UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q

 

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

 

For the Quarterly Period Ended June 30, 2020

 

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 333-224557

 

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.)

 

13241 Bartram Park Blvd., Suite 2401, Jacksonville, Florida 32258

(Address of principal executive offices)

 

(302) 752-2688

(Registrant’s telephone number including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Each Class		Trading Symbol(s)		Name of Each Exchange on Which Registered
None		None		None

 

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 every Interactive Data File required to be submitted 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 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	[X]	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. [X]

 

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

 

 

 

FORM 10-Q

SHEPHERD’S FINANCE, LLC

TABLE OF CONTENTS

 

	Page
Cautionary Note Regarding Forward-Looking Statements	3
PART I. FINANCIAL INFORMATION	4
Item 1. Financial Statements	4
Interim Condensed Consolidated Balance Sheets as of June 30, 2020 (Unaudited) and December 31, 2019	4
Interim Condensed Consolidated Statements of Operations (Unaudited) for the Three and Six Months Ended June 30, 2020 and 2019	5
Interim Condensed Consolidated Statement of Changes in Members’ Capital (Unaudited) for the Six Months Ended June 30, 2020 and 2019 and for the Three Months Ended June 30, 2020 and 2019	6
Interim Condensed Consolidated Statements of Cash Flows (Unaudited) for the Six Months Ended June 30, 2020 and 2019	7
Notes to Interim Condensed Consolidated Financial Statements (Unaudited)	8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	19
Item 3. Quantitative and Qualitative Disclosure About Market Risk	38
Item 4. Controls and Procedures	38
PART II. OTHER INFORMATION	39
Item 1. Legal Proceedings	39
Item 1A. Risk Factors	39
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	39
Item 3. Defaults upon Senior Securities	40
Item 4. Mine Safety Disclosures	40
Item 5. Other Information	40
Item 6. Exhibits	40

 

 

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. These risks and uncertainties include, but are not limited to: uncertainties relating to the effects of COVID-19; the length of the COVID-19 pandemic and severity of such outbreak nationally and across the globe; the pace of recovery following the COVID-19 pandemic; general economic uncertainty in key global markets and a worsening of global economic conditions or low levels of economic growth; the rate and the pace of economic recovery following economic downturns; and those other risks described in other risk factors as outlined in our Registration Statement on Form S-1, as amended, and our Annual Report on Form 10-K. 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. For further information regarding risks and uncertainties associated with our business, and important factors that could cause our actual results to vary materially from those expressed or implied in such forward-looking statements, please refer to the factors set forth in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors” sections of the documents we file from time to time with the U.S. Securities and Exchange Commission, including, but not limited to, our Annual Report on Form 10-K for the year ended December 31, 2019 and subsequent Quarterly Reports on Form 10-Q. When considering forward-looking statements, you should keep these risk factors, as well as the other cautionary statements in this report and in our Annual Report on Form 10-K for the year ended December 31, 2019 in mind. You should not place undue reliance on any forward-looking statement. We are not obligated to update forward-looking statements.

 

 

PART I – FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

Shepherd’s Finance, LLC

Interim Condensed Consolidated Balance Sheets

 

(in thousands of dollars)		June 30, 2020				December 31, 2019
		(Unaudited)
Assets
Cash and cash equivalents		$	2,540			$	1,883
Accrued interest receivable			637				1,031
Loans receivable, net			49,797				55,369
Real estate investments			1,140				-
Foreclosed assets			5,022				4,916
Premises and equipment			919				936
Other assets			259				202
Total assets		$	60,314			$	64,337
Liabilities and Members’ Capital
Customer interest escrow		$	550			$	643
Accounts payable and accrued expenses			153				466
Accrued interest payable			2,700				2,533
Notes payable secured, net of deferred financing costs			24,293				26,991
Notes payable unsecured, net of deferred financing costs			27,606				26,520
PPP Loan and EIDL Advance			371				-
Due to preferred equity member			-				37
Total liabilities		$	55,673			$	57,190
Commitments and Contingencies (Note 10)
Redeemable Preferred Equity
Series C preferred equity		$	3,115			$	2,959
Members’ Capital
Series B preferred equity			1,520				1,470
Class A common equity			6				2,718
Members’ capital		$	1,526			$	4,188
Total liabilities, redeemable preferred equity and members’ capital		$	60,314			$	64,337

