing and advisory services |
470 | 282 | 229 | |||||||||
Other general and administrative |
565 | 758 | 181 | |||||||||
Total operating expenses |
1,035 | 1,040 | 410 | |||||||||
Net income (loss) |
7,657 | (12,824 | ) | 6,030 | ||||||||
Preferred stock dividends |
1,725 | 816 | 3,262 | |||||||||
Net income (loss) available to common stockholder |
$ | 5,932 | $ | (13,640 | ) | $ | 2,768 | |||||
See accompanying notes to financial statements.
44
Table of Contents
EOS PREFERRED CORPORATION
(f/k/a Capital Crossing Preferred Corporation)
(f/k/a Capital Crossing Preferred Corporation)
STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY
Years Ended December 31, 2010, 2009, and 2008
(Dollars In Thousands, except per share data)
Preferred Stock | Preferred Stock | Additional | Accumulated | Total | ||||||||||||||||||||||||||||||||
Series B | Series D | Common Stock | Paid-in | Deficit Less | Stockholders | |||||||||||||||||||||||||||||||
Shares | Amount | Shares | Amount | Shares | Amount | Capital | Dividends | Equity | ||||||||||||||||||||||||||||
Balance at December 31, 2007 |
1 | $ | | 1,500 | $ | 15 | | $ | | $ | 115,354 | $ | | $ | 115,369 | |||||||||||||||||||||
Net Income |
| | | | | | | 6,030 | 6,030 | |||||||||||||||||||||||||||
Cumulative dividends declared on
preferred stock, Series B ($80.00
per share) |
| | | | | | | (75 | ) | (75 | ) | |||||||||||||||||||||||||
Dividends declared on preferred
stock, Series D ($2.1225 per
share) |
| | | | | | | (3,187 | ) | (3,187 | ) | |||||||||||||||||||||||||
Return of capital to common
stockholder |
| | | | | | (20,233 | ) | | (20,233 | ) | |||||||||||||||||||||||||
Dividends declared on common stock |
| | | | | | | (2,768 | ) | (2,768 | ) | |||||||||||||||||||||||||
Balance at December 31, 2008 |
1 | | 1,500 | 15 | | | 95,121 | | 95,136 | |||||||||||||||||||||||||||
Net loss |
| | | | | | | (12,824 | ) | (12,824 | ) | |||||||||||||||||||||||||
Cumulative dividends declared on
preferred stock, Series B ($20.00
per share) |
| | | | | | | (19 | ) | (19 | ) | |||||||||||||||||||||||||
Dividends declared on preferred
stock, Series D ($0.53125 per
share) |
| | | | | | | (797 | ) | (797 | ) | |||||||||||||||||||||||||
Parent contribution |
| | | | | | 199 | | 199 | |||||||||||||||||||||||||||
Balance at December 31, 2009 |
1 | | 1,500 | 15 | | | 95,320 | (13,640 | ) | 81,695 | ||||||||||||||||||||||||||
Net loss |
| | | | | | | 7,657 | 7,657 | |||||||||||||||||||||||||||
Cumulative dividends declared on
preferred stock, Series B
($140.00
per share) |
| | | | | | | (131 | ) | (131 | ) | |||||||||||||||||||||||||
Dividends declared on preferred
stock, Series D ($1.0625 per
share) |
| | | | | | | (1,594 | ) | (1,594 | ) | |||||||||||||||||||||||||
Dividends declared on common stock |
| | | | | | | (2,351 | ) | (2,351 | ) | |||||||||||||||||||||||||
Balance at December 31, 2010 |
1 | $ | | 1,500 | $ | 15 | | $ | | $ | 95,320 | $ | (10,059 | ) | $ | 85,276 | ||||||||||||||||||||
See accompanying notes to financial statements.
45
Table of Contents
EOS PREFERRED CORPORATION
(f/k/a Capital Crossing Preferred Corporation)
(f/k/a Capital Crossing Preferred Corporation)
STATEMENTS OF CASH FLOWS
Years Ended December 31, | ||||||||||||
2010 | 2009 | 2008 | ||||||||||
(Dollars In Thousands) | ||||||||||||
Cash flows from operating activities: |
||||||||||||
Net income (loss) |
$ | 7,657 | $ | (12,824 | ) | $ | 6,030 | |||||
Adjustments to reconcile net income (loss) to net cash from
operating activities: |
||||||||||||
(Gain) loss on loans held for sale |
(6,498 | ) | 16,263 | | ||||||||
Decrease (increase) in accrued interest and other receivables |
180 | (280 | ) | 76 | ||||||||
(Decrease)
increase in accrued expenses and accounts payable to parent |
(98 | ) | 228 | (58 | ) | |||||||
Loan repayments for loans held for sale at fair value |
10,054 | | | |||||||||
Provision for loan losses |
| (915 | ) | (265 | ) | |||||||
Net cash provided by operating activities |
11,295 | 2,472 | 5,783 | |||||||||
Cash flows from investing activities: |
||||||||||||
Loan repayments from loans originally held to maturity |
1,827 | 7,225 | 13,656 | |||||||||
Net cash provided by investing activities |
1,827 | 7,225 | 13,656 | |||||||||
Cash flows from financing activities: |
||||||||||||
Payment of preferred stock dividends |
(909 | ) | (1,631 | ) | (3,262 | ) | ||||||
Payment of common stock dividends |
(1,467 | ) | | (2,768 | ) | |||||||
Return of capital to common stockholder |
| | (20,233 | ) | ||||||||
Net cash used in financing activities |
(2,376 | ) | (1,631 | ) | (26,263 | ) | ||||||
Net change in cash and cash equivalents |
10,746 | 8,066 | (6,824 | ) | ||||||||
Cash and cash equivalents at beginning of year |
51,823 | 43,757 | 50,581 | |||||||||
Cash and cash equivalents at end of year |
$ | 62,569 | $ | 51,823 | $ | 43,757 | ||||||
Supplemental disclosure for non-cash activity: |
||||||||||||
Capital contribution from Aurora Bank |
$ | | $ | 199 | $ | |
See accompanying notes to financial statements.
46
Table of Contents
EOS PREFERRED CORPORATION
(f/k/a Capital Crossing Preferred Corporation)
(f/k/a Capital Crossing Preferred Corporation)
NOTES TO FINANCIAL STATEMENTS
Years Ended December 31, 2010, 2009 and 2008
1. ORGANIZATION
EOS Preferred Corporation (referred to hereafter as the Company, EOS, we, us or our)
is a Massachusetts corporation organized on March 20, 1998, to acquire and hold real estate assets.
Our principal business objective is to hold mortgage assets that will generate net income for
distribution to stockholders.. Aurora Bank, FSB (Aurora Bank), an indirect wholly owned
subsidiary of Lehman Brothers Holdings Inc. (LBHI; LBHI with its subsidiaries, Lehman
Brothers), owns all of our common stock. Prior to the merger with Aurora Bank, which is further
discussed below, we were a subsidiary of Capital Crossing Bank (Capital Crossing), a federally
insured Massachusetts trust company and our corporate name was Capital Crossing Preferred
Corporation and Capital Crossing owned all of our common stock. Effective June 21, 2010, we changed
our corporate name to EOS Preferred Corporation.
We operate in a manner intended to allow us to be taxed as a real estate investment trust, or
a REIT, under the Internal Revenue Code of 1986, as amended. As a REIT, EOS will not be required
to pay federal or state income tax if we distribute our earnings to our shareholders and continues
to meet a number of other requirements.
On March 31, 1998, Capital Crossing Bank capitalized the Company by transferring mortgage
loans valued at $140.7 million in exchange for 1,000 shares of 8% Cumulative Non-Convertible
Preferred Stock, Series B, valued at $1.0 million and 100 shares of our common stock valued at
$139.7 million. The carrying value of these loans approximated their fair values at the date of
contribution.
On May 11, 2004, we closed our public offering of 1,500,000 shares of 8.50% Non-Cumulative
Exchangeable Preferred Stock, Series D. Our net proceeds from the sale of Series D preferred stock
were $35.3 million. As of July 15, 2009, the Series D became redeemable at our option with the
prior consent of the Office of Thrift Supervision (the OTS) and/or the Federal Deposit Insurance
Corporation (the FDIC).
On February 14, 2007, Capital Crossing was acquired by Aurora Bank through a two-step merger
transaction. An interim thrift subsidiary of Aurora Bank was merged into Capital Crossing.
Immediately following such merger, Capital Crossing was merged into Aurora Bank. Under the terms of
the agreement, Lehman Brothers paid $30.00 per share in cash in exchange for each outstanding share
of Capital Crossing.
The Series B preferred stock and Series D preferred stock remain outstanding and remain
subject to their existing terms and conditions, including the call feature with respect to the
Series D preferred stock. The OTS may direct in writing the automatic exchange of the Series D
preferred stock for preferred shares of Aurora Bank at a ratio of one Series D preferred share for
one hundredth of one preferred share of Aurora Bank if Aurora Bank becomes undercapitalized under
prompt corrective action regulations, if Aurora Bank is placed into bankruptcy, reorganization,
conservatorship or receivership, or if the OTS, in its sole discretion, anticipates Aurora Bank
will become undercapitalized in the near term (Exchange Event).
Business
Our principal business objective is to hold mortgage assets that will generate net income for
distribution to our stockholders. We hold mortgage assets in various cities in the United States
with 40% of the carrying value of our mortgage loans secured by properties located in California.
All of the mortgage assets in our loan portfolio at December 31, 2010 were acquired from Capital
Crossing Bank or Aurora Bank and it is anticipated that substantially all additional mortgage
assets, if any are acquired in the future, will be acquired from Aurora Bank.
Aurora Bank administers our day-to-day activities in its roles as servicer under the Master
Service Agreement (MSA) entered into between Aurora Bank and EOS and as advisor under the
Advisory Agreement (AA) entered into between Aurora Bank and EOS.
