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EX-32.1 - Shepherd's Finance, LLCex32-1.htm
EX-31.1 - Shepherd's Finance, LLCex31-1.htm

 

 

 

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 June 30, 2017

 

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, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

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

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [  ]

 

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 June 30, 2017 (Unaudited) and December 31, 2016 4
   
Interim Condensed Consolidated Statements of Operations (Unaudited) for the Three Months and Six Months Ended June 30, 2017 and 2016 5
   
Interim Condensed Consolidated Statement of Changes in Members’ Capital (Unaudited) for the Six Months Ended June 30, 2017 6
   
Interim Condensed Consolidated Statements of Cash Flows (Unaudited) for the Six Months Ended June 30, 2017 and 2016 7
   
Notes to Interim Condensed Consolidated Financial Statements (Unaudited) 8
   
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 22
   
Item 3. Quantitative and Qualitative Disclosure About Market Risk 40
   
Item 4. Controls and Procedures 40
 
PART II. OTHER INFORMATION  
   
Item 1. Legal Proceedings 41
   
Item 1A. Risk Factors 41
   
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 41
   
Item 3. Defaults upon Senior Securities 41
   
Item 4. Mine Safety Disclosures 41
   
Item 5. Other Information 41
   
Item 6. Exhibits 41

 

 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, 2016, 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 2016 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)   June 30, 2017     December 31, 2016  
    (Unaudited)        
Assets            
Cash and cash equivalents   $ 88     $ 1,566  
Accrued interest receivable     354       280  
Loans receivable, net     28,972       20,091  
Foreclosed assets     1,095       2,798  
Property, plant and equipment     652       69  
Other assets     84       82  
                 
Total assets   $ 31,245     $ 24,886  
                 
Liabilities, Redeemable Preferred Equity and Members’ Capital                
                 
Liabilities                
                 
Customer interest escrow   $ 829     $ 812  
Accounts payable and accrued expenses     434       377  
Accrued interest payable     968       986  
Notes payable secured     8,820       7,322  
Notes payable unsecured, net of deferred financing costs     15,574       11,962  
Due to preferred equity member     29       28  
                 
Total liabilities     26,654       21,487  
                 
Commitments and Contingencies (Notes 3 and 10)                
                 
Redeemable Preferred Equity                
                 
Series C preferred equity     1,033        
                 
Members’ Capital                
                 
Series B preferred equity     1,160       1,150  
Class A common equity     2,398       2,249  
Members’ capital     3,558       3,399  
                 
Total liabilities, redeemable preferred equity and members’ capital   $ 31,245     $ 24,886  

 

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 and Six Months ended June 30, 2017 and 2016

 

   Three Months Ended   Six Months Ended 
   June 30,   June 30, 
(in thousands of dollars)  2017   2016   2017   2016 
Interest Income                    
Interest and fee income on loans  $1,356   $898   $2,530   $1,747 
Interest expense:                    
Interest related to secured borrowings   215    144    394    261 
Interest related to unsecured borrowings   401    292    768    537 
Interest expense   616    436    1,162    798 
                     
Net interest income   740    462    1,368    949 
Less: Loan loss provision   15    (2)   26    6 
                     
Net interest income after loan loss provision   725    464    1,342    943 
                     
Non-Interest Income                    
Gain from foreclosure of assets       44        44 
Gain from sale of foreclosed assets           77     
                     
Total non-interest income       44    77    44 
                     
Income   725    508    1,419    987 
                     
Non-Interest Expense                    
Selling, general and administrative   456    305    910    655 
Impairment loss on foreclosed assets   106        155     
                     
Total non-interest expense   562    305    1,065    655 
                     
Net Income  $163   $203   $354   $332 
                     
Earned distribution to preferred equity holders   57    26    88    52 
                     
Net income attributable to common equity holders  $106   $177   $266   $280 

 

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 Six Months Ended June 30, 2017

 

(in thousands of dollars) 

Six Months

Ended

June 30, 2017

 
     
Members’ capital, beginning balance  $3,399 
Net income   354 
Contributions from members (preferred)   10 
Earned distributions to preferred equity holders   (88)
Distributions to common equity holders   (117)
Members’ capital, ending balance  $3,558 

 

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 Six Months Ended June 30, 2017 and 2016

 

  

Six Months Ended

June 30,

 
(in thousands of dollars)  2017   2016 
         
Cash flows from operations          
Net income  $354   $332 
Adjustments to reconcile net income to net cash provided by (used in) operating activities          
Amortization of deferred financing costs   121    134 
Provision for loan losses   26    6 
Net loan origination fees deferred (earned)   254    (93)
Change in deferred origination expense   (71)   (30)
Impairment of foreclosed assets   155     
Gain from foreclosure of assets       (44)
Gain from sale of foreclosed assets   (77)    
Net change in operating assets and liabilities          
Other assets   (2)   (110)
Accrued interest receivable   (74)   (278)
Customer interest escrow   17    (80)
Accounts payable and accrued expenses   39    461 
           
Net cash provided by (used in) operating activities   742    298 
           
Cash flows from investing activities          
Loan originations and principal collections, net   (9,090)   (4,057)
Investment in foreclosed assets   (265)   (375)
Proceeds from sale of foreclosed assets   1,890     
Property plant and equipment additions   (583)    
           
Net cash provided by (used in) investing activities   (8,048)   (4,432)
           
Cash flows from financing activities          
Contributions from redeemable preferred equity   1,004     
Contributions from members (preferred)   10    50 
Distributions to preferred equity holders   (58)   (51)
Distributions to common equity holders   (117)   (235)
Proceeds from secured note payable   5,775    5,023 
Repayments of secured note payable   (4,277)   (3,230)
Proceeds from unsecured notes payable   9,218    2,355 
Redemptions/repayments of unsecured notes payable   (5,687)   (59)
Deferred financing costs paid   (40)   (28)
           
Net cash provided by (used in) financing activities   5,828    3,825 
           
Net increase (decrease) in cash and cash equivalents   (1,478)   (309)
           
Cash and cash equivalents          
Beginning of period   1,566    1,341 
End of period  $88   $1,032 
           
Supplemental disclosure of cash flow information          
Cash paid for interest  $1,062   $378 
           
Non-cash investing and financing activities          
Earned but not paid distribution of preferred equity holders  $29   $26 
Foreclosure of assets  $   $1,813 
Accrued interest reduction due to foreclosure  $   $130 
Net loan origination fees (earned) due to foreclosure  $   $(55)

 

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 subsidiary (the “Company”, “we”, or “our”) was originally formed as a Pennsylvania limited liability company on May 10, 2007. We are the sole member of a consolidating subsidiary, 84 REPA, LLC. The Company operated pursuant to an operating agreement by and among Daniel M. Wallach and the members of the Company from its inception through March 29, 2012, at which time it adopted an amended and restated operating agreement.

