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EX-32.1 - Shepherd's Finance, LLCex32-1.htm
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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

 

 

FORM 10-Q

  

 

 

[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the Quarterly Period Ended March 31, 2016

 

or

 

[  ] 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 333-203707

  

 

 

SHEPHERD’S FINANCE, LLC

(Exact name of registrant as specified on its charter)

 

 

 

DELAWARE   36-4608739
(State or other jurisdiction of   (I.R.S. Employer
Incorporation or organization)   Identification No.)

 

12627 San Jose Blvd., Suite 203, Jacksonville, FL 32223

(Address of principal executive offices)

 

302-752-2688

(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 [X] 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 [X] No [  ]

 

Indicate by check mark whether the registrant is a large accelerated filer, accelerated filer, or non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

 

  Large accelerated filer [  ] Accelerated filer [  ]
  Non-accelerated filer [  ] Smaller reporting company [X]

 

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

 

 

 

 

 

 

FORM 10-Q

SHEPHERD’S FINANCE, LLC

TABLE OF CONTENTS

  

  Page
Cautionary Note Regarding Forward-Looking Statements 3
PART I. FINANCIAL INFORMATION  
Item 1. Financial Statements 4
Interim Condensed Consolidated Balance Sheets as of March 31, 2016 (Unaudited) and December 31, 2015 4
Interim Condensed Consolidated Statements of Operations (Unaudited) for the Three Months Ended March 31, 2016 and 2015 5
Interim Condensed Consolidated Statement of Changes in Members’ Capital (Unaudited) for the Three Months Ended March 31, 2016 6
Interim Condensed Consolidated Statements of Cash Flows (Unaudited) for the Three Months Ended March 31, 2016 and 2015 7
Notes to Interim Condensed Consolidated Financial Statements (Unaudited) 8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 29
Item 3. Quantitative and Qualitative Disclosure About Market Risk 48
Item 4. Controls and Procedures 48
PART II. OTHER INFORMATION  
Item 1. Legal Proceedings 48
Item 1A. Risk Factors 48
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 48
Item 3. Defaults upon Senior Securities 49
Item 4. Mine Safety Disclosures 49
Item 5. Other Information 49
Item 6. Exhibits 49

 

2
 

 

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

Certain statements contained in this Form 10-Q of Shepherd’s Finance, LLC, other than historical facts, may be considered forward-looking statements within the meaning of the federal securities laws. Words such as “may,” “will,” “expect,” “anticipate,” “believe,” “estimate,” “continue,” “predict,” or other similar words identify forward-looking statements. Forward-looking statements appear in a number of places in this report, including without limitation, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and include statements regarding our intent, belief or current expectation about, among other things, trends affecting the markets in which we operate, our business, financial condition and growth strategies. Although we believe that the expectations reflected in these forward-looking statements are based on reasonable assumptions, forward-looking statements are not guarantees of future performance and involve risks and uncertainties. Actual results may differ materially from those predicted in the forward-looking statements as a result of various factors, including but not limited to those set forth in the “Risk Factors” section of our Annual Report on Form 10-K for the year ended December 31, 2015, as filed with the Securities and Exchange Commission. If any of the events described in “Risk Factors” occur, they could have an adverse effect on our business, consolidated financial condition, results of operations and cash flows.

 

When considering forward-looking statements, you should keep these risk factors, as well as the other cautionary statements in this report and in our 2015 Form 10-K in mind. You should not place undue reliance on any forward-looking statement. We are not obligated to update forward-looking statements.

 

3
 

 

PART I – FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

Shepherd’s Finance, LLC

Interim Condensed Consolidated Balance Sheets

 

    As of  
(in thousands of dollars)   March 31, 2016     December 31, 2015  
     (Unaudited)        
Assets                
Cash and cash equivalents   $ 768     $ 1,341  
Accrued interest on loans     249       146  
Loans receivable, net     17,515       14,060  
Foreclosed assets     1,178       965  
Other assets     14       14  
                 
Total assets   $ 19,724     $ 16,526  
                 
Liabilities and Members’ Capital                
Customer interest escrow   $ 463     $ 498  
Accounts payable and accrued expenses     808       539  
Notes payable secured     5,997       3,683  
Notes payable unsecured, net of deferred financing costs     9,168       8,497  
Due to preferred equity member     26       25  
                 
Total liabilities     16,462       13,242  
                 
Commitments and Contingencies (Notes 4 and 9)                
                 
Series B preferred equity     1,050       1,010  
Class A common equity     2,212       2,274  
Members’ capital     3,262       3,284  
                 
Total liabilities and members’ capital   $ 19,724     $ 16,526  

 

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

 

4
 

 

Shepherd’s Finance, LLC

Interim Condensed Consolidated Statements of Operations - Unaudited

For the Three Months ended March 31, 2016 and 2015

 

    Three Months Ended  
(in thousands of dollars)   2016     2015  
             
Net Interest Income                
Interest and fee income on loans   $ 849     $ 376  
Interest expense     362       176  
                 
Net interest income     487       200  
Less: Loan loss provision     8       8  
                 
Net interest income after loan loss provision     479       192  
                 
Non-Interest Income                
Gain from foreclosure of assets            
                 
Income     479       192  
                 
Non-Interest Expense                
Selling, general and administrative     350       150  
                 
Total non-interest expense     350       150  
                 
Net income   $ 129     $ 42  
                 
Earned distribution to preferred equity holder     26       25  
                 
Net income attributable to common equity holders   $ 103     $ 17  

 

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

 

5
 

 

Shepherd’s Finance, LLC

Interim Condensed Consolidated Statements of Changes In Members’ Capital - Unaudited

For the Three Months Ended March 31, 2016

 

(in thousands of dollars)   2016  
       
Members’ capital, beginning balance   $ 3,284  
Net income     129  
Additional capital (preferred)     40  
Earned distributions to preferred equity holder     (26 )
Distributions to common equity holders     (165 )
         
Members’ capital, ending balance   $ 3,262  

 

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

 

6
 

 

Shepherd’s Finance, LLC

Interim Condensed Consolidated Statements of Cash Flows - Unaudited

For the Three Months Ended March 31, 2016 and 2015

 

(in thousands of dollars)   2016     2015  
             
Cash flows from operations                
Net income   $ 129     $ 42  
Adjustments to reconcile net income to net cash provided by (used in) operating activities                
Amortization of deferred financing costs     67       57  
Provision for loan losses     8       8  
Net loan origination fees deferred (earned)     (49 )     (98 )
Change in deferred origination expense     (10 )      
Net change in operating assets and liabilities                
Other assets           7  
Accrued interest on loans     (103 )     (24 )
Customer interest escrow     (35 )     (117 )
Accounts payable and accrued expenses     269       104  
                 
Net cash provided by (used in) operating activities     276       (21 )
                 
Cash flows from investing activities                
Loan originations and principal collections, net     (3,404 )     77  
Investment in foreclosed assets     (213 )      
                 
Net cash provided by (used in) investing activities     (3,617 )     77  
                 
Cash flows from financing activities                
Contributions from members     40        
Distributions to members     (190 )     (75 )
Proceeds from secured note payable     3,892       791  
Repayments of secured note payable     (1,578 )     (192 )
Proceeds from unsecured Notes     633       741  
Redemptions of unsecured Notes     (10 )     (500 )
Repayment of unsecured note payable           (375 )
Deferred financing costs paid     (19 )     (14 )
                 
Net cash provided by (used in) financing activities     2,768       376  
                 
Net increase (decrease) in cash and cash equivalents     (573 )     432  
                 
Cash and cash equivalents                
Beginning of period     1,341       558  
                 
End of period   $ 768     $ 990  
                 
Supplemental disclosure of cash flow information                
Cash paid for interest   $ 152     $ 47  
                 
Non-cash investing and financing activities                
Earned but not paid distribution of preferred equity holder   $ 1     $ 25  

 

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

 

7
 

 

Shepherd’s Finance, LLC

Notes to Interim Condensed Consolidated Financial Statements (unaudited)

 

Information presented throughout these notes to the interim condensed consolidated financial statements (unaudited) is in thousands of dollars.

