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EX-31.1 - CERTIFICATION - TD Holdings, Inc.f10q0914ex31i_chinacomm.htm
EX-32.1 - CERTIFICATION - TD Holdings, Inc.f10q0914ex32i_chinacomm.htm
EX-31.2 - CERTIFICATION - TD Holdings, Inc.f10q0914ex31ii_chinacomm.htm
EX-32.2 - CERTIFICATION - TD Holdings, Inc.f10q0914ex32ii_chinacomm.htm

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2014

 

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from ____________ to ____________

 

Commission file number:  001-36055

 

China Commercial Credit, Inc.

(Exact name of registrant as specified in its charter)

 

Delaware   45-4077653

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

No. 1688, Yunli Road, Tongli

Wujiang

Jiangsu Province

People’s Republic of China

(Address of principal executive offices)

 

(86-0512) 6396-0022

 (Registrant’s telephone number, including area code)

 

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

 

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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes ☐   No ☒

 

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 definition of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer Accelerated filer
Non-accelerated filer Smaller reporting company

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐   No ☒

 

As of March 12, 2015, 12,255,062 shares of the Company’s Common Stock, $0.001 par value per share, were issued and outstanding.

 

 

 

 
 

 

CHINA COMMERCIAL CREDIT, INC.

FORM 10-Q

 

INDEX

 

   

Page

Number

     
NOTE REGARDING FORWARD-LOOKING STATEMENTS 3
     
PART I.  FINANCIAL INFORMATION 4
     
Item 1. Financial Statements 4
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 42
     
Item 3. Quantitative and Qualitative Disclosures About Market Risk 61
     
Item 4. Controls and Procedures 61
     
PART II.  OTHER INFORMATION 63
     
Item 1. Legal Proceedings 63
     
Item 1A. Risk Factors 63
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 63
     
Item 3. Defaults Upon Senior Securities 63
     
Item 4. Mine Safety Disclosures 65
     
Item 5. Other Information 65
     
Item 6. Exhibits 65
     
SIGNATURES 66

 

2
 

 

Note Regarding Forward-Looking Statements

 

The information contained in this Quarterly Report on Form 10-Q includes some statements that are not purely historical and that are “forward-looking statements.” Such forward-looking statements include, but are not limited to, statements regarding our company and our management’s expectations, hopes, beliefs, intentions or strategies regarding the future, including our financial condition and results of operations. In addition, any statements that refer to projections, forecasts or other characterizations of future events or circumstances, including any underlying assumptions, are forward-looking statements. The words “anticipates,” “believes,” “continue,” “could,” “estimates,” “expects,” “intends,” “may,” “might,” “plans,” “possible,” “potential,” “predicts,” “projects,” “seeks,” “should,” “will,” “would” and similar expressions, or the negatives of such terms, may identify forward-looking statements, but the absence of these words does not mean that a statement is not forward-looking.

 

The forward-looking statements contained herein are based on current expectations and beliefs concerning future developments and the potential effects on us. Future developments actually affecting us may not be those anticipated. These forward-looking statements involve a number of risks, uncertainties (some of which are beyond our control) or other assumptions that may cause actual results or performance to be materially different from those expressed or implied by these forward-looking statements. Examples are statements regarding future developments with respect to the following:

 

  Our ability to satisfy the inquiry from NASDAQ in order to have our common stock resume trading and listed on NASDAQ;
     
  Our ability to improve internal controls and procedures;
     
  Our ability to develop and market our microcredit lending and guarantee business in the future;
     
 

Our ability to effectively control the lending risk and collect from default borrowers;

 

 

Our ability to make timely adjustment to ensure adequate loan loss and financial guarantee provisions;

 

  Inflation and fluctuations in foreign currency exchange rates;
     
  Our on-going ability to obtain all mandatory and voluntary government and other industry certifications, approvals, and/or licenses to conduct our business;
     
  Development of a liquid trading market for our securities; and
     
  ●  The costs we may incur in the future from complying with current and future governmental regulations and the impact of any changes in the regulations on our operations.

 

You should not rely upon forward-looking statements as predictions of future events. The events and circumstances reflected in the forward-looking statements may not be achieved or occur. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Moreover, neither we nor any other person assume responsibility for the accuracy and completeness of the forward-looking statements. Except as required by law, we undertake no obligation to update publicly any forward-looking statements for any reason after the date of this report to conform these statements to actual results or to changes in our expectations.

 

You should review the factors described in the section entitled “Risk Factors” herein and other documents we file from time to time with the SEC. We qualify all of our forward-looking statements by these cautionary statements.

 

3
 

 

CHINA COMMERCIAL CREDIT, INC.

CONSOLIDATED BALANCE SHEETS

 

   September 30,
2014
(Unaudited)
   December 31,
2013
 
         
ASSETS        
Cash  $4,132,782   $9,405,865 
Restricted cash   2,872,073    10,784,960 
Notes receivable   323,249    - 
Loans receivable, net of allowance for loan losses $20,992,454 and $1,375,948 for September 30, 2014 and December 31, 2013, respectively,   65,560,582    88,827,465 
Net investment in direct financing lease   2,388,418    - 
Interest receivable   1,397,938    1,124,734 
Tax receivable, net   1,756,207    820,526 
Property and equipment, net   169,833    254,795 
Guarantee paid on behalf of guarantee service customers   8,629,323    1,082,486 
Other assets   1,007,567    702,617 
Total Assets  $88,237,972   $113,003,448 
           
LIABILITIES AND SHAREHOLDERS’ EQUITY          
Liabilities          
Short-term bank loans  $11,373,422   $16,360,721 
Deposits payable   4,260,622    9,659,362 
Unearned income from financial guarantee services   127,147    482,029 
Accrual for financial guarantee services   4,356,381    588,740 
Other current liabilities   131,600    629,073 
Deferred tax liability   342,280    333,617 
Total Liabilities   20,591,452    28,053,542 
Shareholders' Equity          
Series A Preferred Stock (par value $0.001 per share, 1,000,000 shares authorized at September 30, 2014 and December 31, 2013, respectively; nil and nil shares issued and outstanding at September 30, 2014 and December 31, 2013, respectively)  $-   $- 
Series B Preferred Stock (par value $0.001 per share, 5,000,000 shares authorized at September 30, 2014 and December 31, 2013, respectively; nil and nil shares issued and outstanding at September 30, 2014 and December 31, 2013, respectively)   -    - 
Common stock (par value $0.001 per share, 100,000,000 shares authorized; 12,246,812 and 10,430,657 shares issued and outstanding at September 30, 2014 and December 31, 2013, respectively)   12,247    10,431 
Subscription receivable   (1,062)   (1,062)
Additional paid-in capital   59,434,220    52,704,107 
Statutory reserves   5,442,150    5,442,150 
Retained earnings   (1,952,108)   20,300,689 
Due from a non-controlling shareholder   (1,145,466)   - 
Accumulated other comprehensive income   5,856,539    6,493,591 
Total Shareholders’ Equity   67,646,520    84,949,906 
Total Liabilities and Shareholders’ Equity/  $88,237,972   $113,003,448 

 

* All of the VIEs’ assets can be used to settle obligations of their primary beneficiary. Liabilities recognized as a result of consolidating these VIEs do not represent additional claims on the Company’s general assets (Note 1).

 

See notes to the consolidated financial statements

 

4
 

 


CHINA COMMERCIAL CREDIT, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

 

   For the Three Months
Ended
September 30,
   For the Nine Months
Ended
September 30,
 
   2014
(Unaudited)
   2013
(Unaudited)
   2014
(Unaudited)
   2013
(Unaudited)
 
Interest income                
Interests and fees on loans  $1,457,902   $2,969,422   $5,987,935   $9,156,526 
Interests on deposits with banks   7,843    16,922    59,386    135,416 
Total interest and fees income   1,465,745    2,986,344    6,047,321    9,291,942 
                     
Interest expense                    
Interest expense on short-term bank loans   (243,158)   (274,489)   (736,283)   (897,341)
Net interest income   1,222,587    2,711,855    5,311,038    8,394,601 
                     
(Provision)/reversal for loan losses   (5,817,156)   340,965    (21,164,733)   (500,123)
Net interest (loss)/income after provision for loan losses   (4,594,569)   3,052,820    (15,853,695)   7,894,478 
                     
Commissions and fees on financial guarantee services   87,774    401,984    476,134    1,175,060 
(Under) /Over provision on financial guarantee services   (138,457)   53,661    (3,775,816)   202,361 
Commission and fees on guarantee services, net   (50,683)   455,645    (3,299,682)   1,377,421 
                     
Net (Loss) /Revenue   (4,645,252)   3,508,465    (19,153,377)   9,271,899 
                     
Non-interest income                    
Government incentive   (81)   57,460    81,327    83,235 
Other non-interest income   26,276    99,337    195,605    99,337 
Total non-interest income   26,195    156,797    276,932    182,572 
                     
Non-interest expense                    
Salaries and employee surcharge   (206,523)   (167,078)   (614,926)   (511,953)
Rental expenses   (68,078)   (65,244)   (199,060)   (194,091)
Business taxes and surcharge   (69,743)   (103,877)   (228,131)   (361,466)
Other operating expenses   (1,190,762)   (580,233)   (2,323,256)   (1,450,603)
Total non-interest expense   (1,535,106)   (916,432)   (3,365,373)   (2,518,113)
                     
(Loss) /Income Before Taxes   (6,154,163)   2,748,830    (22,241,818)   6,936,358 
Income tax benefit/(expense )   113    (387,561)   (10,979)   (1,041,398)
Net (Loss)/Income   (6,154,050)   2,361,269    (22,252,797)   5,894,960 
                     
Amortization of beneficial conversion feature relating to convertible Series A Preferred Stocks   -    (372,500)   -    (372,500)
Amortization of beneficial conversion feature relating to convertible Series B Preferred Stocks   -    (380,000)   -    (380,000)
Net income attributable to Common Stock shareholders   (6,154,050)   1,608,769    (22,252,797)   5,142,460 
                     
(Loss) /Earnings per Share- Basic and Diluted  $(0.50)  $0.17   $(1.96)  $0.56 
                     
Weighted Average Shares Outstanding-Basic and Diluted   12,246,812    9,692,533    11,377,427    9,233,381 
                     
Net (Loss)/Income   (6,154,050)   2,361,269    (22,252,797)   5,894,960 
Other comprehensive income                    
Foreign currency translation adjustment   33,715    452,537    (637,053)   1,880,603 
Comprehensive (Loss) /Income  $(6,120,335)  $2,813,806   $(22,889,850)  $7,775,563 

 

See notes to the consolidated financial statements

 

5
 

 

CHINA COMMERCIAL CREDIT, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

   For The Nine Months Ended
September30,
 
   2014
(Unaudited)
   2013 (Unaudited) 
Cash Flows from Operating Activities:        
Net (loss) /income  $(22,252,797)  $5,894,960 
Adjustments to reconcile net income to net cash provided by operating activities:          
Depreciation   83,732    83,926 
Provision for loan losses   21,164,733    500,123 
Provision on financial guarantee services   3,775,816    (202,361)
Deferred tax expense    10,979     11,705 
Changes in operating assets and liabilities:          
Interest receivable   (281,277)   62,478 
Tax receivable   (942,373)   (1,021,744)
Other assets   549,426    436,288 
Unearned income from guarantee services   (10,363)   (181,941)
Other current liabilities    (159,050)    (161,387)
Net Cash Provided by Operating Activities   1,938,826    5,422,047 
           
Cash Flows from Investing Activities:          
Originated loans disbursement to third parties   (36,786,516)   (186,874,447)
Loans collection from third parties   37,935,727    184,319,796 
Payment of loans on behalf of guarantees   (11,439,270)   (435,468)
Collection from guarantees for loan paid on behalf of guarantees   1,905,564    - 
Payment for principal of finance lease   (2,732,596)   - 
Deposit released from banks for financial guarantee services   9,955,276    5,447,398 
Deposit paid to banks for financial guarantee services   (5,653,718)   (4,584,430)
Purchases of property and equipment   (2,977)   (58,758)
Net Cash Used in Investing Activities   (6,818,510)   (2,185,909)
           
Cash Flows From Financing Activities :          
Proceeds from short-term bank borrowings   -    4,881,859 
Repayment of short-term bank borrowings   (4,879,636)   (10,563,457)
Issuance of Series A Preferred stocks   -    50,000 
Issuance of Series B Preferred Stocks   -    70,000 
Issuance cost of Series A and Series B Preferred Stocks   -    (12,744)
Proceeds from initial public offering, net off offering costs   -    7,473,528 
Proceeds from second public offering, net off offering costs   6,601,544    - 
Proceeds from exercise of underwriter over-allotment, net off offering costs   25,000    255,992 
Common Stock issuance cost   (872,785)   (80,019)
Capital contribution from a shareholder   11,571    - 
Cash disbursed to a non- controlling shareholder   (2,289,402)   - 
Cash repaid from a non- controlling shareholder   1,135,940    - 
Net Cash (Used in)/Provided by Financing Activities   (267,768)   2,075,159 
           
Effect of Exchange Rate Changes on Cash and Cash Equivalents   (125,631)   72,797 
           
Net (Decrease)/Increase In Cash and Cash Equivalents   (5,273,083)   5,384,094 
Cash and Cash Equivalents at Beginning of Period   9,405,865    1,588,061 
Cash and Cash Equivalents at End of Period  $4,132,782   $6,972,155 
           
Supplemental Cash Flow Information          
Cash paid for interest expense  $658,322   $909,190 
Cash paid for income tax  $930,437   $2,057,841 

 

See notes to the consolidated financial statements

 

6
 

 

 

CHINA COMMERCIAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

 

1. ORGANIZATION AND PRINCIPAL ACTIVITIES

 

China Commercial Credit, Inc. (“CCC” or “the Company”) is a holding company that was incorporated under the laws of the State of Delaware on December 19, 2011.

 

Wujiang Luxiang Rural Microcredit Co., Ltd (“Wujiang Luxiang”) is a company established under the laws of the PRC on October 21, 2008 and its shareholders consist of 11 companies established under the laws of the People's Republic of China (“PRC”) and 1 PRC individual, Mr. Qin Huichun, the Company's former CEO (collectively, the "Wujiang Luxiang Shareholders"). The Company is a microcredit company primarily engaged in providing direct loans and financial guarantee services to small-to-medium sized enterprises (“SMEs”), farmers and individuals in Wujiang City, Jiangsu Province, PRC.

 

On August 7, 2012, CCC entered into certain share exchange agreements with 16 PRC individuals, each of whom is the sole shareholder of a British Virgin Island company (collectively “16 BVI entities”) and the 16 BVI entities. These 16 PRC individuals represent the ultimate owners of the Wujiang Luxiang Shareholders.

 

Upon completion of the share exchange, the 16 PRC individuals, through their respective BVI entities, acquired 7,270,920  shares of Common Stock, par value $0.001 per share (the "Common Stock") of CCC in exchange for their agreement to cause the Wujiang Luxiang Shareholders to enter into the Variable Interest Entity (the “VIE”) Agreements. As a result of the share exchange, the 16 BVI entities became CCC shareholders, who collectively owned approximately 90% of CCC’s total issued and outstanding shares of Common Stock at the time of the share exchange.

 

Since at the time of the share exchange neither CCC nor the 16 BVI entities had any operations and only a minor amount of net assets, the share exchange shall be considered as a capital transaction in substance, rather than a business combination.

 

The share exchange is recorded as a “reverse recapitalization” equivalent to the issuance of stock to the 16 BVI entities for the net monetary assets of CCC. The accounting for the transaction is identical to a reverse acquisition, except that no goodwill is recorded.

 

Management of the Company looked through the 16 BVI entities and treated the share exchange as a reverse merger between CCC and Wujiang Luxiang for accounting purposes, even though the share exchange was between CCC and the 16 BVI entities, because of the following reasons: (i) neither CCC nor the 16 BVI entities had any operations and only a minor amount of net assets; (ii) the 16 PRC individual, who are the owners of the 16 BVI entities, are the ultimate owners of Wujiang Luxiang, and (iii) the sole purpose of the share exchange was to issue approximately 90%  of pre-public offering CCC shares to the ultimate owners of the Wujiang Luxiang Shareholders.

 

7
 

 

CHINA COMMERCIAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

  

VIE AGREEMENTS WITH WUJIANG LUXIANG

 

Subsequent to the share exchange, on September 26, 2012, the Company through its indirectly wholly owned subsidiary, Wujiang Luxiang Information Technology Consulting Co. Ltd. (“WFOE”), entered into a series of VIE Agreements with Wujiang Luxiang and the Wujiang Luxiang Shareholders. The purpose of the VIE Agreements is solely to give WFOE the exclusive control over Wujiang Luxiang’s management and operations.

 

The significant terms of the VIE Agreements are summarized below:

 

Exclusive Business Cooperation Agreement

 

Pursuant to the Exclusive Business Cooperation Agreement between Wujiang Luxiang and WFOE, WFOE provides Wujiang Luxiang with technical support, consulting services and other management services relating to its day-to-day business operations and management, on an exclusive basis, utilizing its advantages in technology, human resources, and information. Additionally, Wujiang Luxiang grants an irrevocable and exclusive option to WFOE to purchase from Wujiang Luxiang any or all of its assets at the lowest purchase price permitted under PRC laws. For services rendered to Wujiang Luxiang by WFOE under the Agreement, the service fee Wujiang Luxiang is obligated to pay shall be calculated based on the time of services rendered multiplied by the corresponding rate, which is approximately equal to the net income of Wujiang Luxiang.

 

The Exclusive Business Cooperation Agreement shall remain in effect for ten years unless it is terminated by WFOE with 30-day prior notice. Wujiang Luxiang does not have the right to terminate the agreement unilaterally. WFOE may unilaterally extend the term of this agreement with prior written notice.

 

8
 

 

CHINA COMMERCIAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

 

Share Pledge Agreement

 

Under the Share Pledge Agreement between the Wujiang Shareholders and WFOE, the 12 Wujiang Shareholders pledged all of their equity interests in Wujiang Luxiang to WFOE to guarantee the performance of Wujiang Luxiang’s obligations under the Exclusive Business Cooperation Agreement.  Under the terms of the agreement, in the event that Wujiang Luxiang or its shareholders breach their respective contractual obligations under the Exclusive Business Cooperation Agreement, WFOE, as pledgee, will be entitled to certain rights, including, but not limited to, the right to collect dividends generated by the pledged equity interests.  The Wujiang Shareholders also agreed that upon occurrence of any event of default, as set forth in the Share Pledge Agreement, WFOE is entitled to dispose of the pledged equity interest in accordance with applicable PRC laws.  The Wujiang Shareholders further agree not to dispose of the pledged equity interests or take any actions that would prejudice WFOE’s interest.

