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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 September 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 4
   
Item 1. Financial Statements 4
   
Interim Condensed Consolidated Balance Sheets as of September 30, 2017 (Unaudited) and December 31, 2016 4
   
Interim Condensed Consolidated Statements of Operations (Unaudited) for the Three Months and Nine Months Ended September 30, 2017 and 2016 5
   
Interim Condensed Consolidated Statement of Changes in Members’ Capital (Unaudited) for the Nine Months Ended September 30, 2017 6
   
Interim Condensed Consolidated Statements of Cash Flows (Unaudited) for the Nine Months Ended September 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 17
   
Item 3. Quantitative and Qualitative Disclosure About Market Risk 33
   
Item 4. Controls and Procedures 33
   
PART II. OTHER INFORMATION 33
   
Item 1. Legal Proceedings 33
   
Item 1A. Risk Factors 33
   
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 33
   
Item 3. Defaults upon Senior Securities 34
   
Item 4. Mine Safety Disclosures 34
   
Item 5. Other Information 34
   
Item 6. Exhibits 34

 

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)  

September 30,

2017

   

December 31,

2016

 
    (Unaudited)        
Assets            
Cash and cash equivalents   $ 2,471     $ 1,566  
Accrued interest receivable     435       280  
Loans receivable, net     29,626       20,091  
Foreclosed assets     1,079       2,798  
Property, plant and equipment     767       69  
Other assets     125       82  
                 
Total assets   $ 34,503     $ 24,886  
                 
Liabilities, Redeemable Preferred Equity and Members’ Capital                
                 
Liabilities                
                 
Customer interest escrow   $ 851     $ 812  
Accounts payable and accrued expenses     462       377  
Accrued interest payable     1,117       986  
Notes payable secured     12,168       7,322  
Notes payable unsecured, net of deferred financing costs     14,993       11,962  
Due to preferred equity member     29       28  
                 
Total liabilities     29,620       21,487  
                 
Commitments and Contingencies (Notes 3 and 10)                
                 
Redeemable Preferred Equity                
                 
Series C preferred equity     1,065        
                 
Members’ Capital                
                 
Series B preferred equity     1,220       1,150  
Class A common equity     2,598       2,249  
Members’ capital     3,818       3,399  
                 
Total liabilities, redeemable preferred equity and members’ capital   $ 34,503     $ 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 Nine Months ended September 30, 2017 and 2016

 

    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
(in thousands of dollars)   2017     2016     2017     2016  
Interest Income                                
Interest and fee income on loans   $ 1,673     $ 909     $ 4,203     $ 2,656  
Interest expense:                                
Interest related to secured borrowings     324       148       718       409  
Interest related to unsecured borrowings     424       315       1,192       852  
Interest expense     748       463       1,910       1,261  
                                 
Net interest income     925       446       2,293       1,395  
Less: Loan loss provision     8       4       34       10  
                                 
Net interest income after loan loss provision     917       442       2,259       1,385  
                                 
Non-Interest Income                                
Gain from foreclosure of assets                       44  
Gain from sale of foreclosed assets                 77        
                                 
Total non-interest income                 77       44  
                                 
Income     917       442       2,336       1,429  
                                 
Non-Interest Expense                                
Selling, general and administrative     537       297       1,447       952  
Impairment loss on foreclosed assets     47             202        
                                 
Total non-interest expense     584       297       1,649       952  
                                 
Net Income   $ 333     $ 145     $ 687     $ 477  
                                 
Earned distribution to preferred equity holders     61       27       149       79  
                                 
Net income attributable to common equity holders   $ 272     $ 118     $ 538     $ 398  

 

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 Nine Months Ended September 30, 2017

 

(in thousands of dollars)  

Nine Months

Ended

September 30,

2017

 
       
Members’ capital, beginning balance   $ 3,399  
Net income     687  
Contributions from members (preferred)     70  
Earned distributions to preferred equity holders     (149 )
Distributions to common equity holders     (189 )
Members’ capital, ending balance   $ 3,818  

 

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 Nine Months Ended September 30, 2017 and 2016

 

   