 

1. Description of Business and Basis of Presentation

 

Description of Business

 

Description of Business

 

Shepherd’s Finance, LLC and subsidiaries (the “Company”, “we” or “our”) is a finance company that engages in commercial lending to residential homebuilders, financing construction of single family homes and residential development. The loans are extended to residential homebuilders and, as such, are commercial loans. We primarily fund our lending and operations by continued extension of Notes to the general public, which Notes are unsecured subordinated debt. We currently have six sources of capital:

 

   

March 31, 2016

    December 31, 2015  
Capital Source                
Purchase and sale agreements   $ 5,997     $ 3,683  
Secured line of credit from affiliates            
Unsecured Notes through our Notes offer, net of deferred costs     8,598       7,897  
Other unsecured debt     600       600  
Preferred equity     1,050       1,010  
Common equity     2,212       2,274  
                 
Total   $ 18,457     $ 15,464  

 

Certain features of the purchase and sale agreements have added liquidity and flexibility, which have lessened the need for the lines of credit from affiliates. Eventually, the Company intends to permanently replace the lines of credit to affiliates with a secured line of credit from a bank or through other liquidity.

 

Basis of Presentation

 

The accompanying (a) condensed consolidated balance sheet as of December 31, 2015, which has been derived from audited consolidated financial statements, and (b) unaudited interim condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. While certain information and disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”), management believes that the disclosures herein are adequate to make the unaudited interim condensed consolidated information presented not misleading. In the opinion of management, the unaudited interim condensed consolidated financial statements reflect all adjustments necessary for a fair presentation of the consolidated financial position, results of operations and cash flows for the periods presented. Such adjustments are of a normal, recurring nature. The results of operations for any interim period are not necessarily indicative of results expected for the fiscal year ending December 31, 2016. These unaudited interim condensed consolidated financial statements should be read in conjunction with the 2015 consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K as of and for the year ended December 31, 2015 (the “2015 Statements”). The accounting policies followed by the Company are set forth in Note 2 - Summary of Significant Accounting Policies of the notes to the 2015 Statements.

 

8
 

 

2. Summary of Significant Accounting Policies

 

Segment Reporting

 

We report all ongoing operations in one segment, commercial lending.

 

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 and disclosure of contingent assets and liabilities at the date of the interim condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. It is reasonably possible that market conditions could deteriorate, which could materially affect our consolidated financial position, results of operations, and cash flows. Among other effects, such changes could result in the need to increase the amount of our allowance for loan losses.

 

Revenue Recognition

 

Interest income generally is recognized on an accrual basis. The accrual of interest is generally discontinued on all loans past due 90 days or more. All interest accrued but not collected for loans that are placed on nonaccrual or charged off is reversed against interest income, unless management believes that the accrued interest is recoverable through liquidation of collateral. Interest received on nonaccrual loans is applied against principal. Interest on accruing impaired loans is recognized as long as such loans do not meet the criteria for nonaccrual status.

 

Advertising

 

Advertising costs are expensed as incurred and are included in selling, general and administrative. Advertising expenses were $18 and $7 for the three months ended March 31, 2016 and 2015, respectively.

 

Cash and Cash Equivalents

 

Management considers highly-liquid investments with original maturities of three months or less to be cash equivalents.

 

Fair Value Measurements

 

The Company follows the guidance of the Financial Accounting Standards Board (FASB) Accounting Standards Codification Topic (ASC) 825, Financial Instruments, and ASC 820, Fair Value Measurements. ASC 825 permits entities to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. ASC 820 clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. Under this guidance, fair value measurements are not adjusted for transaction costs. This guidance establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). See Note 3.

 

Loans Receivable

 

Loans are stated at the amount of unpaid principal, net of any allowances for loan losses, and adjusted for (1) the net unrecognized portion of direct costs and nonrefundable loan fees associated with lending, and (2) deposits made by the borrowers used as collateral for a loan and due back to the builder at or prior to loan payoff. The net amount of nonrefundable loan origination fees and direct costs associated with the lending process, including commitment fees, is deferred and accreted to interest income over the lives of the loans using a method that approximates the interest method.

 

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A loan is classified as nonaccrual, and the accrual of interest on such loan is discontinued, when the contractual payment of principal or interest becomes 90 days past due. In addition, a loan may be placed on nonaccrual at any other time management has serious doubts about further collectability of principal or interest according to the contractual terms, even though the loan is currently performing. A loan may remain on accrual status if it is in the process of collection or well-secured (i.e., the loan has sufficient collateral value). Loans are restored to accrual status when the obligation is brought current or has performed in accordance with the contractual terms for a reasonable period of time and the ultimate collectability of the total contractual principal and interest is no longer in doubt.

 

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. Impaired loans, or portions thereof, are charged off when deemed uncollectible. Once a loan is 90 days past due, management begins a workout plan with the borrower or commences its foreclosure process on the collateral.

 

Allowance for Loan Losses

 

The allowance for loan losses is maintained at a level believed adequate by management to absorb probable losses inherent in the loan portfolio.

 

We establish a collective reserve for all loans which are not more than 60 days past due at the end of a quarter. This collective reserve takes into account both historical information and a qualitative analysis of housing and other economic factors that may impact our future realized losses. For loans to one borrower with committed balances less than 10% of our total committed balances on all loans extended to all customers, we individually analyze for impairment all loans which are more than 60 days past due at the end of a quarter. For loans to one borrower with committed balances equal to or greater than 10% of our total committed balances on all loans extended to all customers, we individually analyze all loans for potential impairment. The analysis of loans, if required, includes a comparison of estimated collateral value to the principal amount of the loan. For impaired loans, if the value determined is less than the principal amount due (less any builder deposit), then the difference is included in the allowance for loan loss. As values change, estimated loan losses may be provided for more or less than the previous period, and some loans may not need a loss provision based on payment history. For homes which are partially complete, we appraise on an as-is and completed basis, and use the one that more closely aligns with our planned method of disposal for the property.

 

For loans greater than 12 months in age that are individually evaluated for impairment, appraisals have been prepared within the last 13 months. For all loans individually evaluated for impairment, there is also a broker’s opinions of value (“BOV”) prepared, if the appraisal is more than six months old. The lower of any BOV prepared in the last six months, or the most recent appraisal, is used, unless we determine a BOV to be invalid based on the comparable sales used. If we determine a BOV to be invalid, we will use the appraised value. Appraised values are adjusted down for estimated costs associated with asset disposal. Broker’s opinion of selling price, currently valid sales contracts on the subject property, or representative recent actual closings by the builder on similar properties may be used in place of a BOV.

 

Impaired Loans

 

A loan is considered to be impaired when it is probable the Company will be unable to collect all principal and interest payments due in accordance with the contractual terms of the loan agreement. The analysis of impaired loans includes a comparison of estimated collateral value to the principal amount of the loan. If the value determined is less than the principal amount due (less any builder deposit), then the difference is included in the allowance for loan loss. As values change, estimated loan losses may be provided for more or less than the previous period. For homes which are partially complete, we appraise on an as-is and completed basis, and use the one that more closely aligns with our planned method of disposal for the property. For loans greater than 12 months in age that are individually evaluated for impairment, appraisals have been prepared within the last 13 months. For all loans individually evaluated for impairment, there is also a BOV prepared, if the appraisal is more than six months old. The lower of any BOV prepared in the last six months, or the most recent appraisal, is used, unless we determine a BOV to be invalid based on the comparable sales used. If we determine a BOV to be invalid, we will use the appraised value. Appraised values are adjusted down for estimated costs associated with asset disposal. Broker’s opinion of selling price, currently valid sales contracts on the subject property, or representative recent actual closings by the builder on similar properties may be used in place of a BOV.