47
Table of Contents
EOS PREFERRED CORPORATION
(f/k/a Capital Crossing Preferred Corporation)
(f/k/a Capital Crossing Preferred Corporation)
NOTES TO FINANCIAL STATEMENTS
Years Ended December 31, 2010, 2009 and 2008
Both the AA and the MSA were amended effective as of January 1, 2010. The amended AA and the
amended MSA change the fees paid by EOS. During 2010, the amended agreement, among other things,
changed the management fee to $25,000 per month. The amended MSA changed the fees paid by EOS to
reflect the fees payable to each sub-servicer. Through December 31, 2009, we paid Aurora Bank an
annual servicing fee equal to 0.20%, payable monthly, and an annual advisory fee equal to 0.05%,
also payable monthly, of the gross average unpaid principal balances of loans in the loan portfolio
it services for the immediately preceding month.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of presentation
Our financial statements are prepared in conformity with accounting principles generally
accepted in the United States (GAAP) which require management to make estimates and assumptions
that affect the amounts reported on the financial statements and accompanying notes. The following
is a description of the more significant accounting policies which we follow in preparing and
presenting our financial statements.
Use of estimates
In preparing financial statements in conformity with GAAP, management is required to make
estimates and assumptions that affect the reported amounts of assets and liabilities as of the date
of the balance sheet and reported amounts of revenues and expenses during the reporting period.
Material estimates that are particularly susceptible to significant change in the near term relate
to the determination of the fair value of loans held for sale. For a more detailed discussion of
the basis for the estimates of the fair value of our loan portfolio, please see Loans Held for
Sale, below, and Note 5, Fair Value of Financial Instruments, below. Prior to February 5, 2009,
material estimates also included the determination of the allowance for losses on loans, the
allocation of purchase discount on loans between accretable and nonaccretable portions, and the
rate at which the discount is accreted into interest income.
Cash and Cash Equivalents
Cash and cash equivalents include cash and interest bearing deposits held at Aurora Bank with
original maturities of ninety days or less. The majority of the cash is held in a money market
account that bears interest at rates determined by Aurora Bank which generally follow federal funds
rates. The money market account has a limitation on the number of monthly withdrawals, but there is
no limit on the amount of the withdrawals either individually or in the aggregate.
Loans Held for Sale
On February 5, 2009, EOS and Aurora Bank entered into an Asset Exchange Agreement (the
February Asset Exchange) pursuant to which we agreed to transfer the entire loan portfolio
secured primarily by commercial real estate and multi-family residential real estate to Aurora Bank
in exchange for loans secured primarily by
residential real estate. As a result, during the first quarter of 2009, we reclassified all of
our loan assets as held for sale, recorded a fair value adjustment and reported these loans at the
lower of the their accreted cost or market value. The February Asset Exchange was terminated prior
to its consummation.
Effective November 1, 2009, EOS and Aurora Bank entered into and consummated the November
Asset Exchange pursuant to which we agreed to an exchange of loans with Aurora Bank, though with a
lesser quantity of loans than the February Asset Exchange. As of December 31, 2010, we continue to
report the portion of the loan assets that were retained after the November Asset Exchange at the
lower of their accreted cost or market value. For these retained loans, the carrying value of the
loans will be recognized only up to the cost on the date they were classified as held for sale. We
have elected the fair value option for the loans that were received from the November Asset
Exchange. For these acquired loans, the carrying value of the loans will be equivalent to fair
value which may
48
Table of Contents
EOS PREFERRED CORPORATION
(f/k/a Capital Crossing Preferred Corporation)
(f/k/a Capital Crossing Preferred Corporation)
NOTES TO FINANCIAL STATEMENTS
Years Ended December 31, 2010, 2009 and 2008
reflect an unrealized gain or loss relative to the cost of the loans. Such recognition is
included in the determination of net income in the period in which the change occurred.
The fair value of our loan portfolio is estimated based upon information, to the extent
available, about then current sale prices, bids, credit quality, liquidity, and other available
information for loans with similar characteristics as our loan portfolio. The geographical location
and geographical concentration of the loans in our portfolio is considered in the analysis. The
valuation of the loan portfolio involves some level of management estimation and judgment, the
degree of which is dependent on the terms of the loans, and the availability of market prices and
inputs.
Loans are generally placed on non-accrual status and the accrual of interest is generally
discontinued when the collectability of principal and interest is not probable or estimable which
generally occurs when the loan is ninety days or more past due as to either principal or interest.
Unpaid interest income previously accrued on such loans is reversed against current period interest
income. Interest payments received on non-accrual loans are recorded as interest income. A loan is
returned to accrual status when it is brought current. Loans are charged off when they are
determined to be uncollectible.
Discounts on Acquired Loans
Prior to February 5, 2009, our loan assets were considered held for investment and recorded at
accreted cost, which accounts for the amortization of any purchase discount and deferred fees, less
an allowance for loan losses. We reviewed acquired loans for differences between contractual cash
flows and cash flows expected to be collected from our initial investment in the acquired loans to
determine if those differences were attributable, at least in part, to credit quality. If those
differences were attributable to credit quality, the loans contractually required payments
receivable in excess of the amount of its cash flows expected at acquisition, or nonaccretable
discount,
were not accreted into income. We recognized the excess of all cash flows expected at
acquisition over our initial investment in the loan as interest income using the interest method
over the term of the loan.
There was judgment involved in estimating the amount of our future cash flows on acquired
loans. The amount and timing of actual cash flows could differ materially from managements
estimates, which could materially affect our financial condition and results of operations.
Depending on the timing of an acquisition of loans, a preliminary allocation may have been utilized
until a final allocation was established. Generally, the allocation was finalized no later than
ninety days from the date of purchase.
Subsequent to loan acquisition, if cash flow projections improved, and it was determined that
the amount and timing of the cash flows related to the nonaccretable discount were reasonably
estimable and collection was probable, the corresponding decrease in the nonaccretable discount was
transferred to the accretable discount and was accreted into interest income over the remaining
life of the loan using the interest method. If cash flow projections deteriorated subsequent to
acquisition, the decline was accounted for through a provision for loan losses included in
earnings.
Any remaining discount relating to our purchase of the loans is not amortized as interest
income during the period the loans are classified as held for sale. Deferred income associated with
loans held for sale is deferred until the related loan is paid in full or sold.
Allowance for Loan Losses
Prior to February 5, 2009, our loan assets were considered held for investment and recorded at
accreted cost, which accounts for the amortization of any purchase discount and deferred fees, less
an allowance for loan losses. Since the loan portfolio is now classified as held for sale and
recorded either at fair value, or the lower of its accreted cost or at fair value, we no longer
maintain an allowance for loan losses. In prior periods, arriving at an
49
Table of Contents
EOS PREFERRED CORPORATION
(f/k/a Capital Crossing Preferred Corporation)
(f/k/a Capital Crossing Preferred Corporation)
NOTES TO FINANCIAL STATEMENTS
Years Ended December 31, 2010, 2009 and 2008
appropriate level of allowance for loan losses required a high degree of judgment. The
allowance for loan losses was increased or decreased through a provision for loan losses.
In determining the adequacy of the allowance for loan losses, management made significant
judgments. Aurora Bank initially reviewed our loan portfolio to identify loans for which specific
allocations were considered prudent. Specific allocations included the results of measuring
impaired loans. Further, the allowance for these loans was determined by a formula whereby the
portfolio was stratified by type and internal risk rating categories. Loss factors were then
applied to each strata based on various considerations including collateral type, loss experience,
delinquency trends, current economic conditions and industry standards. The allowance for loan
losses was managements estimate of the probable loan losses incurred as of the balance sheet date.
The determination of the allowance for loan losses required managements use of significant
estimates and judgments. In making this determination, management considered known information
relative to specific loans, as well as collateral type, loss experience, delinquency trends,
current economic conditions and industry trends, generally. Based on these factors, management
estimated the probable loan losses incurred as of the reporting date
and increased or decreased the allowance through a change in the provision for loan losses.
Loan losses were charged against the allowance when management believed the net investment of the
loan, or a portion thereof, was uncollectible. Subsequent recoveries, if any, were credited to the
allowance when cash payments were received.
Gains and losses on sales of loans are determined using the specific identification method.
The excess or deficiency of any cash received as compared to the carrying value was recorded as
gain or loss on sales of loans.
Transfer of financial assets
Transfers of financial assets are accounted for as sales when control over the assets is
surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets are
isolated from EOS, (2) the transferee obtains the right (free of conditions that constrain it from
taking advantage of that right) to pledge or exchange the transferred assets, and (3) we do not
maintain effective control over the transferred assets through an agreement to repurchase them
before their maturity.
Revenue Recognition
We recognize interest income on loans as revenue as it is earned. This revenue is included in
Interest and fees on loans on the Statements of Operations. Any discount relating to the
purchase of the loans by us is not accreted as interest income during the period the loans are
classified as held for sale but is recognized when the related loan is paid in full or sold.
Accrual status loans include any loan which returns to performing status from non-accrual status.
Taxes
We have elected, for federal income tax purposes, to be treated as a REIT and intend to comply
with the provisions of the Internal Revenue Code (the IRC). Accordingly, we will not be subject
to corporate income taxes to the extent we distribute at least 90% of our REIT taxable income to
stockholders and as long as certain assets, income, distribution, and stock ownership tests are met
in accordance with the IRC. As such, no provision for income taxes is included in the accompanying
financial statements.
As of December 31, 2010, management evaluated the quantitative and qualitative requirements
for REIT status and believes that we qualify as a REIT for federal and state income tax purposes.
Accordingly, we have not recorded any uncertain tax positions. As of December 31, 2010, we do not
have any unrecognized tax benefits. We do not anticipate any material changes in existing
unrecognized tax benefits during the next 12 months. The Company is subject to examination by the
respective taxing authorities for the tax years 2007 to 2009. Our policy is
50
Table of Contents
EOS PREFERRED CORPORATION
(f/k/a Capital Crossing Preferred Corporation)
(f/k/a Capital Crossing Preferred Corporation)
NOTES TO FINANCIAL STATEMENTS
Years Ended December 31, 2010, 2009 and 2008
to include interest and penalties related to income taxes in Other general and administrative
expense if applicable and there was no expense for 2010, 2009, or 2008.
For the year ended December 31, 2009, we accrued an excise tax liability of $60,000 which is
included in Other general and administrative expenses. We were subject to excise tax equal to 4% of
the undistributed portion of adjusted ordinary income. The excise tax liability resulted from us
not distributing 85% of our ordinary income from 2009. There was no excise tax due for the years
ended December 31, 2010 or 2008.