 

The Company lends money to residential homebuilders to construct single family homes, to develop undeveloped land into residential building lots, and to purchase and improve for sale older homes. The loans are extended to residential homebuilders and, as such, are commercial loans. We lend in 16 states as of June 30, 2017.

 

Basis of Presentation

 

The accompanying (a) condensed consolidated balance sheet as of December 31, 2016 , 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 consolidated results of operations for any interim period are not necessarily indicative of results expected for the fiscal year ending December 31, 2017. These unaudited interim condensed consolidated financial statements should be read in conjunction with the 2016 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, 2016 (the “2016 Statements”). The accounting policies followed by the Company are set forth in Note 2 - Summary of Significant Accounting Policies (“Note 2”) of the notes to the 2016 Statements.

 

2. Fair Value

 

Utilizing Financial Accounting Standards Board Accounting Standards Codification (“FASB 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 – Significant other observable inputs for the assets or liabilities
     
  Level 3 – Significant unobservable inputs.

 

 8 
 

 

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.

 

Fair Value Measurements of Non-Financial Instruments on a Recurring Basis

 

At June 30, 2017 and December 31, 2016, the Company had no non-financial instruments measured at fair value on a recurring basis.

 

Fair Value Measurements of Non-Financial Instruments on a Non-Recurring Basis

 

Foreclosed Assets

 

Foreclosed assets consist of properties obtained through foreclosure or in satisfaction of loans and is recorded at the fair value of the property, less estimated costs to sell. Estimates of fair value are generally based on third-party appraisals of the property and are classified within Level 3 of the fair value hierarchy. The appraisals are sometimes discounted based on management’s knowledge of the property and/or changes in market conditions from the date of the most recent appraisal. Such discounts are typically significant unobservable inputs for determining fair value.

 

Impaired Loans

 

At June 30, 2017, the Company had impaired loans, and on December 31, 2016, it had none.

 

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 that are individually evaluated for impairment, appraisals have been prepared within the last 13 months. There are also 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 appraisal done in the last 13 months, 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, generally between 0% and 5%, depending on the type of collateral. Fair value estimates for impaired loans are classified as Level 3.

 

The following tables present the balances of non-financial instruments measured at fair value on a non-recurring basis as of June 30, 2017 and December 31, 2016.

 

June 30, 2017

 

                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  
                                         
Foreclosed assets   $ 1,095     $ 1,095     $     $     $ 1,095  
Impaired loans   $ 1,980     $ 1,980     $     $     $ 1,980  

 

December 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  
                                         
Foreclosed assets   $ 2,798     $ 2,798     $     $     $ 2,798  

 

 9 
 

 

Fair Value of Financial Instruments

 

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.

 

Loans Receivable and Commitments to Extend Credit

 

For variable rate loans that reprice frequently with no significant change in credit risk, estimated fair values are based on carrying values at both June 30, 2017 and December 31, 2016. Because the loans are demand loans 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

 

The fair value approximates the carrying value at both June 30, 2017 and December 31, 2016.

 

Customer Interest Escrow

 

The fair value of the customer interest escrow approximates the carrying value at both June 30, 2017 and December 31, 2016.

 

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 Fixed Rate Subordinated Notes issued pursuant to our public offering (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 both June 30, 2017 and December 31, 2016. The interest on our Notes offering is paid to our Note holders either monthly or at the end of their investment, compounded 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.

 

 10 
 

 

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:

 

June 30, 2017

 

                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   $ 88     $ 88     $ 88     $     $  
Loans receivable, net     28,972       28,972                   28,972  
Accrued interest receivable     354       354                   354  
Financial Liabilities                                        
Customer interest escrow     829       829                   829  
Notes payable secured     8,820       8,820                   8,820  
Notes payable unsecured, net     15,574       15,574                   15,574  
Accrued interest payable     996       996                   996  

 

December 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   $ 1,566     $ 1,566     $ 1,566     $     $  
Loans receivable, net     20,091       20,091                   20,091  
Accrued interest receivable     280       280                   280  
Financial Liabilities                                        
Customer interest escrow     812       812                   812  
Notes payable secured     7,322       7,322                   7,322  
Notes payable unsecured, net     11,962       11,962                   11,962  
Accrued interest payable     993       993                   993  

 

3. Financing Receivables

 

Financing receivables are comprised of the following as of June 30, 2017 and December 31, 2016:

 

   

June 30, 2017

    December 31, 2016  
                 
Loans receivable, gross   $ 31,421     $ 21,569  
Less: Deferred loan fees     (872 )     (618 )
Less: Deposits     (1,623 )     (861 )
Plus: Deferred origination expense     126       55  
Less: Allowance for loan losses     (80 )     (54 )
                 
Loans receivable, net   $ 28,972     $ 20,091  

 

 11 
 

 

Roll forward of loans receivable, net:

 

   

Six Months

Ended
June 30, 2017

   

Year

Ended
December 31, 2016

   

Six Months

Ended
June 30, 2016

 
                         
Beginning balance   $ 20,091     $ 14,060     $ 14,060  
Additions     16,081       23,184       10,692  
Payoffs/sales     (6,229 )     (15,168 )     (6,594 )
Moved to foreclosed assets           (1,639 )     (1,639 )
Change in deferred origination expense     71       55       30  
Change in builder deposit     (762 )     (340 )     (41 )
Change in loan loss provision     (26 )     (16 )     (6 )
New loan fees     (1,153 )     (1,270 )     (540 )
Earned loan fees     899       1,225       633  
                         
Ending balance   $ 28,972     $ 20,091     $ 16,595  

 

Commercial Construction and Development Loans

 

Pennsylvania Loans

 

We have three development loans (the “Pennsylvania Loans”) covering two developments. The loans are to the same borrowing group (the “Hoskins Group”). They are cross-defaulted and cross-collateralized with each other. Our total commitment amount under the Pennsylvania Loans is approximately $5,231 as of June 30, 2017, as described in more detail below. As such, we are currently reliant on a single developer and homebuilder for a significant portion of our revenues. As part of our agreement with the Hoskins Group, they invest in our preferred equity in an amount equal to $10 per closing of a lot payoff in the two developments.