 

10
 

 

Deferred Financing Costs, Net

 

We defer certain costs associated with financing activities related to the issuance of debt securities (deferred financing costs). These costs consist primarily of professional fees incurred related to the transactions. Deferred financing costs are amortized into interest expense over the life of the related debt. We make estimates for the average duration of future investments. If these estimates are determined to be incorrect in the future, the rate at which we are amortizing the deferred offering costs as interest expense would be adjusted and could have a material impact on the consolidated financial statements. The deferred financing costs are reflected as a reduction in the unsecured notes offering liability. The Company adopted the guidance on the presentation of debt issuance costs on January 1, 2016, as required. As a result, the Company retrospectively applied the guidance to the 2015 Consolidated Balance Sheet by reclassifying $599 of deferred financing costs previously classified in the assets section.

 

The following is a roll forward of deferred financing costs:

 

    Three Months       Three Months  
    Ended   Year Ended   Ended  
    March 31, 2016   December 31, 2015   March 31, 2015  
                     
Deferred financing costs, beginning balance   $ 935   $ 737   $ 737  
Additions     19     198     14  
                     
Deferred financing costs, ending balance   $ 954   $ 935   $ 751  
                     
Less accumulated amortization     (403)     (336)     (164)  
                     
Deferred financing costs, net   $ 551   $ 599   $ 587  

 

The following is a roll forward of the accumulated amortization of deferred financing costs:

 

    Three Months       Three Months  
    Ended   Year Ended   Ended  
    March 31, 2016   December 31, 2015   March 31, 2015  
                     
Accumulated amortization, beginning balance   $ 336   $ 107   $ 107  
Additions     67     229     57  
                     
Accumulated amortization, ending balance   $ 403   $ 336   $ 164  

 

Income Taxes

 

The entities included in the consolidated financial statements are organized as pass-through entities under the Internal Revenue Code. As such, taxes are the responsibility of the members. Other significant taxes for which the Company is liable are recorded on an accrual basis.

 

The Company applies ASC Topic 740, Income Taxes. ASC 740 provides guidance for how uncertain tax positions should be recognized, measured, presented and disclosed in the consolidated financial statements and requires the evaluation of tax positions taken or expected to be taken in the course of preparing the Company’s consolidated financial statements to determine whether the tax positions are “more-likely-than-not” to be sustained by the applicable tax authority. Tax positions with respect to income tax at the LLC level not deemed to meet the “more-likely-than-not” threshold would be recorded as a tax benefit or expense in the appropriate period. Management concluded that there are no uncertain tax positions that should be recognized in the consolidated financial statements. With few exceptions, the Company is no longer subject to income tax examinations for years prior to 2012.

 

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The Company’s policy is to record interest and penalties related to taxes in interest expense on the consolidated statements of operations. There have been no significant interest or penalties assessed or paid.

 

Risks and Uncertainties

 

The Company is subject to many of the risks common to the commercial lending and real estate industries, such as general economic conditions, decreases in home values, decreases in housing starts, and high unemployment. These risks, which could have a material and negative impact on the Company’s consolidated financial condition, results of operations, and cash flows include, but are not limited to, declines in housing starts, unfavorable changes in interest rates, and competition from other lenders. At March 31, 2016, our loans were significantly concentrated in a suburb of Pittsburgh, Pennsylvania, so the housing starts and prices in that area are more significant to our business than other areas until and if more loans are created in other markets.

 

Concentrations

 

Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of loans receivable. As of March 31, 2016 and December 31, 2015, 40% and 37%, respectively, of our outstanding loan commitments consist of loans to one borrower, and the collateral is in one real estate market, Pittsburgh, Pennsylvania. Accordingly, the ultimate collectability of a significant portion of these loans is susceptible to changes in market conditions in that area. As of March 31, 2016, our next two largest customers make up 24% and 8% respectively of our loan commitments, with loans in Sarasota, Florida and Savannah, Georgia, respectively. As of December 31, 2015, our next two largest customers made up 22% and 6% respectively of our loan commitments, with loans in Sarasota, Florida and Columbia, South Carolina, respectively.

 

Recent Accounting Pronouncements

 

The FASB issued Accounting Standards Update (ASU) 2014-09, “Revenue from Contracts with Customers (Topic 606).” ASU 2014-09 implements a common revenue standard that clarifies the principles for recognizing revenue. The core principle of ASU 2014-09 is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve that core principle, an entity should apply the following steps: (i) identify the contract(s) with a customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations in the contract and (v) recognize revenue when (or as) the entity satisfies a performance obligation. ASU 2014-09 is effective for the Company on January 1, 2018. The Company is still evaluating the potential impact on the Company’s consolidated financial statements.

 

In April 2015, the FASB issued ASU No. 2015-03, Interest - Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs. The amendments in this ASU require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. This guidance required retrospective application. The Company adopted the guidance on January 1, 2016, as required. See Note 1-Deferred Financing Costs, Net for additional information regarding the adoption of the new guidance.

 

In November 2015, FASB voted to set the effective date of its planned guidance on the Current Expected Loss model (CECL). Under the CECL model, an entity would reserve for all contractual cash flows not expected to be collected from a recognized financial asset (or group of financial assets) or commitment to extend credit. The estimate of expected credit losses would consider all contractual cash flows over the life of the asset. The estimate would be developed based on historical loss experience for similar assets as well as management’s assessment of current conditions and reasonable and supportable forecasts about the future. The FASB expects to publish a final ASU on credit losses in early 2016. The planned guidance will be effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. Early application of the guidance will be permitted for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company is currently evaluating the impact of this amendment on the consolidated financial statements.

 

12
 

 

Subsequent Events

 

Management of the Company has evaluated subsequent events through May 5, 2016, the date these consolidated financial statements were issued. See Note 12.

 

3. Fair Value

 

Utilizing ASC 820, the Company has established a framework for measuring fair value under U.S. GAAP using a hierarchy, which requires the Company to maximize the use of observable inputs and minimize the use of unobservable inputs. Fair value measurements are an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. Three levels of inputs are used to measure fair value, as follows:

 

  Level 1 – quoted prices in active markets for identical assets or liabilities;
     
  Level 2 – quoted prices in active markets for similar assets and liabilities and inputs that are observable for the asset or liability; or
     
  Level 3 – unobservable inputs, such as discounted cash flow models or valuations.

 

A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. The following describes valuation methodologies used for assets measured at fair value:

 

The Company has determined that the carrying value of financial instruments approximates fair value, as outlined below:

 

Fair Value Measurements of financial assets on a Non-recurring Basis

 

Impaired Loans

 

Fair value estimates are determined using the methodology discussed in Note 2. The appraisals are on similar properties at similar times, however due to the differences in time and properties, the impaired loans are classified as Level 3. There were no impaired assets as of March 31, 2016 or December 31, 2015.

 

Fair Value of Financial Instruments on a Recurring Basis

 

ASC 825 requires disclosure of fair value information about financial instruments, whether or not recognized on the face of the balance sheet, for which it is practicable to estimate that value. The following methods and assumptions were used by the Company in estimating the fair value of its financial instruments:

 

Cash and Cash Equivalents

 

The carrying amount approximates fair value because of the short maturity of these instruments.

 

13
 

 

Loans Receivable and Commitments to Extend Credit

 

For variable rate loans that reprice frequently with no significant change in credit risk, estimated fair values of collateral are based on carrying values at March 31, 2016 and December 31, 2015. The estimated fair values for other loans are calculated by discounting the future cash flows using current rates at which similar loans would be made to borrowers with similar credit ratings and the same remaining maturities and approximate carrying values of these instruments at March 31, 2016 and December 31, 2015. Because the loans are demand loan and therefore have no known time horizon, there is no significant impact from fluctuating interest rates. For unfunded commitments to extend credit, because there would be no adjustment between fair value and carrying amount for the amount if actually loaned, there is no adjustment to the amount before it is loaned. The amount for commitments to extend credit is not listed in the tables below because there is no difference between carrying value and fair value, and the amount is not recorded on the consolidated balance sheets as a liability.