 

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

 

 

Shepherd’s Finance, LLC

Interim Condensed Consolidated Statements of Operations - Unaudited

For the Three and Six Months ended June 30, 2020 and 2019

 

		Three Months Ended								Six Months Ended
		June 30,								June 30,
(in thousands of dollars)		2020				2019				2020				2019
Interest Income
Interest and fee income on loans		$	1,356			$	2,454			$	3,931			$	4,886
Interest expense:
Interest related to secured borrowings			810				769				1,627				1,450
Interest related to unsecured borrowings			774				716				1,542				1,341
Interest expense			1,584				1,485				3,169				2,791
Net interest (loss) income			(228	)			969				762				2,095
Less: Loan loss provision			1,560				151				1,595				198
Net interest (loss) income after loan loss provision			(1,788	)			818				(833	)			1,897
Non-Interest Income
Gain on foreclosed assets			-				95				-				95
Gain on sale of foreclosed assets			3				-				3				-
Total non-interest income			3				95				3				95
(Loss) Income			(1,785	)			913				(830	)			1,992
Non-Interest Expense
Selling, general and administrative			462				620				1,169				1,244
Depreciation and amortization			21				22				43				45
Loss on foreclosure of assets			-				169				35				169
Impairment loss on foreclosed assets			91				27				200				107
Total non-interest expense			574				838				1,447				1,565
Net (Loss) Income		$	(2,359	)		$	75			$	(2,277	)		$	427
Earned distribution to preferred equity holders			92				110				218				215
Net (loss) income attributable to common equity holders		$	(2,451	)		$	(35	)		$	(2,495	)		$	212

 

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

 

 

Shepherd’s Finance, LLC

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

For the Six and Three Months Ended June 30, 2020 and 2019

 

For the Six Months Ended June 30, 2020 and 2019

 

(in thousands of dollars)		2020				2019
Members’ capital, beginning balance, December 31		$	4,188			$	3,697
Net (loss) income less distributions to Series C preferred equity holders of $181 and $148			(2,458	)			279
Contributions from Series B preferred equity holders			50				100
Earned distributions to Series B preferred equity holders			(37	)			(66	)
Distributions to common equity holders			(217	)			(166	)
Members’ capital, ending balance, June 30		$	1,526			$	3,844

 

For the Three Months Ended June 30, 2020 and 2019

 

(in thousands of dollars)		2020				2019
Members’ capital, beginning balance, March 31		$	3,927			$	3,888
Net (loss) income less distributions to Series C preferred equity holders of $92 and $75			(2,451	)			171
Contributions from Series B preferred equity holders			50				40
Earned distributions to Series B preferred equity holders			-				(34	)
Distributions to common equity holders			-				(192	)
Members’ capital, ending balance, June 30		$	1,526			$	3,873

 

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

 

 

Shepherd’s Finance, LLC

Interim Condensed Consolidated Statements of Cash Flows - Unaudited

For the Six Months Ended June 30, 2020 and 2019

 