 

Exclusive Option Agreement

 

Under the Exclusive Option Agreement, the Wujiang Shareholders irrevocably granted WFOE (or its designee) an exclusive option to purchase, to the extent permitted under PRC law, once or at multiple times, at any time, part or all of their equity interests in Wujiang Luxiang.  The option price is equal to the capital paid in by the Wujiang Shareholders subject to any appraisal or restrictions required by applicable PRC laws and regulations.

 

Power of Attorney

 

Under the Power of Attorney, the Wujiang Shareholders authorize WFOE to act on their behalf as their exclusive agent and attorney with respect to all rights as shareholders, including but not limited to:  (a) attending shareholders' meetings; (b) exercising all the shareholder's rights, including voting, that shareholders are entitled to under the laws of China and the Articles of Association, including but not limited to the sale or transfer or pledge or disposition of shares in part or in whole; and (c) designating and appointing on behalf of shareholders the legal representative, the executive director, supervisor, the chief executive officer and other senior management members of Wujiang Luxiang. The Power of Attorney is coupled with an interest and shall be irrevocable and continuously valid from the date of execution, so long as the Wujiang Shareholder is a shareholder of the Company.

 

Timely Reporting Agreement

 

To ensure Wujiang Luxiang promptly provides all of the information that WFOE and the Company need to file various reports with the SEC, a Timely Reporting Agreement was entered between Wujiang Luxiang and the Company.

 

Under the Timely Reporting Agreement, Wujiang Luxiang agrees that it is obligated to make its officers and directors available to the Company and promptly provide all information required by the Company so that the Company can file all necessary SEC and other regulatory reports as required.

 

9
 

 

CHINA COMMERCIAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

 

INCORPORATION OF PFL

 

On September 5, 2013, our wholly owned subsidiary, CCC International Investment Holding Ltd. (“CCC HK”), established Pride Financial Leasing (Suzhou) Co. Ltd. (“PFL”) in Jiangsu Province, China. PFL was expected to offer financial leasing of machinery and equipment, transportation vehicles, and medical devices to municipal government agencies, hospitals and SMEs in Jiangsu Province and beyond. As of September 30, 2014, PFL incurred one finance lease transaction.

 

VIE AGREEMENTS WITH PRIDE INFORMATION

 

On February 19, 2014, WFOE entered into certain contractual arrangements with Mr. Huichun Qin and Pride Information Technology Co. Ltd. (“Pride Information”),   a domestic entity established on February 19, 2014 and 100% owned by Mr. Qin. Pursuant to these contractual arrangements, WFOE shall have the power, rights and obligations equivalent in all material respects to those it would possess as the sole equity holder of Pride Information, including absolute control rights and the rights to the assets, property and revenue of Pride Information and as a result, approximately 100% of the net income of Pride Information shall be paid as a service fee to WFOE.

 

The contractual arrangements between WFOE, Pride Information and its sole shareholder, Mr. Huichun Qin, have substantially the same terms as those between WFOE, Wujiang Luxiang and its shareholders.

 

Pride Information operates an online portal (www. pridelendingclub.com) to match prospective borrowers with lenders. As of September 30, 2014, Pride Information is in the beginning stage of operation and has generated minimal revenue.

 

2.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

(a) Basis of presentation and principle of consolidation

 

The unaudited interim consolidated financial statements are prepared and presented in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”).

 

The interim financial information as of September 30, 2014 and for the three months and nine months ended September 30, 2014 and 2013 have been prepared without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) and pursuant to Regulation S-X. Certain information and footnote disclosures, which are normally included in annual financial statements prepared in accordance with U.S. GAAP, have been omitted pursuant to those rules and regulations. The unaudited interim financial information should be read in conjunction with the audited financial statements and the notes thereto, included in the Form 10-K for the fiscal year ended December 31, 2013 filed with the SEC on March 31, 2014.

 

10
 

 

CHINA COMMERCIAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

  

In the opinion of management, all adjustments (which include normal recurring adjustments) necessary to present a fair statement of the Company’s financial position as of September 30, 2014, its results of operations for the three months and nine months ended September 30, 2014 and 2013, and its cash flows for the nine months ended September 30, 2014 and 2013, as applicable, have been made. The unaudited interim results of operations are not necessarily indicative of the operating results for the full fiscal year or any future periods.

 

(b) Operating segments

 

ASC 280, Segment Reporting requires companies to report financial and descriptive information about their reportable operating segments, including segment profit or loss, certain specific revenue and expense items, and segment assets. The Company has no reportable segments. All of the Company's activities are interrelated, and each activity is dependent and assessed based on how each of the activities of the Company supports the others. For example, lending is dependent upon the ability of the Company to fund itself with registered capital and other borrowings and manage interest rate and credit risk.

 

The Company has only one reportable segment, which is to provide financial services in the PRC domestic market, primarily in Wujiang City, Jiangsu Province. The Company’s chief operating decision-maker (“CODM”) has been identified as the Chief Executive Officer, who reviews operating results to make decisions about allocating resources and assessing performance for both the direct lending and guarantee business and the anticipated financial leasing business. The Company’s net revenues are all generated from customers in the PRC. Hence, the Company operates and manages its business without segments. For the three months and nine months ended September 30, 2014 and 2013, there was no one customer that accounted for more than 10% of the Company's revenue.

 

(c) Cash

 

Cash consists of bank deposits with original maturities of three months or less, which are unrestricted as to withdrawal and use The Company maintains accounts at banks and has not experienced any losses from such concentrations.

 

(d) Restricted cash

 

Restricted cash represents cash pledged with banks as guarantor deposit for the guarantee business customers. The banks providing loans to the Company’s guarantee service customers generally require the Company, as the guarantor of the loans, to pledge a cash deposit of 10% to 20% of the guaranteed amount to an escrow account and is restricted from use. The deposits are released after the guaranteed bank loans are paid off and the Company’s guarantee obligation expires which is usually within 12 months.

 

(e) Loans receivable, net

 

Loans receivable primarily represent loan amount due from customers. The management has the intent and ability to hold such receivable for the foreseeable future or until maturity or payoff. Loans receivable are recorded at unpaid principal balances, net of unearned income and allowance that reflects the Company’s best estimate of the amounts that will not be collected. Loan origination and commitment fees and certain direct loan origination costs collected from customers are directly recorded in current year interests and fees on loans. The loans receivable portfolio consists of corporate loans and personal loans (Note 6). The Company does not charge loan origination and commitment fees.

 

11
 

 

CHINA COMMERCIAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

 

(f) Allowance for loan losses

 

The allowance for loan losses is increased by charges to income and decreased by charge offs (net of recoveries). Recoveries represent subsequent collection of amounts previously charged-off. The increase in allowance for loan losses is the netting effect of “reversal” and “provision” for both business and personal loans. If the ending balance of the allowance for loan losses after any charge offs (net of recoveries) is less than the beginning balance, it will be recorded as a “reversal”; if it is larger, it will be recorded as a “provision” in the allowance for loan loss. The netting amount of the “reversal” and the “provision” is presented in the consolidated statements of operations and comprehensive income (loss).

 

The Company recognizes a charge-off when management determines that full repayment of a loan is not probable. The primary factor in making that determination is the potential outcome of a lawsuit against the delinquent debtor. The Company will recognize a charge-off when the Company loses contact with the delinquent borrower for more than six months or when the court rules against the Company to seize the collateral asset of the delinquent debt from either the guarantor or borrower.

 

The allowance for loan losses is maintained at a level believed to be reasonable by management to absorb probable losses inherent in the portfolio as of each balance sheet date. The allowance is based on factors such as the size and current risk characteristics of the portfolio, an assessment of individual loan and actual loss, delinquency, and/or risk rating record within the portfolio (Note 7). The Company evaluates its allowance for loan losses on a quarterly basis or more often as necessary.

 

(g) Interest receivable

 

Interest on loans receivable is accrued and credited to income as earned. The Company determines a loan past due status by the number of days that have elapsed since a borrower has failed to make a contractual loan payment. Accrual of interest is generally discontinued when either (i) reasonable doubt exists as to the full, timely collection of interest or principal or (ii) when a loan becomes past due by more than 90 days. Additionally, any previously accrued but uncollected interest is reversed. Subsequent recognition of income occurs only to the extent payment is received, subject to management’s assessment of the collectability of the remaining interest and principal. Loans are generally restored to an accrual status when it is no longer delinquent and collectability of interest and principal is no longer in doubt and past due interest is recognized at that time.

 

The interest reversed due to the above reason was $1,434,100 and $210,136 as of September 30, 2014 and December 31, 2013, respectively.

 

12
 

 

CHINA COMMERCIAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

 

(h) Property and equipment

 

The property and equipment are stated at cost less accumulated depreciation. The depreciation is computed on a straight-line method over the estimated useful lives of the assets with 5% salvage value. Estimated useful lives of property and equipment are stated in Note 12.

 

The Company eliminates the cost and related accumulated depreciation of assets sold or otherwise retired from the accounts and includes any gain or loss in the statement of income. The Company charges maintenance, repairs and minor renewals directly to expenses as incurred; major additions and betterment to equipment are capitalized.

 

(i) Impairment of long-lived assets

 

The Company applies the provisions of ASC No. 360 Sub topic 10, "Impairment or Disposal of Long-Lived Assets"(ASC 360- 10) issued by the Financial Accounting Standards Board ("FASB"). ASC 360-10 requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable through the estimated undiscounted cash flows expected to result from the use and eventual disposition of the assets. Whenever any such impairment exists, an impairment loss will be recognized for the amount by which the carrying value exceeds the fair value.

 

The Company tests long-lived assets, including property and equipment and finite lived intangible assets, for impairment at least annually or more frequently upon the occurrence of an event or when circumstances indicate that the net carrying amount is greater than its fair value. Assets are grouped and evaluated at the lowest level for their identifiable cash flows that are largely independent of the cash flows of other groups of assets. The Company considers historical performance and future estimated results in its evaluation of potential impairment and then compares the carrying amount of the asset to the future estimated cash flows expected to result from the use of the asset. If the carrying amount of the asset exceeds estimated expected undiscounted future cash flows, the Company measures the amount of impairment by comparing the carrying amount of the asset to its fair value. The estimation of fair value is generally measured by discounting expected future cash flows as the rate the Company utilizes to evaluate potential investments. The Company estimates fair value based on the information available in making whatever estimates, judgments and projections are considered necessary. There were no impairment losses in the three months and nine months ended September 30, 2014 and 2013.

 

(j) Fair values of financial instruments

 

ASC Topic 825, Financial Instruments (“Topic 825”) requires disclosure of fair value information of financial instruments, whether or not recognized in the balance sheets, for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instruments. Topic 825 excludes certain financial instruments and all nonfinancial assets and liabilities from its disclosure requirements. Accordingly, the aggregate fair value amounts do not represent the underlying value of the Company.

 

Level 1 inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2 inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the assets or liability, either directly or indirectly, for substantially the full term of the financial instruments.
Level 3 inputs to the valuation methodology are unobservable and significant to the fair value.

 

13
 

 

CHINA COMMERCIAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

 

As of September 30, 2014 and December 31, 2013, financial instruments of the Company primarily comprise of cash, restricted cash, notes receivable, accrued interest receivable, other receivable, short-term bank loans, deposits payable and accrued expenses, which were carried at cost on the consolidated balance sheets, and carrying amounts approximated their fair values because of their generally short maturities.

 

(k) Foreign currency translation

 

The reporting currency of the Company is United States Dollars (“US$”), which is also the Company’s functional currency. The PRC subsidiaries and VIEs maintain their books and records in its local currency, the Renminbi Yuan (“RMB”), which is their functional currencies as being the primary currency of the economic environment in which these entities operate.

 

For financial reporting purposes, the financial statements of the Company prepared using RMB are translated into the Company’s reporting currency, United States Dollars, at the exchange rates quoted by www.oanda.com. Assets and liabilities are translated using the exchange rate at each balance sheet date. Revenue and expenses are translated using average rates prevailing during each reporting period, and shareholders’ equity is translated at historical exchange rates. Adjustments resulting from the translation are recorded as a separate component of accumulated other comprehensive income in shareholders’ equity.

 

   September 30,
2014
   December 31,
2013
 
Balance sheet items, except for equity accounts   6.1547    6.1122 

 

   For the nine months ended
September 30,
 
   2014   2013 
Items in the statements of operations and comprehensive income (loss), and statements of cash flows   6.1480    6.2173 

 

(l) Use of estimates

 

The preparation of consolidated financial statements in conformity with U.S.GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. On an ongoing basis, management reviews these estimates using the currently available information. Changes in facts and circumstances may cause the Company to revise its estimates. Significant accounting estimates reflected in the financial statements include: (i) the allowance for doubtful debts; (ii) estimates of losses on unexpired loan contracts and guarantee service contracts; (iii) accrual of estimated liabilities; (iv) useful lives of long-lived assets; (v) the impairment of long-lived assets; (vi) the valuation allowance of deferred tax assets; and (vii) contingencies and litigation.

 

14
 

 

CHINA COMMERCIAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

 

(m) Revenue recognition

 

Revenue is recognized when there are probable economic benefits to the Company and when the revenue can be measured reliably, on the following:

 

Interest income on loans. Interest on loan receivables is accrued monthly in accordance with their contractual terms and recorded in accrued interest receivable. The Company does not charge prepayment penalty from customers. Additionally, any previously accrued but uncollected interest is discontinued of accrual and reversed, when either (i) reasonable doubt exists as to the full, timely collection of interest or principal or (ii) when a loan becomes past due by more than 90 days.
   
Commission on guarantee service. The Company receives the commissions from guarantee services in full at inception and records as unearned income before amortizing it throughout the period of guarantee.
   
 ●

Income on direct financing lease. The financing agreements are classified as direct financing lease as prescribed by the Financial Accounting Standards Board (“FASB”). Revenues representing the capitalized costs of the investment are recognized as income upon inception of the leases. The portion of revenues representing the difference between the gross investment in the lease (the sum of the minimum lease payments and the guaranteed residual value, if any) and the sum of the present value of the two components is recorded as unearned income and amortized over the lease term.

   
Taxes assessed by governmental authorities that are directly imposed on revenue-producing transactions between the Company and its customers (which may include, but are not limited to, sales, use, value added and some excise taxes) are excluded from revenues.
   
Lessees are responsible for all taxes, insurance and maintenance costs.
   
Non-interest income. Non-interest income mainly includes government incentive and rental income from the sub-leasing of certain of the Company’s leased office space to third parties. Government incentive is provided by Jiangsu Provincial government on a yearly basis to promote the development of micro credit agencies in Jiangsu Province.

 

(n) Financial guarantee service contracts

 

Financial guarantee service contracts provides guarantees which protects the holder of a debt obligation against default. Pursuant to such guarantee, the Company makes payments if the obligor responsible for making payments fails to do so as scheduled.

 

The contract amounts reflect the extent of involvement the Company has in the guarantee transactions and also represent the Company’s maximum exposure to credit loss in its guarantee business.

 

The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. Financial instruments representing credit risk are as follows:

 

   September 30,
2014
(Unaudited)
   December 31,
2013
 
Guarantee  $21,901,961   $59,692,091 

 

15
 

 

CHINA COMMERCIAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

 

A provision for possible loss to be absorbed by the Company for the financial guarantee it provides is recorded as an accrued liability when the guarantees are made and recorded as “Accrual for financial guarantee services” on the consolidated balance sheets. This liability represents probable losses and is increased or decreased by accruing an “(Under)/over provision on financial guarantee services” against the income of commissions and fees on guarantee services reserve.

 

This is done throughout the life of the guarantee, as necessary when additional relevant information becomes available. The methodology used to estimate the liability for possible guarantee loss considers the guarantee contract amount and a variety of factors, which include, depending on the counterparty, latest financial position and performance of the borrowers, actual defaults, estimated future defaults, historical loss experience, estimated value of collaterals or guarantees the costumers or third parties offered, and other economic conditions such as the economy trend of the area and the country. The estimates are based upon currently available information.

 

Based on the past experience, the Company estimates the probable loss for immature financial guarantee services to be 1% of contract amount and made a provision of $60,848 as of September 30, 2014 for possible credit risk of its guarantees. Besides the Company accrued specific provisions for repayment on behalf of guarantee customers who defaulted on their loans, in the amount of $4,295,533 as of September 30, 2014. The total accrual for financial guarantee services amounted to $4,356,381 and $588,740 as of September 30, 2014 and December 31, 2013, respectively. The Company reviews the provision on a quarterly basis.

 

(o) Non-interest expenses

 

Non-interest expenses primarily consist of salary and benefits for employees, traveling cost, entertainment expenses, depreciation of equipment, office rental expenses, professional service fee, office supplies, etc.

 

(p) Income tax

 

Current income tax expenses are provided for in accordance with the laws of the relevant taxing authorities. As part of the process of preparing financial statements, the Company is required to estimate its income taxes in each of the jurisdictions in which it operates. The Company accounts for income taxes using the liability approach. Under this method, deferred income taxes are recognized for tax consequences in future years of differences between the tax bases of assets and liabilities and their reported amounts in the financial statements at each year-end and tax loss carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates applicable for the differences that are expected to affect taxable income.

 

(q) Comprehensive income

 

Comprehensive income includes net income and foreign currency adjustments. Comprehensive income is reported in the statements of operations and comprehensive income.

 

16
 

 

CHINA COMMERCIAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

 

Accumulated other comprehensive income, as presented on the balance sheets are the cumulative foreign currency translation adjustments.

 

(r) Operating leases

 

The Company leases its principal office under a lease agreement that qualifies as an operating lease. The Company records the rental under the lease agreement in the operating expense when incurred.

 

(s) Commitments and contingencies

 

In the normal course of business, the Company is subject to loss contingencies, such as legal proceedings and claims arising out of its business, that cover a wide range of matters, including, among others, government investigations and tax matters. In accordance with ASC No. 450 Sub topic 20, “Loss Contingencies”, the Company records accruals for such loss contingencies when it is probable that a liability has been incurred and the amount of loss can be reasonably estimated.

 

(t) Recently issued accounting standards

 

The FASB has issued ASU No. 2014-09, Revenue from Contracts with Customers. This ASU supersedes the revenue recognition requirements in Accounting Standards Codification 605 - Revenue Recognition and most industry-specific guidance throughout the Codification. The standard requires that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. This ASU is effective on January 1, 2017 and should be applied retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially applying the ASU recognized at the date of initial application. For all other entities (nonpublic entities), the amendments in this ASU are effective for annual reporting periods beginning after December 15, 2017, and interim periods within annual periods beginning after December 15, 2018. A nonpublic entity may elect to apply this guidance earlier, however, only as prescribed in this ASU. The adoption of this standard is not expected to have a material impact on the Company’s (consolidated) financial position and results of operations.