 

The loans are secured by several first priority mortgages in residential building lots located in the subdivisions commonly known as the Hamlets of Springdale and the Tuscany Subdivision, both in Peters Township, Pennsylvania, a suburb of Pittsburgh, as well as the Interest Escrow.

 

Commercial Loans – Real Estate Development Loan Portfolio Summary

 

The following is a summary of our loan portfolio to builders for land development as of June 30, 2017. The Pennsylvania loans below are the Pennsylvania Loans discussed above.

 

State   Number of Borrowers     Number of Loans     Value of Collateral(1)     Commitment Amount    

Gross Amount

Outstanding

   

Loan to Value

Ratio(2)

    Loan Fee  
Pennsylvania     1       3     $ 6,298     $ 5,231 (3)   $ 4,050       64 %   $ 1,000  
Total     1       3     $ 6,298     $ 5,231     $ 4,050       64 %   $ 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 $1,160 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 does not include letters of credit and cash bonds, as the sum of the total balance outstanding including the cash bonds plus the letters of credit and remaining to fund for construction is less than the $5,231 commitment amount.

 

 12 
 

 

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

 

State   Number of Borrowers     Number of Loans     Value of Collateral(1)     Commitment Amount    

Gross Amount

Outstanding

   

Loan to Value

Ratio(2)

    Loan Fee  
Pennsylvania     1       3     $ 6,586     $ 5,931 (3)   $ 4,082       62 %   $ 1,000  
Total     1       3     $ 6,586     $ 5,931     $ 4,082       62 %   $ 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 $1,150 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 does not include letters of credit and cash bonds, as the sum of the total balance outstanding including the cash bonds plus the letters of credit and remaining to fund for construction is less than the $5,931 commitment amount.

 

Commercial Loans – Construction Loan Portfolio Summary

 

As of June 30, 2017, we have 49 other borrowers, all of whom, along with the Hoskins Group, borrow money for the purpose of building new homes.

 

The following is a summary of our loan portfolio to builders for home construction loans as of June 30, 2017.

 

State   Number of Borrowers     Number of Loans     Value of Collateral(1)     Commitment Amount    

Gross

Amount

Outstanding

   

Loan to Value

Ratio(2)

    Loan Fee  
Colorado     3       6     $ 3,113     $ 2,092     $ 1,082       67 %     5 %
Connecticut     1       1       715       500       500       70 %     5 %
Delaware     1       1       244       171       115       70 %     5 %
Florida     11       42       21,930       13,904       8,110       63 %     5 %
Georgia     9       22       13,958       8,405       4,991       60 %     5 %
Indiana     2       2       995       597       178       60 %     5 %
Michigan     3       13       3,254       2,065       1,139       63 %     5 %
New Jersey     3       8       2,361       1,652       1,098       70 %     5 %
New York     1       7       2,160       1,064       984       49 %     5 %
North Carolina     2       7       1,740       1,218       543       70 %     5 %
Ohio     2       2       2,116       1,340       777       63 %     5 %
Pennsylvania     2       15       12,595       6,407       5,244       51 %     5 %
South Carolina     8       14       4,071       2,699       1,350       66 %     5 %
Tennessee     1       3       1,080       767       711       71 %     5 %
Utah     1       3       1,208       846       353       70 %     5 %
Virginia     1       1       408       260       196       64 %     5 %
Total     50 (4)     147     $ 71,948     $ 43,987     $ 27,371       61 %(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.
   
(4) One builder borrows in multiple states.

 

 13 
 

 

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

 

State   Number of Borrowers     Number of Loans     Value of Collateral(1)     Commitment Amount    

Gross

Amount

Outstanding

   

Loan to Value

Ratio(2)

    Loan Fee  
Colorado     1       3     $ 1,615     $ 1,131     $ 605       70 %     5 %
Connecticut     1       1       715       500       479       70 %     5 %
Delaware     1       2       244       171       40       70 %     5 %
Florida     7       15       14,014       8,548       4,672       61 %     5 %
Georgia     4       9       6,864       4,249       2,749       62 %     5 %
Idaho     1       1       319       215       205       67 %     5 %
Michigan     1       1       210       126       118       60 %     5 %
New Jersey     1       3       977       719       528       74 %     5 %
New York     1       4       1,745       737       685       42 %     5 %
North Carolina     2       2       1,015       633       216       62 %     5 %
Ohio     1       1       1,405       843       444       60 %     5 %
Pennsylvania     2       15       12,725       6,411       5,281       50 %     5 %
South Carolina     5       7       2,544       1,591       783       63 %     5 %
Tennessee     1       3       1,080       767       430       71 %     5 %
Utah     1       2       715       500       252       70 %     5 %
Total     30       69     $ 46,187     $ 27,141     $ 17,487       59 %(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 FASB ASC 310-10-50, Disclosures about the Credit Quality of Finance Receivables and the Allowance for Credit Losses. See our Form 10-K for the year ended December 31, 2016, as filed with the SEC, for more information.

 

Gross finance Receivables – By risk rating:

 

   

June 30, 2017

    December 31, 2016  
             
Pass   $ 25,791     $ 18,275  
Special mention     3,643       3,294  
Classified – accruing            
Classified – nonaccrual     1,987        
Total   $ 31,421     $ 21,569  

 

Gross finance Receivables – Method of impairment calculation:

 

   

June 30, 2017

    December 31, 2016  
             
Performing loans evaluated individually   $ 8,978     $ 12,424  
Performing loans evaluated collectively     20,456       9,145  
Non-performing loans without a specific reserve            
Non-performing loans with a specific reserve     1,987        
Total   $ 31,421     $ 21,569  

 

At June 30, 2017 and December 31, 2016, there were no loans acquired with deteriorated credit quality.