Concentration of Credit Risk
We had cash and cash equivalents of $62.6 million as of December 31, 2010. These funds were
held in interest bearing and non-interest bearing accounts with Aurora Bank. The FDIC provides
coverage on these accounts which as of December 31, 2010 was limited to $250,000. Cash in excess of
FDIC coverage limitations is subject to credit risk.
Concentration of credit risk generally arises with respect to our loan portfolio when a number
of borrowers engage in similar business activities, or activities in the same geographical region.
Concentration of credit risk indicates the relative sensitivity of our performance to both positive
and negative developments affecting a particular industry. Our balance sheet exposure to geographic
concentrations directly affects the credit risk of the loans within our loan portfolio.
At December 31, 2010, approximately 40% of our net real estate loan portfolio consisted of
loans collateralized by properties located in California. Consequently, the portfolio may
experience a higher default rate in the event of adverse economic, political or business
developments or natural hazards in California that may affect the ability of property owners to
make payments of principal and interest on the underlying mortgages. The housing and real estate
sectors in California have been particularly impacted by the recession with higher overall
foreclosure rates than the national average. If California experiences further adverse economic,
political or business conditions, or natural hazards, we will likely experience higher rates of
loss and delinquency on our mortgage loans than if our loans were more geographically diverse.
Subsequent Events
We assessed events that occurred subsequent to December 31, 2010 for potential disclosure and
recognition on the financial statements. No additional events have occurred that would require
disclosure in or adjustment to our financial statements.
Recent Accounting Pronouncements
In January 2010, the Financial Accounting Standards Board (FASB) issued a standards update
on improving disclosures about fair value measurements. The update requires expanded disclosures
including the techniques and inputs used to measure fair value, transfers in and out of Levels 1
and 2, and disaggregation of components within the reconciliation of Level 3 fair value
measurements. This update to the standards was effective beginning
with interim reports during this fiscal
year. The adoption of this update to the standards did not impact our financial statements
as it only impacts the footnote disclosures. We have included the applicable disclosures in Note 5,
Fair Value of Financial Instruments.
In February 2010, the FASB issued a standards update on improving disclosures about subsequent
events so that SEC filers no longer are required to disclose the date through which subsequent
events have been evaluated in originally issued and revised financial statements. This update to
the standards is effective beginning
with interim reports during this fiscal year. The adoption of this update
to the standards did not impact our financial statements as it only impacts the footnote
disclosures.
51
Table of Contents
EOS PREFERRED CORPORATION
(f/k/a Capital Crossing Preferred Corporation)
(f/k/a Capital Crossing Preferred Corporation)
NOTES TO FINANCIAL STATEMENTS
Years Ended December 31, 2010, 2009 and 2008
In July 2010, the FASB issued a standards update requiring additional disclosures about the
allowance for credit losses and the credit quality of the loan portfolio. The additional
disclosures include a roll-forward of the allowance for credit losses on a disaggregated basis and
more information, by type of receivable, on credit quality indicators including aging and troubled
debt restructurings as well as significant purchases and sales. This update to the standards was
effective for our fiscal year ending December 31, 2010 and interim reports thereafter. As our loan
portfolio is classified as held for sale and carried at fair value or the lower of accreted cost or
market value, we do not utilize an allowance for credit losses and this new guidance had no impact
on our results of operations or financial position.
In January 2011, the FASB issued a temporary deferral of the effective date of disclosures
about troubled debt restructurings. This delays the effective date until our interim period ending
June 30, 2011. As our loan portfolio is classified as held for sale and carried at fair value or
the lower of accreted cost or market value, this new guidance will have no impact on our results of
operations or financial position.
3. BANKRUPTCY OF LBHI AND REGULATORY ACTIONS INVOLVING AURORA BANK
Bankruptcy of Lehman Brothers Holding Inc.
Bankruptcy of Lehman Brothers Holdings Inc. On September 15, 2008, LBHI, the indirect parent
company of Aurora Bank, filed a voluntary petition under Chapter 11 of the U.S. Bankruptcy Code.
The bankruptcy filing has led to increased regulatory constraints being placed on Aurora Bank by
its bank regulatory authorities, primarily the OTS. Certain of these constraints apply to Aurora
Banks subsidiaries, including EOS.
Aurora Bank, LBHI, LB Bancorp, and the OTS entered into a Capital Maintenance Agreement
(CMA), effective November 30, 2010. The CMA establishes the requirement that Aurora Bank be sold
to a third party by May 31, 2012. If such a sale does not occur by that date, the CMA requires that
LBHI must purchase the assets of Aurora Bank as soon as practical after that date. If at any time
after February 29, 2012, the OTS determines that a sale of Aurora Bank is not likely to occur by
May 31, 2012, the OTS may require Aurora Bank to submit a plan of dissolution which includes (i)
purchase of Aurora Banks assets for cash by LBHI, (ii) redemption of Aurora Banks deposit
liabilities, (iii) termination of Aurora Banks deposit insurance, and (iv) return of the bank
charter. In the event that such a plan of dissolution were to be submitted, it is the intent of
Aurora Bank to continue the principal operations of the organization, other than depository
functions, for the foreseeable future. We believe that LBHI has the ability and intent to provide
support, if required, in that regard.
There can be no assurance that the sale of Aurora Bank will be consummated within the defined
time frame. There can be no assurance that a potential buyer of Aurora Bank will come forward and
tender an offer acceptable to the bankruptcy court, that the bankruptcy court will approve such
offer, that a potential buyer will have or be able to raise financing for the purchase, and meet
all other conditions necessary to consummate the purchase.
Further, there is complete uncertainty with regards to any and all aspects of a potential sale. The
business strategies of the new owner may not include continued operation of EOS or other business
lines of Aurora Bank.
Both the bankruptcy filing of LBHI and the increased regulatory constraints placed on Aurora
Bank have negatively impacted the ability of EOS to conduct business according to our business
objectives. Following the execution of the Settlement Agreement, the OTS modified, but did not
remove all of the regulatory constraints on Aurora Bank.
Regulatory Actions Involving Aurora Bank
Aurora Bank Regulatory Actions and Capital Levels. On January 26, 2009, the OTS entered a
cease and desist order against Aurora Bank (the Original Order). The Original Order required
Aurora Bank to ensure that each of its subsidiaries, including EOS, was in compliance with the
Original Order, including the operating restrictions contained therein. In addition, on February 4,
2009, the OTS issued a prompt corrective action directive to Aurora Bank (the PCA). The PCA
required Aurora Bank to, among other things; raise its capital ratios such that
52
Table of Contents
EOS PREFERRED CORPORATION
(f/k/a Capital Crossing Preferred Corporation)
(f/k/a Capital Crossing Preferred Corporation)
NOTES TO FINANCIAL STATEMENTS
Years Ended December 31, 2010, 2009 and 2008
it would be deemed
to be adequately capitalized and placed additional constraints on Aurora Bank and its
subsidiaries, including EOS.
Following execution of the Settlement Agreement, on November 30, 2010, Aurora Bank entered
into a Stipulation and Consent to Issuance of Amended Order to Cease and Desist with the OTS
whereby Aurora Bank consented to the issuance of an Amended Order to Cease and Desist (the Amended
Order) issued by the OTS, which amended the Original Order. The Amended Order amended certain
requirements for Aurora Bank contained in the Original Order. The provisions in the Original Order
that require Aurora Bank to ensure that each of its subsidiaries, including EOS, comply with the
Original Order were not amended. These operating restrictions, amount other things, restrict
transactions with affiliates, capital distributions to shareholders (including redemptions),
contracts outside the ordinary course of business, and changes in senior executive officers, board
members or their employment arrangements without prior written notice to the OTS.
Under the Order, EOS must continue to seek and receive approval from the OTS for the
declaration and payment of dividends to our preferred and common shareholders. There is no
assurance that the OTS will approve any future request for the declaration or payment of dividends.
On November 30, 2010, and effective on the same date, the OTS issued an order terminating the
PCA. The Order was still effective as of the date of issuance of this annual report.
More detailed information can be found in the Original Order, the Amended Order, the PCA, and
the termination of the PCA themselves, copies of which are available on the OTS website
(www.ots.treas.gov).
On the Execution Date, LBHI agreed to enter into the CMA in which LBHI agreed for the duration
of LBHIs ownership of Aurora Bank to maintain Aurora Banks tier 1 and risk based capital ratios
at levels greater than the thresholds required to achieve the well-capitalized designation under
OTS regulations.
As of December 31, 2010, as set forth in a public filing with the OTS, Aurora Banks capital
ratios were above the thresholds required under the CMA. The classification of Aurora Banks
capitalization level is subject to review and acceptance by the OTS.
As of December 31, 2009, there was uncertainty regarding our ability to continue as a going
concern as a result of the bankruptcy of LBHI and the issuance of the Original Order and the PCA.
During 2010, this uncertainty diminished due to the execution of the Settlement Agreement and the
CMA along with the actions of the OTS to issue the Amended Order and terminate the PCA.
Dividend Payments. On June 26, 2009, the OTS notified Aurora Bank that, as a result of the
Original Order and the PCA, the approval or non-objection of the OTS would be required prior to
declaration and payment of dividends by EOS. The OTS required Aurora Bank to submit a formal
request for non-objection determination to permit the payment of dividends. A formal request was
submitted to the OTS on July 28, 2009.
As a result of the notice from the OTS, our Board of Directors (the Board of Directors) did
not declare or pay the Series B and Series D preferred stock dividends that would have been
payable for the second, third and fourth quarters of 2009 and the first and second quarters of
2010. The Board of Directors also did not declare or pay dividends on the common stock that would
have been payable for fiscal 2009.
On September 9, 2010, the OTS provided a non-objection determination for the declaration of
dividends by September 14, 2010 and the payment of these dividends between December 15, 2010 and
December 31, 2010 in an amount sufficient to maintain qualification as a REIT for the 2009 tax
year. The Board of Directors of EOS declared such dividends on September 13, 2010, for the quarter
ended September 30, 2010, consistent with the OTS non-objection determination. The dividends were
payable to shareholders of record as of October 29, 2010 and include
53
Table of Contents
EOS PREFERRED CORPORATION
(f/k/a Capital Crossing Preferred Corporation)
(f/k/a Capital Crossing Preferred Corporation)
NOTES TO FINANCIAL STATEMENTS
Years Ended December 31, 2010, 2009 and 2008
cumulative dividends on the Series B preferred stock of $120.00 per share, non-cumulative
dividends on the Series D preferred stock of $0.53125 per share and dividends on our common stock
of $1,467,000.