 

The FASB has issued ASU No. 2014-12, Compensation - Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period. This ASU requires that a performance target that affects vesting, and that could be achieved after the requisite service period, be treated as a performance condition. As such, the performance target should not be reflected in estimating the grant date fair value of the award. This update further clarifies that compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered.. The amendments in this ASU are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Earlier adoption is permitted. The adoption of this standard is not expected to have a material impact on the Company’s consolidated financial position and results of operations.

 

3.VARIABLE INTEREST ENTITIES AND OTHER CONSOLIDATION MATTERS

 

On September 26, 2012, the Company, through WFOE, entered into a series of contractual arrangements, also known as “VIE Agreements” with Wujiang Luxiang and the Wujiang Luxiang Shareholders.

 

On February 19, 2014, WFOE entered into certain contractual arrangements, having substantially the same terms as those of the VIE Agreements with Pride Information and its sole shareholder, Mr. Huichun Qin.

 

The significant terms of the VIE Agreements are summarized in Note 1.

 

17
 

CHINA COMMERCIAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

 

VIEs are entities that have either a total equity investment that is insufficient to permit the entity to finance its activities without additional subordinated financial support, or whose equity investors lack the characteristics of a controlling financial interest, such as through voting rights, right to receive the expected residual returns of the entity or obligation to absorb the expected losses of the entity. The variable interest holder, if any, that has a controlling financial interest in a VIE is deemed to be the primary beneficiary and must consolidate the VIE. WFOE is deemed to have a controlling financial interest and be the primary beneficiary of the entities mentioned in Note 1 above, because it has both of the following characteristics:

 

  1. power to direct activities of a VIE that most significantly impact the entity’s economic performance, and
     
  2. obligation to absorb losses of the entity that could potentially be significant to the VIE or right to receive benefits from the entity that could potentially be significant to the VIE.

 

In addition, as all of these contractual arrangements are governed by PRC law and provide for the resolution of disputes through either arbitration or litigation in the PRC, they would be interpreted in accordance with PRC law and any disputes would be resolved in accordance with PRC legal procedures. The legal environment in the PRC is not as developed as in other jurisdictions, such as the United States. As a result, uncertainties in the PRC legal system could further limit the Company’s ability to enforce these contractual arrangements. Furthermore, these contracts may not be enforceable in China if PRC government authorities or courts take a view that such contracts contravene PRC laws and regulations or are otherwise not enforceable for public policy reasons. In the event the Company is unable to enforce these contractual arrangements, it may not be able to exert effective control over Wujiang Luxiang, and Pride Information and its ability to conduct its business may be materially and adversely affected.

 

All of the Company’s main current operations are conducted through Wujiang Luxiang and PFL. Current regulations in China permit Wujiang Luxiang and PFL to pay dividends to us only out of its accumulated distributable profits, if any, determined in accordance with their articles of association and PRC accounting standards and regulations. The ability of Wujiang Luxiang and PFL to make dividends and other payments to the Company may be restricted by factors including changes in applicable foreign exchange and other laws and regulations.

 

The following financial statement amounts and balances of the VIEs were included in the accompanying consolidated financial statements as of September 30, 2014 and December 31, 2013 and for the three and nine months ended September 30, 2014 and 2013:

 

   September 30,
2014
(Unaudited)
   December 31,
2013
 
Total assets  $87,658,899   $105,477,241 
Total liabilities   20,920,155    28,053,542 

 

   For The Three Months Ended
September 30,
   For The Nine Months Ended
September 30,
 
   2014
(Unaudited)
   2013
(Unaudited)
   2014
(Unaudited)
   2013
(Unaudited)
 
Revenue  $1,553,520   $3,385,431   $6,517,256   $10,464,105 
Net (loss)/income   (5,627,816)   2,404,572    (21,158,128)   6,104,429 

 

18
 

 

CHINA COMMERCIAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

 

All of the Company’s current revenue is generated in RMB. Any future restrictions on currency exchanges may limit our ability to use net revenues generated in RMB to make dividends or other payments in US$ or fund possible business activities outside China.

 

Foreign currency exchange regulation in China is primarily governed by the following rules:

 

  Foreign Exchange Administration Rules (1996), as amended in August 2008, or the Exchange Rules; and
     
  Administration Rules of the Settlement, Sale and Payment of Foreign Exchange (1996), or the Administration Rules.

 

Under the Administration Rules, RMB is freely convertible for current account items, including the distribution of dividends, interest payments, trade and service related foreign exchange transactions, but not for capital account items, such as direct investments, loans, repatriation of investments and investments in securities outside of China, unless the prior approval of the State Administration of Foreign Exchange (“SAFE”) is obtained and prior registration with the SAFE is made. Foreign-invested enterprises like WFOE that need foreign currency for the distribution of profits to their shareholders may validate payment from their foreign currency accounts or purchase and pay foreign currencies at the designated foreign exchange banks to their foreign shareholders by producing board resolutions for such profit distribution. Based on their needs, foreign invested enterprises are permitted to open foreign currency settlement accounts for current account receipts and payments of foreign exchange along with specialized accounts for capital account receipts and payments of foreign currency at certain designated foreign exchange banks.

 

4.RISKS

 

(a) Credit risk

 

Credit risk is one of the most significant risks for the Company’s business. Credit risk exposures arise principally in lending activities, finance lease and financial guarantee activities which is an off-balance sheet financial instrument.

 

Credit risk is controlled by the application of credit approvals, limits and monitoring procedures. The Company manages credit risk through in-house research and analysis of the Chinese economy and the underlying obligors and transaction structures. To minimize credit risk, the Company requires collateral in the form of rights to cash, securities or property and equipment.

 

The Company identifies credit risk collectively based on industry, geography and customer type. This information is monitored regularly by management.

 

1.1 Lending activities

 

In measuring the credit risk of lending loans to corporate customers, the Company mainly reflects the “probability of default” by the customer on its contractual obligations and considers the current financial position of the customer and the exposures to the customer and its likely future development. For individual customers, the Company uses standard approval procedures to manage credit risk for personal loans.

 

19
 

 

CHINA COMMERCIAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

 

The Company measures and manages the credit quality of loans to corporate and personal customers based on the “Guideline for Loan Credit Risk Classification” (the “Guideline”) issued by the China Banking Regulatory Commission, which requires commercial banks and micro-credit institutions to classify their corporate and personal loans into five categories: (1) pass, (2) special-mention, (3) substandard, (4) doubtful and (5) loss, among which loans classified in the substandard, doubtful and loss categories are regarded as non-performing loans. The Guideline also determines the percentage of each category of non-performing loans as allowances, which are 2% on special-mention loan, 25% on substandard loans, 50% on doubtful loans and 100% on loss loans.

 

The five categories are defined as follows:

 

  (1) Pass: loans for which borrowers can honor the terms of the contracts, and there is no reason to doubt their ability to repay principal and interest of loans in full and on a timely basis.
     
  (2) Special-mention: loans for which borrowers are still able to service the loans currently, although the repayment of loans might be adversely affected by some factors.
     
  (3) Substandard: loans for which borrowers’ ability to service loans is apparently in question and borrowers cannot depend on their normal business revenues to pay back the principal and interest of loans. Certain losses might be incurred by the Company even when guarantees are executed.
     
  (4) Doubtful: loans for which borrowers cannot pay back principal and interest of loans in full and significant losses will be incurred by the Company even when guarantees are executed.
     
  (5) Loss: principal and interest of loans cannot be recovered or only a small portion can be recovered after taking all possible measures and resorting to necessary legal procedures.

 

Five-category loan classifications are re-examined on a quarterly basis. Adjustments are made to these classifications as necessary according to customers’ operational and financial position .

 

The Guideline stipulates that micro-credit companies, which are limited to provide short-term loans and financial guarantee services to only small to medium size businesses, should choose a reasonable methodology to provide allowance for the probable loss from the credit risk, and the allowance should not be less than the allowance amount derived from the five-category analysis. The Company continuously performs the analysis and believes that the allowance amount it provided is consistently more than the allowance amount derived from the five-category analysis.

 

1.2 Guarantee activities

 

The off-balance sheet commitments arising from guarantee activities carry similar credit risk to loans and the Company takes a similar approach on risk management.

 

Off-balance sheet commitments with credit exposures are also assessed and categorized with reference to the Guideline.

 

20
 

 

CHINA COMMERCIAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

 

(b) Liquidity risk

 

The Company is also exposed to liquidity risk which is risk that it is unable to provide sufficient capital resources and liquidity to meet its commitments and business needs. Liquidity risk is controlled by the application of financial position analysis and monitoring procedures. When necessary, the Company will turn to other financial institutions and the owners to obtain short-term funding to meet the liquidity shortage.

 

(c) Foreign currency risk

 


A majority of the Company’s operating activities and a significant portion of the Company’s assets and liabilities are denominated in RMB, which is not freely convertible into foreign currencies. All foreign exchange transactions take place either through the Peoples’ Bank of China (“PBOC”) or other authorized financial institutions at exchange rates quoted by PBOC. Approval of foreign currency payments by the PBOC or other regulatory institutions requires submitting a payment application form together with suppliers' invoices and signed contracts. The value of RMB is subject to changes in central government policies and to international economic and political developments affecting supply and demand in the China Foreign Exchange Trading System market.

 

(d) Concentration risk

 

As of September 30, 2014 and December 31, 2013, the Company held cash of $4,132,219 and $9,405,783, respectively, that is uninsured by the government authority. To limit exposure to credit risk relating to deposits, the Company primarily places cash deposits only with large financial institutions in the PRC with acceptable credit ratings.

 

The Company’s operations are carried out in the PRC. Accordingly, the Company’s business, financial condition and results of operations may be influenced by the political, economic and legal environments in the PRC as well as by the general state of the PRC’s economy. The business may be influenced by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, and rates and methods of taxation, among other things.

 

No customer accounted for more than 10% of total loan balance as of September 30, 2014 and December 31, 2013.

 

5.RESTRICTED CASH

 

Restricted cash represents cash pledged with banks as guarantor deposit for the Company's guarantee service customers, amounting to $2.9 and $10.8 million as of September 30, 2014 and December 31, 2013, respectively. The banks providing loans to the Company’s guarantee service customers generally require the Company, as the guarantor of the loans, to pledge a cash deposit usually in the range of 10% to 30% of the guaranteed amount. The deposits are released after the guaranteed bank loans are paid off and the Company’s guarantee obligation expires which is usually within 12 months.

 

21
 

 

CHINA COMMERCIAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

 

At the same time, the Company requires the guarantee service customers to make a deposit to the Company of the same amount as the deposit the Company pledged to the banks for their loans. The Company recorded the deposit received as “deposits payable” on the unaudited consolidated balance sheet. The deposit is returned to the customer after the customer repays the bank loan and the Company’s guarantee obligation expires .

 

6.LOANS RECEIVABLE, NET

 

The interest rates on loan issued ranged between 9.6%~18.0% and 9.6% ~ 21.6% for the nine months ended September 30, 2014 and 2013, respectively.

 

6.1 Loans receivable consist of the following:

 

   September 30,
2014
(Unaudited)
   December 31,
2013
 
         
Business loans  $53,682,882   $56,620,893 
Personal loans   32,870,154    33,582,520 
Total Loans receivable   86,533,036    90,203,413 
Allowance for impairment losses          
Collectively assessed   (20,992,454)   (1,375,948)
Individually assessed   -    - 
Allowance for loan losses   (20,992,454)   (1,375,948)
Loans receivable, net  $65,560,582   $88,827,465 

 

The Company originates loans to customers located primarily in Wujiang City, Jiangsu Province. This geographic concentration of credit exposes the Company to a higher degree of risk associated with this economic region.

 

All loans are short-term loans that the Company has made to either business or individual customers. As of September 30, 2014 and December 31, 2013, the Company had 115 and 105 business loan customers, and 122 and 112 personal loan customers, respectively. Most loans are either guaranteed by a third party whose financial strength is assessed by the Company to be sufficient or secured by collateral. Allowance on loan losses are estimated on quarterly basis in accordance with “The Guidance on Provision for Loan Losses” published by PBOC (Note 7).

 

For the nine months ended September 30, 2014 and 2013, a provision of $21,164,733 and $500,123 were charged to the consolidated statement of income, respectively. For the three months ended September 30, 2014 and 2013, a provision of $5,817,156 and a reversal of $340,965 were charged to the consolidated statement of income, respectively. No write-offs against allowances have occurred for these periods.

 

Interest on loans receivable is accrued and credited to income as earned. The Company determines a loan’s past due status by the number of days that have elapsed since a borrower has failed to make a contractual loan payment. Accrual of interest is generally discontinued when either (i) reasonable doubt exists as to the full, timely collection of interest or principal or (ii) when a loan becomes past due by more than 90 days.

 

22
 

 

CHINA COMMERCIAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

 

The following table presents nonaccrual loans with aging over 90 days by classes of loan portfolio as of September 30, 2014 and December 31, 2013, respectively:

 

   September 30,
2014
(Unaudited)
   December 31,
2013
 
         
Business loans  $17,105,306   $1,866,436 
Personal loans   17,151,933    948,922 
   $34,257,239   $2,815,358 

 

The following table represents the aging of loans as of September 30, 2014 by type of loan:

 

   1-89 Days
Past Due
   90 - 179 Days Past Due   180 - 365 Days Past Due   Over 1 year Past Due   Total Past Due   Current   Total Loans 
   (Unaudited)   (Unaudited)   (Unaudited)   (Unaudited)   (Unaudited)   (Unaudited)   (Unaudited) 
                             
Business loans  $6,685,947   $6,861,142   $2,621,432   $936,785   $17,105,306   $36,577,575   $53,682,882 
Personal loans   10,455,425    5,461,680    1,186,085    48,743    17,151,933    15,718,221    32,870,154 
   $17,141,372   $12,322,822   $3,807,517   $985,528   $34,257,239   $52,295,796   $86,533,036 

 

The following table represents the aging of loans as of December 31, 2013 by type of loan:

 

   1-89 Days
Past Due
   90 - 179 Days Past Due   180 - 365 Days Past Due   Over 1 year Past Due   Total Past Due   Current   Total Loans 
                             
Business loans  $2,039,559   $130,886   $427,479    1,308,071   $3,905,995   $52,714,898   $56,620,893 
Personal loans   312,993    736,232    81,804    130,886    1,261,915    32,320,605    33,582,520 
   $2,352,552   $867,118   $509,283    1,438,957   $5,167,910   $85,035,503   $90,203,413 

 

23
 

 

CHINA COMMERCIAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

 

6.2 Analysis of loans by credit quality indicator

 

The following table summarizes the Company’s loan portfolio by credit quality indicator as of September 30, 2014 and December 31, 2013, respectively:

 

Five Categories  September 30,
2014
(Unaudited)
   %   December 31,
2013
   % 
                 
Pass  $47,099,768    54.4%  $85,035,503    94.2%
Special mention   -    0%   2,207,565    2.4%
Substandard   10,301,883    11.9%   867,118    1.0%
Doubtful   29,102,642    33.6%   1,948,240    2.2%
Loss   48,743    0.1%   144,987    0.2%
Total  $86,553,036    100%  $90,203,413    100%

 

6.3 Analysis of loans by collateral

 

The following table summarizes the Company’s loan portfolio by collateral as of September 30, 2014:

 

   September 30, 2014
   Business Loans
(Unaudited)
   Personal Loans
(Unaudited)
   Total
(Unaudited)
 
Guarantee backed loans  $49,048,456   $30,390,748   $79,439,204 
Pledged assets backed loans   3,253,368    2,479,406    5,732,774 
Collateral backed loans   1,381,058    -    1,381,058 
   $53,682,882   $32,870,154   $86,533,036 

 

The following table summarizes the Company’s loan portfolio by collateral as of December 31, 2013:

 

   December 31, 2013 
   Business Loans   Personal Loans   Total 
Guarantee backed loans  $51,909,006   $29,576,912   $81,485,918 
Pledged assets backed  loans   3,321,226    4,005,608    7,326,834 
Collateral backed loans   1,390,661    -    1,390,661 
   $56,620,893   $33,582,520   $90,203,413 

 

Collateral Backed Loans

 

A collateral backed loan is a loan in which the borrower puts up an asset under their ownership, possession or control, as collateral for the loan. An asset usually is land use rights, inventory, equipment or buildings. The loan is secured against the collateral and we do not take physical possession of the collateral at the time the loan is made. We will verify ownership of the collateral and then register the collateral with the appropriate government agencies to complete the secured transaction. In the event that the borrower defaults, we can then take possession of the collateral asset and sell it to recover the outstanding balance owed. If the sale proceeds of the collateral asset is not sufficient to pay off the debt, we will file a lawsuit against the borrower and seek payment for the remaining balance.

 

Pledged Asset Backed Loans

 

Pledged loans are loans with pledged assets. The pledged assets are usually certificates of deposit. Lenders take physical possession of the pledged assets at the time the loan is made and do not need to register them with government agencies to secure the loan. If the borrower defaults, we can sell the assets to recover the outstanding balance owed.

 

Both collateral loans and pledged loans are considered secured loans. The amount of a loan that lenders provide depends on the value of the collateral pledged. Beginning 2011, the Company does not provide unsecured loans.

 

24
 

 

CHINA COMMERCIAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

 

Guarantee Backed Loans

 

A guaranteed loan is a loan guaranteed by a third party who is usually a corporation or high net worth individual. As of September 30, 2014 and December 31, 2013, guaranteed loans make up 91.8% and 90.3% of our direct loan portfolio, respectively.

 

7.ALLOWANCE FOR LOAN LOSSES

 

The allowance for loan losses is maintained at a level considered adequate to provide for losses that can be reasonably anticipated. Management performs a quarterly evaluation of the adequacy of the allowance. The allowance is based on the Company’s past loan loss history, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant revision as more information becomes available.

 

The allowance is calculated at portfolio-level since our loans portfolio is typically of smaller balance homogenous loans and is collectively evaluated for impairment.

 

For the purpose of calculating portfolio-level reserves, we have grouped our loans into two portfolio segments: Corporate and Personal. The allowance consists of the combination of a quantitative assessment component based on statistical models, a retrospective evaluation of actual loss information to loss forecasts, value of collaterals and could include a qualitative component based on management judgment.

 

In estimating the probable loss of the loan portfolio, the Company also considers qualitative factors such as current economic conditions and/or events in specific industries and geographical areas, including unemployment levels, trends in real estate values, peer comparisons, and other pertinent factors such as regulatory guidance. Finally, as appropriate, the Company also considers individual borrower circumstances and the condition and fair value of the loan collateral, if any.