 

 14 
 

 

Impaired Loans

 

The following is a summary of our impaired nonaccrual commercial construction loans as of June 30, 2017 and December 31, 2016. All loans listed have a related allowance for loan losses.

 

    June 30, 2017     December 31, 2016  
             
Unpaid principal balance (contractual obligation from customer)   $ 1,987     $  
Charge-offs and payments applied            
Gross value before related allowance     1,987        
Related allowance     7        
Value after allowance   $ 1,980     $  

 

Concentrations

 

Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of loans receivable. Our concentration risks for individual borrowers are summarized in the table below:

 

    June 30, 2017   December 31, 2016
        Percent of         Percent of  
    Borrower   Loan     Borrower   Loan  
    City   Commitments     City   Commitments  
                         
Highest concentration risk   Pittsburgh, PA     23 %   Pittsburgh, PA     37 %
Second highest concentration risk   Sarasota, FL     7 %   Sarasota, FL     11 %
Third highest concentration risk   Orlando, FL     5 %   Savannah, GA     6 %

 

4. Foreclosed Assets

 

Roll forward of Foreclosed Assets:

 

   

Six Months

Ended
June 30, 2017

   

Year

Ended
December 31, 2016

   

Six Months

Ended
June 30, 2016

 
                   
Beginning balance   $ 2,798     $ 965     $ 965  
Additions from loans           1,813       1,813  
Additions for construction/development     265       566       375  
Sale proceeds     (1,890 )     (463 )      
Gain on sale     77       28        
Impairment loss on foreclosed assets     (155 )     (111 )      
Ending balance   $ 1,095     $ 2,798     $ 3,153  

 

 15 
 

 

5. Property, Plant and Equipment

 

In the first quarter of 2017, we purchased, for $625, a partially completed building. It is our intent to complete the building for operating purposes. As such, we invested $27 in related improvements to the building in the second quarter. No depreciation has been recorded as the building has not been placed in service. We anticipate another $400 in costs associated with this project.

 

6. Borrowings

 

The following table displays our borrowings and a ranking of priority:

 

    Priority Rank    

June 30, 2017

    December 31, 2016  
Borrowing Source                        
Purchase and sale agreements     1     $ 8,820     $ 7,322  
Secured line of credit from affiliates     2              
Unsecured line of credit (senior)     3       500        
Other unsecured debt (senior subordinated)     4       279       279  
Unsecured Notes through our public offering, gross     5       14,239       11,221  
Other unsecured debt (subordinated)     5       713       700  
Other unsecured debt (junior subordinated)     6       173       173  
Total           $ 24,724     $ 19,695  

 

The following table shows the maturity of outstanding debt as of June 30, 2017.

 

Year Maturing   Total
Amount

Maturing
    Public Offering     Other Unsecured     Purchase
and Sale
Agreements
 
                         
2017   $ 9,693     $ 373     $ 500     $ 8,820  
2018     5,133       4,633       500        
2019     3,569       3,456       113        
2020     1,943       1,943              
2021     4,386       3,834       552        
Total   $ 24,724     $ 14,239     $ 1,665     $ 8,820  

 

Purchase and Sale Agreements

 

We have two current purchase and sale agreement relationships where we are the seller of portions of loans we create. The two purchasers are Builder Finance, Inc. and S.K. Funding, LLC (“S.K. Funding”). Generally, the purchasers buy between 50% and 70% of each loan sold. Builder Finance, Inc., a subsidiary of 1st Financial Bank, USA, began purchasing portions of loans effective as of August 1, 2016. Prior to August 1, 2016, 1st Financial Bank, USA had purchased these loans under a separate loan purchase and sale agreement. S.K. Funding, an affiliate of Seven Kings Holdings, Inc. (“7Kings”), was assigned the loan purchase and sale agreement by 7Kings on or about May 7, 2015.

 

The buyers receive interest rates ranging from our cost of funds to the note rate charged to the borrower (interest rates we paid were between 9% and 12% for both 2017 and 2016). The buyers generally receive none of the loan fees we charge. We have the right to call some of the loans sold, with some restrictions. Once sold, the buyer must fund their portion of the loans purchased. We service the loans. Also, there are limited put options in some cases, whereby the purchaser can cause us to repurchase a loan. The purchase and sale agreements are recorded as secured borrowings.

 

 16 
 

 

The purchase and sale agreements are detailed below:

 

    June 30, 2017     December 31, 2016  
    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/Builder Finance, Inc.   $ 9,507     $ 5,207     $ 5,779     $ 2,517  
S.K. Funding, LLC     8,523       3,613       7,770       4,805  
                                 
Total   $ 18,030     $ 8,820     $ 13,549     $ 7,322  

 

At December 31, 2016, the $7,770 of loans which served as collateral for S.K. Funding did not include the book value of the foreclosed assets which also secured their position, which amount was $1,813. At June 30, 2017, the $8,523 of loans which served as collateral for S.K. Funding included no foreclosed assets.

 

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 4.41% and 4.19% as of June 30, 2017 and December 31, 2016, respectively. They are demand notes. The maximum that can be borrowed under these notes is $1,500, at the discretion of the lenders. The security for the lines of credit includes all of the otherwise unencumbered assets of the Company. The Company did not borrow on these lines in either 2016 or during the six months ended June 30, 2017.

 

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 both June 30, 2017 and December 31, 2016. Interest on the 7Kings loan accrues annually at a rate of 7.5%. The note was due on February 19, 2016 and was renewed several times. The maturity date is now August 18, 2017 and may be prepaid at any time without penalty. Interest is due at the end of each month and was $19 for both of the six month periods ended June 30, 2017 and 2016. The note is included in Other unsecured debt (subordinated) in the table at the start of this note.

 

In January 2017, we entered into an unsecured line of credit with Builder’s Finance, Inc., under which we are the borrower. The note has a maximum amount outstanding of $500, of which $500 was outstanding as of June 30, 2017. Interest on the loan accrues annually at a rate of 10%. The maturity date is January 28, 2018 and may be prepaid at any time without penalty. Interest is due at the end of each month and was $18 for the six month period ended June 30, 2017. The note is included in Unsecured line of credit (senior) in the table at the start of this note.