An additional formal request to declare dividends was submitted to the OTS on December 17,
2010 and on December 30, 2010, the OTS provided a non-objection determination for the declaration
of dividends in an amount sufficient to maintain qualification as a REIT and avoid excise tax for
the 2010 tax year. The non-objection determination did not provide any restriction as to the timing
of declaration or payment. The Board of Directors of EOS declared such dividends on December 31,
2010, for the quarter ended December 31, 2010, consistent with the OTS non-objection determination.
The dividends are payable to shareholders of record as of December 31, 2010 and include dividends
on the Series B preferred stock of $20.00 per share, non-cumulative dividends on the Series D
preferred stock of $0.53125 per share and dividends on our common stock in the amount of $884,000.
These dividends were paid in 2011. At December 31, 2010, there were no dividends in arrears
related to our Series B preferred stock. Dividends on the Series D preferred stock are
non-cumulative and as such, there were no dividends in arrears.
The OTS has not approved any further dividend distributions. There can be no assurance that
such approval will be received from the OTS or when or if such OTS approval requirement will be
removed. Failure to permit the distribution of sufficient dividends in future years will cause EOS
to fail to qualify as a REIT. If EOS no longer qualifies as a REIT, we will be subject to federal
and state income taxes in the tax year when loss of REIT status occurs and in years thereafter.
Furthermore, even if approval is received from the OTS, any future dividends on the preferred stock
will be payable only when, as and if declared by the Board of Directors. Aurora Bank and EOS will
continue to work with the OTS regarding the resumption of normal payment of dividends. There can be
no assurance that the OTS will grant any future dividend declaration request, nor can there be any
assurance that any further dividends will be paid or that EOS will continue to qualify as a REIT.
54
Table of Contents
EOS PREFERRED CORPORATION
(f/k/a Capital Crossing Preferred Corporation)
(f/k/a Capital Crossing Preferred Corporation)
NOTES TO FINANCIAL STATEMENTS
Years Ended December 31, 2010, 2009 and 2008
4. LOANS
As of both December 31, 2010 and 2009, the loan portfolio was comprised primarily of loans
secured by one-to-four family residential real estate loans, the majority of which were located in
California. On November 18, 2009, EOS and Aurora Bank entered into and consummated the November
Asset Exchange pursuant to which EOS agreed to transfer 93 loans secured primarily by commercial
real estate and multi-family residential real estate to Aurora Bank in exchange for 74 loans
secured primarily by residential real estate. There were no other acquisitions, sales or exchanges
of loans during 2010 and 2009.
We use the term carrying value to reflect loans valued at the lower of their accreted cost
or market value, or at their fair value, as applicable to the individual loans valuation method
as selected by us in accordance with accounting standards.
A summary of the carrying value and unpaid principal balance (UPB) of loans by valuation
method and in total is as follows:
December 31, | ||||||||||||||||
2010 | 2009 | |||||||||||||||
Unpaid Principal | Unpaid Principal | |||||||||||||||
Carrying Value | Balance | Carrying Value | Balance | |||||||||||||
(Dollars In Thousands) | ||||||||||||||||
Total mortgage loans, held for sale: |
||||||||||||||||
Commercial real estate |
$ | 6,866 | $ | 9,504 | $ | 6,380 | $ | 11,324 | ||||||||
Multi-family residential |
850 | 1,034 | 693 | 1,203 | ||||||||||||
One-to-four family residential |
16,724 | 22,320 | 22,750 | 32,386 | ||||||||||||
Total |
$ | 24,440 | $ | 32,858 | $ | 29,823 | $ | 44,913 | ||||||||
Portion carried at fair value: |
||||||||||||||||
Commercial real estate |
$ | | $ | | $ | | $ | | ||||||||
Multi-family residential |
| | | | ||||||||||||
One-to-four family residential |
16,505 | 22,048 | 22,531 | 32,007 | ||||||||||||
Total |
$ | 16,505 | $ | 22,048 | $ | 22,531 | $ | 32,007 | ||||||||
Portion carried at lower of accreted cost or market value (1): |
||||||||||||||||
Commercial real estate |
$ | 6,866 | $ | 9,504 | $ | 6,380 | $ | 11,324 | ||||||||
Multi-family residential |
850 | 1,034 | 693 | 1,203 | ||||||||||||
One-to-four family residential |
219 | 272 | 219 | 379 | ||||||||||||
Total loans held for sale |
$ | 7,935 | $ | 10,810 | $ | 7,292 | $ | 12,906 | ||||||||
(1) | Though the table compares the carrying value of these loans against UPB, these loans are carried at the lower of accreted cost or market value and the carrying value cannot exceed the cost of these loans which for all loans is less than UPB. |
55
Table of Contents
EOS PREFERRED CORPORATION
(f/k/a Capital Crossing Preferred Corporation)
(f/k/a Capital Crossing Preferred Corporation)
NOTES TO FINANCIAL STATEMENTS
Years Ended December 31, 2010, 2009 and 2008
A summary of the loans on non-accrual status is as follows:
December 31, | ||||||||||||||||
2010 | 2009 | |||||||||||||||
Unpaid Principal | Unpaid Principal | |||||||||||||||
Carrying Value | Balance | Carrying Value | Balance | |||||||||||||
(Dollars In Thousands) | ||||||||||||||||
Mortgage loans on real estate on non-accrual status: |
||||||||||||||||
Commercial real estate |
$ | 692 | $ | 802 | $ | 318 | $ | 792 | ||||||||
Multi-family residential |
| | | | ||||||||||||
One-to-four family residential |
224 | 337 | | | ||||||||||||
Total loans on non-accrual status |
$ | 916 | $ | 1,139 | $ | 318 | $ | 792 | ||||||||
Years Ended December 31, | ||||||||||||
2010 | 2009 | 2008 | ||||||||||
(Dollars In Thousands) | ||||||||||||
Average carrying value in non-accrual loans |
$ | 738 | $ | 1,532 | $ | 495 |
Activity in the allowance for loan losses follows:
Years Ended December 31, | ||||||||||||
2010 | 2009 | 2008 | ||||||||||
(Dollars In Thousands) | ||||||||||||
Balance at beginning of year |
$ | | $ | 915 | $ | 1,180 | ||||||
Credit for loan losses |
| | (265 | ) | ||||||||
Reversal of allowance |
| (915 | ) | | ||||||||
Balance at end of year |
$ | | $ | | $ | 915 | ||||||
Prior to February 5, 2009, when we classified our loans as held for sale, there was no interest
income recognized on impaired loans or interest income recognized on a cash basis on impaired loans
for the years ended December 31, 2009 or 2008.
5. FAIR VALUE OF FINANCIAL INSTRUMENTS
Fair Value Measurements
Prior to February 5, 2009, our loan assets were classified as held for investment and recorded
at accreted cost, and we amortized any purchase discount and deferred fees, less a provision to the
allowance for loan losses. As a result of entering into the February Asset Exchange, our loans were
reclassified as held for sale and were reported at the lower of their accreted cost or market
value. A valuation allowance was recorded to recognize the excess of accreted cost over fair value.
The February Asset Exchange was terminated prior to consummation.
Effective November 1, 2009, EOS and Aurora Bank entered into and consummated the November
Asset Exchange pursuant to which we agreed to an exchange of loans with Aurora Bank, though with a
lesser quantity of loans than the February Asset Exchange. As of December 31, 2010, we continue to
report the portion of the loan assets that were retained after the November Asset Exchange at the
lower of their accreted cost or market value and these loans are reflected in Loans held for sale,
at lower of accreted cost or market value on the Balance Sheet. For these retained loans, the
carrying value of the loans will be recognized only up to the cost on the date they were classified
as held for sale. We have elected the fair value option for the loans that were received from the
November Asset Exchange and these loans are reflected in Loans held for sale, at fair value on the
Balance Sheet. For these acquired loans, the carrying value of the loans will be equivalent to fair
value which may reflect an unrealized gain
56
Table of Contents
EOS PREFERRED CORPORATION
(f/k/a Capital Crossing Preferred Corporation)
(f/k/a Capital Crossing Preferred Corporation)
NOTES TO FINANCIAL STATEMENTS
Years Ended December 31, 2010, 2009 and 2008
or loss relative to the cost of the loans. Such recognition is included in the determination
of net income in the period in which the change occurred.
Accounting standards define fair value and establish a fair value hierarchy that prioritizes
the inputs to valuation techniques used to measure fair value. The fair value is the price at which
an asset or liability could be exchanged in a current transaction between knowledgeable, willing
parties in an orderly market. Where available, fair value is based on observable market prices or
inputs or derived from such prices or inputs. Where observable prices or inputs are not available,
other valuation methodologies are applied.
At December 31, 2010 and 2009, the fair value of our loan portfolio was estimated based upon various
cash flow models to price the portfolio. These models consider significant inputs such
as loan type loan age, loan to value ratio, payment history, and property location, as well as
significant assumptions such as estimated rates of loan delinquency, potential recovery, discount
rate, and the impact of interest rate reset. Recent trade quotes or prices are identified in
estimating the amount at which a third party might purchase the loans and their yield requirements.
Management also considers market information and quotes received from third parties, when
available. The valuation of the loan portfolio involves managements use of estimates and judgment,
the degree of which is dependent on the terms of the loans and the availability of market prices
and inputs.
Accounting standards require the categorization of financial assets and liabilities based on a
hierarchy of the inputs to the valuation techniques used to measure fair value. The hierarchy gives
the highest priority to quoted prices in active markets for identical assets or liabilities (Level
1) and the lowest priority to valuation methods using unobservable inputs (Level 3). The three
levels are described below:
Level 1 Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date. |
Level 2 Inputs are either directly or indirectly observable for the asset or liability through correlation with market data at the measurement date and for the duration of the instruments anticipated life. |
Level 3 Inputs reflect managements best estimate of what market participants would use in pricing the asset or liability at the measurement date. Consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model. |
The categorization within the fair value hierarchy is based on the lowest level of significant
input to its valuation. All loans were categorized as Level 3 at December 31, 2010 and 2009.