 

In addition, the Company also calculates the provision amount in accordance with PRC regulation “The Guidance for Loan Losses” (“The Provision Guidance”) issued by PBOC and is applied to all financial institutes as below:

 

  1. General Reserve - is based on total loan receivable balance and to be used to cover unidentified probable loan loss. The General Reserve is required to be no less than 1% of total loan receivable balance.
     
  2. Specific Reserve - is based on the level of loss of each loan after categorizing the loan according to their risk.  According to the so-called “Five-Tier Principle” set forth in the Provision Guidance, the loans are categorized as “pass”, “special-mention”, “substandard”, “doubtful” or “loss”. Normally, the provision rate is 2% for “special-mention”, 25% for “substandard”, 50% for “doubtful” and 100% for “loss”.

 

25
 

 

CHINA COMMERCIAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

 

     
  3. Special Reserve - is fund set aside covering losses due to risks related to a particular country, region, industry or type of loans. The reserve rate could be decided based on management estimate of loan collectability.

 

To the extent the general loan loss reserve rate of 1% as required by PBOC differs from management’s estimates, the management elects to use the higher rate. As of September 30, 2014, the Company utilized Specific Reserve in estimating the loan loss as it is higher  than the amount calculated based on the General Reserve.

 

While management uses the best information available to make loan loss allowance evaluations, adjustments to the allowance may be necessary based on changes in economic and other conditions or changes in accounting guidance.

 

The following tables present the activity in the allowance for loan losses and related recorded investment in loans receivable by classes of the loans individually and collectively evaluated for impairment as of and for the three months ended September 30, 2014 and 2013:

 

   Business Loans   Personal Loans   Total 
   (Unaudited)   (Unaudited)   (Unaudited) 
For the three months ended September 30, 2014            
Beginning balance  $9,398,454   $5,763,531   $15,161,985 
Charge-offs   -    -    - 
Recoveries   -    -    - 
Provisions   2,553,644    3,276,825    5,830,469 
Ending balance   11,952,098    9,040,356    20,992,454 
Ending balance: individually evaluated for impairment   -    -      
Ending balance: collectively evaluated for impairment  $11,952,098   $9,040,356   $20,992,454 

 

   Business Loans
(Unaudited)
   Personal Loans
(Unaudited)
   Total
(Unaudited)
 
For the three months ended September 30, 2013            
Beginning balance  $1,212,810   $512,416   $1,725,226 
Charge-offs   -    -    - 
Recoveries   (288,313)   (50,006)   (338,319)
Provisions   -    -    - 
Ending balance   924,497    462,410    1,386,907 
Ending balance: individually evaluated for impairment   -    -    - 
Ending balance: collectively evaluated for impairment  $924,497   $462,410   $1,386,907 

 

26
 

 

CHINA COMMERCIAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

 

The following tables present the activity in the allowance for loan losses and related recorded investment in loans receivable by classes of the loans individually and collectively evaluated for impairment as of and for the nine months ended September 30, 2014 and 2013:

 

   Business Loans
(Unaudited)
   Personal Loans
(Unaudited)
   Total
(Unaudited)
 
For the nine months ended September 30, 2014            
Beginning balance  $1,049,836   $326,112   $1,375,948 
Charge-offs   (784,537)   (731,148)   (1,515,685)
Recoveries   -    -    - 
Provisions   11,686,799    9,445,393    21,132,191 
Ending balance   11,952,098    9,040,356    20,992,454 
Ending balance: individually evaluated for impairment   -    -      
Ending balance: collectively evaluated for impairment  $11,952,098   $9,040,356   $20,992,454 

 

 

   Business Loans
(Unaudited)
   Personal Loans
(Unaudited)
   Total
(Unaudited)
 
For the nine months ended September 30, 2013            
Beginning balance  $638,471   $219,342   $857,813 
Charge-offs   -    -    - 
Recoveries   (288,313)   (140,882)   (429,195)
Provisions   574,339    383,950    958,289 
Ending balance   924,497    462,410    1,386,907 
Ending balance: individually evaluated for impairment   -    -    - 
Ending balance: collectively evaluated for impairment  $924,497   $462,410   $1,386,907 

 

The following table presents the classes of the loan portfolio summarized by the aggregate pass rating and the classified ratings of special mention, substandard, doubtful and loss within the Company's internal risk rating system as of September 30, 2014:

 

   Pass   Special Mention   Substandard   Doubtful   Loss   Total
(Unaudited)
 
                         
Business loans  $26,975,157   $3,542,009   $2,843,355   $20,322,360   $-   $53,682,881 
Personal loans   13,934,219    568,672    9,489,496    8,829,025    48,743    32,870,155 
   $40,909,376   $4,110,681   $12,332,851   $29,151,385   $48,743   $86,553,036 

 

The following table presents the classes of the loan portfolio summarized by the aggregate pass rating and the classified ratings of special mention, substandard, doubtful and loss within the Company's internal risk rating system as of December 31, 2013:

 

   Pass   Special Mention   Substandard   Doubtful   Loss   Total 
                         
Business loans  $52,714,898   $1,894,572   $130,886   $1,735,550   $144,987   $56,620,893 
Personal loans   32,320,605    312,993    736,232    212,690    -    33,582,520 
   $85,035,503   $2,207,565   $867,118   $1,948,240   $144,987   $90,203,413 

 

8.LOAN IMPAIRMENT

 

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for corporate and personal loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is collateral dependent.

 

27
 

 

CHINA COMMERCIAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

 

An allowance for loan losses is established for an impaired loan if its carrying value exceeds its estimated fair value. Currently, estimated fair values of substantially all of the Company’s impaired loans are measured based on the estimated fair value of the loan’s collateral which approximates to the carrying value due to the short term nature of the loans.

 

Loans with modified terms are classified as troubled debt restructurings if the Company grants such borrowers concessions and it is deemed that those borrowers are experiencing financial difficulty. Concessions granted under a troubled debt restructuring generally involve a temporary below market rate reduction in interest rate or an extension of a loan’s stated maturity date. Non-accrual troubled debt restructurings are restored to accrual status if principal and interest payments, under the modified terms, are current for nine consecutive months after modification. Loans classified as troubled debt restructurings are designated as impaired.

 

Even though the Company allows a one-time loan extension with a period up to the original loan period, which is usually twelve months. Such extension is not considered to be a troubled debt restructuring because the Company does not grant a concession to borrowers. The principal of the loan remains the same and the interest rate is fixed at the current interest rate at the time of extension. Therefore, there were no troubled debt restructurings during the three months and nine months ended September 30, 2014 and 2013, respectively.

 

9.GUARANTEE PAID ON BEHALF OF GUARANTEE CUSTOMERS

 

   September 30,
2014
(Unaudited)
   December 31,
2013
 
Guarantee paid on behalf of guarantee service customers  $8,629,323   $1,082,486 

 

Guarantee paid on behalf of guarantee service customers represents payment made by the Company to banks on behalf of twenty-six of its guarantee service customers who defaulted on their loan repayments to the banks. Management performs an evaluation of the adequacy of the allowance. The allowance is based on the Company’s past loan loss history, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. As of September 30, 2014 and December 31, 2013, the Company accrued allowance on the balance in “accrual for financial guarantee services” in the value of $4,356,381 and $588,740 respectively.

 

10.OTHER ASSETS

 

Other assets as of September 30, 2014 and December 31, 2013 consisted of:

   September 30,
2014
(Unaudited)
   December 31,
2013
 
Prepaid bank service charges  $-   $181,641 
Prepaid interest expense to bank   2,121    80,554 
Prepaid expenses to investor relationship service providers (Note 19)   606,775    - 
Other prepaid expense   72,033    283,800 
Other receivables   326,638    156,622 
   $1,007,567   $702,617 

 

Other receivable mainly represents the court filing fees and legal fees which will be claimed from default customers.

 

28
 

 

CHINA COMMERCIAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

 

11.NET INVESTMENT IN DIRECT FINANCING LEASE

 

On September 25, 2014, PFL entered into a finance lease agreement for the leasing of manufacturing equipment with a total lease receivable of $2.73 million. The lease bears an interest rate of 10.36% per annum. 

 

Future minimum lease receipts under non-cancellable finance lease arrangements are as follows:

 

   September 30,
2014
 
   (Unaudited) 
2014  $341,203 
2015   1,364,811 
2016   1,023,608 
Total minimum lease receipts   2,729,622 
Less: amount representing interest   (341,204)
Present value of minimum lease receipts  $2,388,418 

 

Following is a summary of the components of the Company’s net investment in direct financing leases as of September 30, 2014:

 

   September 30,
2014
(Unaudited)
   December 31,
2013
 
         
Total minimum lease payments to be received  $2,729,622   $- 
Less: Amounts representing estimated executory costs   -    - 
Minimum lease payments receivable   2,729,622    - 
Less Allowance for uncollectible   -    - 
Net minimum lease payments receivable   2,729,622    - 
Estimated residual value of leased property   -    - 
Less: Unearned income   (341,204)   - 
Net investment in direct financing lease  $2,388,418   $- 

 

29
 

 

CHINA COMMERCIAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

 

12.PROPERTY AND EQUIPMENT

 

The Company’s property and equipment used to conduct day-to-day business are recorded at cost less accumulated depreciation. Depreciation expenses are calculated using straight-line method over the estimated useful life with 5% salvage value below:

 

Property and equipment consist of the following:

 

   Useful Life
(years)
  September 30,
2014
(Unaudited)
   December 31,
2013
 
Furniture and fixtures  5  $23,480   $23,201 
Vehicles  4   242,533    244,220 
Electronic equipment  3   125,156    126,026 
Leasehold improvement  3   180,158    181,410 
Less: accumulated depreciation      (401,494)   (320,062)
Property and equipment, net     $169,833   $254,795 

 

Depreciation expense totaled $27,841 and $28,647 for the three months ended September 30, 2014 and 2013, respectively. For the nine months ended September 30, 2014 and 2013, depreciation expense totaled $83,731 and $83,926 respectively.

 

13.SHORT-TERM BANK LOANS

 

Bank Name  Interest rate  Term  September 30,
2014
(Unaudited)
   December 31,
2013
 
Agricultural Bank Of China  Fixed annual rate of 6.00%  From September 26, 2013 to September 25, 2014   -    4,908,216 
Agricultural Bank Of China  Fixed annual rate of 6.00%,  From October 15, 2013 to October 14, 2014   4,874,324    4,908,216 
Agricultural Bank Of China  Fixed annual rate of 6.00%,  From October 18, 2013 to October 17, 2014   6,499,098    6,544,289 
         $11,373,422   $16,360,721 

 

As of September 30, 2014 and December 31, 2013, the short-term bank loans have maturity terms within 1 year. These loans were guaranteed by the Wujiang Luxiang shareholders.

 

Interest expense incurred on short-term loans for the three months ended September 30, 2014 and 2013 was $243,158 and $274,489, respectively, and $736,283 and $897,341for the nine months ended September 30, 2014 and 2013, respectively.

 

14.DEPOSITS PAYABLE

 

Deposits payable are security deposits required from customers in order to obtain loans and guarantees from the Company. The deposits are refundable to the customers when the customers fulfill their obligations under loan and guarantee contracts.

 

15.UNEARNED INCOME FROM FINANCIAL GUARANTEE SERVICES

 

The Company receives guarantee commissions in full at the inception and records unearned income before amortizing it throughout the guarantee service life. Unearned income from guarantee services was $127,147 and $482,029 as of September 30, 2014 and December 31, 2013, respectively.

 

30
 

 

CHINA COMMERCIAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

 

16.OTHER CURRENT LIABILITIES

 

Other current liabilities as of September 30, 2014 and December 31, 2013 consisted of:

 

   September 30,
2014
(Unaudited)
   December 31,
2013
 
Accrued payroll  $25,114   $459,623 
Other tax payable   94,625    157,507 
Other payable   11,861    11,943 
   $131,600   $629,073 

 

17.OTHER OPERATING EXPENSE

 

Other operating expense for the three and nine months ended September 30, 2014 and 2013 consisted of:

 

   For The Three Months Ended
September 30,
   For The Nine Months Ended
September 30,
 
   2014
(Unaudited)
   2013
(Unaudited)
   2014
(Unaudited)
   2013
(Unaudited)
 
Depreciation  $27,841   $28,647   $83,731   $83,926 
Travel expenses   387    96,910    28,718    149,052 
Entertainment expenses   4,050    22,371    36,961    54,098 
Promotion expenses   -    7,909    7,075    91,193 
Legal and consulting expenses   966,356    107,686    1,460,969    286,964 
Car expenses   18,666    22,815    61,983    66,158 
Bank charges   28,074    96,800    167,020    296,235 
Audit-related expense   -    57,411    133,142    211,717 
Insurance expense   59,062    -    200,812    - 
Other expenses   86,327    139,684    142,845    211,260 
Total   1,190,763    580,233    2,323,256    1,450,603 

 

18.EMPLOYEE RETIREMENT BENEFIT

 

The Company has made employee benefit contributions in accordance with relevant Chinese regulations, including retirement insurance, unemployment insurance, medical insurance, housing fund, work injury insurance and maternity insurance. The Company recorded the contribution in the salary and employee charges when incurred. The contributions made by the Company were $18,028 and $23,025 for the three months ended September 30, 2014 and 2013, respectively, and $60,964 and $66,907 for the nine months ended September 30, 2014 and 2013, respectively

 

19.DISTRIBUTION OF PROFIT

 

The Company did not distribute any dividend to its shareholders for the three months and nine months ended September 30, 2014 and 2013, respectively.

 

31
 

 

CHINA COMMERCIAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

 

20.CAPITAL TRANSACTION

 

Initial Public Offering

 

On August 16, 2013, the Company closed an initial public offering (“IPO”) of 1,370,000 shares of Common Stock. On August 26, 2013, the Company sold additional 45,657 shares of Common Stock from the exercise of the overallotment option of shares granted to the underwriters. The public offering price of the shares sold in the IPO was $6.50 per share. The total gross proceeds from the offering were $9.2 million. After deducting underwriting discounts and commissions and offering expenses payable by the Company, the aggregate net proceeds received by the Company totaled approximately $7.6 million.

 

Upon the consummation of the Company’s IPO on August 16, 2013, the Series A Stock and the Series B Stock (defined below) were automatically converted into shares of Common Stock.

 

Follow-on Public Offering

 

On May 13, 2014, the Company closed its second public offering (“Follow-on Offering”) of 1,750,000 shares of Common Stock and 1,750,000 warrants to purchase an additional 875,000 shares of Common Stock. The public offering price of the shares was $3.99 per share and the offering pricing for the warrants was $0.01 per warrant. 1,650,386 shares of Common Stock were newly issued by the Company and 99,614 shares of Common Stock were sold by certain selling stockholders. On June 12, 2014, the representative in the Follow-on Offering exercised its over-allotment option to purchase 252,000 warrants to purchase 126,250 shares of Common Stock. The total gross proceeds in the Follow-on Offering and the over-allotment were $6.6 million. After deducting underwriting discounts and commissions and offering expenses payable by the Company and the proceeds to the selling stockholders, the aggregate net proceeds received by the Company totaled approximately $5.7 million.

 

Common Stock

 

The Company is authorized to issue up to 100,000,000 shares of Common Stock.

 

As of December 31, 2013, there were 10,430,657shares of Common Stock issued and outstanding.

 

On March 7, 2014, the Company issued an aggregate of 15,769 shares of Common Stock to a certain investor relations services provider to the Company, at a par value of $0.001 per share and recorded it as a deferred expense and amortized over service term. (Note 10)

 

On April 9 and April 24, 2014, the Company issued an aggregate of 20,000 and 130,000 shares of Common Stock, respectively, to one consulting firm in consideration of certain investor relations services to be rendered by such firm, at a par value of $0.001 per share and recorded it as a deferred expense and amortized over service term. (Note 10)

 

On May 13, 2014, the Company closed the Follow on Offering of 1,750,000 shares of Common Stock and 1,750,000 warrants to purchase 875,000 shares of Common Stock. Among the 1,750,000 shares of Common Stock, 1,650,386 shares were newly issued by the Company and 99,614 shares were offered by certain selling stockholders.

 

As of September 30, 2014, there were 12,246,812 shares of Common Stock issued and outstanding.

 

32
 

 

CHINA COMMERCIAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

 


Warrants

 

The IPO underwriters’ and their affiliates’ received warrants to purchase an aggregate of  95,900 shares of Common Stock, which are exercisable at any time, and from time to time, in whole or in part, during the three-year period from February 10, 2014. The warrants are initially exercisable at a per share price of $6.50.

 

Warrants to purchase an aggregate of 875,000 shares of Common Stock were issued in the Follow-on Offering on May 13, 2014. The issuance price was $0.01 per warrant, and are exercisable at any time, and from time to time, in whole or in part, during the three-year period from May 13, 2014. The warrants are initially exercisable at a per share price of $5.60.

 

Warrants to purchase 252,500 shares of Common Stock were issued to the underwriters in the Follow-on Offering. The warrants have a cashless exercise provision and are exercisable at any time, and from time to time, in whole or in part, during the three-year period from May 13, 2014. The warrants are initially exercisable at a per share price of $4.80.

 

Preferred Stock

 

The Company is authorized to issue up to 10,000,000 shares of preferred stock, of which 1,000,000 shares are designated as Series A Convertible Preferred Stock (the “Series A Stock”) and 5,000,000 shares are designated as Series B Convertible Preferred Stock (the “Series B Stock”).

 

The Series A Stock ranked (i) prior to the Common Stock and to all other classes and series of equity securities of the Company which by their terms do not rank senior to the Series A Stock, and (ii) junior to any class or series of equity securities which by its terms ranked senior to the Series A Stock. The Series A Stock was subordinate to and ranked junior to all indebtedness of the Company. Each share of the Series A Stock was on the day on which the Company consummated its IPO, automatically and without any action on the part of the holder thereof converted into issued and outstanding shares of Common Stock beneficially owned by a consultant who received the shares on December 19, 2011. The number of shares of Common Stock issued upon conversion of the Series A Stock was equal to the purchase price of the Series A Stock divided by a per share conversion price of 50% of the price of a share of Common Stock in the IPO. No new shares were issued by the Company at the conversion. In addition, the holders were not permitted to convert their preferred stock prior to consummation of the IPO.

 

33
 

 

CHINA COMMERCIAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

 

The Series B Preferred Stock ranked (i) prior to the Common Stock and to all other classes and series of equity securities of the Company which by their terms do not rank senior to the Series B Preferred Stock and (ii) junior to any class or series of equity securities which by its terms ranked senior to the Series B Preferred Stock. The Series B Stock was subordinate to and ranked junior to all indebtedness of the Company. Each share of the Series B Stock was on the day on which the Company consummated its IPO, automatically and without any action on the part of the holder thereof converted into issued and outstanding shares of Common Stock beneficially owned by a consultant who received the shares on December 19, 2011. The number of shares of Common Stock issued upon conversion of the Series B Stock was equal to the purchase price of the Series B Stock divided by a per share conversion price of 25% of the price of a share of Common Stock in the IPO. No new shares were issued by the Company at the conversion. In addition, the holders were not permitted to convert their preferred stock prior to consummation of the IPO.