 

We have four other unsecured notes, which are listed in the first two tables of this Note 6. The interest rates and priorities vary. We recorded $30 and $6 in interest related to these four notes for the six months ended June 30, 2017 and 2016, respectively.

 

 17 
 

 

Unsecured Notes through the Public Offering (Notes Program)

 

The effective interest rate on the Notes offered pursuant to our public offering at June 30, 2017 and December 31, 2016 was 8.58% and 8.26%, 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:

 

   

Six Months
Ended
June 30, 2017

   

Year

Ended
December 31, 2016

   

Six Months
Ended
June 30, 2016

 
                   
Gross notes outstanding, beginning of period   $ 11,221     $ 8,496     $ 8,496  
Notes issued     8,105       4,972       2,255  
Note repayments / redemptions     (5,087 )     (2,247 )     (59 )
                         
Gross notes outstanding, end of period   $ 14,239     $ 11,221     $ 10,692  
                         
Less deferred financing costs, net     330       411       493  
                         
Notes outstanding, net   $ 13,909     $ 10,810     $ 10,199  

 

The following is a roll forward of deferred financing costs:

 

    Six Months     Year     Six Months  
    Ended     Ended     Ended  
   

June 30, 2017

    December 31, 2016    

June 30, 2016

 
                   
Deferred financing costs, beginning balance   $ 1,014     $ 935     $ 935  
Additions     40       79       28  
Deferred financing costs, ending balance   $ 1,054     $ 1,014     $ 963  
Less accumulated amortization     (724 )     (603 )     (470 )
Deferred financing costs, net   $ 330     $ 411     $ 493  

 

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

 

    Six Months     Year     Six Months  
    Ended     Ended     Ended  
   

June 30, 2017

    December 31, 2016    

June 30, 2016

 
                   
Accumulated amortization, beginning balance   $ 603     $ 336     $ 336  
Additions     121       267       134  
Accumulated amortization, ending balance   $ 724     $ 603     $ 470  

 

7. Redeemable Preferred Equity

 

Series C cumulative preferred units (“Series C Preferred Units”) were issued to Margaret Rauscher IRA LLC (Margaret Rauscher is the wife of one of our independent managers, Eric A. Rauscher) in March 2017, and to an IRA owned by William Myrick, another one of our independent managers, in April 2017. They are redeemable by the Company at any time, upon a change of control or liquidation, or by the investor any time after 6 years from the initial date of purchase. The Series C Preferred Units have a fixed value which is their purchase price, and preferred liquidation and distribution rights. Yearly distributions of 12% of the Series C Preferred Units’ value (provided profits are available) will be made quarterly. This rate can increase if any interest rate on our Note Program rises above 12%. Dividends can be reinvested monthly into additional Series C Preferred Units.

 

 18 
 

 

Roll forward of redeemable preferred equity:

 

   

Six Months

Ended
June 30, 2017

   

Year

Ended
December 31, 2016

   

Six Months

Ended
June 30, 2016

 
                   
Beginning balance   $     $     $  
Additions from new investment     1,004     $     $  
Additions from reinvestment     29              
                         
Ending balance   $ 1,033     $     $  

 

The following table shows the earliest redemption options for investors in Series C Preferred Units as of June 30, 2017.

 

Year Maturing   Total Amount
Redeemable
 
       
2023   $ 1,033  
         
Total   $ 1,033  

 

8. Members’ Capital

 

There are currently two classes of units outstanding: Class A common units and Series B cumulative preferred units (“Series B Preferred Units”).

 

The Class A common units are held by eight 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 June 30, 2017 and December 31, 2016. On December 31, 2015, an affiliate of 7Kings, S.K. Funding, purchased 4% of our common equity from the Wallach family. In March 2017, S.K. Funding sold its 4% interest in our common equity in equal 1% portions to each of our three independent managers and our Executive Vice President of Operations.

 

The Series B Preferred Units were issued to the Hoskins Group through a reduction in a loan issued by the Hoskins Group to the Company. The Series B Preferred Units are redeemable only at the option of the Company or upon a change or control or liquidation. Ten Series B Preferred Units were initially issued for a total of $1,000. The Series B Preferred Units have a fixed value which is their purchase price, and preferred liquidation and distribution rights. Yearly distributions of 10% of the Series B Preferred Units’ value (provided profits are available) will be made quarterly. The Hoskins Group’s Series B Preferred Units are also used as collateral for that group’s loans to the Company. There is no liquid market for the Series B Preferred Units, so we can give no assurance as to our ability to generate any amount of proceeds from that collateral. In December 2015, the Hoskins Group agreed to purchase 0.1 Series B Preferred Units for $10 at each closing of a lot to a third party in the Hamlets and Tuscany subdivision. As of June 30, 2017, the Hoskins Group owns a total of 11.6 Series B Preferred Units, which were issued for a total of $1,160.

 

There are two additional authorized unit classes, of which no units are outstanding: 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 or Series  

June 30, 2017

    December 31, 2016  
Series B Preferred Units   $ 1,160     $ 1,150  
Class A Common Units     2,398       2,249  
                 
Members’ Capital   $ 3,558     $ 3,399  

 

 19 
 

 

9. Related Party Transactions

 

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

 

The Company has loan agreements with the Hoskins Group, as more fully described in Note 3.

 

The Hoskins Group has a preferred equity interest in the Company, as more fully described in Note 8.

 

An IRA owned by the wife of Eric A. Rauscher, one of our independent managers, and an IRA owned by William Myrick, also one of our independent managers, each own Series C Preferred Units, as more fully described in Note 7.

 

Each of our three independent managers and our Executive Vice President of Operations own 1% of our Class A common units.