The table presented below summarizes the change in balance sheet carrying value associated
with Level 3 loans during the years ended December 31, 2010 and 2009. Caution should be utilized
when evaluating reported net revenues for Level 3 loans.
Balance | ||||||||||||||||||||
Balance | Net Transfers In / | Net Gains | December 31, | |||||||||||||||||
December 31, 2009 | Out(1) | Payments | (Losses)(2) | 2010 | ||||||||||||||||
(Dollars In Thousands) | ||||||||||||||||||||
Loans Held for Sale: |
||||||||||||||||||||
Commercial real estate |
$ | 6,380 | $ | | $ | (1,551 | ) | $ | 2,037 | $ | 6,866 | |||||||||
Multi-family residential |
693 | | (168 | ) | 325 | 850 | ||||||||||||||
One-to-four family
residential |
22,750 | | (10,162 | ) | 4,136 | 16,724 | ||||||||||||||
Total |
$ | 29,823 | $ | | $ | (11,881 | ) | $ | 6,498 | $ | 24,440 |
57
Table of Contents
EOS PREFERRED CORPORATION
(f/k/a Capital Crossing Preferred Corporation)
(f/k/a Capital Crossing Preferred Corporation)
NOTES TO FINANCIAL STATEMENTS
Years Ended December 31, 2010, 2009 and 2008
November Asset | Balance | |||||||||||||||||||||||
Balance | Net Transfers In / | Exchange, | Net Gains | December 31, | ||||||||||||||||||||
December 31, 2008 | Out(1) | Payments | net(3) | (Losses)(2) | 2009 | |||||||||||||||||||
(Dollars In Thousands) | ||||||||||||||||||||||||
Loans Held for Sale: |
||||||||||||||||||||||||
Commercial real estate |
$ | | $ | 29,775 | $ | (3,291 | ) | $ | (11,235 | ) | $ | (8,869 | ) | $ | 6,380 | |||||||||
Multi-family residential |
| 19,982 | (1,334 | ) | (10,776 | ) | (7,179 | ) | 693 | |||||||||||||||
One-to-four family
residential |
| 970 | (303 | ) | 22,298 | (215 | ) | 22,750 | ||||||||||||||||
Total |
$ | | $ | 50,727 | $ | (4,928 | ) | $ | 287 | $ | (16,263 | ) | $ | 29,823 |
(1) | The amounts presented as transfers into and out of Level 3 represent the carrying value as of the actual date of the event or change in circumstances that caused the transfer. | |
(2) | Net Gains and Losses are included in Gain (loss) on loans held for sale on the Statements of Operations. The current period gains and losses from changes in values of Level 3 loans represent gains/losses on loans held for sale and reflect changes in values of those loans only for the period(s) in which the loans were classified as Level 3. | |
(3) | The Exchange also entailed the transfer of accrued interest receivable of $88, resulting in a net capital contribution of $199 from the transaction. |
Fair Value of Financial Instruments
Accounting standards require disclosure of estimated fair values of all financial instruments
where it is practicable to estimate such values. In determining the fair value measurements for
financial assets and liabilities, we utilize quoted prices, when available. If quoted prices are
not available, we estimate fair value using present value or other valuation techniques that
utilize inputs that are observable for the asset or liability, either directly or indirectly, when
available. When observable inputs are not available, inputs may be used that are unobservable and,
therefore, reflect our own assumptions about the assumptions market participants would use in
pricing the asset or liability based on the best information available in the circumstances.
Accounting standards exclude certain financial instruments and all nonfinancial instruments
from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not
represent the underlying value of the entire company.
In addition to the fair value of our loans, as discussed above, the following methods and
assumptions were used by us in estimating fair value of financial instruments:
Cash and cash equivalents: The carrying value of cash and interest-bearing deposits
approximate fair value because of the short-term maturity of these instruments.
Accrued interest receivable: The carrying value of accrued interest receivable approximates
fair value because of the short-term nature of these financial instruments.
58
Table of Contents
EOS PREFERRED CORPORATION
(f/k/a Capital Crossing Preferred Corporation)
(f/k/a Capital Crossing Preferred Corporation)
NOTES TO FINANCIAL STATEMENTS
Years Ended December 31, 2010, 2009 and 2008
The estimated fair values, and related carrying value, of our financial instruments are as
follows:
December 31, | ||||||||||||||||
2010 | 2009 | |||||||||||||||
Carrying | Carrying | |||||||||||||||
Value | Fair Value | Value | Fair Value | |||||||||||||
(Dollars In Thousands) | ||||||||||||||||
Cash and cash equivalents |
$ | 62,569 | $ | 62,569 | $ | 51,823 | $ | 51,823 | ||||||||
Loans, net |
24,440 | 24,440 | 29,823 | 29,823 | ||||||||||||
Accrued interest receivable |
213 | 213 | 393 | 393 |
6. PREFERRED STOCK
On March 31, 1998, we issued 1,000 shares of 8% Cumulative Non-Convertible Preferred Stock,
Series B, to Capital Crossing. Holders of Series B preferred stock are entitled to receive, if
declared by the Board of Directors, dividends at a rate of 8% of the average daily outstanding
liquidation amount, as defined. Dividends accumulate at the completion of each completed period, as
defined, and payment dates are determined by the Board of Directors.
Series B preferred stock has a liquidation amount of $1,000 per share. In the event of a
voluntary or involuntary dissolution or liquidation of EOS, preferred stockholders are entitled to
the total liquidation amount, as defined, plus any accrued and accumulated dividends.
On May 11, 2004, we completed a public offering of 1,500,000 shares of Non-Cumulative
Exchangeable Preferred Stock, Series D, with a dividend rate of 8.50% and a liquidation preference
of $25 per share, which raised net proceeds of $35,259,000, after related offering costs of
$2,241,000. The Series D preferred stock is exchangeable for preferred shares of Aurora Bank at a
ratio of one Series D preferred share for one-hundredth of one preferred share of Aurora Bank if
the OTS so directs. The OTS could order this action upon the occurrence of an Exchange Event. The
liquidation preference for each Series D preferred share is $25.00, plus an accrued and unpaid
dividend for the quarter in which the liquidation occurs.
At any time following the occurrence of certain changes in the tax laws or regulations
concerning REITs, EOS will have the right to redeem the Series D preferred stock in whole, subject
to the prior written approval of the OTS. We would have the right to redeem the Series D preferred
stock if we received an opinion of counsel to the effect that, as a result of changes to the tax
laws or regulations:
| dividends paid or to be paid by us with respect to our capital stock are not, or will not be, fully deductible by us for income tax purposes | ||
| we are otherwise unable to qualify as a REIT. |
As of July 15, 2009, the Series D preferred stock became redeemable at the option of EOS with
the prior consent of the OTS.
Shares of preferred stock have been and may again be issued from time-to-time in one or more
series, subject to the receipt of regulatory approval, and the Board of Directors is authorized to
determine the rights, preferences, privileges, and restrictions, including the dividend rights,
conversion rights, voting rights, terms of redemption, redemption price or prices, and liquidation
preferences, of any series of preferred stock, and to fix the number of shares of any such series
of preferred stock without any further vote or action by the shareholders. However, we may not
issue additional shares of preferred stock ranking senior to the Series D preferred stock without
consent of holders of at least two-thirds of the outstanding Series D preferred stock. The voting
and other rights of the holders of common stock will be subject to, and may be adversely affected
by, the rights of holders of any preferred stock that may be issued in the future.
59
Table of Contents
EOS PREFERRED CORPORATION
(f/k/a Capital Crossing Preferred Corporation)
(f/k/a Capital Crossing Preferred Corporation)
NOTES TO FINANCIAL STATEMENTS
Years Ended December 31, 2010, 2009 and 2008
7. RELATED PARTY TRANSACTIONS
Aurora Bank
performs advisory services and services the loans owned by us.
Servicing Agreement
Our loan portfolio is serviced by Aurora Bank pursuant to the terms of the MSA. The amended
MSA changed the fees paid by EOS to reflect the fees payable to each sub-servicer. Through December
31, 2009, Aurora Bank in its role as servicer under the terms of the MSA received an annual
servicing fee equal to 0.20%, payable monthly, on the gross average unpaid principal balances of
loans serviced for the immediately preceding month.
The MSA requires Aurora Bank to service the loan portfolio in a manner substantially the same
as for similar work performed by Aurora Bank for transactions on its own behalf. Aurora Bank
collects and remits principal and interest payments on at least a monthly basis, maintains
perfected collateral positions, submits and pursues insurance claims, and initiates and supervises
foreclosure proceedings on the loan portfolio it services. Aurora Bank also provides accounting and
reporting services required by us for such loans. We may also direct Aurora Bank to dispose of any
loans placed on non-accrual status, or are modified due to financial deterioration of the borrower.
Aurora Bank may facilitate loan modifications and short sales where circumstances are so warranted.
Aurora Bank may institute foreclosure proceedings and foreclose, manage, and protect the mortgaged
premises, including exercising any power of sale contained in any mortgage or deed of trust,
obtaining a deed-in-lieu-of-foreclosure, or otherwise acquiring title to a mortgaged property
underlying a mortgage loan by operation of law or otherwise in accordance with the terms of the
MSA.
The amended MSA may be terminated at any time by written agreement between the parties or at
any time by either party upon 30 days prior written notice to the other party and appointment of a
successor servicer. The amended MSA will automatically terminate if EOS ceases to be an affiliate
of Aurora Bank.
When any mortgaged property underlying a mortgage loan is conveyed by a mortgagor, Aurora Bank
generally, upon notice of the conveyance, will enforce any due-on-sale clause contained in the
mortgage loan, to the extent permitted under applicable law and governmental regulations. The terms
of a particular mortgage loan or applicable law, however, may prohibit Aurora Bank from exercising
the due-on-sale clause under certain circumstances related to the collateral underlying the
mortgage loan and the borrowers ability to fulfill the obligations under the related mortgage
note.
