Attached files
file | filename |
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EX-32.1 - Shepherd's Finance, LLC | ex32-1.htm |
EX-31.1 - Shepherd's Finance, LLC | ex31-1.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 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
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
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.
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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.
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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 |
Year Ended |
Nine
Months Ended |
||||||||||
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.
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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 2017 |
Year Ended 2016 |
Nine
Months 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 2017 |
Year Ended 2016 |
Nine Months Ended 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 | – | – | – | – | – | – | – | – | ||||||||||||||||||||||||
Interest expense unsecured | 380 | 5 | % | 246 | 5 | % | 1,027 | 5 | % | 648 | 5 | % | ||||||||||||||||||||
Interest expense secured | 324 | 4 | % | 147 | 3 | % | 718 | 3 | % | 409 | 3 | % | ||||||||||||||||||||
Amortization offering costs | 44 | – | % | 70 | 2 | % | 165 | 1 | % | 204 | 1 | % | ||||||||||||||||||||
Interest expense | 748 | 9 | % | 463 | 10 | % | 1,910 | 9 | % | 1,261 | 9 | % | ||||||||||||||||||||
Net interest income (spread) | 925 | 12 | % | 446 | 9 | % | 2,293 | 11 | % | 1,395 | 10 | % | ||||||||||||||||||||
Weighted average outstanding loan asset balance | $ | 31,742 | $ | 18,893 | $ | 27,161 | $ | 17,966 |
*annualized amount as percentage of weighted average outstanding gross loan balance
There are three main components that can impact our interest spread:
20 |
● Difference between the interest rate received (on our loan assets) and the interest rate paid (on our borrowings). The loans we have originated have interest rates which are based on our cost of funds, with a minimum cost of funds of 5%. For most loans, the margin is fixed at 2%. Future loans are anticipated to be originated at approximately the same 2% margin. This component is also impacted by the lending of money with no interest cost (our equity). For the nine months ended September 30, 2017 as compared to the period in 2016, the increase in this calculation is due to an increase in default interest we charged and collected on certain of our loans. The impacted loans were either terminated as of September 30, 2017, or no longer in default. $104 of the associated interest income of these defaulted loans which was not recognized in the second quarter of 2017 was recognized in the third quarter of 2017. We anticipate the difference between interest income and interest expense to be between 3% and 4% during the remainder of 2017. This number is greater than the 2% margin mentioned above because some of the funds we lend are from our equity, so there is no interest cost associated with those funds, and some loans pay higher interest rates due to their age, even though they are not in default.
● Fee income. Fee income is displayed in the table above. The two loans originated in December 2011 had a net origination fee of $924. This fee was recognized over the life of the loans, and was fully recognized as of August 2016. Our construction loans have a 5% fee on the amount we commit to lend, which is amortized over the expected life of each of those loans. When loans terminate quicker than their expected life, the remaining unrecognized fee is recognized upon the termination of the loan. For the nine month period ended September 30, 2017, our fee income decreased as a percentage of our loan balance by 1% because of the completion of the recognition of our development loan fees in 2016; this decrease was offset by an increase of 1% from construction loans which generally have higher rates than development loans. We currently anticipate that fee income will continue at the same 6% rate for the remainder of 2017.
● Amount of nonperforming assets. Generally we can have three types of nonperforming assets that negatively affect interest spread: loans not paying interest, foreclosed assets, and cash. We had no nonperforming loans in the first three months of both 2017 and 2016,and two nonperforming loans in the second quarter of 2017, which terminated in the third quarter. Foreclosed assets do not have a monthly interest return. The difference between our average foreclosed asset balance in 2017 as compared to 2016 did not have a major impact on our performance in the first two quarters of 2017, but did have a positive impact in the third quarter of 2017. The amount of nonperforming assets is expected to rise over the next twelve months, both due to work expected on the two lots we currently own and due to idle cash increases which are anticipated due to large borrowing inflows.