		Six Months Ended June 30,
(in thousands of dollars)		2020				2019
Cash flows from operations
Net (loss) income		$	(2,277	)		$	427
Adjustments to reconcile net (loss) income to net cash provided by operating activities
Amortization of deferred financing costs			79				133
Provision for loan losses			1,595				198
Change in loan origination fees, net			(203	)			220
Gain on sale of foreclosed assets			(3	)			-
Loss on sale of foreclosed assets			35				-
Impairment and loss on foreclosed assets			200				276
Gain on foreclosed assets			-				(95	)
Depreciation and amortization			43				45
Net change in operating assets and liabilities:
Other assets			(83	)			(72	)
Accrued interest receivable			394				(241	)
Customer interest escrow			(167	)			170
Accrued interest payable			167				129
Accounts payable and accrued expenses			(313	)			(310	)
Net cash (used in) provided by operating activities			(533	)			880
Cash flows from investing activities
Loan additions and principal collections, net			3,040				(6,021	)
Investment in foreclosed assets			(686	)			(456	)
Proceeds from the sale of foreclosed assets			348				-
Net cash provided by (used in) investing activities			2,702				(6,477	)
Cash flows from financing activities
Contributions from preferred equity holders			50				300
Distributions to preferred equity holders			(25	)			(85	)
Distributions to common equity holders			(217	)			(166	)
Proceeds from secured notes payable			7,302				11,016
Repayments of secured notes payable			(8,879	)			(6,648	)
Proceeds from unsecured notes payable			6,604				6,186
Redemptions/repayments of unsecured notes payable			(6,594	)			(3,923	)
Proceeds from PPP Loan and EIDL Advance			371				-
Deferred financing costs paid			(124	)			(331	)
Net cash (used in) provided by financing activities			(1,512	)			6,349
Net increase in cash and cash equivalents			657				752
Cash and cash equivalents
Beginning of period			1,883				1,401
End of period		$	2,540			$	2,153
Supplemental disclosure of cash flow information
Cash paid for interest		$	3,002			$	2,662
Non-cash investing and financing activities
Earned by Series B preferred equity holders but not distributed to customer interest escrow		$	-			$	34
Earned by Series B preferred equity holders and distributed to customer interest escrow		$	74			$	33
Earned but not paid distributions of Series C preferred equity holders		$	181			$	72
Secured transferred to unsecured notes payable		$	1,116			$	1,014
Transfer of loan receivables to real estate investments		$	1,140			$	-
Reclassification of deferred financing costs from other assets		$	-			$	189

 

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

 

 

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

 

Shepherd’s Finance, LLC and subsidiary (the “Company”) was originally formed as a Pennsylvania limited liability company on May 10, 2007. The Company is the sole member of a consolidating subsidiary, 84 REPA, LLC. The Company operates pursuant to its Second Amended and Restated Operating Agreement, as amended, by and among Daniel M. Wallach and the other members of the Company effective as of March 16, 2017.

 

As of June 30, 2020, the Company extends commercial loans to residential homebuilders (in 20 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) interim condensed consolidated balance sheet as of June 30, 2020, 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, the instructions to Form 10-Q and Article 8 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, 2020. These unaudited interim condensed consolidated financial statements should be read in conjunction with the 2019 consolidated financial statements and notes thereto (the “2019 Financial Statements”) included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019 (the “2019 Form 10-K”). The accounting policies followed by the Company are set forth in Note 2 – Summary of Significant Accounting Policies in the 2019 Financial Statements.

 

Accounting Standards to be Adopted

 

Financial Accounting Standards Board (“FASB”) Accounting Standards Update (“ASU”) 2016-13, “Financial Instruments-Credit Losses: Measurement of Credit Losses on Financial Instruments”. The amendments in ASU 2016-13 introduce a new current expected credit loss (“CECL”) model for certain financial assets, including mortgage loans and reinsurance receivables. The new model will not apply to debt securities classified as available-for-sale. For assets within the scope of the new model, an entity will recognize as an allowance against earnings its estimate of the contractual cash flows not expected to be collected on day one of the asset’s acquisition. The allowance may be reversed through earnings if a security recovers in value. This differs from the current impairment model, which requires recognition of credit losses when they have been incurred and recognizes a security’s subsequent recovery in value in other comprehensive income. ASU 2016-13 also makes targeted changes to the current impairment model for available-for-sale debt securities, which comprise the majority of the Company’s invested assets. Similar to the CECL model, credit loss impairments will be recorded in an allowance against earnings that may be reversed for subsequent recoveries in value. The amendments in ASU 2016-13, along with related amendments in ASU No. 2018-19, “Codification Improvements to Topic 326, Financial Instruments—Credit Losses,” are effective for annual and interim periods beginning after December 15, 2019 on a modified retrospective basis. For smaller reporting companies, the effective date for annual and interim periods is January 1, 2023. The Company is reviewing its policies and processes to ensure compliance with the requirements in ASU 2016-13.