 

Interest Receivable

 

Interest receivable from our customers does not yield interest to us, but because interest is due roughly 10 days after it is billed, the fair value approximates the carrying value at both March 31, 2016 and December 31, 2015.

 

Customer Interest Escrow

 

The customer interest escrow does not yield interest to the customer, but because: 1) the customer loans are demand loans, 2) there is no way to estimate how long the escrow will be in place, and 3) the interest rate which could be used to discount this amount is negligible, the fair value approximates the carrying value at both March 31, 2016 and December 31, 2015.

 

Borrowings under Credit Facilities

 

The fair value of the Company’s borrowings under credit facilities is estimated based on the expected cash flows discounted using the current rates offered to the Company for debt of the same remaining maturities. As all of the borrowings under credit facilities or the Notes are either payable on demand or at similar rates to what the Company can borrow funds for today, the fair value of the borrowings is determined to approximate carrying value at March 31, 2016 and December 31, 2015. The interest on our Notes offering is paid to our Note Holders either monthly or at the end of their investment, compounding on a monthly basis. For the same reasons as the determination for the principal balances on the Notes, the fair value approximates the carrying value for the interest as well. The interest payable makes up the bulk of our accounts payable and accrued expenses.

 

The table below is a summary of fair value estimates for financial instruments and the level of the fair value hierarchy (as discussed in Note 2) within which the fair value measurements are categorized at the periods indicated:

 

March 31, 2016

 

                Quoted Prices              
                in Active     Significant        
                Markets for     Other     Significant  
                Identical     Observable     Unobservable  
    Carrying     Estimated     Assets     Inputs     Inputs  
    Amount     Fair Value     Level 1     Level 2     Level 3  
Financial Assets                                        
Cash and cash equivalents   $ 768     $ 768     $ 768     $     $  
Loans receivable, net     17,515       17,515                   17,515  
Accrued interest on loans     249       249       249              
Financial Liabilities                                        
Customer interest escrow     463       463                   463  
Notes payable secured     5,997       5,997                   5,997  
Notes payable unsecured, net     9,168       9,168                   9,168  
Accounts payable and accrued expenses     808       808                   808  

 

 

14
 

 

December 31, 2015

 

                Quoted Prices              
                in Active     Significant        
                Markets for     Other     Significant  
                Identical     Observable     Unobservable  
    Carrying     Estimated     Assets     Inputs     Inputs  
    Amount     Fair Value     Level 1     Level 2     Level 3  
Financial Assets                                        
Cash and cash equivalents   $ 1,341     $ 1,341     $ 1,341     $     $  
Loans receivable, net     14,060       14,060                   14,060  
Accrued interest on loans     146       146       146              
Financial Liabilities                                        
Customer interest escrow     498       498                   498  
Notes payable secured     3,683       3,683                   3,683  
Notes payable unsecured, net     8,497       8,497                   8,497  
Accounts payable and accrued expenses     539       539                   539  

 

Fair Value Measurements of nonfinancial assets on a Non-recurring Basis

 

Foreclosed assets

 

The Company has no non-financial assets or non-financial liabilities measured at fair value on a recurring basis. Foreclosed assets (upon initial recognition or subsequent impairment) are non-financial assets measured at fair value on a non-recurring basis.

 

During 2015, certain foreclosed assets, upon initial recognition, were measured and reported at fair value. The excess of fair value measurements of foreclosed assets over the carrying value of the underlying loans result in a gain in non-interest income. The excess of the carrying value of the underlying loans over the fair value measurements of foreclosed assets are charged-off to the allowance for possible loan losses. These valuations are Level 3 valuations because the appraisal is comparing similar properties which sold at a similar date, but not the same. Foreclosed assets were $1,178 and $965 as of March 31, 2016 and December 31, 2015, respectively. In connection with the measurement and initial recognition of the foregoing foreclosed assets in 2015, the Company recognized a gain in non-interest income of approximately $105. During 2015 there were no foreclosed assets remeasured at fair value subsequent to initial recognition. During 2016, there were no foreclosures of real estate reported at fair value upon initial recognition by the Company and no foreclosed assets remeasured at fair value subsequent to initial recognition. The increase in foreclosed assets during 2016 was caused by capital expenditures to build or finish homes on the foreclosed assets.

 

4. Financing Receivables

 

Financing receivables are comprised of the following as of March 31, 2016 and December 31, 2015:

 

    March 31, 2016     December 31, 2015  
             
Commercial loans, gross   $ 18,594     $ 15,247  
Less: Deferred loan fees     (579 )     (628 )
Less: Deposits     (464 )     (521 )
Plus: Deferred origination expense     10        
Less: Allowance for loan losses     (46 )     (38 )
                 
Commercial loans, net   $ 17,515     $ 14,060  

 

15
 

 

Roll forward of commercial loans:

 

   

Three Months

Ended
March 31, 2016

   

Year

Ended
December 31, 2015

   

Three Months

Ended
March 31, 2015

 
                   
Beginning balance   $ 14,060     $ 8,097     $ 8,097  
Additions     7,081       13,760       1,233  
Payoffs/Sales     (3,620 )     (6,436 )     (1,320 )
Moved to foreclosed assets           (767 )      
Change in deferred origination expense     10              
Change in builder deposit     (57 )     (387 )     10  
Change in loan loss provision     (8 )     (17 )     (8 )
New loan fees     (332 )     (897 )     (44 )
Earned loan fees     381       707       142  
                         
Ending balance   $ 17,515     $ 14,060     $ 8,110  

  

Commercial Construction and Development Loans

 

Pennsylvania Loans

 

On December 30, 2011, pursuant to a credit agreement (as amended, the “Credit Agreement”) by and between us, Benjamin Marcus Homes, LLC (“BMH”), Investor’s Mark Acquisitions, LLC (“IMA”), and Mark L. Hoskins (“Hoskins”) (collectively, the “Hoskins Group”), we originated two new loan assets, one to BMH as borrower (the “BMH Loan”) and one to IMA as borrower (the “New IMA Loan”). Pursuant to the Credit Agreement and simultaneously with the origination of the BMH Loan and the New IMA Loan, we also assumed the position of lender on an existing loan to IMA (the “Existing IMA Loan”) and assumed the position of borrower on another existing loan in which IMA serves as the lender (the “SF Loan”). Throughout this report, we refer to the BMH Loan, the New IMA Loan, and the Existing IMA Loan collectively as the “Pennsylvania Loans.” When we assumed the position of the lender on the Existing IMA Loan, we purchased a loan which was originated by the borrower’s former lender, and assumed that lender’s position in the loan and maintained the recorded collateral position in the loan. The borrower’s former lender and the seller of the BMH property are the same independent third party. The BMH Loan, the New IMA Loan and the Existing IMA Loan are all cross-defaulted and cross-collateralized with each other. Further, IMA and Hoskins serve as guarantors of the BMH Loan, and BMH and Hoskins serve as guarantors of the New IMA Loan and the Existing IMA Loan. As such, we are currently reliant on a single developer and homebuilder for a significant portion of our revenues.

 

In April, July, September, and December 2013, in March and December 2014, and in March, June, and December of 2015, we entered into amendments to the Pennsylvania Loans. As a result of these amendments, BMH was allowed to borrow for the construction of homes on lots 204, 205, and 206 of the Hamlets subdivision and lots 2 and 5 of the Tuscany subdivision, both located in a suburb of Pittsburgh, Pennsylvania, and to borrow for the purchase of lot 5 of the Hamlets subdivision. As of March 31, 2016, all of the construction loans for homes extended by amendment to the credit agreement have been repaid. The lot loan for lot 5 in the Hamlets subdivision is still outstanding.

 

As a result of these amendments to the Credit Agreement, we converted $1,000 of the SF Loan from debt to preferred equity. The new preferred equity serves as collateral for the Pennsylvania Loans. There is no liquid market for the preferred equity instrument, so we can give no assurance as to our ability to generate any amount of proceeds from that collateral. We also reduced the balance of the SF Loan by $125, which was added to the Interest Escrow, and repaid the remaining $375 with cash. The interest rate on the Existing IMA Loan was raised to match the New IMA Loan. As of March 2016, the Hoskins Group invests in our preferred equity in an amount equal to $10 per closing of a lot payoff in the Hamlets or Tuscany subdivisions.