Non-Interest Income
We sold a foreclosed asset in 2017 and recognized a gain of $77. In 2016, we foreclosed on a loan, which resulted in a gain of $44 being booked in the second quarter of 2016.
SG&A Expenses
The following table displays our SG&A expenses:
Three Months | Nine Months | |||||||||||||||
Ended September 30, | Ended September 30, | |||||||||||||||
2017 | 2016 | 2017 | 2016 | |||||||||||||
Selling, general and administrative expenses | ||||||||||||||||
Legal and accounting | $ | 39 | $ | 27 | $ | 164 | $ | 139 | ||||||||
Salaries and related expenses | 393 | 207 | 976 | 593 | ||||||||||||
Board related expenses | 27 | 29 | 82 | 84 | ||||||||||||
Advertising | 17 | 6 | 42 | 31 | ||||||||||||
Rent and utilities | 8 | 5 | 22 | 15 | ||||||||||||
Loan and foreclosed asset expenses | 4 | – | 30 | 17 | ||||||||||||
Travel | 13 | 7 | 45 | 26 | ||||||||||||
Other | 36 | 15 | 86 | 47 | ||||||||||||
Total SG&A | $ | 537 | $ | 297 | $ | 1,447 | $ | 952 |
We had roughly twice as many employees during the three and nine month periods ended September 30, 2017 as 2016, which increased our payroll and travel costs. We anticipate adding more staff in 2017. We will also have expenses related to operating from our new office in the fourth quarter of 2017. We added a loan document software package in the second half of 2016, and the amortization of that system is in Other SG&A. Loan expenses, mostly post-closing title searches designed to ensure our mortgage is in first position, have increased with the increased volume of loans.
21 |
Impairment Loss on Foreclosed Assets
During 2017, we have owned five different foreclosed assets. Two are lots that we plan to build houses on to maximize our return, one was a lot which we sold and for which we recorded a gain, and two were partially built homes which we needed to complete. The two which were partially built have resulted in the impairment recorded in 2017. We do not anticipate more losses on those homes in the future, but depending on the final selling price of those homes, more loss may need to be recorded.
Consolidated Financial Position
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 |
We anticipate some additions in the fourth quarter of 2017 in actual payments, and continued recognition, both at similar levels to earlier periods this year.
Loans Receivable
Commercial Loans – Construction Loan Portfolio Summary
We anticipate that the aggregate balance of our construction loan portfolio will increase as loans near maturity, and due to new loan originations.
22 |
The following is a summary of our loan portfolio to builders for home construction loans as of September 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 | 5 | $ | 2,563 | $ | 1,707 | $ | 1,058 | 67 | % | 5 | % | ||||||||||||||||
Connecticut | 1 | 1 | 715 | 500 | 500 | 70 | % | 5 | % | |||||||||||||||||||
Delaware | 1 | 1 | 244 | 171 | 133 | 70 | % | 5 | % | |||||||||||||||||||
Florida | 12 | 46 | 22,740 | 14,435 | 9,320 | 63 | % | 5 | % | |||||||||||||||||||
Georgia | 7 | 17 | 10,020 | 6,124 | 3,192 | 61 | % | 5 | % | |||||||||||||||||||
Indiana | 2 | 2 | 995 | 597 | 401 | 60 | % | 5 | % | |||||||||||||||||||
Michigan | 4 | 23 | 6,238 | 3,860 | 2,163 | 62 | % | 5 | % | |||||||||||||||||||
New Jersey | 3 | 8 | 2,288 | 1,567 | 1,064 | 68 | % | 5 | % | |||||||||||||||||||
New York | 1 | 4 | 1,460 | 703 | 703 | 48 | % | 5 | % | |||||||||||||||||||
North Carolina | 3 | 6 | 1,650 | 1,155 | 364 | 70 | % | 5 | % | |||||||||||||||||||
Ohio | 2 | 2 | 2,116 | 1,341 | 1010 | 63 | % | 5 | % | |||||||||||||||||||
Pennsylvania | 2 | 17 | 14,637 | 7,747 | 5,967 | 53 | % | 5 | % | |||||||||||||||||||