Nine Months Ended

September 30,

 
(in thousands of dollars)   2017     2016  
             
Cash flows from operations                
Net income   $ 687     $ 477  
Adjustments to reconcile net income to net cash provided by (used in) operating activities                
Amortization of deferred financing costs     165       204  
Provision for loan losses     34       10  
Net loan origination fees deferred (earned)     120       (133 )
Change in deferred origination expense     (26 )     (30 )
Impairment of foreclosed assets     202        
Gain from foreclosure of assets           (44 )
Gain from sale of foreclosed assets     (77 )      
Net change in operating assets and liabilities                
Other assets     (43 )     (75 )
Accrued interest receivable     (155 )     (192 )
Customer interest escrow     39       (109 )
Accounts payable and accrued expenses     217       626  
                 
Net cash provided by operating activities     1,163       734  
                 
Cash flows from investing activities                
Loan originations and principal collections, net     (9,663 )     (5,091 )
Investment in foreclosed assets     (296 )     (459 )
Proceeds from sale of foreclosed assets     1,890        
Property plant and equipment additions     (698 )      
                 
Net cash provided by (used in) investing activities     (8,767 )     (5,550 )
                 
Cash flows from financing activities                
Contributions from redeemable preferred equity     1,004        
Contributions from members (preferred)     70       90  
Distributions to preferred equity holders     (88 )     (78 )
Distributions to common equity holders     (189 )     (355 )
Proceeds from secured note payable     11,760       6,544  
Repayments of secured note payable     (6,914 )     (4,405 )
Proceeds from unsecured notes payable     9,412       3,629  
Redemptions/repayments of unsecured notes payable     (6,481 )     (1,336 )
Deferred financing costs paid     (65 )     (53 )
                 
Net cash provided by financing activities     8,509       4,036  
                 
Net increase (decrease) in cash and cash equivalents     905       (780 )
                 
Cash and cash equivalents                
Beginning of period     1,566       1,341  
End of period   $ 2,471     $ 561  
                 
Supplemental disclosure of cash flow information                
Cash paid for interest   $ 1,616     $ 671  
                 
Non-cash investing and financing activities                
Earned but not paid distribution of preferred equity holders   $ 29     $ 27  
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.

 

As of September 30, 2017, the Company extends commercial loans to residential homebuilders (in 16 states) to:

 

  construct single family homes,
  develop undeveloped land into residential building lots, and
  purchase and improve for sale older homes.

 

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

 

There has been no change in our fair value policy during 2017.

 

8
 

 

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

 

September 30, 2017

 

                Quoted              
                Prices              
                in Active            
                Markets   Significant    

 
                for     Other      Significant  
                Identical     Observable     Unobservable  
    Carrying     Estimated     Assets     Inputs     Inputs  
    Amount     Fair Value     Level 1     Level 2     Level 3  
                                         
Foreclosed assets   $ 1,079     $ 1,079     $     $     $ 1,079  

 

December 31, 2016

 

                Quoted
Prices
             
                in Active            
                Markets
for
    Significant
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  

 

The table below is a summary of fair value estimates for financial instruments and the level of the fair value hierarchy within which the fair value measurements are categorized at the periods indicated:

 

September 30, 2017

 

                Quoted Prices              
                in Active            
                Markets
for
    Significant
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   $ 2,471     $ 2,471     $ 2,471     $     $  
Loans receivable, net     29,626       29,626                   29,626  
Accrued interest receivable     435       435                   435  
Financial Liabilities                                        
Customer interest escrow     851       851                   851  
Notes payable secured     12,168       12,168                   12,168  
Notes payable unsecured, net     14,993       14,993                   14,993  
Accrued interest payable     1,117       1,117                   1,117  

 

December 31, 2016

 

                Quoted Prices              
                in Active            
                Markets
for
   

Significant

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  

 

9
 

 

3. Financing Receivables

 

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

 

   

September 30,

2017

   

December 31,

2016

 
                 
Loans receivable, gross   $ 31,858     $ 21,569  
Less: Deferred loan fees     (738 )     (618 )
Less: Deposits     (1,487 )     (861 )
Plus: Deferred origination expense     81       55  
Less: Allowance for loan losses     (88 )     (54 )
                 
Loans receivable, net   $ 29,626     $ 20,091  

 

Commercial Construction and Development Loans

 

Commercial Loans – Construction Loan Portfolio Summary

 

As of September 30, 2017, we have 48 borrowers, all of whom, including our one development loan customer (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 September 30, 2017 and December 31, 2016.