 

 

FASB ASU 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement” amends the disclosure requirements of Topic 820, Fair Value Measurement, to remove disclosure of transfers between Level 1 and Level 2 of the fair value hierarchy and to include disclosure of the range and weighted average used in Level 3 fair value measurements, among other amendments. The ASU applies to all entities that are required to provide disclosures about recurring or non-recurring fair value measurements. Amendments should be applied retrospectively to all periods presented, except for certain amendments, which should be applied prospectively for only the most recent interim or annual period presented in the initial fiscal year of adoption. ASU 2018-13 became effective for the Company on January 1, 2020. The adoption of ASU 2018-13 did not have a material impact on the Company’s consolidated financial statements.

 

Reclassifications

 

Certain prior year amounts have been reclassified for consistency with current period presentation.

 

2. Fair Value

 

The Company had no financial instruments measured at fair value on a recurring basis as of June 30, 2020 and December 31, 2019.

 

The following tables present the balances of non-financial instruments measured at fair value on a non-recurring basis as of June 30, 2020 and December 31, 2019.

 

		June 30, 2020								Quoted Prices in Active Markets for Identical				Significant Other Observable				Significant Unobservable
		Carrying				Estimated				Assets				Inputs				Inputs
		Amount				Fair Value				Level 1				Level 2				Level 3
Foreclosed assets		$	5,022			$	5,022			$	–			$	–			$	5,022
Impaired loans due to COVID-19, net			10,337				10,337				–				–				10,337
Other impaired loans, net			1,457				1,457				–				–				1,457
Total		$	16,816			$	16,816			$	–			$	–			$	16,816

 

		December 31, 2019								Quoted Prices in Active Markets for Identical				Significant Other Observable				Significant Unobservable
		Carrying				Estimated				Assets				Inputs				Inputs
		Amount				Fair Value				Level 1				Level 2				Level 3
Foreclosed assets		$	4,916			$	4,916			$	–			$	–			$	4,916
Impaired loans, net			1,487				1,487				–				–				1,487
Total		$	6,403			$	6,403			$	–			$	–			$	6,403

 

 

The table below is a summary of fair value estimates for financial instruments:

 

		June 30, 2020								December 31, 2019
		Carrying				Estimated				Carrying				Estimated
		Amount				Fair Value				Amount				Fair Value
Financial Assets
Cash and cash equivalents		$	2,540			$	2,540			$	1,883			$	1,883
Loans receivable, net			49,797				49,797				55,369				55,369
Accrued interest on loans			637				637				1,031				1,031
Financial Liabilities
Customer interest escrow			550				550				643				643
Notes payable secured, net			24,293				24,293				26,991				26,991
Notes payable unsecured, net			27,606				27,606				26,520				26,520
PPP Loan and EIDL Advance			371				371				-				-
Accrued interest payable			2,700				2,700				2,533				2,533

 

3. Financing Receivables

 

Financing receivables are comprised of the following as of June 30, 2020 and December 31, 2019:

 

		June 30, 2020				December 31, 2019
Loans receivable, gross		$	52,905			$	57,608
Less: Deferred loan fees			(725	)			(856	)
Less: Deposits			(965	)			(1,352	)
Plus: Deferred origination costs			276				204
Less: Allowance for loan losses			(1,694	)			(235	)
Loans receivable, net		$	49,797			$	55,369

 

The allowance for loan losses at June 30, 2020 was $1,694, of which $154 is related to loans without specific reserves. The Company recorded specific reserves for loans impaired due to impacts from COVID-19 of $1,152, special mention loans of $340, and impaired loans not due to impacts from COVID-19 of $47. As of December 31, 2019, the allowance was $235, of which $230 related to loans without specific reserves. During the quarter and six months ended June 30, 2020, we incurred $136 in direct charge-offs compared to $173 for the year ended December 31, 2019.

 

Commercial Construction and Development Loans

 

Commercial Loans – Construction Loan Portfolio Summary

 

As of June 30, 2020, the Company’s portfolio consisted of 223 commercial construction and eight development loans with 64 borrowers in 20 states.