South Carolina | 5 | 9 | 3,016 | 1,993 | 1,191 | 66 | % | 5 | % | |||||||||||||||||||
Tennessee | 1 | 3 | 1,080 | 767 | 752 | 71 | % | 5 | % | |||||||||||||||||||
Utah | 1 | 3 | 1,208 | 846 | 535 | 70 | % | 5 | % | |||||||||||||||||||
Virginia | 1 | 1 | 335 | 235 | 51 | 70 | % | 5 | % | |||||||||||||||||||
Total | 48 | (4) | 148 | $ | 71,305 | $ | 43,748 | $ | 28,404 | 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. |
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. |
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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 |
(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. |
Combined Loan Portfolio Summary
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 |
Roll forward of commercial loans:
Nine Months Ended 2017 | Year Ended 2016 | Nine Months Ended 2016 | ||||||||||
Beginning balance | $ | 20,091 | $ | 14,060 | $ | 14,060 | ||||||
Additions | 24,099 | 23,184 | 15,264 | |||||||||
Payoffs/sales | (13,810 | ) | (15,168 | ) | (9,739 | ) | ||||||
Moved to foreclosed assets | – | (1,639 | ) | (1,639 | ) | |||||||
Change in deferred origination expense | 26 | 55 | 30 | |||||||||
Change in builder deposit | (626 | ) | (340 | ) | (184 | ) | ||||||
Change in loan loss provision | (34 | ) | (16 | ) | (10 | ) | ||||||
New loan fees | (1,494 | ) | (1,270 | ) | (792 | ) | ||||||
Earned loan fees | 1,374 | 1,225 | 925 | |||||||||
Ending balance | $ | 29,626 | $ | 20,091 | $ | 17,915 |
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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 |
Below is an aging schedule of gross loans receivable as of September 30, 2017, on a recency basis:
No.
Accts. | Unpaid Balances | % | ||||||||||
Current loans (current accounts and accounts on which more than 50% of an original contract payment was made in the last 59 days) | 151 | $ | 31,858 | 100 | % | |||||||
60-89 days | – | – | 0 | % | ||||||||
90-179 days | – | – | 0 | % | ||||||||
180-269 days | – | – | 0 | % | ||||||||
Subtotal | 151 | $ | 31,858 | 100 | % | |||||||
Interest only accounts (Accounts on which interest, deferment, extension and/or default charges were received in the last 60 days) | – | $ | – | 0 | % | |||||||
Partial Payment accounts (Accounts on which the total received in the last 60 days was less than 50% of the original contractual monthly payment. “Total received” to include interest on simple interest accounts, as well as late charges on deferment charges on pre-computed accounts.) | – | $ | – | 0 | % | |||||||
Total | 151 | $ | 31,858 | 100 | % |
Below is an aging schedule of gross loans receivable as of September 30, 2017, on a contractual basis:
No.
Accts. |
Unpaid Balances |
% | ||||||||||
Contractual Terms - All current Direct Loans and Sales Finance Contracts with installments past due less than 60 days from due date. | 151 | $ | 31,858 | 100 | % | |||||||
60-89 days | – | – | 0 | % | ||||||||
90-179 days | – | – | 0 | % | ||||||||
180-269 days | – | – | 0 | % | ||||||||
Subtotal | 151 | $ | 31,858 | 100 | % | |||||||
Interest only accounts (Accounts on which interest, deferment, extension and/or default charges were received in the last 60 days) | – | $ | – | 0 | % | |||||||
Partial Payment accounts (Accounts on which the total received in the last 60 days was less than 50% of the original contractual monthly payment. “Total received” to include interest on simple interest accounts, as well as late charges on deferment charges on pre-computed accounts.) | – | $ | – | 0 | % | |||||||
Total | 151 | $ | 31,858 | 100 | % |
25 |
Below is an aging schedule of gross loans receivable as of December 31, 2016, on a recency basis:
No.