 

Between January 1, 2012 and April 1, 2013, the Company issued a total of 745 shares of Series A Stock to an aggregate of 11 investors pursuant to certain subscription agreements. We received gross proceeds of $372,500 and incurred costs associated with this private placement of $93,125.

 

Between October 12, 2012 and May 8, 2013, the Company issued a total of 760 shares of Series B Stock to an aggregate of 44 investors pursuant to certain subscription agreements. We received gross proceeds of $380,000 and incurred costs associated with this private placement of $95,000.

 

On August 16, 2013 when the Company closed its IPO, all outstanding shares of the Series A Stock and Series B Stock were converted into an aggregate of 348,462 shares of already issued and outstanding Common Stock beneficially owned by a consultant who received our shares on December 19, 2011, automatically and without any action on the part of the holder thereof. The per share conversion price of Series A Stock and Series B Stock was equal to $3.25 and $1.63, respectively.

 

The discount on the Series A and B Stock was accounted for as a beneficial conversion feature upon conversion. The total amount of discount was $752,500, which was accounted for as a reduction to retained earnings and an offsetting increase to additional paid in capital in the Company's financial statements.

 

21.STATUTORY RESERVE

 

In accordance with the PRC Regulations on Enterprises with Foreign Investment and the articles of association of the Company’s PRC subsidiaries, a foreign-invested enterprise established in the PRC is required to provide statutory reserve, which is appropriated from net profit as reported in the enterprise’s PRC statutory accounts. A foreign-invested enterprise is required to allocate at least 10% of its annual after-tax profit to the general reserve until such reserve has reached 50% of its respective registered capital based on the enterprise’s PRC statutory accounts. The Company allocates 15% of its annual after-tax profit to the statutory reserve. The statutory reserve can only be used for specific purposes and are not distributable as cash dividends. WFOE was established as a foreign-invested enterprise and, therefore, is subject to the above mandated restrictions on distributable profits. For the nine months ended September 30, 2014, the Company did not accrue the statutory reserve due to net loss.

 

34
 

 

CHINA COMMERCIAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

 

22.(LOSS)/EARNINGS PER COMMON SHARE

 

The following table sets forth the computation of basic and diluted (loss)/earnings per common share for the three months and nine months ended September 30, 2014 and 2013, respectively:

 

   For the Three Months Ended   For the Nine Months Ended 
   September 30,   September 30, 
   2014
(Unaudited)
   2013
(Unaudited)
   2014
(Unaudited)
   2013
(Unaudited)
 
                     
Net (loss) income attributable to the common shareholders  $(6,154,050)  $1,608,769   $(22,252,797)  $5,142,460 
                     
Basic weighted-average common shares outstanding   12,246,812    9,692,533    11,377,427    9,233,381 
Effect of dilutive securities   -    -    -    - 
Diluted weighted-average common shares outstanding   12,246,812    9,692,533    11,377,427    9,233,381 
                     
(Loss)earnings per share:                    
Basic  $(0.50)  $0.17   $(1.96)  $0.56 
Diluted  $(0.50)  $0.17   $(1.96)  $0.56 

 

Basic earnings (loss) per share are computed by dividing the net income or loss by the weighted average number of common shares outstanding during the period. Diluted earnings/(loss) per share were the same as basic earnings per share due to the lack of dilutive items in the Company and the fact that Company is in net loss position for three and nine months ended September 30, 2014.

 

23.INCOME TAXES AND TAX RECEIVABLE

 

Effective January 1, 2008, the New Taxation Law of PRC stipulates that domestically owned enterprises and foreign invested enterprises (the “FIEs”) are subject to a uniform tax rate of 25%. While the New Tax Law equalizes the tax rates for FIEs and domestically owned enterprises, preferential tax treatment may continue to be given to companies in certain encouraged sectors and to entities classified as high-technology companies, regardless of whether these are domestically-owned enterprises or FIEs. In November 2009, the Jiangsu Province Government issued Su Zheng Ban Fa [2009] No. 132 which  stipulates that micro-credit companies in Jiangsu Province is subject to preferential tax rate of 12.5%. As a result, the Company is subject to the preferential tax rate of 12.5% for its loan business for the periods presented. The taxation practice implemented by the tax authority governing the Company is that the Company pays enterprise income taxes at rate of 25% on a quarterly basis, and upon annual tax settlement done by the Company and the tax authority in five (5) months after December 31 the tax authority will refund the Company the excess enterprise income taxes it paid beyond the rate of 12.5%.

 

The Company evaluates the level of authority for each uncertain tax position (including the potential application of interest and penalties) based on the technical merits, and measures the unrecognized benefits associated with the tax positions. For the nine months ended September 30, 2014 and 2013, the Company had no unrecognized tax benefits. For the nine months ended September 30, 2014, the Company has net tax operating losses from its PRC subsidiaries and its consolidated VIEs of $12,179,982, which will expire in 2019. Considering the recovery is not likely, we increase our provision for taxes by recording a charge to income tax expense, in the form of a valuation allowance, for the deferred tax assets that we estimate will not ultimately be recoverable.

 

The Company does not anticipate any significant increase to its liability for unrecognized tax benefit within the next 12 months. The Company will classify interest and penalties related to income tax matters, if any, in income tax expense.

 

35
 

 

CHINA COMMERCIAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

 

Income tax receivable/(payable) is comprised of:

 

   As of
September 30,
2014
(Unaudited)
   As of
December 31,
2013
 
         
Income tax payable  $-   $(164,806)
Income tax receivable   1,756,207    985,332 
Total income tax receivable /(payable), net  $1,756,207   $820,526 

 

Income tax payables represented enterprise income tax at a rate of 25% that the Company accrued but had not paid as of September 30, 2014 and December 31, 2013, respectively. Income tax receivable represented the income tax refund the Company will receive from the tax authority in the annual income tax settlement or can deduct future income tax payables.

 

Income tax expense for the three months ended September 30, 2014 and 2013 is comprised of:

 

   For The Three Months Ended 
   September 30, 
   2014   2013 
   (Unaudited)   (Unaudited) 
         
Current income tax  $-   $379,506 
Deferred income tax   (113)   8,055 
Total provision for income taxes  $(113)  $387,561 

 

Income tax expense for the nine months ended September 30, 2014 and 2013 is comprised of:

 

   For The Nine Months Ended 
   September 30, 
   2014
(Unaudited)
   2013
(Unaudited)
 
         
Current income tax  $-   $1,029,693 
Deferred income tax   10,979    11,705 
Total provision for income taxes  $10,979   $1,041,398 

 

The effective tax rates for the nine months ended September 30, 2014 and 2013 are 0.08% and 15.0%, respectively.

 

Deferred tax liability arises from government incentive for the purpose of covering the Company’s actual loan losses and ruled that the income tax will be imposed on the subsidy if the purpose is not fulfilled within 5 years after the Company receives the subsidy. As of September 30, 2014 and December 31, 2013, the deferred tax liability amounted to $342,280 and $333,617, respectively.

 

36
 

 

CHINA COMMERCIAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

 

As of September 30, 2014 and December 31, 2013, the Company intends to permanently reinvest the undistributed earnings from its foreign subsidiaries to fund future operations. The amount of unrecognized deferred tax liabilities for temporary differences related to investments in foreign subsidiaries is not determined because such a determination is not practicable.

 

24.RELATED PARTY TRANSACTIONS AND BALANCES

 

1)Nature of relationships with related parties

 

Name   Relationship with the Company
Wujiang Chunjia Textile Trading Co., Ltd (“Chunjia Textile”)   Controlled by major shareholders
Huichun Qin   Non-controlling shareholder and former CEO

 

2)Related party transactions

 

Loans to related parties consisted of the following:

 

   For Nine Months Ended September 30, 
   2014   2013 
   (Unaudited)   (Unaudited) 
Chunjia Textile  $1,137,010   $- 
Huichun Qin  $2,289,402   $- 

 

Loans repaid from related parties consisted of the following:

 

   For Nine Months Ended September 30, 
   2014   2013 
   (Unaudited)   (Unaudited) 
Chunjia Textile  $1,137,010   $- 
Huichun Qin  $1,135,940   $- 

 

3)Related party balances

 

Amount due from related parties were as follows:

 

   September 30,
2014
   December 31, 2013 
   (Unaudited)   (Unaudited) 
Chunjia Textile  $-   $- 
Huichun Qin  $1,145,466   $- 

 

The loan to Chunjia Textile is subject to an annual interest rate of 14.4%. The amount was fully repaid in July 2014.

 

Huichun Qin transferred the above amount to his personal account without proper authorization on July 2, 2014. The amount was recorded as a deduction of the Company’s equity as of September 30, 2014.

 

37
 

 

CHINA COMMERCIAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

 

25.COMMITMENTS AND CONTINGENCIES

 

1)Lease Commitments

 

The Company extended its lease agreement of its principal office for a 5-year period from October 1, 2013 to September 30, 2018.The following table sets forth the Company’s contractual obligations as of September 30, 2014 in future periods:

 

   Rental payments 
   (Unaudited) 
     
Within 1 year  $261,420 
Within 1-2 years   261,420 
Within 2-3 years   261,420 
Within 3-4 years   261,420 
Total  $1,045,680 

 

2)Guarantee Commitments

 

The guarantees will terminate upon payment and/or cancellation of the obligation; however, payments by the Company would be triggered by failure of the guaranteed party to fulfill its obligation covered by the guarantee. Generally, the average guarantee expiration terms ranged within 6 to 12 months and the average percentage of the guarantee amount as security deposit is 10% ~ 20%. As of September 30, 2014 and December 31, 2013, the loan amount guaranteed by the Company were $21,901,961 and $59,692,091, respectively, for its financial guarantee service customers.

 

38
 

 

CHINA COMMERCIAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

 

3)Contingencies

 

The Company is involved in various legal actions arising in the ordinary course of its business. During nine months ended September 30, 2014, the Company was involved in 54 lawsuits, among which 39 were related to its loan business and 15 were related to guarantee business. The Company initiated legal proceedings to collect delinquent balances from borrowers. 31 of these cases with an aggregated claim of $11.58 million have been adjudicated by the Court in favor of the Company and these cases are settled or in the process of enforcement. The remaining 23 cases with an aggregated claim of $13.77 million have not been adjudicated by the Court as of September 30, 2014.

 

On August 6, 2014, a purported shareholder Andrew Dennison filed a putative class action complaint in the United States District Court District of New Jersey (the “N.J. district court”) relating to a July 25, 2014 press release about the Company’s progress in recovering a significant portion of the $5.4 million the Company paid in the first quarter of 2014 on behalf of loan guarantee customers. The action is captioned Andrew Dennison v. China Commercial Credit, Inc., et al., Case No. 2:2014-cv-04956. The action alleges that the Company and its current and former officers and directors Huichun Qin, Long Yi, Jianming Yin, Jinggen Ling, Xiangdong Xiao, and John F. Levy violated the federal securities laws by misrepresenting in prior public filings certain material facts about the risks associated with its loan guarantee business. On October 2, 2014, two purported shareholders Zhang Yun and Sanjiv Mehrotra (the “Yun Group”) asserted substantially similar claims against the same defendants in a putative class action captioned Zhang Yun v. China Commercial Credit, Inc., et al., Case No. 2:14-cv-06136 (D. N.J.). Neither complaint states the amount of damages sought.

 

26.SUBSEQUENT EVENTS

 

Contingencies

 

During the period from October 1, 2014 to the date of this report, the Company was involved in 27 new lawsuits, 19 of which are related to its loan business and 8 are related to its guarantee business, The Company initiated legal proceedings to collect delinquent loan balance from borrowers. Cases with a total claim of $0 have been adjudicated by the court and cases with a total claim of $10.98 million are still at the initial stage of the litigation.

 

Appointment of Executive Officers

 

On December 29, 2014, the Board of Directors appointed Mr. Jingen Ling as the Chief Executive Officer and President of the Company to fill the vacancy created by Mr. Huichun Qin’s resignation and simultaneously Mr. Long Yi, the Chief Financial Officer of the Company, ceased to be the Interim Chief Executive Officer of the Company. 

 

39
 

 

CHINA COMMERCIAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

 

Completion of the Internal Review

 

Based on the Chief Financial Officer’s review of the books and records of the Company, the Company has made a preliminary determination that following the close of the fiscal quarter ended June 30, 2014, RMB 7 million (approximately $1.1 million) was transferred (the “Transfer at Issue”) from the bank account of WFOE, without authorization to the personal account of a former executive officer of the Company, who was still an executive officer at the time of the transfer. The funds were supposed to be used for the purpose of increasing the registered capital account of Wujiang Luxiang. The Company has sought return of the funds but to date has not recovered them. The Company’s Board of Directors explored all means, including legal avenues, to recover the funds and has formed a Special Committee to undertake an internal review of the circumstances surrounding the transfer

 

On January 26, 2015 , the Special Committee notified the Board of Directors that the internal review surrounding the Transfer at Issue was completed. The internal review confirmed that Mr. Qin transferred RMB 7 million (approximately $1.1 million ) from WFOE’s bank account to his personal bank account. The internal review team was unable to interview Mr. Qin. The missing funds have not yet been recovered and the Company has engaged local PRC counsel to assist in the matter.

 

During the internal review, the independent counsel examined whether other transfers had occurred that were similar to the Transfer at Issue, in that the Company’s funds were transferred to a related party in a manner that was not consistent with the Company’s corporate governance and internal control procedures. The independent counsel identified four transfers made by Mr. Qin that were not consistent with the Company’s corporate governance and internal control procedures. With respect to the first three transfers, all funds were either returned to the Company or applied to the Company’s business. With respect to the fourth transfer, the funds were used to increase the registered capital of Wujiang Luxiang, a variable interest entity the Company controls via a series of contractual arrangements, as intended and reflected in an application made to the PRC government for such increase of registered capital.

 

The internal review indicated that the Company’s control deficiencies contributed to the Transfer at Issue. The internal review also found that, since the discovery of the Transfer at Issue, the Company has taken various steps to improve its internal controls and procedures, including implementing a new fund transfer approval policy and procedures and new standards of credit risk assessment which are carried out by the newly formed Loan Review Committee. The internal review conducted by independent counsel engaged by the Special Committee of the Board of Directors observed that such new controls and procedures appear to be much more thorough and comprehensive.

 

Legal Proceedings 

 

On or about October 6, 2014, Dennison, the Yun Group and another purported shareholder, Jason Stark, filed motions to consolidate the cases, be appointed as lead plaintiff and to have their respective counsel appointed as lead counsel. On October 31, 2014, the N.J. district court entered an order consolidating the cases under the caption “In re China Commercial Credit Inc. Securities Litigation” and appointing the Yun Group as lead plaintiff and the Yun Group’s counsel as lead counsel.

 

On November 18, 2014, the Yun Group and the Company, which at that point was the only defendant served, entered into a stipulation to transfer of the case to the Southern District of New York. On December 18, 2014, Mr. Levy, who had by then been served, joined in the stipulation. On December 29, 2014, the N.J. district court entered an order transferring the action. The transfer was effected on January 22, 2015, and assigned docket number 1:15-cv-00557-ALC (S.D.N.Y.).

 

40
 

 

CHINA COMMERCIAL INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

 

 

Under the schedule stipulated by the parties, the Yun Group is to file an amended complaint within 60 days of the date that the transfer was effected, and the defendants’ date to answer or move is within 60 days of that filing. The Company and Mr. Levy anticipate that they will file a motion to dismiss the amended complaint. The Company believes that this lawsuit is without merit and intends to vigorously defend against it. At this early stage of the proceedings, the Company is not able to estimate the probability of success or loss.

 

On February 3, 2015, a purported shareholder Kiram Kodali filed a putative shareholder derivative complaint in the United States District Court for the Southern District of New York, captioned Kiran Kodali v. Huichin Qin, et al., Case No. 15-cv-806.  The action alleges that the Company and its current and former officers and directors Huichun Qin, Long Yi, Jianming Yin, Jinggen Ling, Xiangdong Xiao, John F. Levy, Xiaofang Shen and Chunjiang Yu violated their fiduciary duties, grossly mismanaged the Company and were unjustly enriched based upon the transfer that was the subject of the internal review conducted by the special committee of the board and other grounds substantially similar to those asserted in the class action complaints.   Kodali did not serve a demand upon the Company and seeks to allege that demand is excused.  To the Company’s knowledge, as of this date, neither it nor any individual defendant has been served by Kodali.  The Company believes that this lawsuit is without merit and intends to vigorously defend against it.  At this stage of the proceedings, the Company is not able to estimate the probability of success or loss.

 

41
 

 

Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS   

 

Overview 

 

The following discussion and analysis of our financial condition and results of operations for the nine and three months  ended September 30, 2014 should be read in conjunction with the Financial Statements and corresponding notes included in this Quarterly Report on Form 10-Q. Our discussion includes forward-looking statements based upon current expectations that involve risks and uncertainties, such as our plans, objectives, expectations, and intentions. Actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including those set forth under the Risk Factors and Notes Regarding Forward-Looking Statements in this report. We use words such as “anticipate,” “estimate,” “plan,” “project,” “continuing,” “ongoing,” “expect,” “believe,” “intend,” “may,” “will,” “should,” “could,” “target”, “forecast” and similar expressions to identify forward-looking statements.

 

We are a financial services firm operating in China. Our current operations are mainly conducted through Wujiang Luxiang, a fully licensed microcredit company which we control through our subsidiaries and certain contractual arrangement, and consist of providing short-term direct loans and loan guarantees to SMEs located in Wujiang City, Jiangsu Province of China. As of September 30, 2014, we have built an $86.5 million portfolio of direct loans to 190 borrowers and a total of $21.9 million in loan guarantees for 23 borrowers. We were established under the 2008 Guidance on the Small Loan Company Pilot of the China Banking Regulatory Commission and the People's Bank of China (“PBOC”) (No.23) (“Circular No. 23”) to extend short term loans and loan guarantees to SMEs, a class of borrowers that we believe have been underserved in the Chinese lending market. The loans that we provide bridge the gap between Chinese-state run banks that have not traditionally served the capital needs of SMEs and high interest rate “underground” lenders, and our loans provide capital at more favorable terms and sustainable interest rates.