Advisory Agreement
Under the AA Aurora Bank administers our day-to-day operations. The amended AA changes the
fees paid by EOS. Through December 31, 2009, Aurora Bank was paid an annual advisory fee equal to
0.05%, payable monthly, of the gross average unpaid principal balances of our loans for the
immediately preceding month, plus reimbursement for certain expenses incurred by Aurora Bank as
advisor. During 2010, the amended agreement, among other things, changed the management fee to
$25,000 per month. As advisor, Aurora Bank is responsible for:
| monitoring the credit quality of our loan portfolio; | ||
| advising us with respect to the acquisition, management, financing, and disposition of loans and other assets; and | ||
| maintaining our corporate and shareholder records. |
Aurora Bank may, from time to time, subcontract all or a portion of its obligations under the
AA to one or more of its affiliates involved in the business of managing mortgage assets or, with
the approval of a majority of Board of Directors as well as a majority of its independent
directors, subcontract all or a portion of its obligations under the AA to unrelated third parties.
Aurora Bank will not, in connection with the subcontracting of any of its obligations under the AA,
be discharged or relieved in any respect from its obligations under the AA.
The AA had a term of one year, and currently is renewed annually for an additional one-year
period unless EOS delivers notice of nonrenewal to Aurora Bank. We may terminate the AA at any time
upon ninety days prior notice. As long as any Series D preferred stock remains outstanding, any
decision by us either not to renew the AA or to terminate the AA must be approved by a majority of
its Board of Directors, as well as by a majority of our independent directors. Other than the
servicing fee and the advisory fee, Aurora Bank is not entitled to a fee for providing advisory and
management services to EOS.
Servicing and advisory fees for the years ended December 31, 2010, 2009, and 2008 totaled
$470,000, $127,000, and $192,000, respectively, and were recorded in Loan Servicing and advisory
services. Amounts due to Aurora Bank as of December 31, 2010 and 2009 were $87,000 and $69,000,
respectively and were recorded in Accounts payable to parent on the balance sheet.
All of the mortgage assets in our loan portfolio at December 31, 2010 were purchased from
Capital Crossing or Aurora Bank. See November Asset Exchange in Note 2 above for the transaction to
exchange commercial and multi-family loans for residential loans during 2009. It is anticipated
that substantially all additional mortgage assets, purchased or contributed in the future, if any,
will be purchased from Aurora Bank, our sole common stockholder. No loans were purchased or
contributed from Aurora Bank in 2010 or 2008.
The following table summarizes capital transactions between us and Aurora Bank, our sole
common shareholder and parent:
Years Ended December 31, | ||||||||||||
2010 | 2009 | 2008 | ||||||||||
(Dollars In Thousands) | ||||||||||||
Returns of capital to parent |
$ | | $ | | $ | 20,233 | ||||||
Common stock dividends paid to parent |
1,467 | | 2,768 | |||||||||
Series B preferred stock dividends paid to parent |
108 | 18 | 72 | |||||||||
Contribution of capital in the form of loans (November Asset Exchange) |
| 199 | |
Additionally dividends were declared to Aurora Bank on December 31, 2010, which included
$18,000 for the Series B preferred stock and $884,000 for the common stock dividends and are
included in Dividends payable to parent as of December 31, 2010.
Our cash and cash equivalents balances of $62.6 million and $51.8 million at December 31, 2010
and 2009, respectively, consist entirely of deposits with Aurora Bank.
60
Table of Contents
EOS PREFERRED CORPORATION
(f/k/a Capital Crossing Preferred Corporation)
(f/k/a Capital Crossing Preferred Corporation)
NOTES TO FINANCIAL STATEMENTS
Years Ended December 31, 2010, 2009 and 2008
8. QUARTERLY DATA (UNAUDITED)
Supplemental Financial Information
Years Ended December 31, | ||||||||||||||||||||||||||||||||
2010 | 2009 | |||||||||||||||||||||||||||||||
Fourth | Third | Second | First | Fourth | Third | Second | First | |||||||||||||||||||||||||
Quarter | Quarter | Quarter | Quarter | Quarter | Quarter | Quarter | Quarter | |||||||||||||||||||||||||
(Dollars In Thousands) | ||||||||||||||||||||||||||||||||
Interest income |
$ | 529 | $ | 465 | $ | 524 | $ | 676 | $ | 749 | $ | 914 | $ | 881 | $ | 1,020 | ||||||||||||||||
Gain (loss) on loans held for sale |
1,263 | 2,715 | 756 | 1,764 | 488 | (541 | ) | (1,029 | ) | (15,181 | ) | |||||||||||||||||||||
Reduction in allowance for loan losses |
| | | | | | | 915 | ||||||||||||||||||||||||
Operating expenses |
247 | 265 | 249 | 274 | 201 | 181 | 328 | 330 | ||||||||||||||||||||||||
Net income (loss) |
1,545 | 2,915 | 1,031 | 2,166 | 1,036 | 192 | (476 | ) | (13,576 | ) | ||||||||||||||||||||||
Preferred stock dividends declared |
816 | 909 | | | | | | 816 | ||||||||||||||||||||||||
Net income (loss) available to common stockholder |
$ | 729 | $ | 2,006 | $ | 1,031 | $ | 2,166 | $ | 1,036 | $ | 192 | $ | (476 | ) | $ | (14,392 | ) | ||||||||||||||
61
Table of Contents
Schedule IV Mortgage Loans on Real Estate
December 31, 2010
December 31, 2010
Principal | ||||||||||||||||||||||||||||||||||||
Amount | Interest Due | Interest | ||||||||||||||||||||||||||||||||||
Subject to | Amount of | and | Income | |||||||||||||||||||||||||||||||||
Carrying | Unpaid | Delinquent | Mortgage | Accrued | Earned | |||||||||||||||||||||||||||||||
Amount of | Principal | Principal or | being | at End of | Applicable | |||||||||||||||||||||||||||||||
Prior Liens | Location | Interest Rate | Mortgage | Balance | Interest | Foreclosed | Period | to Period | ||||||||||||||||||||||||||||
(Dollars In Thousands) | ||||||||||||||||||||||||||||||||||||
Farms |
| | | $ | | $ | | $ | | $ | | $ | | $ | | |||||||||||||||||||||
Residential |
| Various U.S. Cities | 4.3 6.0 | % | 16,505 | 22,047 | 337 | | 146 | 1,272 | ||||||||||||||||||||||||||
Apartments and businesses |
| Various U.S. Cities | 3.1 14.5 | % | 7,935 | 10,811 | 802 | | 67 | 750 | ||||||||||||||||||||||||||
Unimproved |
| | | | | | | | | |||||||||||||||||||||||||||
Total |
$ | 24,440 | $ | 32,858 | $ | 1,139 | $ | | $ | 213 | $ | 2,022 | ||||||||||||||||||||||||
Balance at December 31, 2009 |
$ | 29,823 | ||
Additions during period: |
||||
Gains on loans held for sale |
6,498 | |||
Deductions during period: |
||||
Loan repayments |
(11,881 | ) | ||
Balance at December 31, 2010 |
$ | 24,440 | ||
62
Table of Contents
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
On September 17, 2010, the Audit Committee of the Board of Directors approved the dismissal of
Ernst & Young LLP (Ernst & Young) as our independent registered public accounting firm.
No reports of
Ernst & Young on our financial statements for the past two
fiscal years; specifically the fiscal years ended December 31, 2009 and 2008, contained any adverse opinion or
disclaimer of opinion or was qualified as to audit scope or accounting
principles, except that the Ernst & Young audit reports on the 2009 and 2008 financial statements
were modified for the uncertainty of our ability to continue as a going concern.
During the fiscal years ended December 31, 2009 and 2008 and the subsequent interim period
through September 17, 2010, there were no disagreements with Ernst & Young on any matter of
accounting principles or practices, financial statement disclosure, or audit scope or procedure,
which disagreement(s), if not resolved to the satisfaction of Ernst & Young, would have caused it
to make reference thereto in any report and there were no reportable events (as defined in Item
304(a)(1)(v) of Regulation S-K).
On September 17,
2010, we engaged Grant Thornton LLP (Grant Thornton) as our independent registered public
accounting firm to audit our financial statements. The members of the Audit Committee of the Board of
Directors approved the engagement of Grant Thornton.
Prior to the engagement of Grant Thornton, neither us nor any person on our behalf consulted
with Grant Thornton regarding the application of accounting principles to a specified completed or
proposed transaction or the type of audit opinion that might be rendered on our financial
statements, and neither a written report nor oral advice was provided that Grant Thornton concluded
was an important factor considered by us in reaching a decision as to the accounting, auditing, or
financial reporting issue.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
EOS management, with the participation of our President and Chief Financial Officer,
evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, the Exchange Act)
as of December 31, 2010. Based on this evaluation, our President and Chief Financial Officer
concluded that, as of December 31, 2010, our disclosure controls and procedures were (1) designed
to ensure that material information relating to EOS is made known to the President and Chief
Financial Officer by others within the entity, particularly during the period in which this report
was being prepared, and (2) effective, in that they provide reasonable assurance that information
required to be disclosed by us in the reports that we files or submits under the Exchange Act is
recorded, processed, summarized, and reported within the time periods specified in the SECs rules
and forms.
Changes in Internal Control Over Financial Reporting
No change to our internal control over financial reporting (as defined in Rules 13a-15(f) and
15d-15(f) under the Exchange Act) occurred during the fiscal quarter ended December 31, 2010 that
has materially affected, or is reasonably likely to materially affect, our internal control over
financial reporting.
Managements Report on Internal Control over Financial Reporting
The management of EOS is responsible for establishing and maintaining adequate internal
control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Under the
supervision and with the participation of management, including our President and Chief Financial
Officer, an evaluation of the effectiveness of our internal control over financial reporting was
conducted. In making this assessment, management followed the criteria in Internal
Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the
63
Table of Contents
Treadway Commission (COSO). Based on this assessment, management determined that our
internal control over financial reporting was effective as of December 31, 2010 based on the
criteria in Internal Control-Integrated Framework issued by COSO.
This annual report does not include an attestation report of our registered public accounting
firm regarding internal control over financial reporting. Managements report was not subject to
attestation by our registered public accounting firm pursuant to rules of the SEC that permit us to
provide only managements report in this annual report.
ITEM 9B. OTHER INFORMATION
None.
64
Table of Contents
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Directors and Executive Officers
The names and ages of each of our directors and executive officers and their principal
occupation and business experience for at least the last five years are set forth below. The
executive officers hold office until their successors are duly elected and qualified.