Accts. |
Unpaid Balances |
% | ||||||||||
Current loans (current accounts and accounts on which more than 50% of an original contract payment was made in the last 59 days) | 71 | $ | 18,617 | 86 | % | |||||||
60-89 days | 1 | 2,952 | 14 | % | ||||||||
90-179 days | – | – | 0 | % | ||||||||
180-269 days | – | – | 0 | % | ||||||||
Subtotal | 72 | $ | 21,569 | 100 | % | |||||||
Interest only accounts (Accounts on which interest, deferment, extension and/or default charges were received in the last 60 days) | – | $ | – | 0 | % | |||||||
Partial Payment accounts (Accounts on which the total received in the last 60 days was less than 50% of the original contractual monthly payment. “Total received” to include interest on simple interest accounts, as well as late charges on deferment charges on pre-computed accounts.) | – | $ | – | 0 | % | |||||||
Total | 72 | $ | 21,569 | 100 | % |
Below is an aging schedule of gross loans receivable as of December 31, 2016, on a contractual basis:
No.
Accts. |
Unpaid Balances |
% | ||||||||||
Contractual Terms - All current Direct Loans and Sales Finance Contracts with installments past due less than 60 days from due date. | 71 | $ | 18,617 | 86 | % | |||||||
60-89 days | 1 | 2,952 | 14 | % | ||||||||
90-179 days | – | – | 0 | % | ||||||||
180-269 days | – | – | 0 | % | ||||||||
Subtotal | 72 | $ | 21,569 | 100 | % | |||||||
Interest only accounts (Accounts on which interest, deferment, extension and/or default charges were received in the last 60 days) | – | $ | – | 0 | % | |||||||
Partial Payment accounts (Accounts on which the total received in the last 60 days was less than 50% of the original contractual monthly payment. “Total received” to include interest on simple interest accounts, as well as late charges on deferment charges on pre-computed accounts.) | – | $ | – | 0 | % | |||||||
Total | 72 | $ | 21,569 | 100 | % |
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Foreclosed Assets
Below is a roll forward of foreclosed assets:
Nine Months Ended 2017 | Year Ended 2016 | Nine Months Ended 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 |
Property, Plant and 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 anticipate another $275 in costs associated with this project in the fourth quarter of 2017.
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.
Customer Interest Escrow
Below is a roll forward of interest escrow:
Nine
Months Ended 2017 |
Year
Ended 2016 |
Nine
Months Ended 2016 |
||||||||||
Beginning balance | $ | 812 | $ | 498 | $ | 498 | ||||||
+ Preferred equity dividends | 86 | 104 | 77 | |||||||||
+ Additions from Pennsylvania Loans | 345 | 926 | 551 | |||||||||
+ Additions from other loans | 962 | 430 | 302 | |||||||||
- Interest and fees | (1,229 | ) | (1,109 | ) | (789 | ) | ||||||
- Repaid to borrower or used to reduce principal | (125 | ) | (37 | ) | – | |||||||
Ending balance | $ | 851 | $ | 812 | $ | 639 |
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Notes Payable Unsecured
During the third quarter of 2017, we renewed our $500 note with 7Kings, which is now due in February 2018.
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 Hoskins Group’s 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.
Secured Borrowings – 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.
During the remainder of 2017 and all of 2018, we intend to increase our secured borrowings to fund additional growth in loan balances.
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Secured Borrowings – Summary
The secured borrowings are detailed below:
September 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 or Lender | 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 |
Typical
Current Advance Rate | Does Buyer Portion | |||||||||||||
Year Initiated | On New Loans | Have Priority? | Rate | |||||||||||
Loan purchaser | ||||||||||||||
1st Financial Bank, USA/Builder Finance, Inc. | 2014 | 70 | % | Yes | The rate our customer pays us | |||||||||
S.K. Funding, LLC | 2015 | 55 | % | Varies | 9-9.5% | |||||||||
Shuman | 2017 | 67 | % | Yes | 10 | % |
Redeemable Preferred Equity and Members’ Capital
We strive to maintain a reasonable (about 15%) balance between 1) redeemable preferred equity plus members’ capital and 2) total assets. The ratio of redeemable preferred equity plus members’ capital to assets was 14% as of both September 30, 2017 and December 31, 2016. We anticipate this ratio dropping until more preferred equity is added. We are currently exploring potential increases in preferred equity.