 

The Company has accepted new investments under the Notes program from employees, managers, members and relatives of managers and members, with $1,701 and $2,810 outstanding at June 30,2017 and June 30, 2016, respectively. The larger of these investments are detailed below:

 

    Relationship to    Amount invested as of    

Weighted
average

interest

Rate as of

 

Interest earned

during the
six months ended

 
    Shepherd’s   June 30     December 31     June 30,     June 30,  
Investor   Finance   2017     2016     2017     2017     2016  
David Wallach   Parent of Independent Manager     211       111       9.42 %     6       5  
                                             
R. Scott Summers   Son of Independent Manager     275       75       8.00 %     8       12  
                                             
Wallach Family Irrevocable Educational Trust   Trustee is Member     200       200       9.00 %     9       8  
                                             
Eric A. Rauscher   Independent Manager     475       600       10.00 %     21       22  
                                             
Joseph Rauscher   Parent of Independent Manager     195       186       9.33 %     9       8  

 

10. 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. The Company has several Letters of Credit relating to development loans which are part of the unfunded commitment amount. Unfunded commitments to extend credit, which have similar collateral, credit risk and market risk to our outstanding loans, were $17,797 and $11,503 at June 30, 2017 and December 31, 2016, respectively.

 

 20 
 

 

The Company plans to fund its new loan growth, unfunded commitment, and principal amounts due on its debt using various sources of funding. In July 2017, we sold a participating interest in the Pennsylvania Loans for $3,000 (see note 13), and became the borrower on a secured line of credit for $1,325. The combined $4,325 added to our liquidity. We sell 70% participating interests in most of the loans we create. The portions of loans sold already that has not been funded is $3,356. There are loans that we have designated for sale which, at 70% funding, will eventually provide $4,442 in liquidity, and there are loans we have not designated for sale, which, if sold at 70% funding, would eventually provide $3,387 in liquidity. In addition, the Company receives payoffs on loans, a portion of which is returned to the loan purchaser, if any. Also, the Company receives funds from new public offering sales, and many of the Notes which mature are renewed, reducing the funding needed.

 

11. Selected Quarterly Condensed Consolidated Financial Data (Unaudited)

 

Summarized unaudited quarterly condensed consolidated financial data for the four quarters of 2017 and 2016 are as follows (in thousands):

 

   

Quarter

4

   

Quarter

3

   

Quarter

2

   

Quarter

1

   

Quarter

4

   

Quarter

3

   

Quarter

2

   

Quarter

1

 
    2017     2017     2017     2017     2016     2016     2016     2016  
                                                 
Net Interest Income after Loan Loss Provision   $     $     $ 725     $ 617     $ 491     $ 442     $ 464     $ 479  
Non-Interest Income                       77       28             44        
SG&A expense                 456       454       367       297       305       350  
Impairment loss on foreclosed assets                 106       49       111                    
Net Income   $     $     $ 163     $ 191     $ 41     $ 145     $ 203     $ 129  

 

12. Non-Interest expense detail

 

The following table displays our selling, general and administrative (“SG&A”) expenses:

 

    For the Six Months Ended
June 30,
 
    2017     2016  
Selling, general and administrative expenses                
Legal and accounting   $ 125     $ 112  
Salaries and related expenses     583       385  
Board related expenses     55       55  
Advertising     25       25  
Rent and utilities     14       10  
Loan and foreclosed  asset expenses     26       17  
Travel     32       19  
Other     50       32  
Total SG&A   $ 910     $ 655  

 

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13. Subsequent Events

 

On July 24, 2017, we entered into the Sixth Amendment (the “Sixth Amendment”) to our Loan Purchase and Sale Agreement (the “Agreement”) with S.K. Funding, LLC (the “S.K. Funding”). The Agreement was originally entered into between the Company and Seven Kings Holdings, Inc. (“7Kings”). However, on or about May 7, 2015, 7Kings assigned its right and interest in the Agreement to S.K. Funding.

 

The purpose of the Sixth Amendment was to allow S.K. Funding to purchase portions of the Pennsylvania Loans for a purchase price of $3,000 under parameters different from those specified in the Agreement. The Pennsylvania Loans purchased pursuant to the Sixth Amendment consist of a portion of the Hoskins Group loans. We will continue to service the Loans.

 

The timing of the Company’s principal and interest payments to S.K. Funding under the Sixth Amendment, and S.K. Funding’s obligation to fund the Pennsylvania Loans, vary depending on the total principal amount of the Pennsylvania Loans outstanding at any time. The Pennsylvania Loans had a principal amount in excess of $4,000 as of the effective date of the Sixth Amendment. While the total principal amount of the Pennsylvania Loans exceeds $1,000, S.K. Funding must fund (by paying the Company) the amount by which the total principal amount of the Pennsylvania Loans exceeds $1,000, with such total amount funded not exceeding $3,000. The interest rate accruing to S.K. Funding under the Sixth Amendment is 10.5% calculated on a 365/366 day basis. When the total principal amount of the Pennsylvania Loans is less than $4,000, the Company will also repay S.K. Funding’s principal as principal payments are received on the Pennsylvania Loans from the underlying borrowers in the amount by which the total principal amount of the Pennsylvania Loans is less than $4,000 until S.K. Funding’s principal has been repaid in full. S.K. Funding will continue to be obligated, as described in this paragraph, to fund (by paying the Company) the Pennsylvania Loans for any increases in the outstanding balance of the Pennsylvania Loans up to no more than a total outstanding amount of $4,000.

 

The Sixth Amendment has a term of 24 months from the effective date and will automatically renew for additional six month terms unless either party gives written notice of its intent not to renew the Sixth Amendment at least six months prior to the end of a term. Further, no Protective Advances (as such term is defined in the Agreement) will be required with respect to the Pennsylvania Loans. S.K. Funding will have a priority position as compared to the Company in the case of a default by any of the borrowers.

 

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

 

(All dollar [$] amounts shown in thousands.)

 

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our interim condensed consolidated financial statements and the notes thereto contained elsewhere in this report. The following Management’s Discussion and Analysis of Financial Condition and Results of Operations should also be read in conjunction with our audited annual consolidated financial statements and related notes and other consolidated financial data included in the Company’s Annual Report on Form 10-K as of and for the year ended December 31, 2016. See also “Cautionary Note Regarding Forward-Looking Statements” preceding Part I.

 

Overview

 

We were organized in the Commonwealth of Pennsylvania in 2007 under the name 84 RE Partners, LLC and changed our name to Shepherd’s Finance, LLC on December 2, 2011. We converted to a Delaware limited liability company on March 29, 2012. Our business is focused on commercial lending to participants in the residential construction and development industry. We believe this market is underserved because of the lack of traditional lenders currently participating in the market. We are located in Jacksonville, Florida. Our operations are governed pursuant to our operating agreement.