 

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Also as a result of these amendments to the Credit Agreement, we funded an additional $500 of interest escrow, we issued a letters of credit to a sewer authority relating to BMH Loan which totaled $68 at both March 31, 2016 and December 31, 2015 (the “Letter of Credit”), and we issued cash bonds for development with $257 outstanding at both March 31, 2016 and December 31, 2015. We also allowed a fully funded mortgage in the amount of $1,146 to be placed in superior position to our mortgage, with the $1,146 proceeds being used to reduce the balance of BMH’s outstanding loan with us. The terms and conditions of the Pennsylvania Loans are set forth in further detail below.

 

BMH Loan

 

The BMH Loan is a revolving demand loan in the original principal amount of up to $4,164, of which $3,568 was funded at closing. We collected a fee of $750 upon closing of the BMH Loan, which was funded from proceeds of the loan. Additionally, $450 of the loan proceeds was allocated to an interest escrow account (the “Interest Escrow”). Interest on the BMH Loan accrues annually at 2% (7% starting August 1, 2016) plus the greater of (i) 5.0% or (ii) the weighted average price paid by us on or in connection with all of our borrowed funds (such weighted average price includes interest rates, loan fees, legal fees and any and all other costs paid by us on our borrowed funds, and, in the case of funds borrowed by us from our affiliates, the weighted average price paid by such affiliate on or in connection with such borrowed funds) (“COF”). Pursuant to the Credit Agreement, interest payments on the BMH Loan are funded from the Interest Escrow, with any shortfall funded by BMH. Payments of principal on the BMH Loan are due upon our demand and in accordance with the payment schedule and other terms and conditions set forth in the Credit Agreement. The Credit Agreement obligates BMH to make payoffs to us in varying amounts upon the sale or transfer of, or obtaining construction financing for, all or a portion of the property securing the BMH Loan. The BMH Loan may be prepaid in whole or in part at any time without penalty; provided, however, that prepayments will not relieve BMH of its obligation to continue to make payments on the BMH Loan as set forth in the Credit Agreement.

 

The BMH Loan is secured by a second priority mortgage in residential property consisting of one building lot and a parcel of land of approximately 34 acres which is currently partially under development, all located in the subdivision commonly known as the Hamlets of Springdale in Peters Township, Pennsylvania, a suburb of Pittsburgh, as well as the Interest Escrow. The seller of the property securing the BMH Loan retained a third mortgage in the amount of $400, with a balance of approximately $147 and $157 as of March 31, 2016 and December 31, 2015, respectively. The property securing the BMH Loan is subject to a mortgage in the amount of $1,146, which is held by United Bank and guaranteed by the seller, an independent third party. The superior mortgage balance is subtracted from the appraised value of the land in the land valuation detail of the Pennsylvania loan financing receivables at March 31, 2016 and December 31, 2015 in the tables detailing the Pennsylvania Loans below.

 

New IMA Loan

 

The New IMA Loan is a demand loan in the original principal amount of up to $2,225, of which $250 was funded at closing. We collected a fee of $250 upon closing of the New IMA Loan, which was funded from proceeds of the loan. Interest on the New IMA Loan accrues annually at 2.0% (7% starting August 1, 2016) plus the greater of (i) 5.0% or (ii) the weighted average price paid by us on or in connection with all of our borrowed funds (such weighted average price includes interest rates, loan fees, legal fees and any and all other costs paid by us on our borrowed funds, and, in the case of funds borrowed by us from our affiliates, the weighted average price paid by such affiliate on or in connection with such borrowed funds). Pursuant to the Credit Agreement, interest payments on the New IMA Loan are funded from the Interest Escrow, with any shortfall funded by IMA. Payments of principal on the New IMA Loan are due upon our demand and in accordance with the payment schedule and other terms and conditions set forth in the Credit Agreement. The Credit Agreement obligates IMA to make payoffs to us in varying amounts upon the sale or transfer of, or obtaining construction financing for, all or a portion of the property securing the New IMA Loan. The New IMA Loan may be prepaid in whole or in part at any time without penalty; provided, however, that prepayments will not relieve IMA of its obligation to continue to make payments on the New IMA Loan as set forth in the Credit Agreement.

 

17
 

 

The New IMA Loan is secured by a mortgage in residential property originally consisting of 18 lots (6 and 8 lots remained as of March 31, 2016 and December 31, 2015, respectively) located in the subdivision commonly known as the Tuscany Subdivision in Peters Township, Pennsylvania, a suburb of Pittsburgh. Construction of the improvements for the Tuscany Subdivision began in December 2012, with $85 remaining to be completed as of March 31, 2016.

 

Existing IMA Loan

 

The Existing IMA Loan is a demand loan in the original principal amount of $1,687, of which $1,687 was outstanding as of both March 31, 2016 and December 31, 2015. Interest on the Existing IMA Loan accrued annually at a rate of 7.0% through December 30, 2014. Beginning December 31, 2014, the interest rate was the same as the New IMA Loan. Pursuant to the Credit Agreement, interest payments on the Existing IMA Loan are funded from the Interest Escrow, with any shortfall funded by IMA. Payments of principal on the Existing IMA Loan are due upon the earlier of our demand or the satisfaction in full of the indebtedness related to the BMH Loan and the New IMA Loan. The Credit Agreement obligates IMA to make payoffs to us in varying amounts upon the sale or transfer of, or obtaining construction financing for, all or a portion of the property securing the Existing IMA Loan. The Existing IMA Loan may be prepaid in whole or in part at any time without penalty; provided, however, that prepayments will not relieve IMA of its obligation to continue to make payments on the Existing IMA Loan as set forth in the Credit Agreement.

 

The Existing IMA Loan is secured by a mortgage in the residential property that also secures the New IMA Loan.

 

SF Loan

 

Concurrent with the execution of the loans above, we entered into the SF Loan with the Hoskins Group, under which we are the borrower. The SF Loan is described in Note 6.

 

Interest Escrow

 

The Pennsylvania Loans called for a funded Interest Escrow account which was funded with proceeds from the Pennsylvania Loans. The initial funding on that Interest Escrow was $450. The balance as of March 31, 2016 and December 31, 2015 was $230 and $267, respectively. To the extent the balance is available in the Interest Escrow, interest due on certain loans is deducted from the Interest Escrow on the date due. The Interest Escrow is increased by 10% of lot payoffs on the same loans, and by interest and/or distributions on the SF Loan and Hoskins Group preferred equity. All of these transactions are noncash to the extent that the total escrow amount does not need additional funding. The Interest Escrow is also used to contribute to the reduction of the $400 subordinated mortgage upon certain lot sales of the collateral of the BMH Loan.

 

Initial Funding

 

On December 30, 2011, we purchased the Existing IMA Loan from the original lender with a cash payment of $186 and the assumption of that lender’s obligations under the SF Loan. We also loaned our borrower $2,368 in funded cash for its purchase of the land and lots securing the BMH Loan. Our borrower’s loan balances were increased by the $750 loan fee on the BMH Loan, the $250 loan fee on the New IMA Loan, and the $450 Interest Escrow, all of which were not funded with cash.

 

Construction loans

 

The Pennsylvania Loans have been modified from time to time to allow for funding of construction of homes. Those loans are detailed in the tables below.