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. In March and April of 2017, we received an aggregate of $1,004 of new investment in our redeemable preferred equity from one of our independent managers and the wife of another of our independent managers.
Priority of Borrowings
The following table displays our borrowings and a ranking of priority. The lower the number, the higher the 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 |
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Liquidity and Capital Resources
The Company’s anticipated primary sources of liquidity going forward, and the amounts received from such sources as of the nine months ended September 30, 2017 and 2016, are:
Source of Liquidity | Nine
Months Ended September 30, 2017 | Nine
Months Ended September 30, 2016 | Comment and Future Outlook | |||||||
Purchase and sale agreements and secured borrowings | $ | 11,760 | $ | 6,544 | We increased our purchase and sale agreements by $3,000 in relation to our development loans and added a line of credit for $1,325 in the third quarter of 2017. We are working to obtain additional secured funding. | |||||
Unsecured borrowings (including Notes issued through our public offering) | 9,412 | 3,629 | We initiated a $500 line of credit in January 2017, which we used during 2017 but which had a $0 balance as of September 30, 2017. We also have increased the balance of our unsecured Notes. We plan to continue to increase our unsecured borrowings as needed. | |||||||
Principal payments | 13,810 | 9,739 | Our loan volume increased in the third quarter of 2017 resulting in an increase in principal payments. Repayments were particularly high in the third quarter of 2017 as our volume has increased. Our concentrations in large borrowers adds risk to this source of liquidity. We anticipate continued growth in payoffs as our volume increases. | |||||||
Interest income | 4,203 | 2,656 | We anticipate interest income increasing as our loan balances grow. Our concentrations in large borrowers adds risk to this source of liquidity. | |||||||
Funds from the sale of foreclosed assets | 1,890 | – | We anticipate selling more foreclosed assets in the future. | |||||||
Unsecured bank line of credit | – | – | We have $500 available as of September 30, 2017. |
The Company’s anticipated primary uses of liquidity going forward, and the amounts expended on such uses as of the nine months ended September 30, 2017 and 2016, are:
Use of Liquidity | Nine
Months Ended 2017 | Nine
Months Ended 2016 | Comment and Future Outlook | |||||||
Purchase and sale agreements and secured borrowings | $ | 6,914 | $ | 4,405 | These will continue to grow as loan payoffs continue to rise. | |||||
Unsecured borrowings | 6,481 | 1,336 | Consists mostly of borrowings from our Notes program. The increase in 2017 is due to both the increase in the balance of notes, and the maturing of this portfolio of debt. | |||||||
Loan funding | 23,473 | 14,830 | We have unfunded loan commitments of $16,489 as of September 30, 2017. | |||||||
Interest expense | 1,910 | 1,261 | We anticipate interest expense increasing as we grow. | |||||||
Distributions | 189 | 335 | Distributions are based on income |
30 |
To help manage our liquidity, we:
● | do not offer demand deposits (for instance, a checking account). We manage the duration of our Notes through the interest rates we offer at any time; | |
● | fund loan requests with varying sources of capital, not just our Notes offering; and | |
● | match our interest rate to our borrower to our cost of funds. |
Inflation, Interest Rates, and Housing Starts
Since we are in the housing industry, we are affected by factors that impact that industry. Housing starts impact our customers’ ability to sell their homes. Faster sales mean higher effective interest rates for us, as the recognition of fees we charge is spread over a shorter period. Slower sales mean lower effective interest rates for us. Slower sales are likely to increase the default rate we experience.