 

Due to substantial increase in the amount of default loans in the loan guarantees business, the amount of underlying loans we guaranteed has been reduced by 63.1% as of September 30, 2014 compared to as of December 31, 2013. As the rate of fees and commissions generated from the guarantee business has been decreasing, the Company has declined that the revenue does not justify the default risks involved, and therefore expects to further reduce the traditional guarantee business and hold off on pursuing the guarantee business to be provided via the Kaixindai Financing Services Jiangsu Co. Ltd (“Kaixindai”) platform as previously planned. Management may actively resume the guarantee business if economic conditions improve in the future.

 

On September 5, 2013, our wholly owned subsidiary, CCC International Investment Holding Ltd. (“CCC HK”), established Pride Financial Leasing (Suzhou) Co. Ltd. (“PFL”) in Jiangsu Province, China. PFL was expected to offer financial leasing of machinery and equipment, transportation vehicles, and medical devices to municipal government agencies, hospitals and SMEs in Jiangsu Province and beyond. During the nine months ended September 30, 2014, PFL had one financial leasing transaction. As of the date of this quarterly report, PFL entered into two financial leasing agreements for an aggregate of $4.87 million (one with a monthly principle and interest income of $81,239 and the other with a quarterly principle and interest income of $341,463. We do not currently have further funds to deploy in the financial leasing business.

 

On February 19, 2014, WFOE entered into certain contractual arrangements with Mr. Huichun Qin and Suzhou Pride Information Technology Co. Ltd. (“Pride Online”), a domestic entity established on February 19, 2014 and 100% owned by Mr. Qin. Pursuant to these contractual arrangements, WFOE shall have the power, rights and obligations equivalent in all material respects to those it would possess as the sole equity holder of Pride Online, including absolute control rights and the rights to the assets, property and revenue of Pride Online and as a result, approximately 100% of the net income of Pride Online will be paid as a service fee to WFOE. Pride Online operates an online platform (www. pridelendingclub.com) to match prospective borrowers with lenders. As of the date of this quarterly report, Pride Online did not generate any income and management expect to terminate the contractual arrangements with Pride Online. The registered capital contributed to Pride Online by WFOE, after deduction of organizational costs and certain start-up operational expenses, has been returned to WFOE.

 

42
 

 

Key Factors Affecting Our Results of Operation

 

Our business and operating results are affected by China’s overall economic growth local, economic condition, market interest rate and the borrowers repayment ability. Unfavorable changes could affect the demand for the services that we provide and could materially and adversely affect our results of operations. Our results of operations are also affected by the regulations and industry policies related to the microcredit industry in the PRC.

 

Due to changes in the applicable microcredit lending regulations in Jiangsu Province, starting August 2012 we elected to charge no more than three times the PBOC Benchmark Rate. Prior to August 2012, we were allowed to charge up to four times the PBOC Benchmark Rate. The decrease in the PBOC Benchmark Rate and the revised restriction on the allowable points above PBOC Benchmark Rate have slowed our growth in net interest income. 

 

Our results of operations are also affected by the provision for loan losses and provision for financial guarantee loss which are noncash items and represents an assessment of the risk of future loan losses. Increases in the allowance for loan losses are achieved through provision for loan losses that are charged against net interest income.

 

Although we have generally benefited from China’s economic growth and the policies to encourage lending to farmers and SMEs, we are also affected by the complexity, uncertainties and changes in the PRC regulations governing the micro lending industry. Due to PRC legal restrictions on foreign equity ownership of and investment in the micro lending sector in China, we rely on contractual arrangements with Wujiang Luxiang, and its shareholders to conduct most of our current business in China. We face risks associated with our control over our variable interest entity, as our control is based upon contractual arrangements rather than equity ownership

 

43
 

 

Results of Operations

 

Three Months ended September 30, 2014 as Compared to Three Months ended September 30, 2013

 

CHINA COMMERCIAL CREDIT, INC

UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

 

   For the Three Months Ended September 30, 
   2014   2013   Amount   Change % 
Interest income                
Interests and fees on loans  $1,457,902   $2,969,422   $(1,511,520)   (51)%
Interests on deposits with banks   7,843    16,922    (9,079)   (54)%
Total interest and fees income   1,465,745    2,986,344    (1,520,599)   (51)%
                     
Interest expense                    
Interest expense on short-term bank loans   (243,158)   (274,489)   31,331    (11)%
Net interest income   1,222,587    2,711,855    (1,489,268)   (55)%
                     
(Provision)/reversal for loan losses   (5,817,156)   340,965    (6,158,121)   (1806)%
Net interest (loss)/income after provision for loan losses   (4,594,569)   3,052,820    (8,727,577)   (286)%
                     
Commissions and fees on financial guarantee services   87,774    401,984    (314,210)   (78)%
(Under) /Over provision on financial guarantee services   (138,457)   53,661    (192,118)   (358)%
Commission and fees on guarantee services, net   (50,683)   455,645    (506,328)   (111)%
                     
Net (Loss) /Revenue   (4,645,252)   3,508,465    (8,153,715)   (232)%
                     
Non-interest income                    
Government incentive   (81)   57,460    (57,541)   (100)%
Other non-interest income   26,276    99,337    (73,061)   (74)%
Total non-interest income   26,195    156,797    (130,602)   (83)%
                     
Non-interest expense                    
Salaries and employee surcharge   (206,523)   (167,078)   (39,445)   24%
Rental expenses   (68,078)   (65,244)   (2,834)   4%
Business taxes and surcharge   (69,743)   (103,877)   34,134    (33)%
Other operating expenses   (1,190,762)   (580,233)   (610,529)   105%
Total non-interest expense   (1,535,106)   (916,432)   (618,674)   68%
                     
(Loss) /Income Before Taxes   (6,154,163)   2,748,830    (8,902,991)   (324)%
Income tax expense   113    (387,561)   387,674    (100)%
Net (Loss)/Income   (6,154,050)   2,361,269    (8,515,317)   (360)%
                     
Amortization of beneficial conversion feature relating to convertible Series A Preferred Stocks   -    (372,500)          
Amortization of beneficial conversion feature relating to convertible Series B Preferred Stocks   -    (380,000)          
Net income attributable to Common Stock shareholders  $(6,154,050)  $1,608,769   $(7,762,817)   (483)%
                     
(Loss) /Earnings per Share- Basic and Diluted  $(0.50)  $0.17   $(0.67)   (394)%
                     
Weighted Average Shares Outstanding-Basic and Diluted   12,246,812    9,692,533    2,554,279    26%
                     
Net (Loss)/Income  $(6,154,050)  $2,361,269   $(8,515,317)   (361)%
Other comprehensive income                    
Foreign currency translation adjustment   33,715    452,537    (418,822)   (93)%
Comprehensive (Loss) /Income  $(6,120,335)  $2,813,806   $(8,934,139)   (318)%

 

44
 

 

The Company’s net loss for the three months ended September 30, 2014 was $6,154,050 representing a decrease of $8,515,317, or 361%, from net income of $2,361,269 for the three months ended September 30, 2013. The net loss for the three months ended September 30, 2014 was the net effect of the changes in the following components:

 

a decrease in net interest income of $1,489,268;
an increase in the provision for loan losses of $6,158,121
a decrease in commission and fees from our guarantee business of $314,210;
an increase of provision on financial guarantee services of $192,118
an increase in other non-interest expense of $618,674; and
a decrease in enterprise income tax of $387,674

 

The following paragraphs discuss changes in the components of net (loss)/income in greater details during the three months ended September 30, 2014, as compared to the three months ended September 30, 2013.

 

Net Interest income

 

Net interest income is equal to interest income we generated less interest expenses we incurred. The Company’s net interest income decreased by $1,489,268 or 55%, to $1,222,587 during the three months ended September 30, 2014, as compared to net interest income of $2,711,855 for the three months ended September 30, 2013.

 

The decrease is due to the combined effect of: (1) decrease in effective weighted average loan interest rate from 14.57% for the loan portfolio as of September 30, 2013 to 14.11% as of September 30, 2014 due to the mandatory requirement promulgated by Jiangsu Finance Bureau in June of 2013 that effective from October 1, 2013 the maximum interest rate a microcredit company in Jiangsu province is permitted to charge shall be fifteen percent (15%) compared to eighteen percent (18%) previously permitted; and (2) the decrease in the amount of monthly interest received. Compared to the same period last year, a substantial amount of borrowers chose to repay the principal and the interest due at the maturity of the loan term instead of making monthly interest payments. Both payments are permissible under the agreements we have with the borrowers.

 

Since the beginning of 2014, People’s Bank of China continued to withdraw a significant amount of liquidity from the market, which has made it even harder for SMEs to gain access to capital. The bank lenders usually require an old loan be paid in full upon maturity before they approve a new loan to the same borrower. Some SMEs have to borrow from so-called “underground” lenders, or shadow banks to repay the loans due to the banks. During the three months ended September 30, 2014, the banks denied to extend new loans to some SMEs even after they made the full repayment for the loans due and satisfied other conditions. Management is concerned that the borrowers may use the proceeds from the loans we grant to them as a means of repayment to the other banks or even to the underground lenders, instead of using them in operations. Therefore, management decided to grant new loans in a more cautious manner. The number of new loans/renewed loans reduced from 420 as of September 30, 2013 to 102 as of September 30, 2014 and as a result, the interest income declined.

 

45
 

 

Due to the long-term nature of our restricted deposits with third party banks, we utilized these deposits as term deposits during the three months ended September 30, 2014 which in turn generated interest income on deposits with banks of $7,843 as compared to $16,922 during the three months ended September 30, 2013. The decrease was mainly due to the reduction of our traditional guarantee business with banks, and we have closed several restricted deposit accounts with banks through which we provided guarantee services to our customers. As of September 30, 2014, the balance of restricted cash was $2,872,073, a decrease of 73.3% from $10,784,960 as of September 30, 2013.

 

Interest expense represents interest incurred on short-term bank loans. The interest incurred on short-term bank loans decreased by $31,331, or 11%. This was mainly caused by a decrease of the total bank borrowing balance of $4.09 million, from $15.5 million as of September 30, 2013 to $11.4 million as of September 30, 2014. The aggregate amount of credit available to us under the line of credit we have with the Agriculture Bank of China remains unchanged as RMB100 million (approximately $16 million) as of September 30, 2014 and as of the date of this report.

 

Provision for Loan Losses

 

The Company’s provision/(reversal) for loan losses were $5,817,156 and $(340,965) for the three months ended September 30, 2014 and 2013, respectively. The provision for loan losses was determined by comparing the beginning and ending balance of allowance for loan losses for business and personal loans. If the ending balance of the allowance of loan losses after any charge offs (net of recoveries) is less than the beginning balance, it will be recorded as a “reversal”; if it is larger, it will be recorded as a “provision” in the allowance for loan loss. The netting amount of “reversal” and “provision” is presented in the consolidated statements of operations and comprehensive income (loss) and the components of the provision for loan losses were disclosed in Note 7 of financial statements.

 

The increase in provision for loan losses reflects the increase in the allowance for loan losses for the reporting period as our loan receivable balance increased and hence higher risk was assessed. In accordance with the aging schedule, during the three months ended September 30, 2014, more “special mention” loans were moved down to the “substandard” and “doubtful” category subject to the higher provision ratio of 25% and 50%, respectively. We have initiated several legal proceedings against long-aging customers and it may take a long time to collect the outstanding balance from these customers. In order to speed up the collection of past due loans, we engaged He-Partners Law Firm, one of the largest law firms in Suzhou City to represent us in these lawsuits. 

 

Since the beginning of 2014, the economic conditions in the eastern part of China, especially the Yangtze River Delta region, has been challenging due to the downturn of the general economic situation in China. Wujiang, which is in the heart of this region, has been significantly affected. The textile industry, which is the pillar industry in Wujiang area, as well as other industries, have been facing downward pressure. As the local SMEs’ profitability and repayment ability deteriorates, “special mentioned”, “substandard” and “doubtful’ bank loans drastically increased. As such, our provision for loan losses substantially increased during this quarter.

 

46
 

 

Net Commission and Fees from Our Guarantee Business

 

The Company also generated net income by charging fees for financial guarantee services provided to our customers to help them obtain loans from other banks. We generally charge a one-time fee by annual rate of 1.8% to 3.6% multiplied by the amount of loans being guaranteed based on the nature of the guarantee and whether the customer is new or existing. The commissions and fees generated from our financial guarantee services decreased from $401,984 for the three months ended September 30, 2013, to $87,774 for the three months ended September 30, 2014, representing a decrease of $314,210 or 78%.

 

As of September 30, 2014, we have provided guarantees for a total of $21.9 million underlying loans to approximately 23 borrowers, a reduction of 63.3% as compared to December 31, 2013. We expect to further reduce our traditional guarantee services and gradually get out from this business, as the rate of fees and commissions generated from this service has been decreasing and the revenue does not justify the default risks involved.

 

Provision on Financial Guarantee Services

 

The provision on financial guarantee services increased from an over provision of $53,661 for the three months ended September 30, 2013, to an under provision of $138,457 for the three months ended September 30, 2014, representing an increase of $192,118  or 358%.

 

The methodology the Company used to estimate the liability for probable guarantee loss considers the guarantee contract amount and a variety of factors, which include, dependence on the counterparty, latest financial position and performance of the customers, actual defaults, estimated future defaults, historical loss experience, estimated value of collaterals or guarantees the costumers or third parties offered, and other economic conditions such as the economic trend of the area and the country. The estimates are based upon currently available information.

 

Based on the past experience, we estimates the probable loss for immature financial guarantee services to be 1% of contract amount and made a provision for possible credit risk of its guarantee. Additionally we accrued allowance on matured but defaulted financial guarantee services. During the three months ended September 30, 2014, a number of our financial guarantee customers defaulted on their loans and we repaid for the underlying loans. As of September 30, 2014, the outstanding repayment balance amounted to $8.6 million.

 

As explained above, since the beginning of 2014, People’s Bank of China continued to withdraw a significant amount of liquidity from the market, which has made it even harder for SMEs to gain access to capital. The bank lenders usually require an old loan be paid in full upon maturity before they approve a new loan to the same borrower. During the first nine months of 2014, the banks denied to extend new loans to many SMEs even after they made the full repayment for the loans due and satisfied other conditions. As a result, some of the SME borrowers for which we provided the guarantees decided to default on the bank loans. Therefore the amount of repayment we made to the bank lenders substantially increased during the three months ended September 30, 2014.

 

47
 

 

We are in the process of negotiating and possibly litigating against both the borrowers and their counter-guarantors. Due to the uncertainty of the outcome, we increased our provision for the guarantee services significantly from an over provision of $53,661 for the three months ended September 30, 2013, to an under provision of $138,457 for  the three months ended September 30, 2014, representing an increase of $192,118. We engaged He-Partners Law Firm, one of the largest law firms in Suzhou City, to represent us in the legal proceedings against the borrowers and their counter guarantors, and expect to collect part of the outstanding balance in a period ranging from nine months to one year upon adjudication by the Court in favor of the Company. The timing of collection and ultimate amount of funds we can recover depend on a few factors, including the repayment ability of the borrower and their counter-guarantors, the execution time of the court, other obligations the borrowers have and the priority over the claim for the Company.

 

We accrued specific provision on the balance of repayment on behalf of defaulted customers according to “Five-Tier” principal. The Specific Reserve is based on the level of loss of each repayment after categorizing the repayment according to their risk. According to the “Five-Tier Principle” set forth in the Provision Guidance, the guarantees are categorized as “pass”, “special-mention”, “substandard”, “doubtful” or “loss”. Normally, the provision rate is 2% for “special-mention”, 25% for “substandard”, 50% for “doubtful” and 100% for “loss”.

 

Non-interest expenses

 

Non-interest expenses increased from $916,432 for the three months ended September 30, 2013 to $1,535,106 for the three months ended September 30, 2014, representing an increase of $618,674 or 68%. Non-interest expenses primarily consisted of salary and benefits for employees, business tax and surcharge, traveling cost, entertainment expenses, depreciation of equipment, office rental expenses, professional service fees, and office supplies. The increase was mainly attributable to (1) salaries and employee surcharge, which increased by $39,445, and (2) an increase in other operating expenses of $610,529. Other operating expenses were higher during the three months ended September 30, 2014 as compared to the same period of 2013, primarily due to an increase in legal and consulting expense of $910,823, netting off against a decrease in bank charges of $57,964 and a decrease in travel expense of $88,828.

 

Income tax

 

Income taxes decreased from an income tax expense of $387,561 for the three months ended September 30, 2013 to an income tax credit of $113 for the three months ended September 30, 2014, representing a decrease of $387,674. The decrease in income tax is mainly due to the decrease of pre-tax income for the three months ended September 30, 2014.

 

48
 

 

Nine Months ended September 30, 2014 as Compared to Nine Months ended September 30, 2013

 

CHINA COMMERCIAL CREDIT, INC

UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

 

   For the Nine Months Ended September 30, 
   2014   2013   Amount   Change % 
Interest income                
Interests and fees on loans   5,987,935    9,156,526    (3,168,591)   (35)%
Interests on deposits with banks   59,386    135,416    (76,030)   (56)%
Total interest and fees income   6,047,321    9,291,942    (3,244,621)   (35)%
                     
Interest expense                    
Interest expense on short-term bank loans   (736,283)   (897,341)   161,058    (18)%
Net interest income   5,311,038    8,394,601    (3,083,563)   (37)%
                     
Provision for loan losses   (21,164,733)   (500,123)   (20,664,610)   4132%
Net interest (loss)/income after provision for loan losses   (15,853,695)   7,894,478    (23,748,173)   (301)%
                     
Commissions and fees on financial guarantee services   476,134    1,175,060    (698,926)   (59)%
(Under) /Over provision on financial guarantee services   (3,775,816)   202,361    (3,978,177)   (1966)%
Commission and fees on guarantee services, net   (3,299,682)   1,377,421    (4,677,103)   (339)%
                     
Net (Loss) /Revenue   (19,153,377)   9,271,899    (28,425,276)   (307)%
                     
Non-interest income                    
Government incentive   81,327    83,235    (1,908)   (2)%
Other non-interest income   195,605    99,337    96,268    97%
Total non-interest income   276,932    182,572    94,360    52%
                     
Non-interest expense                    
Salaries and employee surcharge   (614,926)   (511,953)   (102,973)   20%
Rental expenses   (199,060)   (194,091)   (4,969)   3%
Business taxes and surcharge   (228,131)   (361,466)   133,335    (37)%
Other operating expenses   (2,323,256)   (1,450,603)   (872,653)   60%
Total non-interest expense   (3,365,373)   (2,518,113)   (847,260)   34%
                     
(Loss) /Income Before Taxes   (22,241,818)   6,936,358    (29,178,176)   (421)%
Income tax expense   (10,979)   (1,041,398)   1,030,419    (99)%
Net (Loss)/Income   (22,252,797)   5,894,960    (28,147,757)   (477)%
                     
Amortization of beneficial conversion feature relating to convertible Series A Preferred Stocks   -    (372,500)          
Amortization of beneficial conversion feature relating to convertible Series B Preferred Stocks   -    (380,000)          
Net income attributable to Common Stock shareholders   (22,252,797)   5,142,460    (27,395,257)     
                     
(Loss) /Earnings per Share- Basic and Diluted   (1.96)   0.56    (2.52)   (450)%
                     
Weighted Average Shares Outstanding-Basic and Diluted   11,377,427    9,233,381    2,144,046    23%
                     
Net (Loss)/Income   (22,252,797)   5,894,960    (28,147,757)   (477)%
Other comprehensive income                    
Foreign currency translation adjustment   (637,053)   1,880,603    (2,517,656)   (134)%
Comprehensive (Loss) /Income   (22,889,850)   7,775,563    (30,665,413)   (394)%

 

49
 

 

The Company’s net loss for the nine months ended September 30, 2014 was $22,252,797 representing a decrease of $28,147,757 or 477%, from net income of $5,894,960 for the nine months ended September 30, 2013. The decrease in net income for the nine months ended September 30, 2014 was the net effect of the changes in the following components:

 

  a decrease in net interest income of $3,083,563;
  an increase in the provision for loan losses of $20,664,610;
  a decrease in commission and fees on guarantee services of $698,926;
  an increase of provision on financial guarantee services of $3,978,177;
  an increase in total non-interest expense of $847,260; and
  a decrease in enterprise income tax of $1,030,419;

 

The following paragraphs discuss changes in the components of net (loss)/income in greater details during the nine months ended September 30, 2014, as compared to the nine months ended September 30, 2013. 