 

  Year   Number of States   Number of Borrowers   Number of Loans   Value of Collateral(1)   Commitment Amount  

Gross

Amount

Outstanding

  

Loan to Value

Ratio(2)

  

Loan Fee

 
  2017    16    48    148   $71,305   $43,748   $28,404    61%(3)  5
  2016    15    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.

 

Commercial Loans – Real Estate Development Loan Portfolio Summary

 

The following is a summary of our loan portfolio to builders for land development as of September 30, 2017 and December 31, 2016. These loans are referred to as the Pennsylvania Loans.

 

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

Gross Amount

Outstanding

  

Loan to Value

Ratio(2)

   Loan Fee 
 2017    Pennsylvania    1    3   $5,339   $4,600(3)  $3,454    65%  $1,000 
 2016    Pennsylvania    1    3    6,586    5,931(3)   4,082    62%   1,000 

 

10
 

 

(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 $1,220 in 2017 and $1,150 in 2016 of preferred equity in our Company. In the event of a foreclosure on the property securing these loans, the portion of our collateral that is preferred equity in our Company 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 calculated as described above.
   
(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 $4,600 commitment amount.

 

Credit Quality Information

 

The following table presents credit-related information at the “class” level in accordance with Financial Accounting Standards Board Accounting Standards Codification 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:

 

   

September 30,

2017

   

December 31,

2016

 
             
Pass   $ 26,931     $ 18,275  
Special mention     4,927       3,294  
Classified – accruing            
Classified – nonaccrual            
Total   $ 31,858     $ 21,569  

 

Gross finance Receivables – Method of impairment calculation:

 

   

September 30,

2017

   

December 31,

2016

 
             
Performing loans evaluated individually   $ 9,367     $ 12,424  
Performing loans evaluated collectively     22,491       9,145  
Non-performing loans without a specific reserve            
Non-performing loans with a specific reserve            
Total   $ 31,858     $ 21,569  

 

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

 

11
 

 

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:

 

    September 30, 2017   December 31, 2016
        Percent of         Percent of  
    Borrower   Loan     Borrower   Loan  
    City   Commitments     City   Commitments  
                         
Highest concentration risk   Pittsburgh, PA     25 %   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:

 

   

Nine Months

Ended
September 30,
2017

   

Year

Ended
December 31,
2016

   

Nine Months

Ended
September 30,
2016

 
                   
Beginning balance   $ 2,798     $ 965     $ 965  
Additions from loans           1,813       1,813  
Additions for construction/development     296       566       459  
Sale proceeds     (1,890 )     (463 )      
Gain on sale     77       28        
Impairment loss on foreclosed assets     (202 )     (111 )      
Ending balance   $ 1,079     $ 2,798     $ 3,237  

 

5. Property, Plant, Equipment and Long Lived Assets

 

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 $142 in related improvements to the building for the nine months ended September 30, 2017. No depreciation has been recorded as the building has not been placed in service.

 

We are developing operations software and invested $41 in this project for the nine months ended September 30, 2017. We purchased loan document software in 2016 for $71. Total depreciation of that software has been $25, of which $19 has been recognized in 2017.

 

6. Borrowings

 

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

 

    Priority Rank    

September 30,

2017

   

December 31,

2016

 
Borrowing Source                        
Purchase and sale agreements and other secured borrowings     1     $ 12,168     $ 7,322  
Secured line of credit from affiliates     2              
Unsecured line of credit (senior)     3              
Other unsecured debt (senior subordinated)     4       279       279  
Unsecured Notes through our public offering, gross     5       14,139       11,221  
Other unsecured debt (subordinated)     5       713       700  
Other unsecured debt (junior subordinated)     6       173       173  
Total           $ 27,472     $ 19,695  

 

12
 

 

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

 

Year Maturing   Total
Amount
Maturing
    Public Offering     Other Unsecured     Purchase
and Sale
Agreements and other secured borrowings
 
                         
2017   $ 12,247     $ 79     $     $ 12,168  
2018     5,133       4,633       500        
2019     3,754       3,641       113        
2020     2,494       1,942       552        
2021     3,844       3,844        –        
Total   $ 27,472     $ 14,139     $ 1,165     $ 12,168  

 

Secured Borrowings

 

Purchase and Sale Agreements

 

In July 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 loans to the Hoskins Group. 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.