 

The following is a summary of the loan portfolio to builders for home construction loans as of June 30, 2020 and December 31, 2019:

 

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
2020				20				64				223			$	86,627			$	59,513			$	43,929				69	%(3)			5	%
2019				21				70				241			$	93,211			$	65,273			$	48,611				70	%(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 June 30, 2020 and December 31, 2019:

 

Year			Number of States				Number of Borrowers				Number of Loans				Gross Value of Collateral(1)				Commitment Amount(2)				Gross Amount Outstanding				Loan to Value Ratio(3)				Interest Spread
2020				4				5				8			$	11,023			$	10,608			$	8,976				81	%(4)			7	%
2019				4				5				9			$	13,007			$	9,866			$	8,997				69	%(4)			7	%

 

(1)	The value is determined by the appraised value adjusted for remaining costs to be paid. For both June 30, 2020 and December 31, 2019, a portion of this collateral is $1,520 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 might be difficult to sell, which may impact our ability to recover the loan balance. In addition, a portion of the collateral value is estimated based on the selling prices anticipated for the homes.
(2)	The commitment amount does not include letters of credit and cash bonds.
(3)	The loan to value ratio is calculated by taking the outstanding amount and dividing by the appraised value calculated as described above.
(4)	Represents the weighted average loan to value ratio of the loans.

 

Credit Quality Information

 

The following tables present credit-related information at the “class” level in accordance with FASB ASC 310-10-50, “Receivables - Disclosures.” See our 2019 Form 10-K, as filed with the SEC, for more information.

 

Gross finance receivables – By risk rating:

 

		June 30, 2020				December 31, 2019
Pass		$	37,478			$	53,542
Special mention			2,434				2,571
Classified – accruing			–				–
Classified – nonaccrual			12,993				1,495
Total		$	52,905			$	57,608

 

Finance Receivables – Method of impairment calculation:

 

		June 30, 2020				December 31, 2019
Performing loans evaluated individually		$	18,108			$	26,233
Performing loans evaluated collectively			21,804				29,880
Non-performing loans without a specific reserve			-				1,467
Non-performing loans with a specific reserve to COVID-19			11,489				-
Other non-performing loans with a specific reserve			1,504				28
Total evaluated collectively for loan losses		$	52,905			$	57,608

 

As of June 30, 2020, and December 31, 2019, there were no loans acquired with deteriorated credit quality.

 

 

Impaired Loans

 

The following is a summary of our impaired nonaccrual commercial construction loans as of June 30, 2020 and December 31, 2019.

 

		June 30, 2020				December 31, 2019
Unpaid principal balance (contractual obligation from customer)		$	13,014			$	1,495
Charge-offs and payments applied			(21	)			-
Gross value before related allowance			12,993				1,495
Related allowance			(1,199	)			(8	)
Value after allowance		$	11,794			$	1,487

 

Concentrations

 

Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of loans receivable. Our concentration risks for our top three customers listed by geographic real estate market are summarized in the table below:

 

June 30, 2020

December 31, 2019

Percent of

Percent of

Borrower

Loan

Borrower

Loan

City

Commitments

City

Commitments

Highest concentration risk

Pittsburgh, PA

29

%

Pittsburgh, PA

25

%

Second highest concentration risk

Orlando, FL

14

%

Orlando, FL

15

%

Third highest concentration risk

Cape Coral, FL

6

%

Cape Coral, FL

3

%

 

4. Real Estate Investment Assets

 

During June 2020, the Company acquired two lots from a borrower in exchange for extinguishing two loans secured by those lots in the principal amount of $640. In a subsequent transaction with an unrelated party the Company transferred the two lots in exchange for five lots. In addition, the Company paid a $500 management fee for the development of homes on the five lots acquired from the unrelated party. The management fee was paid through reducing the principal balance on a current loan receivable with the borrower who initially sold us the two lots.

 

The following table is a roll forward of real estate investment assets:

 

Six Months Ended June 30, 2020

Year Ended December 31, 2019

Six Months Ended June 30, 2019

Beginning balance

$

–

$

–

$

–

Transfers from loans

1,140

–

–

Ending balance

$

1,140

$

–

$

–

 

 

5. Foreclosed Assets

 

The following table is a roll forward of foreclosed assets:

 

		Six Months Ended June 30, 2020				Year Ended December 31, 2019				Six Months Ended June 30, 2019
Beginning balance		$	4,916			$	5,973			$	5,973
Additions from loans			-				3,352				1,716
Additions for construction/development			686				763				456
Sale proceeds			(348	)			(4,543	)			–
Loss on sale			(35	)			(274	)			–
Gain on foreclosure			-				203				95
Gain on sale of foreclosed assets			3				-				-
Impairment loss on foreclosed assets due to COVID-19			(91	)			-				-
Other impairment loss on foreclosed assets			(109	)			(558	)			(276	)
Ending balance		$	5,022			$	4,916			$	7,964