 

Net Interest Income

 

Net interest income is equal to interest income we generated less interest expenses we incurred. The Company’s net interest income decreased by $3,083,563, or 37% to $5,311,038 during the nine months ended September 30, 2014, as compared to net interest income of $8,394,601 for the nine months ended September 30, 2013.

 

The interest and fees on loans decreased by $3,168,591, or 35% from $9,156,526 for the nine months ended September 30, 2013 to $5,987,935 for the nine months ended September 30, 2014. The decrease is the combined effect of: (1) decrease in effective weighted average loan interest rate from 14.57%  for the loan portfolio as of September 30, 2013 to 14.11% as of September 30, 2014 due to the mandatory requirement promulgated by Jiangsu Finance Bureau in June of 2013 that effective from October 1, 2013 the maximum interest rate a microcredit company in Jiangsu province is permitted to charge shall be fifteen percent (15%) compared to eighteen percent (18%) previously permitted; (2) reversal of interest income of $356,017 due from some long-aging customers according to interest waive agreement between Wujiang Luxiang and these customers: and (3) the decrease in the amount of monthly interest received. Compared to the same period last year, a substantial amount of borrowers chooses to repay the principal and the interest due at the maturity of the loan term instead of making monthly interest payments. Both payments are permissible under the agreements we have with the borrowers.

 

50
 

 

Since the beginning of 2014, People’s Bank of China continued to withdraw a significant amount of liquidity from the market, which has made it even harder for SMEs to gain access to capital. The bank lenders usually require an old loan be paid in full upon maturity before they approve a new loan to the same borrower. Some SMEs have to borrow from so-called “underground” lenders, or shadow banks to repay the loans due to the banks. During the nine months ended September 30, 2014, the banks denied to extend new loans to some SMEs even after they made the full repayment for the loans due and satisfied other conditions. Management is concerned that the borrowers may use the proceeds from the loans we grant to them as a means of repayment to the other banks or even to the underground lenders, instead of using them in operations. Therefore, management decided to grant new loans in a more cautious manner. During the nine months ended September 30, 2014, we granted 102 loans and the average loan size was approximately $336,000, as compared to 450 loans with an average loan size of $450,000 during the nine months ended September 30, 2013, and as a result, the interest income declined.

 

Due to the long-term nature of our restricted deposits with third party banks, we utilized these deposits as term deposits which in turn generated interest income on deposits with banks of $59,386 during the nine months ended September 30, 2014 as compared to $135,416 during the nine months ended September 30, 2013. The decrease was mainly due to the reduction of our traditional guarantee business with banks, and we have closed several restricted deposit accounts with banks through which we provided guarantee services to our customers. As of September 30, 2014, the balance of restricted cash was $2,872,073, a decrease of 77.3% from $12,676,190 as of September 30, 2013.

  

Interest expense represents interest incurred on short-term bank loans. The interest incurred on short-term bank loans decreased by $161,058 or 18%. This was mainly caused by a decrease of total bank borrowing balance by $4.1 million from $15.5 million as of September 30, 2013 to $11.4 million as of September 30, 2014. During both nine months ended September 30, 2014 and 2013, there was no interest expense related to the loans from related parties, as a result of our effort to reduce related party transactions.

 

Provision for Loan Losses

 

The Company’s provision for loan losses was $21,164,733 and $500,123 for the nine months ended September 30, 2014 and 2013, respectively. The provision for loan losses was determined by comparing the beginning and ending balance of allowance for loan losses for business and personal loans. If the ending balance of the allowance of loan losses after any charge offs (net of recoveries) is less than the beginning balance, it will be recorded as a “reversal”; if it is larger, it will be recorded as a “provision” in the allowance for loan loss. The netting amount of “reversal” and “provision” is presented in the consolidated statements of operations and comprehensive income (loss) and the components of the provision for loan losses were disclosed in Note 7 of financial statements.

 

The increase in provision for loan losses reflects the increase in the allowance for loan losses for the reporting period as our loan receivable balance increased and hence higher risk was assessed. In accordance with the aging schedule, during the nine months ended September 30, 2014, there was an increase of $1.9 million in  “special mention” loans compared to December 31, 2013 which are subject to a provision ratio of 2%. Besides more “pass” or “special mention” loans were moved down to the “substandard” and “doubtful” category subject to the higher provision ratio of 25% and 50%, respectively. We have initiated several legal proceedings against long-aging customers and it may take a long time to settle the case. In order to speed up the collection of past due loans, we, engaged He-Partners Law Firm, one of the largest law firms in Suzhou City to represent us in these lawsuits.

 

51
 

 

Since the beginning of 2014, the economic conditions in the eastern part of China, especially the Yangtze River Delta region, has been challenging due to the downturn of the general economic situation in China. Wujiang, which is in the heart of this region, has been significantly affected. The textile industry, which is the pillar industry in the Wujiang area, as well as other industries, have been facing downward pressure. As the local SMEs’ profitability and repayment ability deteriorates, “special mentioned”, “substandard” and “doubtful’ bank loans drastically increased. As such, our provision for loan losses substantially increased during this quarter.

 

Net Commission and Fees on Guarantee Business

 

The Company also generated net income by charging fees for financial guarantee services provided to our customers to help them obtain loans from other banks. We generally charge a one-time fee of 1.8% - 3.6% multiplied by the amount of loans being guaranteed, based on the nature of the guarantee and whether the customer is new or existing. The commissions and fees generated from our financial guarantee services decreased from $1,175,060 for the nine months ended September 30, 2013 to $476,134 for the nine months ended September 30, 2014, representing a decrease of $698,926, or 59%.

 

As of September 30, 2014, we have provided guarantees for a total of $21.9 million underlying loans to approximately 23 borrowers, a reduction of 63.3% compared to December 31, 2013.

 

Provision on Financial Guarantee Services

 

The provision on financial guarantee services increased from an over provision of $202,361 for the nine months ended September 30, 2013, to an under provision of $3,775,816 for the nine months ended September 30, 2014, representing an increase of $3,978,177.

 

The methodology the Company used to estimate the liability for probable guarantee loss considers the guarantee contract amount and a variety of factors, which include, dependence on the counterparty, latest financial position and performance of the customers, actual defaults, estimated future defaults, historical loss experience, estimated value of collaterals or guarantees the costumers or third parties offered, and other economic conditions such as the economic trend of the area and the country. The estimates are based upon currently available information.

 

As explained above, since the beginning of 2014, People’s Bank of China continued to withdraw a significant amount of liquidity from the market, which has made it even harder for SMEs to gain access to capital. The bank lenders usually require an old loan be paid in full upon maturity before they approve a new loan to the same borrower. During the first nine months of 2014, the banks denied to extend new loans to many SMEs even after they made the full repayment for the loans due and satisfied other conditions. As a result, some of the SME borrowers for which we provided the guarantees decided to default on the bank loans. Therefore the amount of repayment we made to the bank lenders substantially increased during the nine months ended September 30, 2014. We are in the process of negotiating and possibly litigating against both the borrowers and their counter-guarantors. Due to the uncertainty of the outcome, we increased our provision for the guarantee services significantly from an over provision of $202,361 for the nine months ended September 30, 2013, to an under provision of $3,775,816 for the nine months ended September 30, 2014, representing an increase of $43,978,177. We engaged He-Partners Law Firm, one of the largest law firms in Suzhou City, to represent us in the legal proceedings against the borrowers and their counter guarantors, and expect to collect part of the outstanding balance in a period ranging from nine months to one year upon adjudication by the court in favor of the Company. The timing of collection and ultimate amount of funds we can recover depend on a few factors, including the repayment ability of the borrower and their counter-guarantors, the execution time of the court, other obligations the borrowers have and priority over the claim for the Company.

 

52
 

 

We accrued specific provision on the balance of repayment on behalf of defaulted customers according to “Five-Tier” principal. The Specific Reserve is based on the level of loss of each loan after categorizing the loan according to their risk. According to the “Five-Tier Principle” set forth in the Provision Guidance, the guarantees are categorized as “pass”, “special-mention”, “substandard”, “doubtful” or “loss”. Normally, the provision rate is 2% for “special-mention”, 25% for “substandard”, 50% for “doubtful” and 100% for “loss”.

 

Non-interest Expenses

 

Non-interest expenses increased from $2,518,113 for the nine months ended September 30, 2013 to $3,365,173 for the nine months ended September 30, 2014, representing an increase of $847,260 or 34%. Non-interest expenses primarily consisted of salary and employee surcharge, office rental expense, business tax and surcharge, depreciation of equipment, travel expenses, entertainment expenses, professional service fees, and other office supplies. The increase was mainly attributable to an increase in salaries and employee surcharge by $102,973 and an increase of other operating expenses by $872,653, or 60%. Other operating expenses were higher during the nine months ended September 30, 2014 as compared to the nine months ended September 30, 2013, primarily due to a net effect of an increase in legal and consulting fee of 1,081,347, against a decrease in bank charge of $132,512 and a decrease in travel expenses of $119,479.

 

Income Tax

 

Income taxes decreased from $1,041,398 for the nine months ended September 30, 2013 to $10,979 for the nine months ended September 30, 2014, representing a decrease of $1,030,419 or 99%. The decrease in income tax is mainly attributable to a decrease of income before tax of $29,178,176 or 421%, from $6,936,358 for the nine months ended September 30, 2013 to a loss of $22,241,818 for the nine months ended September 30, 2014.

 

Loan Portfolio Quality

 

One of our key objectives is to maintain a high level of loan portfolio quality. When a borrower fails to make a scheduled payment, we attempt to cure the deficiency by personally contacting the borrower. Initial contacts typically are made seven days after the date the payment is due, and warning letters are sent by our legal counsel approximately 90 days after the default. In most cases, deficiencies are promptly resolved. If the outstanding amount cannot be collected within 180 days after the maturity date and the parties could not reach an agreement on a specific repayment program, we will initiate legal proceedings.

 

We also keep the frequency of visits to our customers and observe their daily production on site from time to time to observe their operating condition and collect their financial information. Since most of our customers are in the Jiangsu area, it is also relatively easy to obtain information about our customers. Due to the bad economic condition of the first nine months of 2014, we increased the frequency of our visits in order to better identify the potential default risk.

 

On loans where the collection of principal or interest payments is doubtful, the accrual of interest income ceases and become “non-accrual” loans. Except for loans that are sufficiently secured and in the process of collection, it is our policy to discontinue accruing additional interest and reverse any interest accrued on any loan which is 90 days or more past due.

 

53
 

 

We account for our impaired loans in accordance with U.S. GAAP. An impaired loan generally is one for which it is probable, based on current information, that the lender will not collect all the amounts due under the contractual terms of the loan. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment history and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for business and personal loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is collateralized.

 

We allow a one-time loan extension with time duration up to the original loan term, which is usually within twelve months. In order to qualify, the borrower must be current with its interest payments. We do not grant concession to borrowers as the principal of the loan remains the same and interest rate is fixed at the current interest rate at the time of extension.

 

We use a comprehensive methodology to monitor credit quality and prudently manage credit concentration within our portfolio of loans. Currently our loan portfolio concentrates in the textile industry and during the nine months ended September 30, 2014, both the domestic and international demand for textile products have been decreasing. To maintain our loan portfolio quality, we have modified our loan policy to accept only textile companies with real estate as collateral or guaranteed by guarantee companies.

  

In addition, we plan to diversify our risks by concentrating in smaller amount loans that are below $490,000 (or approximately RMB 3.0 million). We have also eliminated related party loans and extended more loans to agriculture related business since 2012.

 

Currently, the banking industry encourages SMEs to apply for loans as individual with recourse so that when it is past due, both the SME and the responsible individual are both liable for the past due amount and the individual borrower carries personal liability. As of September 30, 2014, our business loan balance decreased by 5.2% as compared to that as of December 31, 2013 while personal loan decreased by 2.1%.

 

The following table sets forth the classification of loans receivable as of September 30, 2014 and December 31, 2013, respectively:

 

   September
2014
(Unaudited)
Amount
   Percent
of Total
   December 31,
2013
Amount
   Percent
of Total
 
                 
Business loans   53,682,882    62.03%   56,620,893    62.77%
Personal loans   32,870,154    37.98%   33,582,520    37.23%
Total Loans receivable   86,533,036         90,203,413      

 

Nonaccrual loans totaled $17.1 million, or 19.40% of total assets as of September 30, 2014, up from $2.8 million, or 2.49% of total assets, as of December 31, 2013. The allowance for loan losses was $21.0 million, representing 24.25% of loans receivable and 122.65% of non-accrual loans as of September 30, 2014. As of December 31, 2013, the allowance for loan losses was $1.38 million, representing 1.53% of loans receivable and 48.87% of non-accrual loans.

 

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The following table sets forth information concerning our nonaccrual loans as of September 30, 2014 and December 31, 2013, respectively:

 

   September 30,
2014
   December 31,
2013
 
         
Nonaccrual loans  $17,115,867   $2,815,358 
Allowance for loan losses  $20,992,454   $1,375,948 
Loans receivable  $86,553,036   $90,203,413 
Total assets  $88,237,972   $113,003,448 
Nonaccrual loans to loans receivable   19.78%   3.12%
Nonperforming assets to total assets   19.40%   2.49%
Allowance for loan losses to loans receivable   24.25%   1.53%
Allowance for loan losses to non-accrual loans   122.65%   48.87%

 

Since the beginning of 2014, the economic conditions in eastern part of China, especially the Yangtze River Delta region, has been challenging due to the downturn of the general economic situation in China. Wujiang, which is in the heart of this region, has been significantly affected. The textile industry, which is the pillar industry in Wujiang area, as well as other industries, have been facing downward pressure. As the local SMEs’ profitability and repayment ability deteriorates, “special mentioned”, “substandard” and “doubtful’ bank loans drastically increased. As such, our provision for loan losses substantially increased during this quarter.

 

Cash Flows and Capital Resources

 

We have financed our operations primarily through shareholder contributions, cash flow from operations and bank loans, and from public offerings of securities. As a result of our total cash activities, net cash decreased from $9,405,865 as of December 31, 2013 to $4,132,782 as of September 30, 2014.

 

We require cash for working capital, making loans, repayment of debt and guarantee, salaries, commissions and related benefits and other operating expenses and income taxes. We expect that without the needs of future business expansion, our current working capital is sufficient to support our routine operations for the next twelve months.

 

However, as a micro-credit company regulated by the Chinese Banking Regulatory Commission, we are prohibited from providing saving or checking services to our customers; our borrowing capacity from other financial institutions is also limited to 50% of our equity.

 

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In order to meet the capital needs for our continued operations, we may take the following actions: (1) continue to improve our collection of loan receivable and interest receivable; (2) if necessary, raise additional capital through the sale of equity; and/or (3) enter into new, or refinance existing, short- and/or long term commercial loans. We cannot assure you that financing will be available in the amounts we need or on terms acceptable to us, if at all. On May 13, 2014, the Company closed its second public offering (“Follow-on Offering”) offering of 1,750,000 shares of Common Stock and 1,750,000 warrants to purchase 875,000 shares of Common Stock. The public offering price of the shares sold in the Follow-on Offering was $3.99 per share and the offering pricing for the warrants was $0.01 per warrant. 1,650,386 shares of Common Stock were newly issued by the Company and 99,614 shares of Common Stock were registered and sold by existing shareholders. The aggregate gross proceeds in the Follow-on Offering were $6.6 million. After deducting underwriting discounts and commissions and offering expenses payable by the Company and the proceeds to the selling shareholders, the aggregate net proceeds received by the Company totaled approximately $5.7 million. The sale of additional equity securities, including convertible debt securities, would dilute our current shareholders. The incurrence of debt could result in operating and financial covenants that would restrict our operations and our ability to pay dividends to our shareholders. If we are unable to obtain additional equity or debt financing as required, our business, operations and prospects may be adversely affected.

 

In March 2014, approximately $5.7 million (RMB 30 million) of the net proceeds raised in our IPO was transferred and have already been contributed to Wujiang Luxiang and approved as an increase of the registered capital of Wujiang Luxiang. In October 2014, approximately $5.6 million (RMB 30 million) of the net proceeds raised in our Follow-on Offering was transferred to PFL to fund its operation.

 

Statement of Cash Flows

 

The following table sets forth a summary of our cash flows for the nine months ended September 30, 2014 and 2013, respectively:

 

   For the nine months ended
September 30,
 
   2014
(Unaudited)
   2013
(Unaudited)
 
         
Net cash provided by operating activities  $1,938,826   $5,422,047 
Net cash used in investing activities  $(6,818,510)  $(2,185,909)
Net cash (used in)/provided by financing activities  $(267,768)  $2,075,159 
Effects of exchange rate changes on cash  $(125,631)  $72,797 
Net cash (outflow)/inflow  $(5,273,083)  $5,384,094 

 

Net Cash Provided by Operating Activities

 

During the nine months ended September 30, 2014, we had positive cash flow from operating activities of $1,938,826 a decrease of $3,483,221 from the nine months ended September 30, 2013, during which we had cash flow from operating activities of $5,422,047. The net income for the nine months ended September 30, 2014 decreased by $28,147,757 as compared to the nine months ended September 30, 2013. The decrease in net cash provided by operating activities was the result of several factors, including:

 

  An increase in cash flow due to an increase of non-cash items which was primarily due to the increase in the provision for loan losses of $20,664,610 and the increase in the provision for financial guarantee services of $3,978,177.