 

Line of Credit

 

Also in July 2017, we entered into a line of credit agreement with a group of lenders (“Shuman”). The line is secured with assignments of certain notes and mortgages and carries a total cost of funds to us of 10%. The maximum amount we can draw on the line is $1,325, which was fully borrowed as of September 30, 2017. It is due in July 2018.

 

13
 

 

Summary

 

The secured borrowings are detailed below:

 

    September 30, 2017     December 31, 2016  
        Due From         Due From  
    Book Value of     Shepherd’s     Book Value of     Shepherd’s  
    Loans which     Finance to Loan     Loans which     Finance to Loan  
    Served as
Collateral
    Purchaser or Lender     Served as
Collateral
    Purchaser or Lender  
Loan purchaser                                
1st Financial Bank, USA/Builder Finance, Inc.   $ 9,482     $ 4,830     $ 5,779     $ 2,517  
S.K. Funding, LLC     11,169       6,013       7,770       4,805  
Shuman     2,147       1,325              
                                 
Total   $ 22,798     $ 12,168     $ 13,549     $ 7,322  

 

Unsecured Borrowings

 

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 September 30, 2017 and December 31, 2016. The note was due on February 19, 2016 and was renewed several times. The maturity date is now February 19, 2018 and may be prepaid at any time without penalty. This note is separate from the purchase and sale agreement with 7Kings mentioned above.

 

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 $0 was outstanding as of September 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.

 

Unsecured Notes through the Public Offering (Notes Program)

 

The effective interest rate on the notes offered pursuant to our public offering (“Notes”) at September 30, 2017 and December 31, 2016 was 9.15% and 8.26%, respectively, not including the amortization of deferred financing costs. There are limited rights of early redemption. The following table shows the roll forward of our Notes program:

 

   

Nine Months
Ended
September 30,

2017

   

Year

Ended
December 31,

2016

   

Nine Months
Ended
September 30,

2016

 
                   
Gross Notes outstanding, beginning of period   $ 11,221     $ 8,496     $ 8,496  
Notes issued     8,299       4,972       3,529  
Note repayments / redemptions     (5,381 )     (2,247 )     (1,336 )
                         
Gross Notes outstanding, end of period   $ 14,139     $ 11,221     $ 10,689  
                         
Less deferred financing costs, net     311       411       448  
                         
Notes outstanding, net   $ 13,828     $ 10,810     $ 10,241  

 

14
 

 

The following is a roll forward of deferred financing costs:

 

    Nine Months     Year     Nine Months  
    Ended     Ended     Ended  
   

September 30,

2017

   

December 31,

2016

   

September 30,

2016

 
                   
Deferred financing costs, beginning balance   $ 1,014     $ 935     $ 935  
Additions     65       79       53  
Deferred financing costs, ending balance   $ 1,079     $ 1,014     $ 988  
Less accumulated amortization     (768 )     (603 )     (540 )
Deferred financing costs, net   $ 311     $ 411     $ 448  

 

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

 

    Nine Months     Year     Nine Months  
    Ended     Ended     Ended  
   

September 30,

2017

   

December 31,

2016

   

September 30,

2016

 
                   
Accumulated amortization, beginning balance   $ 603     $ 336     $ 336  
Additions     165       267       204  
Accumulated amortization, ending balance   $ 768     $ 603     $ 540  

 

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 public Notes offering rises above 12%. Dividends can be reinvested monthly into additional Series C Preferred Units.

 

Roll forward of redeemable preferred equity:

 

   

Nine Months

Ended
September 30,

2017

   

Year

Ended
December 31,

2016

   

Nine Months

Ended
September 30,

2016

 
                   
Beginning balance   $     $     $  
Additions from new investment     1,004              
Additions from reinvestment     61              
                         
Ending balance   $ 1,065     $     $  

 

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

 

Year Maturing   Total Amount
Redeemable
 
       
2023   $ 1,065  
         
Total   $ 1,065  

 

15
 

 

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 September 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. 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 September 30, 2017, the Hoskins Group owns a total of 12.2 Series B Preferred Units, which were issued for a total of $1,220.