Housing inflation has a positive impact on our operations. When we lend initially, we are lending a percentage of a home’s expected value, based on historical sales. If those estimates prove to be low (in an inflationary market), the percentage we loaned of the value actually decreases, reducing potential losses on defaulted loans. The opposite is true in a deflationary housing price market. It is our opinion that values are average in many of the housing markets in the U.S. today, and our lending against these values is safer than loans made by financial institutions in 2006 to 2008.
Interest rates have several impacts on our business. First, rates affect housing (starts, home size, etc.). High long term interest rates may decrease housing starts, having the effects listed above. Higher interest rates will also affect our investors. We believe that there will be a spread between the rate our Notes yield to our investors and the rates the same investors could get on deposits at FDIC insured institutions. We also believe that the spread may need to widen if these rates rise. For instance, if we pay 7% above average CD rates when CDs are paying 0.5%, when CDs are paying 3%, we may have to have a larger than 7% difference. This may cause our lending rates, which are based on our cost of funds, to be uncompetitive. High interest rates may also increase builder defaults, as interest payments may become a higher portion of operating costs for the builder. Higher short term rates may increase the rates builders are charged by banks faster than our rates to the builder will grow, which might be a benefit for us. Below is a chart showing three year U.S. treasury rates, which are being used by us here to approximate CD rates. Short term interest rates have risen slightly but are generally low historically.
31 |
Housing prices are also generally correlated with housing starts, so that increases in housing starts usually coincide with increases in housing values, and the reverse is generally true. Below is a graph showing single family housing starts from 2000 through today.
Source: U.S. Census Bureau
32 |
To date, changes in housing starts, CD rates, and inflation have not had a material impact on our business.
Off-Balance Sheet Arrangements
As of September 30, 2017 and December 31, 2016, we had no off-balance sheet transactions, nor do we currently have any such arrangements or obligations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
We are a smaller reporting company as defined by Rule 12b-2 of the Securities Exchange Act of 1934 and are not required to provide the information under this item.
ITEM 4. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
As of the end of the period covered by this report our chief executive officer (our principal executive officer and principal financial officer) evaluated the effectiveness of the design and operation of our disclosure controls and procedures. Based upon, and as of the date of, the evaluation, our chief executive officer (our principal executive officer and principal financial officer) concluded that the disclosure controls and procedures were effective as of the end of the period covered by this report to ensure that information required to be disclosed in the reports we file and submit under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported as and when required. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports we file and submit under the Exchange Act is accumulated and communicated to our management, including our chief executive officer (our principal executive officer and principal financial officer), as appropriate to allow timely decisions regarding required disclosure.
Internal Control over Financial Reporting
There have been no changes in our internal control over financial reporting that occurred during the quarter ended September 30, 2017 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
None.
Not applicable.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
(a) | Issuance of Partial Series B Cumulative Preferred Units
We previously entered into an agreement with Investor’s Mark Acquisitions, LLC (“IMA”) pursuant to which we sell IMA 0.1 of a Series B cumulative preferred unit (“Series B Preferred Units”) upon the closing of a lot in the Tuscany subdivision or any subdivisions thereof or in the Hamlets of Springdale subdivision phases 3, 4, and 5. We issued 0.1 of a Series B Preferred Unit to IMA on August 1, 2017 for $10,000, and 0.1 of a Series B Preferred Unit to IMA on August 21, 2017 for $10,000. We also issued 0.2 of a Series B Preferred Unit to IMA on September 8, 2017 for $20,000, and 0.2 of a Series B Preferred Unit to IMA on September 29, 2017 for $20,000. The proceeds received from the sales of the partial Series B Preferred Units in those transactions were used for the funding of construction loans.
The transactions in Series B Preferred Units described above were effected in private transactions exempt from the registration requirements of the Securities Act under Section 4(a)(2) of the Securities Act. The transactions described above did not involve any public offering, were made without general solicitation or advertising, and the buyer represented to us that it is an “accredited investor’’ within the meaning of Rule 501 of Regulation D promulgated under the Securities Act, with access to all relevant information necessary to evaluate the investment in the Series B Preferred Units.