 

6. Borrowings

 

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

 

		Priority Rank		June 30, 2020				December 31, 2019
Borrowing Source
Purchase and sale agreements and other secured borrowings		1		$	23,651			$	26,806
Secured line of credit from affiliates		2			651				189
Unsecured line of credit (senior)		3			500				500
PPP Loan and EIDL Advance		3			371				-
Other unsecured debt (senior subordinated)		4			1,407				1,407
Unsecured Notes through our public offering, gross		5			20,777				20,308
Other unsecured debt (subordinated)		5			4,788				4,131
Other unsecured debt (junior subordinated)		6			590				590
Total				$	52,735			$	53,931

 

The following table shows the maturity of outstanding debt as of June 30, 2020:

 

Year Maturing		Total Amount Maturing				Public Offering				Other Unsecured				Secured Borrowings
2020		$	28,532			$	1,381			$	3,830			$	23,321
2021			13,540				11,856				1,668				16
2022			5,526				3,661				1,849				16
2023			1,116				821				189				106
2024 and thereafter			4,021				3,058				120				843
Total		$	52,735			$	20,777			$	7,656			$	24,302

 

(1)

Other Unsecured includes our PPP Loan of $361 and EIDL Advance of $10 (each described below) of which $21, $247, and $103, collectively, matures during 2020, 2021 and 2022, respectively. All or a portion of the PPP Loan may be forgiven.

 

 

Secured Borrowings

 

Lines of Credit from Affiliates

 

As of June 30, 2020, the Company had borrowed $651 on its lines of credit from affiliates, which have a total limit of $2,500.

 

Community Bank Loan (the “Community Bank Loan”)

 

On June 30, 2020, the Company entered into a business loan agreement with Community Bank. The Community Bank Loan is secured by 13 of our foreclosed assets and includes the following terms:

 

	●	Principal not to exceed $362;
	●	Principal payments begin July 30, 2023;
	●	Interest rate of 3.8% per annum based on a year of 360 days; and
	●	Due date of June 30, 2025.

 

Secured Deferred Financing Costs

 

The Company had secured deferred financing costs of $9 and $5 as of June 30, 2020 and December 31, 2019, respectively. Amortization expense for secured deferred financing costs was immaterial for the quarter and six months ended June 30, 2020 and for the year ended December 31, 2019.

 

Summary

 

Borrowings secured by commercial and development loan assets are summarized below:

 

		June 30, 2020								December 31, 2019
		Book Value of Loans which Served as Collateral				Due from Shepherd’s Finance to Loan Purchaser or Lender				Book Value of Loans which Served as Collateral				Due from Shepherd’s Finance to Loan Purchaser or Lender
Loan Purchaser
Builder Finance, Inc.		$	10,804			$	7,918			$	13,711			$	9,375
S.K. Funding, LLC			8,730				5,815				10,394				6,771
Lender
Shuman			2,201				1,325				1,785				1,325
Jeff Eppinger			1,821				1,000				1,821				1,000
Hardy Enterprises, Inc.			1,141				800				1,684				1,000
Gary Zentner			642				250				472				250
R. Scott Summers			1,443				847				841				628
Paul Swanson			6,319				4,708				8,377				5,824
Total		$	33,101			$	22,663			$	39,085			$	26,173

 

 

Unsecured Borrowings

 

Unsecured Notes through the Public Offering (“Notes Program”)

 

On March 22, 2019, the Company terminated its second public offering and commenced its third public offering of fixed rate subordinated notes (the “Notes”). The effective interest rate on borrowings through our Notes Program at June 30, 2020 and December 31, 2019 was 10.48% and 10.56%, respectively, not including the amortization of deferred financing costs. We generally offer four durations at any given time, ranging from 12 to 48 months from the date of issuance. There are limited rights of early redemption. Our 36-month Note has a mandatory early redemption option, subject to certain conditions. The following table shows the roll forward of our Notes Program:

 