 

18
 

 

A detail of the financing receivables for the Pennsylvania loans at March 31, 2016 is as follows:

 

Item   Term   Interest Rate   Funded to
borrower
    Estimated
collateral values
 
                     
BMH Loan   Demand(1)   COF +2%
(7% Floor)
               
Land for phase 5 (10 acres)           $     $ 1,079  
Lots             1,063       2,406 (7)
Interest Escrow             950       230  
Cash Bond             257 (9)     257  
Loan Fee             750        
                         
Total BMH Loan             3,020       3,972  
IMA Loans                        
New IMA Loan (loan fee)   Demand(1)   COF +2%
(7% Floor)
    250        
New IMA Loan (advances)   Demand(1)   COF +2%
(7% Floor)
    514        
Existing IMA Loan   Demand(2)   COF +2%
(7% Floor)
    1,687       2,284 (3)
                         
Total IMA Loans             2,451       2,284  
                         
Unearned Loan Fee             (66 )      
SF Preferred Equity                   1,050 (8)
                         
Total           $ 5,405     $ 7,306  

 

A detail of the financing receivables for the Pennsylvania loans at December 31, 2015 is as follows:

 

Item   Term   Interest Rate   Funded to
borrower
    Estimated
collateral values
 
                     
BMH Loan   Demand(1)   COF +2%
(7% Floor)
               
Land for phase 5 (10 acres)           $     $ 1,079  
Lots             974       2,338 (4)
Interest Escrow             950       267  
Cash Bond             257 (9)     257  
Loan Fee             750        
                         
Total BMH Loan             2,931       3,941  
IMA Loans                        
New IMA Loan (loan fee)   Demand(1)   COF +2%
(7% Floor)
    250        
New IMA Loan (advances)   Demand(1)   COF +2%
(7% Floor)
    1,251        
Existing IMA Loan   Demand(2)   COF +2%
(7% Floor)
    1,687       2,951 (6)
                         
Total IMA Loans             3,188       2,951  
                         
Unearned Loan Fee             (115 )      
SF Preferred Equity                   1,010 (8)
                         
Total           $ 6,004     $ 7,902  

 

(1) These are the stated terms; however, in practice, principal will be repaid upon the sale of each developed lot.

 

19
 

 

(2) These are the stated terms; however, in practice, principal will be repaid upon the sale of each developed lot after the BMH loan and the New IMA loan are satisfied.

 

(3) Estimated collateral value is equal to the appraised value of the remaining lots of $2,369, net of the net estimated costs to finish the development of $85.

 

(4) Estimated collateral value is equal to the appraised value of the remaining lots of $3,600, net of the net estimated costs to finish the development of $531 and the first mortgage amount of $731.

 

(5) Excess Paydown is the amount of initial funding of the Interest Escrow and/or Loan Fee that has/have been repaid to date. These amounts are available to be reborrowed in the future.

 

(6) Estimated collateral value is equal to the appraised value of $3,101, net of estimated costs to finish the development of $150.

 

(7) Estimated collateral value is equal to the lots’ appraised value of $3,200 minus remaining improvements of $467, net of the outstanding first mortgage of $327.

 

(8) In the event of a foreclosure on the property securing certain of our loans, a portion of our collateral is preferred equity in our Company, which might be difficult to sell, which could impact our ability to eliminate the loan balance. The loans are collectively cross-collateralized and, therefore, treated as one loan for the purpose of calculating the effective interest rate and for available remedies upon an instance of default. As lots are released, a specific release price is repaid by the borrower, with 10% of that amount being used to fund the Interest Escrow (except for the construction funding for homes). The customer will make cash interest payments only when the Interest Escrow is fully depleted, except for construction funding for homes, where the customer makes interest payments monthly.

 

(9) The cash bond is in place to guarantee to the township that work will be completed on this project. We will fund this work and expect to cancel the bond upon completion of the work.

 

The Pennsylvania Loans created in 2011 had a $1,000 loan fee. The expenses incurred related to issuing the loan were approximately $76, which were netted against the loan amount. The remaining $924, which is netted against the gross loan amount, is being recognized over the expected life of the loans using the straight-line method in accordance with ASC 310-20, Nonrefundable Fees and Other Costs.

 

The Company has a credit agreement with its largest borrower which includes a maximum exposure on all three loans, as described in the chart below. This limit does not include construction loans.

 

Commercial Loans – Real Estate Development Loan Portfolio Summary

 

The following is a summary of our loan portfolio to builders for land development as of March 31, 2016. The Pennsylvania loans below are included as part of the Pennsylvania Loans discussed above.

 

State   Number of
Borrowers
    Number of
Loans
    Value of
Collateral(1)
    Commitment
Amount
    Amount
Outstanding
    Loan to
Value Ratio(2)
    Loan Fee  
Pennsylvania     1       3     $ 7,306     $ 6,456 (3)   $ 5,471       75 %   $ 1,000  
Total     1       3     $ 7,306     $ 6,456     $ 5,471       75 %   $ 1,000  

  

  (1) The value is determined by the appraised value adjusted for remaining costs to be paid and third party mortgage balances. Part of this collateral is $1,050 of preferred equity in our Company. In the event of a foreclosure on the property securing certain of our loans, a portion of our collateral is preferred equity in our Company, which might be difficult to sell, which could impact our ability to eliminate the loan balance.
     
  (2) The loan to value ratio is calculated by taking the outstanding amount and dividing by the appraised value.
     
  (3) The commitment amount includes letters of credit and cash bonds.

 

20
 

 

The following is a summary of our loan portfolio to builders for land development as of December 31, 2015. The Pennsylvania loans below are included as part of the Pennsylvania Loans discussed above.

 

State   Number of
Borrowers
    Number of
Loans
    Value of
Collateral(1)
    Commitment
Amount
    Amount
Outstanding
    Loan to
Value Ratio(2)
    Loan Fee  
Pennsylvania     1       3     $ 7,902     $ 6,456 (3)   $ 6,118       77 %   $ 1,000  
Total     1       3     $ 7,902     $ 6,456     $ 6,118       77 %   $ 1,000  

  

  (1) The value is determined by the appraised value adjusted for remaining costs to be paid and third party mortgage balances. Part of this collateral is $1,010 of preferred equity in our Company. In the event of a foreclosure on the property securing certain of our loans, a portion of our collateral is preferred equity in our Company, which might be difficult to sell, which could impact our ability to eliminate the loan balance.
     
  (2) The loan to value ratio is calculated by taking the outstanding amount and dividing by the appraised value.
     
  (3) The commitment amount includes letters of credit and cash bonds.

 

Commercial Loans – Construction Loan Portfolio Summary

 

The following is a summary of our loan portfolio to builders for home construction loans as of March 31, 2016.

 

State   Number of
Borrowers
  Number of
Loans
  Value of
Collateral (1)
    Commitment
Amount
    Amount
Outstanding
    Loan to
Value Ratio(2)
  Loan Fee  
Colorado   1   4   $ 2,170     $ 1,519     $ 1,115     70 %   5 %
Connecticut   1   1     715       500       251     70 %   5 %
Delaware   1   2     1,074       671       313     62 %   5 %
Florida   3   11     12,637       7,809       5,816     62 %   5 %
Georgia   2   3     3,916       2,278       859     58 %   5 %
New Jersey   1   2     670       452       316     67 %   5 %
New York   1   1     1,000       350       344     35 %   5 %
North Carolina   1   1     208       146       146     70 %   5 %
Pennsylvania   2   8     7,637       4,558       3,250     60 %   5 %
South Carolina   2   8     1,324       951       664     72 %   5 %
Utah   1   2     730       511       49     70 %   5 %
Total   16   43   $ 32,081     $ 19,745     $ 13,123     62 %(3)   5 %

  

  (1) The value is determined by the appraised value.
     
  (2) The loan to value ratio is calculated by taking the commitment amount and dividing by the appraised value.
     
  (3) Represents the weighted average loan to value ratio of the loans.

 

21
 

 

The following is a summary of our loan portfolio to builders for home construction loans as of December 31, 2015.