Name | Age | Position(s) Held | ||||
Thomas OSullivan
|
44 | President, Director, Chairman | ||||
Robert J. Leist, Jr.
|
61 | Chief Financial Officer | ||||
Michael Milversted
|
63 | Director | ||||
William Wesp
|
59 | Director | ||||
Lana Franks
|
47 | Director | ||||
Eric Graham
|
41 | Director |
Thomas OSullivan. On January 25, 2010, the Board of Directors elected Mr. OSullivan as President
of EOS. On March 4, 2010, he was elected as a director and Chairman of the Board of Directors of
EOS. Mr. OSullivan is also Chief Financial Officer of Aurora Bank and receives no separate
compensation from EOS for his services. He has served in a variety of capacities at Lehman Brothers
since 2000. Mr. OSullivan served as the Chief Financial Officer of EOS from 2008 to 2010. He
serves as an officer of EOS so long as he is an employee of Aurora Bank. For the past 10 years Mr.
OSullivan was not subject to any legal or other proceeding.
Robert J. Leist, Jr. On March 4, 2010, the Board of Directors elected Mr. Leist as Chief Financial
Officer of EOS. Mr. Leist has served as Senior Vice President and Controller of Aurora Bank since
September 2009 and previously served as Senior Vice President and Controller of Aurora Loan
Services from February 2007. From April 1999 to January 2007, he served as Senior Vice President
and Chief Accounting Officer of Ocwen Financial Corporation. Mr. Leist serves as an officer of EOS
so long as he is an employee of Aurora Bank. He receives no separate compensation from EOS for his
services. For the past 10 years Mr. Leist was not subject to any legal or other proceeding.
Michael Milversted. Mr. Milversted has been a director of EOS since May 2007. He is retired. Prior
to his retirement, he was an employee of Lehman Brothers and served in a variety of capacities,
including Treasurer of Lehman Brothers and Chief Financial Officer of Lehman Brothers Bank, FSB.
For the past 10 years Mr. Milversted was not subject to any legal or other proceeding.
William Wesp. On January 28, 2009, Mr. Wesp was elected a director of EOS. During October 2010, he
became Chairman of the Aurora Bank FSB Board of Directors and has served as a Director of Aurora
Bank FSB since July 2009, as approved by the Office of Thrift Supervision. Mr. Wesp is retired.
Prior to his retirement, he served on the Board of Directors of Conceco Finance Corporation from
2001-2003. Mr. Wesp served as Lehman Brothers Bank, FSB Chief Executive Officer from 1999-2000. For
the past 10 years Mr. Wesp was not subject to any legal or other proceeding.
Lana Franks. On December 8, 2008, the Board of Directors elected Ms. Franks a director. Ms. Franks
is retired. Prior to her retirement, she was an employee of Lehman Brothers and served in a variety
of positions. She was also President of EOS from December 2008 to January 2010. For the past 10
years Ms. Franks was not subject to any legal or other proceeding.
Eric Graham. Mr. Graham was elected as a director of EOS on December 3, 2009. Mr. Graham is a
securities and corporate finance lawyer, a certified public accountant, and has many years of legal
and accounting experience with real estate investment trusts. For the past 10 years Mr. Graham was
not subject to any legal or other proceeding.
65
Table of Contents
There are no known family relationships between any director or executive officer and any
other director or executive officer of EOS.
The Board of Directors has established a process for shareholders of EOS to communicate with
our Audit Committee or any member thereof. A shareholder who is interested in communicating
directly with the Audit Committee or any member thereof may do so by email at the following
address:
BankBoardSecretary@AuroraBankFSB.com.
The Board of Directors and its Committees
EOS and our Board of Directors have determined that Messrs. Milversted, Wesp and Graham
satisfy the standards for independence promulgated by the NASDAQ Stock Market, Inc. (NASDAQ) and
the standards for independence contained in our charter.
The Board of Directors held nine meetings and did not act by written consent during 2010.
Our By-laws establish the President as Chairman of the Board of Directors, who, subject to the
direction of the Board of Directors, shall have general supervision and controls of its business.
This decision is based upon the Boards determination of what is in the best interests of EOS and
our shareholders.
Audit Committee. EOS has an Audit Committee, which consists of Messrs. Milversted, Wesp and
Graham. Each member of the Audit Committee satisfies the standards for independence promulgated by
NASDAQ. The Audit Committee reports its activities to the Board of Directors. Pursuant to its
written charter, the principal purpose of the Audit Committee is to assist the Board of Directors
in fulfilling its oversight of:
| The quality and integrity of our financial statements; | ||
| Our compliance with legal and regulatory requirements; | ||
| The qualifications and independence of our independent auditors; and | ||
| The performance of our internal audit and compliance functions and our independent auditors. |
The Audit Committee held four meetings in 2010. Mr. Milversted, the Audit Committee Chairman, meets
the qualifications of an audit committee financial expert as defined in the applicable rules
promulgated by the Securities and Exchange Commission.
Nominating and Corporate Governance Committee. EOS has a Nominating and Corporate Governance
Committee, which consists of Messrs. Graham, Milversted and Wesp. Each member of the Nominating and
Corporate Governance Committee satisfies the standards for independence promulgated by NASDAQ.
Pursuant to its written charter, the purpose of the Nominating and Corporate Governance Committee
is to:
| Identify and review the qualifications of individuals identified by our parent or other voting stockholders to become directors and select, or recommend that the Board of Directors select, the candidates for all directorships to be filled by the Board of Directors or by the stockholders; | ||
| Develop and recommend to the Board of Directors a set of corporate governance principles applicable to EOS; and | ||
| Otherwise take a leadership role in overseeing the corporate governance of EOS. |
In identifying or reviewing candidates for membership on the Board of Directors, the
Nominating and Corporate Governance Committee takes into account the qualifications for board
membership established by the Board of Directors from time to time and all other factors it
considers appropriate, which may include strength of character, mature judgment, career
specialization, relevant technical skills, diversity, and the extent to which the candidate would
fill a present need on the Board of Directors. The Nominating and Corporate Governance Committee
weighs diversity as one of many of the factors it considers appropriate when taking into account
the
66
Table of Contents
criteria for board membership. In 2010, the full Board of Directors performed the duties of
the Nominating and Corporate Governance Committee.
Code of Ethics and Other Matters
On August 10, 2010, the Board of Directors adopted the EOS Preferred Corporation Code of
Ethics, which applies to our officers and employees. We will provide a copy of the EOS Preferred
Corporation Code of Ethics free of charge to any stockholder who sends a written request to that
effect to EOS Preferred Corporation, 1271 Avenue of the Americas, 46th Floor, New York, NY 10020,
Attention: Secretary.
The Board of Directors has determined that EOS is a controlled company, as defined in Rule
4350(c)(5) of the listing standards of NASDAQ, based on Aurora Banks beneficial ownership of 100%
of our outstanding voting common stock. Accordingly, we are exempt from certain requirements of the
NASDAQ listing standards, including the requirement to maintain a majority of independent directors
on our Board of Directors.
Compensation of Directors
In 2010, EOS paid our independent directors an annual fee of $10,000 each for their services
as independent directors. We do not pay any compensation to our other directors. No director of EOS
was granted stock awards, option awards, any bonus or other non-equity incentive or any other type
or form of compensation in 2010. Independent direct compensation was determined by a vote of the
Board of Directors.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Exchange Act requires that our executive officers and directors and
persons who own more than 10% of our outstanding shares of Series D preferred stock file reports of
ownership and changes in ownership with the Securities Exchange Commission and NASDAQ. Executive
officers, directors and greater than 10% stockholders are required by applicable regulations to
furnish us with copies of all reports filed by such persons pursuant to the Exchange Act and the
rules and regulations promulgated there under. Based on a review of our records and except as set
forth below, we believe that all reports required by the Exchange Act were filed on a timely basis.
During 2010, following the election of Mr. Leist as an officer of the Company, Mr. Leist
inadvertently failed to timely file a Form 3. The required Form 3 report was subsequently filed.
ITEM 11. EXECUTIVE COMPENSATION
Compensation Committee Report; Compensation Committee Interlocks and Insider Participation
EOS does not have a compensation committee as all employees of EOS are employees of Aurora Bank and
no compensation is paid by EOS to our officers.
67
Table of Contents
ITEM 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS |
The following table sets forth, as of March 31, 2011, (i) the number and percentage of
outstanding shares of each class of voting stock beneficially owned by each person known by EOS to
be the beneficial owner of more than 5% of such shares; and (ii) the number and percentage of
outstanding equity securities of EOS beneficially owned by (a) each of our directors; (b) each of
our executive officers; and (c) all of our executive officers and directors as a group. The persons
or entities named in the table have sole voting and sole investment power with respect to each of
the shares beneficially owned by such person or entity. The calculations were based on a total of
100 shares of common stock, 937 shares of Series B preferred stock and 1,500,000 shares of Series D
preferred stock outstanding as of such date.
Percentage of | ||||
Name and Address of Beneficial Owner(1) | Amount of Shares (Class) | Outstanding Shares | ||
Aurora Bank (4) |
100 shares of common stock | 100.0% | ||
900 shares of Series B preferred stock | 96.1% | |||
Thomas OSullivan (2)(3) |
| * | ||
Robert J. Leist, Jr. (2) |
| * | ||
Michael Milversted (3) |
| * | ||
William Wesp (3) |
| * | ||
Lana Franks (3) |
| * | ||
Eric Graham (3) |
| * | ||
All executive officers and directors as a Group
(6 persons) |
| * |
* | Less than 1%. | |
(1) | The address of each beneficial owner is c/o EOS Preferred Corporation, 1271 Avenue of the Americas, 46th Floor, New York, NY 10020. | |
(2) | Executive officer of EOS. | |
(3) | Director of EOS. | |
(4) | The address of Aurora Bank is 1271 Avenue of the Americas, 46th Floor, New York, NY 10020. |
68
Table of Contents
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
Because of the nature of EOS relationship with Aurora Bank and its affiliates, we engage, and
will continue to engage, in transactions with related parties. It is our policy that the terms of
any financial dealings with Aurora Bank and its affiliates will be consistent with those available
from unaffiliated third parties in the mortgage lending industry. In addition, we maintain both an
Audit Committee and a Nominating and Corporate Governance Committee of our Board of Directors, each
of which is comprised solely of independent directors who satisfy the standards for independence
promulgated by NASDAQ. We and the Board of Directors have determined that Messrs. Milversted,
Graham and Wesp satisfy the standards for independence promulgated by NASDAQ and the standards for
independence contained in our charter. Among other functions, the Audit Committee (or the Board of
Directors as a whole) will review transactions between EOS and Aurora Bank and its affiliates.