		Six Months Ended June 30, 2020				Year Ended December 31, 2019				Six Months Ended June 30, 2019
Gross Notes outstanding, beginning of period		$	20,308			$	17,348			$	17,348
Notes issued			5,668				11,127				5,818
Note repayments / redemptions			(5,199	)			(8,167	)			(3,925	)
Gross Notes outstanding, end of period		$	20,777			$	20,308			$	19,241
Less deferred financing costs, net			456				416				460
Notes outstanding, net		$	20,321			$	19,892			$	18,781

 

The following is a roll forward of deferred financing costs:

 

		Six Months Ended June 30, 2020				Year Ended December 31, 2019				Six Months Ended June 30, 2019
Deferred financing costs, beginning balance		$	786			$	1,212			$	1,212
Additions			119				365				331
Disposals			–				(791	)			–
Deferred financing costs, ending balance			905				786				1,543
Less accumulated amortization			(449	)			(370	)			(1,083	)
Deferred financing costs, net		$	456			$	416			$	460

 

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

 

		Six Months Ended June 30, 2020				Year Ended December 31, 2019				Six Months Ended June 30, 2019
Accumulated amortization, beginning balance		$	370			$	1,000			$	1,000
Additions			79				161				83
Disposals			–				(791	)			–
Accumulated amortization, ending balance		$	449			$	370			$	1,083

 

 

Other Unsecured Debts

 

Our other unsecured debts are detailed below:

 

								Principal Amount Outstanding as of
Loan		Maturity Date		Interest Rate(1)				June 30, 2020				December 31, 2019
Unsecured Note with Seven Kings Holdings, Inc.		Demand(2)			9.5	%		$	500			$	500
Unsecured Line of Credit from Builder Finance, Inc.		January 2021			10.0	%			500				-
Unsecured Line of Credit from Paul Swanson		October 2020(6)			10.0	%			2,293				1,176
Subordinated Promissory Note		September 2020			9.5	%			563				563
Subordinated Promissory Note		December 2021			10.5	%			146				146
Subordinated Promissory Note		April 2024			10.0	%			100				100
Subordinated Promissory Note		April 2021			10.0	%			174				174
Subordinated Promissory Note		August 2022			11.0	%			200				200
Subordinated Promissory Note		March 2023			11.0	%			169				169
Subordinated Promissory Note		April 2020			6.5	%			-				500
Subordinated Promissory Note		February 2021			11.0	%			600				600
Subordinated Promissory Note		Demand			5.0	%			-				500
Subordinated Promissory Note		December 2020			5.0	%			3				3
Subordinated Promissory Note		December 2023			11	%			20				-
Subordinated Promissory Note		February 2024			11	%			20				-
Senior Subordinated Promissory Note		March 2022(3)			10.0	%			400				400
Senior Subordinated Promissory Note		March 2022(4)			1.0	%			728				728
Junior Subordinated Promissory Note		March 2022(4)			22.5	%			417				417
Senior Subordinated Promissory Note		October 2020(5)			1.0	%			279				279
Junior Subordinated Promissory Note		October 2020(5)			20.0	%			173				173
								$	7,285			$	6,628

 

(1)	Interest rate per annum, based upon actual days outstanding and a 365/366-day year.
(2)	Due six months after lender gives notice.
(3)	Lender may require us to repay $20 of principal and all unpaid interest with 10 days’ notice.
(4)	These notes were issued to the same holder and, when calculated together, yield a blended return of 11% per annum.
(5)	These notes were issued to the same holder and, when calculated together, yield a blended return of 10% per annum.
(6)	Amount due in October 2020 is $1,000 with the remainder due in November 2020.

 

Paycheck Protection Program Loan

 

On May 5, 2020 the Company entered into a loan agreement (the “PPP Loan”) with LCA Bank Corporation to borrow $361 pursuant to the Paycheck Protection Program (“PPP”), created under the Coronavirus Aid, Relief, and Economic Security Act, or CARES Act. The PPP is intended to provide loans to qualified businesses to cover payroll and certain other identified costs. The loan has an interest rate of 1.0% and a term of 24 months. No payments are due for the first six months, although interest accrues, and monthly payments, which include interest, are due over the next 18 months to pay off the loan. Funds from the loan may only be used for certain purposes, including payroll, benefits, rent, and utilities. All or a portion of the loan may be forgivable, as provided by the terms of the PPP. The loan is evidenced by a promissory note, which contains customary events of default relating to, among other things, payment defaults and breaches of representations. We may prepay the loan at any time prior to maturity with no prepayment penalties.