 

State   Number of
Borrowers
  Number of
Loans
  Value of
Collateral (1)
    Commitment
Amount
    Amount
Outstanding
    Loan to
Value Ratio(2)
  Loan Fee  
Colorado   1   4   $ 2,160     $ 1,519     $ 830     70 %   5 %
Connecticut   1   1     715       500       251     70 %   5 %
Delaware   1   2     1,074       671       105     63 %   5 %
Florida   3   10     10,683       6,440       4,378     60 %   5 %
Georgia   2   3     3,916       2,278       712     58 %   5 %
New Jersey   1   2     510       357       268     70 %   5 %
North Carolina   1   2     385       270       172     70 %   5 %
Pennsylvania   2   6     4,107       2,391       1,275     58 %   5 %
South Carolina   2   16     2,395       1,699       1,136     71 %   5 %
Total   14   46   $ 25,945     $ 16,125     $ 9,127     62 %(3)   5 %

 

  (1) The value is determined by the appraised value.
     
  (2) The loan to value ratio is calculated by taking the commitment amount and dividing by the appraised value.
     
  (3) Represents the weighted average loan to value ratio of the loans.

 

Credit Quality Information

 

The following table presents credit-related information at the “class” level in accordance with ASC 310-10-50, Disclosures about the Credit Quality of Finance Receivables and the Allowance for Credit Losses. A class is generally a disaggregation of a portfolio segment. In determining the classes, the Company considered the finance receivable characteristics and methods it applies in monitoring and assessing credit risk and performance.

 

The following table summarizes finance receivables by the risk ratings that regulatory agencies utilize to classify credit exposure and which are consistent with indicators the Company monitors. Risk ratings are reviewed on a regular basis and are adjusted as necessary for updated information affecting the borrowers’ ability to fulfill their obligations.

 

The definitions of these ratings are as follows:

 

  Pass – finance receivables in this category do not meet the criteria for classification in one of the categories below.
     
  Special mention – a special mention asset exhibits potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may, at some future date, result in the deterioration of the repayment prospects.
     
  Classified – a classified asset ranges from: 1) assets that are inadequately protected by the current sound worth and paying capacity of the borrower, and are characterized by the distinct possibility that some loss will be sustained if the deficiencies are not corrected to 2) assets with weaknesses that make collection or liquidation in full unlikely on the basis of current facts, conditions, and values. Assets in this classification can be accruing or on non-accrual depending on the evaluation of these factors.

 

Finance Receivables – By risk rating:

 

   

March 31, 2016

    December 31, 2015  
             
Pass   $ 13,607     $ 14,060  
Special mention     3,908        
Classified – accruing            
Classified – nonaccrual            
                 
Total   $ 17,515     $ 14,060  

 

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Finance Receivables – Method of impairment calculation:

 

   

March 31, 2016

    December 31, 2015  
             
Performing loans evaluated individually   $ 12,084     $ 9,971  
Performing loans evaluated collectively     5,431       4,089  
Non-performing loans without a specific reserve   $     $  
Non-performing loans with a specific reserve            
                 
Total evaluated collectively for loan losses   $ 17,515     $ 14,060  

 

At March 31, 2016 and December 31, 2015, there were no loans acquired with deteriorated credit quality, past due loans, impaired loans, or loans on nonaccrual status.

 

5. Foreclosed Assets

 

Roll forward of Foreclosed Assets:

 

   

Three Months

Ended
March 31, 2016

   

Year

Ended
December 31, 2015

   

Three Months

Ended
March 31, 2015

 
                   
Beginning balance   $ 965     $     $  
Additions from loans           885        
Additions for construction/development     213       85        
                         
Ending balance   $ 1,178     $ 965     $  

 

We foreclosed on five properties during 2015, of which four were acquired at the foreclosure sale and one was acquired via a deed in lieu of foreclosure. Three of the properties were lots in Georgia. We have an agreement with a builder to build a house on one of the lots and will likely start construction on a second home once the first has a sales agreement. The first home started construction in November of 2015. Two of the properties are partially completed homes in Louisiana, and work is proceeding to complete those homes. During the three months ended March 31, 2016, the Company did not foreclose on any additional properties.

 

6. Borrowings

 

Purchase and Sale Agreements

 

In December 2014, the Company entered into a purchase and sale agreement with 1st Financial Bank USA whereby the purchaser may buy loans offered to it by us, and we may be obligated to offer certain loans to purchaser. Purchaser is buying senior positions in the loans they purchase, originally 50%, 60% on new loans as of January 2016, of each loan. Purchaser generally receives the interest rate we charge the borrower (with a floor of 10%) on their portion of the loan balance, and we receive the rest of the interest and all of the loan fee. We service the loans. There is an unlimited right for us to call any loan sold, however in any case of such call, a minimum of 4% of the commitment amount of purchaser must have been received by purchaser in interest, or we must make up the difference. Also, the purchaser has a put option, which is limited to 10% of the funding made by purchaser under all loans purchased in the trailing 12 months.

 

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In April 2015, the Company entered into a purchase and sale agreement with Seven Kings Holdings, Inc. (“7Kings”) as purchaser and the Company as seller, whereby 7Kings buys loans offered to it by us, providing that their portions of the loans always total less than $1,500. On or about May 7, 2015, 7Kings assigned its right and interest in the purchase and sale agreement to S.K. Funding, LLC (“S.K. Funding”), an affiliate of 7Kings. S.K. Funding may adjust the $1,500 with notice, but such change will not cause a buyback by us. S.K. Funding is buying pari-passu positions in the loans they purchase, generally 50% of each loan. S.K. Funding generally receives a 9% interest rate on its portion of the loan balance, and we receive the rest of the interest and all of the loan fees. We service the loans. There is an unlimited right for us to call any loan sold. This transaction is accounted for as a secured line of credit. In the fourth quarter of 2015, we entered into a modification of our agreement with S.K. Funding whereby S.K. Funding agreed to buy priority interests of $1,000 each in two large loans we originated. In the first quarter of 2016, after one of the $1,000 loans repaid, we entered into an additional modification whereby S.K. Funding agreed to buy priority interests totaling $2,000 in a total of three large loans we originated. The interest rate for the loans covered by these modifications is 9.5% to S.K. Funding. On December 31, 2015, S.K. Funding purchased 4% of our common equity from the Wallach family.

 

The purchase and sale agreements are recorded as secured borrowings.

 

The purchase and sale agreements are detailed below:

 

    March 31, 2016     December 31, 2015  
    Book Value of     Due From     Book Value of     Due From  
    Loans which     Shepherd’s     Loans which     Shepherd’s  
    Served as     Finance to Loan     Served as     Finance to Loan  
    Collateral     Purchaser     Collateral     Purchaser  
Loan purchaser                                
1st Financial Bank, USA   $ 4,403     $ 2,069     $ 2,723     $ 1,061  
S.K. Funding, LLC     7,335       3,928       4,522       2,622  
                                 
Total   $ 11,738     $ 5,997     $ 7,245     $ 3,683  

 

Affiliate Loans

 

In December 2011, the Company entered into two secured revolving lines of credit with affiliates, both of whom are members. These loans have an interest rate of the affiliates’ cost of funds, which was 4.12% and 4.20% as of March 31, 2016 and December 31, 2015, respectively. They are demand notes. The maximum that can be borrowed under these notes is $1,500, at the discretion of the lenders. The actual amount borrowed was $0 at both March 31, 2016 and December 31, 2015, leaving $1,500 in potential credit availability on those dates. There is no obligation of the affiliates to lend money up to the note amount. The security for the lines of credit includes all of the assets of the Company. The Company has not borrowed on these lines in either 2015 or 2016.

 

S.K. Funding owns 4% of our common equity. S.K. Funding is also a buyer in a purchase and sale agreement where we are the seller. 7Kings is an investor in our notes program for $500 and has a $500 unsecured note due from us.

 

Other Unsecured Loans

 

In August 2015, we entered into an unsecured note with 7Kings, under which we are the borrower. The note has a maximum amount outstanding of $500, of which $500 was outstanding as of March 31, 2016 and December 31, 2015. Interest on the 7Kings loan accrues annually at a rate of 7.5%. The note was due on February 19, 2016, was renewed through August 18, 2016, and may be prepaid at any time without penalty. Interest is due at the end of each month and was $14 in 2015 and $9 in in the first three months of 2016. On December 31, 2015, S.K. Funding, an affiliate of 7Kings, purchased 4% of our common equity from the Wallach family. In December 2015, we entered into an unsecured note with an unrelated third party, under which we are the borrower. The note has a maximum amount outstanding of $100, of which $100 was outstanding on both March 31, 2016 and December 31, 2015. Interest on this note accrues annually at a rate of 7.9%. The note is due on June 23, 2017 and may be prepaid at any time without penalty. Interest accrues and compounds monthly.