Servicing Agreement
Our loan portfolio is serviced by Aurora Bank pursuant to the terms of the MSA. The amended
MSA changed the fees paid by EOS to reflect the fees payable to each sub-servicer. Through December
31, 2009, Aurora Bank in its role as servicer under the terms of the MSA received an annual
servicing fee equal to 0.20%, payable monthly, on the gross average unpaid principal balances of
loans serviced for the immediately preceding month.
The MSA requires Aurora Bank to service the loan portfolio in a manner substantially the same
as for similar work performed by Aurora Bank for transactions on its own behalf. Aurora Bank
collects and remits principal and interest payments on at least a monthly basis, maintains
perfected collateral positions, submits and pursues insurance claims, and initiates and supervises
foreclosure proceedings on the loan portfolio it services. Aurora Bank also provides accounting and
reporting services required by us for such loans. We may also direct Aurora Bank to dispose of any
loans placed on non-accrual status, or are modified due to financial deterioration of the borrower.
Aurora Bank may facilitate loan modifications and short sales where circumstances are so warranted.
Aurora Bank may institute foreclosure proceedings and foreclose, manage, and protect the mortgaged
premises, including exercising any power of sale contained in any mortgage or deed of trust,
obtaining a deed-in-lieu-of-foreclosure, or otherwise acquiring title to a mortgaged property
underlying a mortgage loan by operation of law or otherwise in accordance with the terms of the
MSA.
The amended MSA may be terminated at any time by written agreement between the parties or at
any time by either party upon 30 days prior written notice to the other party and appointment of a
successor servicer. The amended MSA will automatically terminate if EOS ceases to be an affiliate
of Aurora Bank.
When any mortgaged property underlying a mortgage loan is conveyed by a mortgagor, Aurora Bank
generally, upon notice of the conveyance, will enforce any due-on-sale clause contained in the
mortgage loan, to the extent permitted under applicable law and governmental regulations. The terms
of a particular mortgage loan or applicable law, however, may prohibit Aurora Bank from exercising
the due-on-sale clause under certain circumstances related to the collateral underlying the
mortgage loan and the borrowers ability to fulfill the obligations under the related mortgage
note.
Advisory Agreement
Under the AA Aurora Bank administers our day-to-day operations. The amended AA changes the
fees paid by EOS. Through December 31, 2009, Aurora Bank was paid an annual advisory fee equal to
0.05%, payable monthly, of the gross average unpaid principal balances of our loans for the
immediately preceding month, plus reimbursement for certain expenses incurred by Aurora Bank as
advisor. During 2010, the amended agreement, among other things, changed the management fee to
$25,000 per month. As advisor, Aurora Bank is responsible for:
| monitoring the credit quality of our loan portfolio; | ||
| advising us with respect to the acquisition, management, financing, and disposition of loans and other assets; and | ||
| maintaining our corporate and shareholder records. |
69
Table of Contents
Aurora Bank may, from time to time, subcontract all or a portion of its obligations under the
AA to one or more of its affiliates involved in the business of managing mortgage assets or, with
the approval of a majority of Board of Directors as well as a majority of its independent
directors, subcontract all or a portion of its obligations under the AA to unrelated third parties.
Aurora Bank will not, in connection with the subcontracting of any of its obligations under the AA,
be discharged or relieved in any respect from its obligations under the AA.
The AA had a term of one year, and currently is renewed annually for an additional one-year
period unless EOS delivers notice of nonrenewal to Aurora Bank. We may terminate the AA at any time
upon ninety days prior notice. As long as any Series D preferred stock remains outstanding, any
decision by us either not to renew the AA or to terminate the AA must be approved by a majority of
its Board of Directors, as well as by a majority of our independent directors. Other than the
servicing fee and the advisory fee, Aurora Bank is not entitled to a fee for providing advisory and
management services to EOS.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Audit Fees. During 2010, The Audit Committee of EOS approved changing the provider of our
independent accounting services to Grant Thornton from Ernst & Young. During 2010, we paid fees to
Grant Thornton of $37,000 for its professional services rendered for the audit of our financial
statements for the year ended December 31, 2010 and the reviews of our financial statements
included in our quarterly reports on Form 10-Q for the quarter ended September 30, 2010.
We paid fees to Ernst & Young of $50,000 for its professional services rendered for the
reviews of our financial statements included in our quarterly reports on Form 10-Q for the quarters
ended March 31, 2010 and June 30, 2010. We also incurred fees from Ernst & Young of $123,000 for
its professional services rendered for the audit of our financial statements for the year ended
December 31, 2009 and the review of our financial statements included in our quarterly reports on
Form 10-Q during that year.
Audit-Related Fees. There were no fees billed to EOS by either Grant Thornton or Ernst &
Young for assurance and related services that are reasonably related to the performance of the
audits and reviews of our financial statements that are not already reported in the paragraph
immediately above for the years 2010 and 2009 respectively.
Tax Fees. There were no fees billed to EOS by either Grant Thornton or Ernst & Young for tax
compliance, tax advice, tax planning services or other services for 2010 or 2009.
All Other Fees. There were no fees billed to EOS by either Grant Thornton or Ernst & Young
for products and services other than as set forth above for the years 2010 and 2009.
Approval Policies. The Audit Committee has the sole authority to review and approve the
engagement of the independent registered public accounting firm to perform audit services or any
permissible non-audit services. All audit-related and non-audited related services to be provided
by the independent registered public accounting firm must be approved in advance by the Audit
Committee.
70
Table of Contents
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) Contents:
(1) Financial Statements: All Financial Statements are included as Part II, Item 8 of this
Report.
(2) All other schedules for which provision is made in the applicable accounting regulations
of the Securities and Exchange Commission are not required under the related instruction or are
inapplicable and therefore have been omitted.
71
Table of Contents
(b) Exhibits:
Exhibit No. | Description | |
3.1
|
Restated Articles of Organization of the Company, effective February 15, 2007, incorporated by reference from the Companys Current Report on Form 8-K dated February 15, 2007. | |
3.2
|
Amended and Restated By-laws of the Company, incorporated by reference from the Companys Annual Report on Form 10-K for the fiscal year ended December 31, 1998. | |
10.1
|
Master Mortgage Loan Purchase Agreement between the Company and Capital Crossing Bank, incorporated by reference from the Companys registration statement on Form S-11 (No. 333-66677), filed November 3, 1998, as amended (the 1998 Form S-11). | |
10.2
|
Master Service Agreement between the Company and Capital Crossing Bank, incorporated by reference from the 1998 Form S-11. | |
10.3
|
Advisory Agreement between the Company and Capital Crossing Bank, incorporated by reference from the 1998 Form S-11. | |
10.4
|
Form of Letter Agreement between the Company and Capital Crossing Bank regarding issuance of certain securities, incorporated by reference from the 1998 Form S-11. | |
10.5
|
Asset Exchange Agreement between the Company and Lehman Bank, dated February 5, 2009, incorporated by reference from the Companys Annual Report on Form 10-K for the fiscal year ended December 31, 2008. | |
10.6
|
Termination to the Asset Exchange Agreement entered into on February 5, 2009, between the Company and Aurora Bank FSB, dated July 20, 2009, incorporated by reference from the Companys Annual Report on Form 10-K for the fiscal year ended December 31, 2009. | |
10.7
|
Asset Exchange Agreement between the Company and Aurora Bank FSB, dated November 18, 2009, incorporated by reference from the Companys Annual Report on Form 10-K for the fiscal year ended December 31, 2009. | |
10.8
|
Amended and Restated Master Service Agreement between the Company and Aurora Bank FSB, dated March 29, 2010, incorporated by reference from the Companys Annual Report on Form 10-K for the fiscal year ended December 31, 2009. | |
10.9
|
Amended and Restated Advisory Agreement between the Company and Aurora Bank FSB, dated March 29, 2010, incorporated by reference from the Companys Annual Report on Form 10-K for the fiscal year ended December 31, 2009. | |
+12.1
|
Computation of Earnings to Combined Fixed Charges and Preferred Stock Dividends | |
14.1
|
Code of Ethics, incorporated by reference from the Companys Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2007. | |
+23.1
|
Consent of Independent Registered Public Accounting Firm | |
+31.1
|
Certification pursuant to Exchange Act Rules 13a-15(e) and 15d-15(e) of the President | |
+31.2
|
Certification pursuant to Exchange Act Rules 13a-15(e) and 15d-15(e) of the Chief Financial Officer. | |
+32
|
Certification pursuant to 18 U.S.C. Section 1350 of the President and Chief Financial Officer. |
+ | Filed herewith |
72
Table of Contents
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
EOS Preferred Corporation |
||||
By: | /s/ Thomas OSullivan | |||
Thomas OSullivan | ||||
President (Principal Executive Officer) | ||||
Date: March 31, 2011
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant in the capacities and on the
dates indicated.
Signature | Title | Date | ||
/s/ Thomas OSullivan
|
President, Director | March 31, 2011 | ||
/s/ Robert J. Leist, Jr.
|
Chief Financial Officer | March 31, 2011 | ||
/s/ William Wesp
|
Director | March 31, 2011 | ||
/s/ Michael Milversted
|
Director | March 31, 2011 | ||
/s/ Lana Franks
|
Director | March 31, 2011 | ||
/s/ Eric Graham
|
Director | March 31, 2011 |
73
Table of Contents
EXHIBIT INDEX
Exhibit | Name | |
12.1
|
Computation of Earnings to Combined Fixed Charges and Preferred Stock Dividends | |
23.1
|
Consent of Independent Registered Public Accounting Firm | |
31.1
|
Certification pursuant to Exchange Act Rules 13a-15(e) and 15d-15(e) of the President | |
31.2
|
Certification pursuant to Exchange Act Rules 13a-15(e) and 15d-15(e) of the Chief Financial Officer | |
32
|
Certification pursuant to 18 U.S.C. Section 1350 of the President and Chief Financial Officer |
74