 

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From 2007 through the majority of 2011, we were the lessor in three commercial real estate leases with a then affiliate, 84 Lumber Company. Beginning in late 2011, we began commercial lending to residential homebuilders. Our current loan portfolio is described more fully in this section under the sub heading “Commercial Construction and Development Loans.” Since 2011, we have originated approximately 275 construction loans totaling $77,000. We currently have 10 paid employees, including our Executive Vice President of Operations. We currently use three employees to originate most of our new loans. Our office staff processes, underwrites, documents, and funds our loans. Our office staff also manages our investor relations and relationships with other debt holders. Our board of managers is comprised of Daniel M. Wallach and three independent managers — William Myrick, Eric A. Rauscher, and Kenneth R. Summers. Our officers are responsible for our day-to-day operations, while the board of managers is responsible for overseeing our business.

 

The commercial loans we extend are secured by mortgages on the underlying real estate. We extend and service commercial loans to small-to-medium sized homebuilders for the purchase of lots and/or the construction of homes thereon. In some circumstances, the lot is purchased with an older home on the lot which is then either removed or rehabilitated. If the home is rehabilitated, the loan is referred to as a “rehab” loan. We also extend and service loans for the purchase of undeveloped land and the development of that land into residential building lots. In addition, we may, depending on our cash position and the opportunities available to us, do none, any or all of the following: purchase defaulted unsecured debt from suppliers to homebuilders at a discount (and then secure that debt with real estate or other collateral), purchase defaulted secured debt from financial institutions at a discount, and purchase real estate in which we will operate our business. In February 2017, we purchased a building in which we intend to operate once renovation has been completed. We anticipate that renovation will be completed in the third quarter of 2017.

 

Our Chief Executive Officer, Mr. Wallach, has been in the housing industry since 1985. He was the CFO of a multi-billion dollar supplier of building materials to home builders for 11 years. He also was responsible for that company’s lending business for 20 years. During those years, he was responsible for the creation and implementation of many secured lending programs to builders. Some of these were performed fully by that company, and some were performed in partnership with banks. In general, the creation of all loans, and the resolution of defaulted loans, was his responsibility, whether the loans were company loans or loans in partnership with banks. Through these programs, he was responsible for the creation of approximately $2,000,000 in loans which generated interest spread of $50,000, after deducting for loan losses. Through the years, he managed the development of systems for reducing and managing the risks and losses on defaulted loans. Mr. Wallach also was responsible for that company’s unsecured debt to builders, which reached over $300,000 at its peak. He also gained experience in securing defaulted unsecured debt.

 

We had $28,972 and $20,091 in loan assets as of June 30, 2017 and December 31, 2016, respectively. As of June 30, 2017, we have 147 construction loans in 16 states with 50 borrowers, and have three development loans in Pittsburgh, Pennsylvania. We have entered into two purchase and sale agreement relationships with third-parties to sell portions of our loans. The first loan portions sold under the program took place during the first quarter of 2015. These agreements have allowed us to increase our loan balances and commitments significantly. In January 2017, we entered into a line of credit agreement with a bank for $500, which we used at times during the first six months of 2017. In March 2017, we added a third class of equity, Series C cumulative preferred units (“Series C Preferred Units”). These Series C Preferred Units have a redemption feature after six years, and therefore appear as mezzanine equity on our financial statements.

 

We currently have eight sources of capital:

 

   

June 30, 2017

   

December 31, 2016

 
Capital Source                
Purchase and sale agreements (1)   $ 8,820     $ 7,322  
Secured line of credit from affiliates            
Unsecured senior line of credit from a bank     500        
Unsecured Notes through our public offering     14,239       11,221  
Other unsecured debt     1,165       1,152  
Preferred equity, Series B units     1,160       1,150  
Preferred equity, Series C units     1,033        
Common equity     2,398       2,249  
                 
Total   $ 29,315     $ 23,094  

 

(1) We have two current purchase and sale agreement relationships where we are the seller of portions of loans we create. The two purchasers are Builder Finance, Inc. and S.K. Funding, LLC. Generally, the purchasers buy between 50% and 70% of each loan sold. Builder Finance, Inc., a subsidiary of 1st Financial Bank, USA, began purchasing portions of loans effective as of August 1, 2016. Prior to August 1, 2016, 1st Financial Bank, USA had purchased these loans under a separate loan purchase and sale agreement. S.K. Funding, LLC, an affiliate of Seven Kings Holdings, Inc., was assigned the loan purchase and sale agreement by Seven Kings Holdings, Inc. on or about May 7, 2015.

 

Critical Accounting Estimates

 

To assist in evaluating our consolidated financial statements, we describe below the critical accounting estimates that we use. We consider an accounting estimate to be critical if: (1) the accounting estimate requires us to make assumptions about matters that were highly uncertain at the time the accounting estimate was made, and (2) changes in the estimate that are reasonably likely to occur from period to period, or use of different estimates that we reasonably could have used, would have a material impact on our consolidated financial condition or results of operations.

 

Loan Losses

 

Loan losses, as applicable, are accounted for both on the consolidated balance sheets and the consolidated statements of operations. On the consolidated statements of operations, management estimates the amount of losses to capture during the current year. This current period amount incurred is referred to as the loan loss provision. The calculation of our allowance for loan losses, which appears on our consolidated balance sheets, requires us to compile relevant data for use in a systematic approach to assess and estimate the amount of probable losses inherent in our commercial lending operations and to reflect that estimated risk in our allowance calculations. We use the policy summarized as follows:

 

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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.

 

Appraisers are state certified, and are selected by first attempting to utilize the appraiser who completed the original appraisal report. If that appraiser is unavailable or unreasonably expensive, we use another appraiser who appraises routinely in that geographic area. BOVs are created by real estate agents. We try to first select an agent we have worked with, and then, if that fails, we select another agent who works in that geographic area.

 

Fair value of collateral has the potential to impact the calculation of the loan loss provision. Specifically relevant to the allowance for loan loss reserve is the fair value of the underlying collateral supporting the outstanding loan balances. 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. Due to a rapidly changing economic market, an erratic housing market, the various methods that could be used to develop fair value estimates, and the various assumptions that could be used, determining the collateral’s fair value requires significant judgment.