 

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  A decrease in cash flow due to the increase in changes in interest receivable by $343,755. The interest receivable increased by $281,277 and $(62,478) as of September 30, 2014 and 2013, respectively, as compared to December 31, 2013 and 2012. This is mainly attributable to a significant increase in interest receivable overdue 90 days as of September 30, 2014.

 

  A decrease in cash flow due to the increase in changes in net tax receivable by $79,371. The net tax receivable as of September 30, 2014 and 2013 is $942,373 and $1,021,744 respectively. The Company was required to prepay enterprise income taxes at a rate of 25% on a quarterly basis when the applicable tax rate was 12.5% to loan business and 25% to guarantee business, respectively. Within five months after fiscal year end, the Company and the tax authority resolved the difference between the taxes paid and taxes due. 

  

Net Cash Used in Investing Activities 

 

Net cash used in investing activities for the nine months ended September 30, 2014 was $6,818,510 as compared to net cash used in investing activities of $2,185,909 for the nine months ended September 30, 2013. The increase in the cash used in investing activities for the nine months ended September 30, 2014 was mainly due to repayment made on behalf of defaulted customers in the financial guarantee service, decrease in originated loans disbursement to third parties and decrease in loans collection from third parties.

 

Net Cash (Used in)/Provided by Financing Activities

 

Net cash used in financing activities for the nine months ended September 30, 2014 totaled $267,768 as compared to net cash provided by financing activities of $2,075,159 for the nine months ended September 30, 2013. The cash provided by financing activities for the nine months ended September 30, 2014 was mainly attributable to the net proceeds of $5.7 million received from issuance of common stock and warrants in the Follow-on Offering closed on May 13, 2014, repayment of short term bank borrowings of $4,879,636 and common stock issuance cost of $872,785.

 

Contractual Obligations

 

As of September 30, 2014, the annual amounts of future minimum payments under certain of our contractual obligations were:  

 

   Payment due by period 
   Total   Less than
1 year
   1-2 years   2-3 years   3-5 years   5 years
and after
 
Contractual obligations:                        
Short term bank loans (1)   11,373,422    11,373,422    -    -    -      
Operating lease (2)   1,045,680    261,420    261,420    261,420    261,420      
                               
    12,419,102    11,634,842    261,420    261,420    261,420      

 

(1)  The bank loans bear an average annual interest rate of 6.0%.

 

(2) Our renewed lease for our office in Wujiang commenced on October 1, 2013 and will expire on September 30, 2018. The Company has the right to extend the lease before its expiration with a one-month's prior written notice.

 

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Off-Balance Sheet Arrangements

 

These financial guarantee contracts consist of providing guarantees to banks on behalf of borrowers to help them obtain loans from banks. The contract amounts reflect the extent of involvement the Company has in the guarantee business and also represents the Company’s maximum exposure to credit loss.

 

The Company is party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its borrowers. Financial instruments whose contract amounts represent credit risk are as follows.

 

   September 30,
2014
(Unaudited)
   December 31,
2013
 
Guarantee  $21,901,961   $59,692,091 

 

Critical Accounting Policies

 

We prepare our financial statements in conformity with U.S. GAAP, which requires us to make judgments, estimates and assumptions that affect our reported amount of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the financial statements, and reported amounts of revenue and expenses during the reporting periods. We continually evaluate these estimates and assumptions based on the most recently available information, our own historical experience and various other assumptions that we believe to be reasonable under the circumstances. Since the use of estimates is an integral component of the financial reporting process, actual results could differ from our expectations as a result of changes in our estimates.

 

An accounting policy is considered critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time such estimate is made and if different accounting estimates that reasonably could have been used, or changes in the accounting estimates that are reasonably likely to occur, could materially impact the condensed financial statements. We believe that the following accounting policies involve a higher degree of judgment and complexity in their application and require us to make significant accounting estimates. The following descriptions of critical accounting policies, judgments and estimates should be read in conjunction with our condensed financial statements and other disclosures included in this report.

 

Revenue recognition

 

Revenue is recognized when there are probable economic benefits to the Company and when the revenue can be measured reliably, on the following:

 

  Interest income on loans. Interest on loan receivables is accrued monthly in accordance with their contractual terms and recorded in accrued interest receivable. The Company does not charge prepayment penalty from customers.
     
  Commission on guarantee service. The Company receives the commissions from guarantee services in full at inception and records as unearned income before amortizing it throughout the period of guarantee.
     
 

 

 

 

Non-interest income. Non-interest income mainly includes government incentive and rental income from the sub-leasing of certain of the Company’s leased office space to third parties. Government incentive is provided by Jiangsu Provincial government on a yearly basis to promote the development of micro credit agencies in Jiangsu Province.
 

The finance lease agreements are classified as direct financing lease as prescribed by the Financial Accounting Standards Board (“FASB”). Revenues representing the capitalized costs of the investment are recognized as income upon inception of the leases. The portion of revenues representing the difference between the gross investment in the lease (the sum of the minimum lease payments and the guaranteed residual value, if any) and the sum of the present value of the two components is recorded as unearned income and amortized over the lease term.

 

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Loans receivable, net

 

Loans receivable primarily represent loan amount due from customers that the management has the intent and ability to hold for the foreseeable future or until maturity or payoff. Loans receivable are recorded at unpaid principal balances, net of unearned income and allowance that reflects the Company’s best estimate of the amounts that will not be collected. Loan origination and commitment fees and certain direct loan origination costs collected from customers are directly recorded as interests and fees on loans. The loans receivable portfolio consists of business loans and personal loans. The Company does not charge loan origination and commitment fees.

 

Allowance for loan losses and loan impairment

 

The allowance for loan losses is maintained at a level considered adequate to provide for losses that can be reasonably anticipated. Management performs a quarterly evaluation of the adequacy of the allowance. The allowance is based on the Company’s past loan loss history, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant revision as more information becomes available.

 

The allowance is calculated at portfolio-level  since our loans portfolio is typically of smaller balance homogenous loans and is collectively evaluated for impairment.

 

For the purpose of calculating portfolio-level reserves, we have grouped our loans into two portfolio segments: Business and Personal. The allowance consists of the combination of a quantitative assessment component based on statistical models, a retrospective evaluation of actual loss information to loss forecasts, value of collaterals and potentially a qualitative component based on management judgment.

 

The allowance for loan losses is increased by charges to income and decreased by charge offs (net of recoveries). Recoveries represent subsequent collection of amounts previously charged-off. The increase in allowance for loan losses is the netting effect of “reversal” and “provision” for both business and personal loans. If the ending balance of the allowance for loan losses after any charge offs (net of recoveries) is less than the beginning balance, it will be recorded as a “reversal”; if it is larger, it will be recorded as a “provision” in the allowance for loan loss. The netting amount of the “reversal” and the “provision” is presented in the consolidated statements of operations and comprehensive income (loss).

 

The Company recognizes a charge-off when management determines that full repayment of a loan is not probable. The primary factor in making that determination is the potential outcome of a lawsuit against the delinquent debtor. The Company will recognize a charge-off when the Company loses contact with the delinquent borrower for more than nine months or when the court rules against the Company to seize the collateral asset of the delinquent debt from either the guarantor or borrower. The Company has recorded a $1,515,685 charge-off to date .

 

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In estimating the probable loss of the loan portfolio, the Company also considers qualitative factors such as current economic conditions and/or events in specific industries and geographical areas, including unemployment levels, trends in real estate values, peer comparisons, and other pertinent factors such as regulatory guidance. Finally, as appropriate, the Company also considers individual borrower circumstances and the condition and fair value of the loan collateral, if any.

 

In addition, the Company also calculates the provision amount in accordance with PRC regulation “The Guidance for Loan Losses” (“The Provision Guidance”) issued by PBOC and is applied to all financial institutes as below:

 

  1.

General Reserve - is based on total loan receivable balance and to be used to cover unidentified probable loan loss. The General Reserve is required to be no less than 1% of total loan receivable balance.

 

  2. Specific Reserve - is based on the level of loss of each loan after categorizing the loan according to their risk. According to the so-called “Five-Tier Principle” set forth in the Provision Guidance, the loans are categorized as “pass”, “special-mention”, “substandard”, “doubtful” or “loss”. Normally, the provision rate is 2% for “special-mention”, 25% for “substandard”, 50% for “doubtful” and 100% for “loss”.
     
  3. Special Reserve - is fund set aside covering losses due to risks related to a particular country, region, industry or type of loans. The reserve rate could be decided based on management estimate of loan collectability.

 

To the extent the mandatory loan loss reserve rate of 1% as required by PBOC differs from management’s estimates, the management elects to use the higher rate. As of September 30, 2014, the Company utilized Specific Reserve in the determination of the loan loss reserve as it is higher than the amount calculated based on the General Reserve.

 

While management uses the best information available to make loan loss allowance evaluations, adjustments to the allowance may be necessary based on changes in economic and other conditions or changes in accounting guidance.

 

Income Tax

 

Current income taxes are provided for in accordance with the laws of the relevant taxing authorities. As part of the process of preparing financial statements, the Company is required to estimate its income taxes in each of the jurisdictions in which it operates. The Company accounts for income taxes using the liability method. Under this method, deferred income taxes are recognized for tax consequences in future years of differences between the tax bases of assets and liabilities and their reported amounts in the financial statements at each year-end and tax loss carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates applicable for the differences that are expected to affect taxable income.

 

60
 

 

Recently issued accounting standards 

  

The FASB has issued ASU No. 2014-09, Revenue from Contracts with Customers. This ASU supersedes the revenue recognition requirements in Accounting Standards Codification 605 - Revenue Recognition and most industry-specific guidance throughout the Codification. The standard requires that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. This ASU is effective on January 1, 2017 and should be applied retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially applying the ASU recognized at the date of initial application. For all other entities (nonpublic entities), the amendments in this ASU are effective for annual reporting periods beginning after December 15, 2017, and interim periods within annual periods beginning after December 15, 2018. A nonpublic entity may elect to apply this guidance earlier, however, only as prescribed in this ASU. The adoption of this standard is not expected to have a material impact on the Company’s (consolidated) financial position and results of operations.

 

The FASB has issued ASU No. 2014-12, Compensation - Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period. This ASU requires that a performance target that affects vesting, and that could be achieved after the requisite service period, be treated as a performance condition. As such, the performance target should not be reflected in estimating the grant date fair value of the award. This update further clarifies that compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered.. The amendments in this ASU are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Earlier adoption is permitted. The adoption of this standard is not expected to have a material impact on the Company’s consolidated financial position and results of operations.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Not applicable.

 

ITEM 4. CONTROLS AND PROCEDURES 

 

Evaluation of Disclosure Controls and Procedures

 

Based on an evaluation under the supervision and with the participation of the Company’s management, the Company’s principal executive officer and principal financial officer have concluded that the Company’s disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act were not effective as of September 30, 2014 to provide reasonable assurance that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission (“SEC”) rules and forms, and (ii) accumulated and communicated to the Company’s management, including its principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.

 

61
 

 

Inherent Limitations Over Internal Controls

 

The Company’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S GAAP. The Company’s internal control over financial reporting includes those policies and procedures that:

 

  i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the Company’s assets;
     
  ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. GAAP, and that the Company’s receipts and expenditures are being made only in accordance with authorizations of the Company’s management and directors; and
     
  iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.

 

Management, including the Company’s principal executive officer and principal financial officer, does not expect that the Company’s internal controls will prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of internal controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. Also, any evaluation of the effectiveness of controls in future periods are subject to the risk that those internal controls may become inadequate because of changes in business conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

Changes in Internal Control over Financial Reporting

 

There were no changes in our internal control over financial reporting during the third quarter of 2014 that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.

 

As the Company’s control deficiencies contributed to the transfer (“Transfer at Issue”) of RMB7 million (approximately $1.1 million) by the Company’s former CEO from the bank account of Wujiang Luxiang to his personal bank account without proper authorization, the Company has since taken various steps to improve its internal controls and procedures, including implementing a new fund transfer approval policy and procedures and new standards of credit risk assessment which are carried out by the newly formed Loan Review Committee. The internal review conducted by independent counsel engaged by the Special Committee of the Board of Directors observed that such new controls and procedures appear to be much more thorough and comprehensive.

 

62
 

 

PART II.  OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

On August 6, 2014, a purported shareholder Andrew Dennison filed a putative class action complaint in the United States District Court District of New Jersey (the “N.J. district court”) relating to a July 25, 2014 press release about the Company’s progress in recovering a significant portion of the $5.4 million the Company paid in the first quarter of 2014 on behalf of loan guarantee customers. The action is captioned Andrew Dennison v. China Commercial Credit, Inc., et al., Case No. 2:2014-cv-04956. The action alleges that the Company and its current and former officers and directors Huichun Qin, Long Yi, Jianming Yin, Jinggen Ling, Xiangdong Xiao, and John F. Levy violated the federal securities laws by misrepresenting in prior public filings certain material facts about the risks associated with its loan guarantee business. On October 2, 2014, two purported shareholders Zhang Yun and Sanjiv Mehrotra (the “Yun Group”) asserted substantially similar claims against the same defendants in a putative class action captioned Zhang Yun v. China Commercial Credit, Inc., et al., Case No. 2:14-cv-06136 (D. N.J.). Neither complaint states the amount of damages sought.

 

On or about October 6, 2014, Dennison, the Yun Group and another purported shareholder, Jason Stark, filed motions to consolidate the cases, be appointed as lead plaintiff and to have their respective counsel appointed as lead counsel. On October 31, 2014, the N.J. district court entered an order consolidating the cases under the caption “In re China Commercial Credit Inc. Securities Litigation” and appointing the Yun Group as lead plaintiff and the Yun Group’s counsel as lead counsel.

 

On November 18, 2014, the Yun Group and the Company, which at that point was the only defendant served, entered into a stipulation to transfer of the case to the Southern District of New York. On December 18, 2014, Mr. Levy, who had by then been served, joined in the stipulation. On December 29, 2014, the N.J. district court entered an order transferring the action. The transfer was effected on January 22, 2015, and assigned docket number 1:15-cv-00557-ALC (S.D.N.Y.).

 

Under the schedule stipulated by the parties, the Yun Group is to file an amended complaint within 60 days of the date that the transfer was effected, and the defendants’ date to answer or move is within 60 days of that filing. The Company and Mr. Levy anticipate that they will file a motion to dismiss the amended complaint. The Company believes that this lawsuit is without merit and intends to vigorously defend against it. At this early stage of the proceedings, the Company is not able to estimate the probability of success or loss.

 

On February 3, 2015, a purported shareholder Kiram Kodali filed a putative shareholder derivative complaint in the United States District Court for the Southern District of New York, captioned Kiran Kodali v. Huichin Qin, et al., Case No. 15-cv-806.  The action alleges that the Company and its current and former officers and directors Huichun Qin, Long Yi, Jianming Yin, Jinggen Ling, Xiangdong Xiao, John F. Levy, Xiaofang Shen and Chunjiang Yu violated their fiduciary duties, grossly mismanaged the Company and were unjustly enriched based upon the transfer that was the subject of the internal review conducted by the special committee of the board and other grounds substantially similar to those asserted in the class action complaints.   Kodali did not serve a demand upon the Company and seeks to allege that demand is excused.  To the Company’s knowledge, as of this date, neither it nor any individual defendant has been served by Kodali.  The Company believes that this lawsuit is without merit and intends to vigorously defend against it.  At this stage of the proceedings, the Company is not able to estimate the probability of success or loss.

 

ITEM 1A. RISK FACTORS

 

There were no material changes to the risks included in the Company’s quarterly report on Amendment No. 1 to Form 10-Q filed with the SEC on March 12, 2015 except as set forth below.

 

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Risks Relating to Recent Events

 

We have received notice from NASDAQ related to our failure to timely file this report. If we are not able to file this report to the satisfaction of NASDAQ, then our shares of common stock will be delisted.

 

On February 19, 2015 the Company received a Nasdaq Staff Deficiency Letter indicating that, since the Company failed to file this report with the SEC by the required date of February 17, 2015, NASDAQ would remove the Company’s securities from listing and registration on The NASDAQ Stock Market unless the Company requests an appeal of this determination. The Company appealed such determination to a hearings panel who has granted an extended stay of the delisting until the hearing date, April 16, 2015. Failure by us to file the this 10-Q by April 16, 2015 and receiving NASDAQ approval may result in NASDAQ initiating delisting proceedings.

 

If our common stock is delisted from NASDAQ and transferred to the over-the-counter market, the spreads between the bid and ask prices for our common stock may increase and the execution time for orders may be longer. The delisting of our common stock from NASDAQ may result in decreased liquidity, thereby making the trading of our common stock more difficult. In addition, delisting from the NASDAQ might negatively impact our reputation and, as a consequence, our business.

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

None.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

 

None.

 

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ITEM 4. MINE SAFETY DISCLOSURES

 

Not applicable.

 

ITEM 5. OTHER INFORMATION

 

None.

 

ITEM 6. EXHIBITS 

 

The following exhibits are filed herewith:

 

Exhibit

No.

  Description
     
31.1   Certification of Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934
31.2   Certification of Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934
32.1   Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2   Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS   XBRL Instance Document
101.SCH   XBRL Taxonomy Extension Schema Document
101.CAL   XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF   XBRL Taxonomy Extension Definition Linkbase Document
101.LAB   XBRL Taxonomy Extension Label Linkbase Document
101.PRE   XBRL Taxonomy Extension Presentation Linkbase Document

 

65
 

 

SIGNATURES

 

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

 

March 13, 2015 CHINA COMMERCIAL CREDIT, INC.
   
  By: /s/ Jingen Lin
    Jingen Lin
    Chief Executive Officer
    (Principal Executive Officer)
     
  By: /s/ Long Yi
    Long Yi
   

Chief Financial Officer

(Principal Financial and Accounting Officer)

 

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EXHIBIT INDEX

 

Exhibit

No.

  Description
     
31.1   Certification of Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934
31.2   Certification of Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934
32.1   Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2   Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS   XBRL Instance Document
101.SCH   XBRL Taxonomy Extension Schema Document
101.CAL   XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF   XBRL Taxonomy Extension Definition Linkbase Document
101.LAB   XBRL Taxonomy Extension Label Linkbase Document
101.PRE   XBRL Taxonomy Extension Presentation Linkbase Document

 

 

67