 

9. Related Party Transactions

 

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.

 

Our independent manager Kenneth Summers and his son are minor participants in the Shuman line of credit, which is more fully described in Note 6.

 

10. Commitments and Contingencies

 

Unfunded commitments to extend credit, which have similar collateral, credit risk and market risk to our outstanding loans, were $16,489 and $11,503 at September 30, 2017 and December 31, 2016, respectively.

 

11. Selected Quarterly Condensed Consolidated Financial Data (Unaudited)

 

Summarized unaudited quarterly condensed consolidated financial data for the 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   $     $ 917     $ 725     $ 617     $ 491     $ 442     $ 464     $ 479  
Non-Interest Income                       77       28             44        
SG&A expense           537       456       454       367       297       305       350  
Impairment loss on foreclosed assets           47       106       49       111                    
Net Income   $     $ 333     $ 163     $ 191     $ 41     $ 145     $ 203     $ 129  

 

16
 

 

12. Non-Interest expense detail

 

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

 

    For the Nine Months Ended
September 30,
 
    2017     2016  
Selling, general and administrative expenses                
Legal and accounting   $ 164     $ 139  
Salaries and related expenses     976       593  
Board related expenses     82       84  
Advertising     42       31  
Rent and utilities     22       15  
Loan and foreclosed asset expenses     30       17  
Travel     45       26  
Other     86       47  
Total SG&A   $ 1,447     $ 952  

 

13. Subsequent Events

 

On October 23, 2017, we entered into a Line of Credit Agreement (the “LOC Agreement”) with Paul Swanson (the “Lender”). Pursuant to the LOC Agreement, the Lender will provide us with a revolving line of credit (the “Line of Credit”) not to exceed $4,000. The LOC Agreement is effective as of October 23, 2017 and will terminate 15 months after that date unless extended by the Lender for one or more additional 15 month periods. We may terminate the LOC Agreement by providing the Lender with notice at least 60 days in advance of the original termination or any renewal termination date.

 

The Line of Credit requires monthly payments of interest only during the term of the Line of Credit, with the principal balance due upon termination. The unpaid principal amounts advanced on the Line of Credit bear interest for each day until due at a fixed rate per annum (computed on the basis of a year of 360 days for actual days elapsed) for each day at 9%. We may, at our option, choose to prepay the principal, interest, or other amounts due from us under the Line of Credit in whole or in part at any time.

 

We are pledging, and will continue to pledge in the future, certain of our commercial loans as collateral for the Line of Credit (the “Collateral Loans”) pursuant to the Collateral Assignment of Notes and Documents dated as of October 23, 2017. The amount outstanding under the Line of Credit may not exceed 67% of the aggregate amount outstanding on the Collateral Loans then pledged to secure the Line of Credit. Our obligation to repay the Line of Credit is evidenced by two Promissory Notes from us dated October 23, 2017 (the “Promissory Notes”), one evidencing a promise to repay the secured portion of the Line of Credit and one evidencing a promise to repay the unsecured portion of the Line of Credit.

 

R. Scott Summers, P.L.L.C., a West Virginia professional limited liability company (the “Custodian”) will serve as the custodian to hold the Collateral Loans for the benefit of the Lender pursuant to the Custodial Agreement dated as of October 23, 2017 between us, the Lender, and the Custodian. The Custodian is owned by R. Scott Summers, an investor in our public Notes offering and the son of Kenneth R. Summers, one of our independent managers. The Custodian is responsible for certifying to the Lender that it has received the relevant Collateral Loan assignment documentation from us. We are responsible for paying the Custodian’s monthly fee, which is equal to 1% interest on the amount of the Collateral Loans outstanding in the Custodian’s custody.

 

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.

 

17
 

 

Overview

 

We had $29,626 and $20,091 in loan assets as of September 30, 2017 and December 31, 2016, respectively. As of September 30, 2017, we have 148 construction loans in 16 states with 48 borrowers, and have three development loans in Pittsburgh, Pennsylvania. We have entered into two purchase and sale agreement relationships with third-parties to finance portions of our loans. The first loan portions that are accounted for as financing arrangements 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 nine 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. In July 2017, we entered into a secured line of credit agreement for $1,325.