 

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SF Loan

 

The SF Loan, under which we were the borrower, was an unsecured loan in the original principal amount of $1,500. Interest on the SF Loan accrued annually at a rate of 5.0%. On December 31, 2014, the Company and the Hoskins Group entered into a series of agreements which, among other things, 1) converted $1,000 of the SF Loan from debt to preferred equity, 2) repaid $125 of the SF Loan and applied those proceeds to increase the Interest Escrow, and 3) required elimination of the remaining balance of the SF Loan with a cash payment upon the repayment of the construction loan on lot 5, Tuscany. This payment was made in the first quarter of 2015.

 

Notes Program

 

Borrowings through our public offerings were $9,119 and $8,496 at March 31, 2016 and December 31, 2015, respectively. The effective interest rate on the borrowings at March 31, 2016 and December 31, 2015 was 7.44% and 7.30%, respectively, not including the amortization of deferred financing costs. There are limited rights of early redemption. We generally offer four durations at any given time, ranging anywhere from 12 to 48 months. The following table shows the roll forward of our Notes program:

 

    Three Months Ended
March 31, 2016
    Year Ended
December 31, 2015
    Three Months Ended
March 31, 2015
 
                         
Notes outstanding, beginning of period   $ 8,496     $ 5,427     $ 5,427  
Notes issued     633       3,737       741  
Note repayments / redemptions     (10 )     (668 )     (500 )
                         
Notes outstanding, end of period   $ 9,119     $ 8,496     $ 5,668  
                         
Less deferred financing costs, net     551       599       587  
                         
Notes outstanding, net     8,568       7,897       5,081  

 

The following table shows the maturity of outstanding debt as of March 31, 2016.

 

Year Maturing   Total
Amount
Maturing
    Public Offering     Other
Unsecured
    Purchase and Sale
Agreements
 
                         
2016   $ 8,734     $ 2,237     $ 500     $ 5,997  
2017     2,801       2,701       100        
2018     2,141       2,141              
2019     1,579       1,579                  
2020     461       461              
                                 
Total   $ 15,716     $ 9,119     $ 600     $ 5,997  

 

Purchase and sale agreements are treated as secured lines of credit, where the collateral is demand loans, and therefore they are considered short term liabilities.

 

7. Members’ Capital

 

There are currently two classes of units (class A common units and series B cumulative preferred units).

 

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The Class A common units are held by three members, all of whom have no personal liability. All Class A common members have voting rights in proportion to their capital account. There were 2,629 Class A common units outstanding at both March 31, 2016 and December 31, 2015. On December 31, 2015, an affiliate of 7Kings, S.K. Funding, purchased 4% of our common equity from the Wallach family.

 

The series B cumulative preferred units were issued to the Hoskins Group through a reduction in the SF Loan. They are redeemable only at the option of the Company or upon a change or control or liquidation. Ten units were issued for a total of $1,000. The series B units have a fixed value which is their purchase price, and preferred liquidation and distribution rights. Yearly distributions of 10% of the units’ value (providing profits are available) will be made quarterly. The Hoskins Group series B cumulative preferred units are also used as collateral for that group’s loans to the Company. There is no liquid market for the preferred equity instrument, so we can give no assurance as to our ability to generate any amount of proceeds from that collateral. In December of 2015, the Hoskins Group agreed to purchase 0.1 unit for $10 at each closing of a lot to a third party in the Hamlets and Tuscany subdivision.

 

There are two additional authorized unit classes: class A preferred units and class B profit units. Once class B profit units are issued, the existing class A common units will become class A preferred units. Class A preferred units will receive preferred treatment in terms of distributions and liquidation proceeds.

 

The members’ capital balances by class are as follows:

 

Class   March 31, 2016     December 31, 2015  
B Preferred Units   $ 1,050     $ 1,010  
A Common Units     2,212       2,274  
                 
Members’ Capital   $ 3,262     $ 3,284  

 

8. Related Party Transactions

 

Notes and Accounts Payable to Affiliates

 

The Company has a loan agreement with two of our affiliates, as more fully described in Note 6 – Affiliate Loans.

 

The Company had loan agreements with the Hoskins Group, as more fully described in Note 6 – SF Loan and Note 4 – Pennsylvania Loans.

 

The Hoskins Group has a preferred equity interest in the Company, as more fully described in Note 7.

 

S.K. Funding, an affiliate of 7Kings, owns 4% of our common equity. S.K. Funding is also a buyer in a purchase and sale agreement where we are the seller. 7Kings is an investor in our notes program for $500 and has a $500 unsecured note due from us.

 

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The Company has accepted new investments under the Notes program from employees, managers, members and relatives of managers and members, with $2,681 outstanding at March 31, 2016. The larger of these investments are detailed below:

 

    Relationship to         Weighted
average interest
    Interest earned
during the
three months ended
 
    Shepherd’s   Amount invested as of     rate as of     March 31,  
Investor   Finance  

March 31, 2016

    December 31, 2015    

March 31, 2016

    2016     2015  
Bill Myrick   Independent Manager   $ 275     $ 268       7.75 %   $ 6     $ 3  
                                             
R. Scott Summers   Son of Independent Manager     475       475       7.26 %     6       2  
                                             
Wallach Family Irrevocable Educational Trust   Trustee is Member     200       200       7.00 %     4       4  
                                             
David and Carole Wallach   Parents of Member     111       111       8.00 %     2       2  
                                             
Eric Rauscher   Independent Manager     600       600       7.13 %     11       9  
                                             
Joseph Rauscher   Parents of Independent Manager     186       186       8.00 %     4       4  
                                             
Schultz Family Revocable Living Trust   Parents of Member     111       96       8.21 %     2       2  
                                             
Seven Kings Holdings, Inc.   Member     500       500       7.00 %     9       9  

 

9. Commitments and Contingencies

 

In the normal course of business there may be outstanding commitments to extend credit that are not included in the consolidated financial statements. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon and some of the funding may come from the earlier repayment of the same loan (in the case of revolving lines), the total commitment amounts do not necessarily represent future cash requirements. The financial instruments involve, to varying degrees, elements of credit and interest rate risk in excess of amounts recognized in the consolidated financial statements. The Company evaluates each customer’s creditworthiness on a case-by-case basis. Unfunded commitments to extend credit, which have similar collateral, credit risk and market risk to our outstanding loans, were $7,606 and $7,332 at March 31, 2016 and December 31, 2015, respectively.

 

In September 2013, the Company issued a Letter of Credit for $155 to a sewer authority relating to the BMH Loan. Refer to the chart in Note 4 – Commercial Loans – Real Estate Development Loan Portfolio Summary for further details describing this commitment.

 

The property securing the BMH Loan is subject to a mortgage in the amount of $1,146, which is held by United Bank and guaranteed by 84 FINANCIAL, L.P. The subordinated mortgage balance of $327 and $731 is subtracted from the appraised value of the land in the land valuation detail of the Pennsylvania financing receivables in Note 4 at March 31, 2016 and December 31, 2015, respectively.

 

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10. Selected Quarterly Condensed Consolidated Financial Data (Unaudited)

 

Summarized unaudited quarterly condensed consolidated financial data for the four quarters of 2016 and 2015 are as follows (in thousands):

 

    Quarter 4     Quarter 3    

Quarter 2

    Quarter 1     Quarter 4     Quarter 3     Quarter 2     Quarter 1  
    2016     2016     2016     2016     2015     2015     2015     2015  
                                                                 
Net Interest Income   $     $     $     $ 479     $ 326     $ 210     $ 212     $ 192  
Non-Interest Income                             105                    
SG&A expense                       350       163       115       119