 

    June 30, 2017  
    Loan Loss  
    Provision  
Change in Fair Value Assumption   Higher/(Lower)  
Increasing fair value of the real estate collateral by 30%*   $  
Decreasing fair value of the real estate collateral by 30%**   $ 481  

 

* Increases in the fair value of the real estate collateral do not impact the loan loss provision, as the value generally is not “written up.”

 

** If the loans were nonperforming, assuming a book amount of the loans outstanding of $28,972, and the fair value of the real estate collateral on all outstanding loans was reduced by 30%, an addition to the loan loss provision of $481 would be required.

 

Foreclosed Assets

 

Foreclosed assets, as applicable, are accounted for both on the consolidated balance sheets and the interim condensed consolidated statements of operations. On the interim condensed consolidated statements of operations, management estimates the amount of impairment to capture when a loan is converted to a foreclosed asset, the impairment when the value of an asset drops below its carrying amount, and any gain or loss upon final disposition of the asset. The calculation of the impairment, which appears on our interim condensed consolidated balance sheets as a reduction in the asset, requires us to compile relevant data for use in a systematic approach to assess and estimate the value of the asset and therefore any required impairment thereof. We use the policy summarized as follows:

 

For properties which exist in the condition in which we intend to sell them, we obtain an appraisal of the asset’s current value. We reduce the appraised value by 10% to account for selling costs. This amount is used to initially record the asset. Typically, prior to the initial booking of the foreclosed asset, the loan has already been reserved to this level. If during ownership, the value of the foreclosed asset drops, an additional impairment is recorded. For assets that need to be improved prior to sale, the above calculation is performed at the time of the booking of the foreclosed asset (an appraisal “as-is”), but subsequent to that, we look at the to be completed value minus 10% and subtract off the estimated cost of remaining work to be done. If this results in additional impairment, it is booked in non-interest expense. For assets which are going to be improved, while the asset is a loan (before it becomes a foreclosed asset) the calculation of the specific loan loss reserve is done based on the to be completed value as compared to the book value plus estimated completion costs. This can result in an impairment at the initial booking of the foreclosed asset.

 

The fair value of real estate will impact our foreclosed asset value, which is booked at 100% of fair value (after selling costs are deducted). 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.

 

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    June 30, 2017  
    Foreclosed  
    Assets  
Change in Fair Value Assumption   Higher/(Lower)  
Increasing fair value of the foreclosed asset by 30%*   $  
Decreasing fair value of the foreclosed asset by 30%   $ (329 )

 

* Increases in the fair value of the foreclosed assets do not impact the carrying value, as the value generally is not “written up.” Those gains would be recognized at the sale of the asset.

 

Amortization of Deferred Financing Costs

 

We amortize our deferred financing costs based on the effective interest method. As such, we make estimates for the duration of the future investment proceeds we anticipate receiving from our Notes offering. If this estimate is determined to be incorrect in the future, the rate at which we are amortizing the deferred financing costs as interest expense would be adjusted.

 

Currently, we anticipate a consistent average duration of 34 months for the Notes in our current offering. An increasing average duration over the remaining anticipated length of the Notes offering would decrease the amount of amortization reflected in interest in the next 12 months, and a decreasing average duration of investments over the remaining anticipated length would increase the amount reflected in the next 12 months.

 

Change in Anticipated Average Duration  

Resulting

adjustment needed

to Interest Expense

during the next 12

months
Higher/(Lower)

 
Decreasing the average duration to 5 months for all remaining months of origination   $ 4  
Increasing the average duration to 5 months for all remaining months of origination   $ (22 )

 

Other Loss Contingencies

 

Other loss contingencies are recorded as liabilities when it is probable that a liability has been incurred and the amount of the loss is reasonably estimable. Disclosure is required when there is a reasonable possibility that the ultimate loss will exceed the recorded provision. Contingent liabilities are often resolved over long time periods. Estimating probable losses requires analysis of multiple forecasts that often depend on judgments about potential actions by third-parties such as courts, arbitrators, juries, or regulators.

 

Accounting and Auditing Standards Applicable to “Emerging Growth Companies”

 

We are an “emerging growth company” under the recently enacted JOBS Act. For as long as we are an “emerging growth company,” we are not required to: (1) comply with any new or revised financial accounting standards that have different effective dates for public and private companies until those standards would otherwise apply to private companies, (2) provide an auditor’s attestation report on management’s assessment of the effectiveness of internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act, (3) comply with any new requirements adopted by the Public Company Accounting Oversight Board, or the PCAOB, requiring mandatory audit firm rotation or a supplement to the auditor’s report in which the auditor would be required to provide additional information about the audit and the financial statements of the issuer, or (4) comply with any new audit rules adopted by the PCAOB after April 5, 2012, unless the SEC determines otherwise. We intend to take advantage of such extended transition period. Since we will not be required to comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for other public companies, our consolidated financial statements may not be comparable to the financial statements of companies that comply with public company effective dates. If we were to subsequently elect to instead comply with these public company effective dates, such election would be irrevocable pursuant to Section 107 of the JOBS Act.

 

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Other Significant Accounting Policies

 

Other significant accounting policies, not involving the same level of measurement uncertainties as those discussed above, are nevertheless important to an understanding of the consolidated financial statements. Policies related to credit quality information, fair value measurements, offsetting assets and liabilities, related party transactions and revenue recognition require difficult judgments on complex matters that are often subject to multiple and recent changes in the authoritative guidance. Certain of these matters are among topics currently under reexamination or have recently been addressed by accounting standard setters and regulators. Specific conclusions have not been reached by these standard setters, and outcomes cannot be predicted with confidence. Also, see Notes 1 and 2 to our 2016 consolidated financial statements, as they discuss accounting policies that we have selected from acceptable alternatives.

 

Consolidated Results of Operations

 

Key financial and operating data for the three and six months ended June 30, 2017 and 2016 are set forth below. For a more complete understanding of our industry, the drivers of our business, and our current period results, this discussion should be read in conjunction with our consolidated financial statements, including the related notes and the other information contained in this document.

 

    Three Months Ended     Six Months Ended  
    June 30,     June 30,  
    2017     2016     2017     2016  
Interest Income