 

We currently have eight sources of capital:

 

   

September 30,

2017

   

December 31,

2016

 
Capital Source                
Purchase and sale agreements and other secured borrowings   $ 12,168     $ 7,322  
Secured line of credit from affiliates            
Unsecured senior line of credit from a bank            
Unsecured Notes through our public offering     14,139       11,221  
Other unsecured debt     1,165       1,152  
Preferred equity, Series B units     1,220       1,150  
Preferred equity, Series C units     1,065        
Common equity     2,598       2,249  
                 
Total   $ 32,355     $ 23,094  

 

Our net income has been higher for the first nine months of 2017 as compared to the same period in 2016 mostly due to increased loan originations. In the third quarter of 2017, our borrowers paid off several loans on which we had not recognized interest income in the second quarter of 2017. When those loans paid off, we received the interest income; therefore, income was recognized in the third quarter of 2017. Earnings in the third quarter of 2017 and 2016 were $333 and $145, respectively, and earnings for the nine months ended September 30, 2017 were $687 as compared to $477 for the same period of 2016. Cash provided by operations was $1,163 as of September 30, 2017 as compared to $734 for the same period of 2016. Cash flow from operations has been higher than net profit because amortized financing costs, interest expensed but not paid at lenders request (to allow for compounding) and impairment charges all reduce net income but not operating cash flow.

 

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. See our Form 10-K for the year ended December 31, 2016, as filed with the SEC, for more information on our critical accounting estimates. No material changes to our critical accounting estimates have occurred since December 31, 2016 unless listed below.

 

18
 

 

Loan Losses

 

Fair value of collateral has the potential to impact the calculation of the loan loss provision (the amount we have expensed over time in anticipation of loan losses we have not yet realized). 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.

 

    September 30, 2017  
    Loan Loss  
    Provision  
Change in Fair Value Assumption   Higher/(Lower)  
Increasing fair value of the real estate collateral by 35%*   $  
Decreasing fair value of the real estate collateral by 35%**   $ 493  

 

* 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.”

 

** Assumes the loans were nonperforming and a book amount of the loans outstanding of $29,626.

 

Foreclosed Assets

 

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

 

    September 30, 2017  
    Foreclosed  
    Assets  
Change in Fair Value Assumption   Higher/(Lower)  
Increasing fair value of the foreclosed asset by 35%*   $  
Decreasing fair value of the foreclosed asset by 35%   $ (378 )

 

* 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.

 

Consolidated Results of Operations

 

Key financial and operating data for the three and nine months ended September 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.

 

19
 

 

    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
(in thousands of dollars)   2017     2016     2017     2016  
Interest Income                                
Interest and fee income on loans   $ 1,673     $ 909     $ 4,203     $ 2,656  
Interest expense:                                
Interest related to secured borrowings     324       148       718       409  
Interest related to unsecured borrowings     424       315       1,192       852  
Interest expense     748       463       1,910       1,261  
                                 
Net interest income     925       446       2,293       1,395  
Less: Loan loss provision     8       4       34       10  
                                 
Net interest income after loan loss provision     917       442       2,259       1,385  
                                 
Non-Interest Income                                
Gain from foreclosure of assets                       44  
Gain from sale of foreclosed assets                 77        
                                 
Total non-interest income                 77       44  
                                 
Income     917       442       2,336       1,429  
                                 
Non-Interest Expense                                
Selling, general and administrative     537       297       1,447       952  
Impairment loss on foreclosed assets     47             202        
                                 
Total non-interest expense     584       297       1,649       952  
                                 
Net Income   $ 333     $ 145     $ 687     $ 477  
                                 
Earned distribution to preferred equity holders     61       27       149       79  
                                 
Net income attributable to common equity holders   $ 272     $ 118     $ 538     $ 398  

 

Interest Spread

 

The following table displays a comparison of our interest income, expense, fees, and spread:

 

    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2017     2016     2017     2016  
Interest Income             *               *               *               *  
Interest income on loans   $ 1,198       15 %   $ 623       13 %   $ 2,829       14 %   $ 1,737       13 %
Fee income on loans     475       6 %     286       6 %     1,374       6 %     919       6 %
Interest and fee income on loans     1,673       21 %     909       19 %     4,203       20 %     2,656       19 %
Interest expense related parties