Reinvestments in Partial Series C Cumulative Preferred Units
Investors in the Series C cumulative preferred units (“Series C Preferred Units”) may elect to reinvest their distributions in additional Series C Preferred Units (the “Series C Reinvestment Program”). Pursuant to the Series C Reinvestment Program, on July 31, 2017, we issued approximately 0.0455526 of a Series C Preferred Unit to Margaret Rauscher IRA LLC in exchange for distribution proceeds of approximately $4,555.26, and approximately 0.0578155 of a Series C Preferred Unit to an IRA owned by William Myrick in exchange for distribution proceeds of approximately $5,781.55. On August 31, 2017, we issued approximately 0.0460081 of a Series C Preferred Unit to Margaret Rauscher IRA LLC in exchange for distribution proceeds of approximately $4,600.81, and approximately 0.0583936 of a Series C Preferred Unit to an IRA owned by William Myrick in exchange for distribution proceeds of approximately $5,839.36. On September 30, 2017, we issued approximately 0.0464682 of a Series C Preferred Unit to Margaret Rauscher IRA LLC in exchange for distribution proceeds of approximately $4,646.82, and approximately 0.0589776 of a Series C Preferred Unit to an IRA owned by William Myrick in exchange for distribution proceeds of approximately $5,897.76. The proceeds received from the sales of the partial Series C Preferred Units in those transactions were used for the funding of construction loans.
The transactions in Series C Preferred Units described above were effected in private transactions exempt from the registration requirements of the Securities Act under Section 4(a)(2) of the Securities Act. The transactions described above did not involve any public offering, were made without general solicitation or advertising, and the buyer represented to us that it is an “accredited investor’’ within the meaning of Rule 501 of Regulation D promulgated under the Securities Act, with access to all relevant information necessary to evaluate the investment in the Series C Preferred Units. | |
(b) | We registered up to $70,000,000 in Fixed Rate Subordinated Notes in our public offering (SEC File No. 333-203707, effective September 29, 2015). As of September 30, 2017, we had issued $14,538,000 in Notes pursuant to that public offering. From September 29, 2015 through September 30, 2017, we incurred expenses of $170,000 in connection with the issuance and distribution of the Notes, which were paid to third parties. These expenses were not for underwriters or discounts, but were for advertising, printing, and professional services. Net offering proceeds as of September 30, 2017 were $14,368,000, 100% of which was used to increase loan balances. | |
(c) | None. |
33 |
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
(a) | During the quarter ended September 30, 2017, there was no information required to be disclosed in a report on Form 8-K which was not disclosed in a report on Form 8-K. | |
(b) | During the quarter ended September 30, 2017, there were no material changes to the procedures by which members may recommend nominees to our board of managers. |
The exhibits required to be filed with this report are set forth on the Exhibit Index hereto and incorporated by reference herein.
34 |
EXHIBIT INDEX
The following exhibits are included in this report on Form 10-Q for the period ended September 30, 2017 (and are numbered in accordance with Item 601 of Regulation S-K).
101.INS** | XBRL Instance Document | |
101.SCH** | XBRL Schema Document | |
101.CAL** | XBRL Calculation Linkbase Document | |
101.DEF** | XBRL Definition Linkbase Document | |
101.LAB** | XBRL Labels Linkbase Document | |
101.PRE** | XBRL Presentation Linkbase Document |
* Filed herewith.
**Pursuant to Regulation 406T of Regulation S-T, these Interactive Data Files are deemed not filed or part of a registration statement or prospectus for purpose of Section 11 or 12 of the Securities Act of 1933, as amended, or Section 18 of the Securities Exchange Act of 1934, as amended, and are otherwise not subject to liability.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
SHEPHERD’S FINANCE, LLC (Registrant) | ||
Dated: November 2, 2017 | By: | /s/ Daniel M. Wallach |
Daniel M. Wallach | ||
Chief Executive Officer and Manager |
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