 

Economic Injury Disaster Loan Advance (the “EIDL Advance”)

 

The Economic Injury Disaster Loan Emergency Advance is a $10 grant for companies that successfully submit an EIDL (“Economic Injury Disaster Loan”) application. During April 2020, the Company received the grant (the “EIDL Advance”) which may be used for payroll and other certain operating expenses. The EIDL Advance will reduce the forgiveness of the PPP Loan depending on certain parameters required by the CARES Act.

 

 

7. Redeemable Preferred Equity

 

The following is a roll forward of our Series C cumulative preferred equity (“Series C Preferred Units”):

 

		Six Months Ended June 30, 2020				Year Ended December 31, 2019				Six Months Ended June 30, 2019
Beginning balance		$	2,959			$	2,385			$	2,385
Additions from new investment			-				300				200
Distributions			(25	)			(42	)			(18	)
Additions from reinvestment		$	181				316				148
Ending balance		$	3,115			$	2,959			$	2,715

 

The following table shows the earliest redemption options for investors in our Series C Preferred Units as of June 30, 2020:

 

Year Maturing			Total Amount Redeemable
2024			$	2,888
2025				227
Total			$	3,115

 

8. Members’ Capital

 

There are currently two classes of equity units outstanding that the Company classifies as Members’ Capital: Class A common units (“Class A Common Units”) and Series B cumulative preferred units (“Series B Preferred Units”). As of June 30, 2020, 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 as of June 30, 2020 and December 31, 2019.

 

Series B Preferred Units were initially issued to the Hoskins Group (consisting of Benjamin Marcus Homes, LLC, Investor’s Mark Acquisitions, LLC, and Mark L. Hoskins) 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 subdivisions. As of June 30, 2020, the Hoskins Group owned a total of 15.2 Series B Preferred Units, which were issued for a total of $1,520.

 

9. Related Party Transactions

 

As of June 30, 2020, the Company had $1,249, $250, and $350 available to borrow against the line of credit from Daniel M. Wallach (our Chief Executive Officer and chairman of the board of managers) and his wife, the line of credit from the 2007 Daniel M. Wallach Legacy Trust, and the line of credit from William Myrick (our Executive Vice President of Sales), respectively. A more detailed description is included in Note 6 of our 2019 Financial Statements. These borrowings are in notes payable secured, net of deferred financing costs on the interim condensed consolidated balance sheet.

 

 

10. Commitments and Contingencies

 

Unfunded commitments to extend credit, which have similar collateral, credit risk, and market risk to our outstanding loans, were $15,585 and $16,662 at June 30, 2020 and December 31, 2019, respectively.

 

11. Selected Quarterly Condensed Consolidated Financial Data (Unaudited)

 

Summarized unaudited quarterly condensed consolidated financial data for the quarters of 2020 and 2019 are as follows:

 

		Quarter 2				Quarter 1				Quarter 4				Quarter 3				Quarter 2				Quarter 1
		2020(1)				2020				2019				2019				2019				2019
Net (loss) interest Income after Loan Loss Provision		$	(1,788	)		$	955			$	1,117			$	1,115			$	818			$	1,079
Non-Interest Income			3				-				22				86				95				-
SG&A Expense			462				708				447				703				620				624
Depreciation and Amortization			21				21				26				21				22				23
Loss on Sale of Foreclosed Assets			–				35				–				274				–				–
Impairment Loss on Foreclosed Assets			91				109				282				–				196				80
Net (loss) income		$	(2,359	)		$	82			$	384			$	203			$	75			$	352

 

(1)

During the quarter ended June 30, 2020, net interest income after loan loss provision was reduced due to COVID-19 by $1,492 and $469 for loan loss provision and charges to interest income, respectively.  In addition, the Company wrote off $469 of interest income directly related to COVID-19.  During the quarter ended June 30, 2020, impairment loss on foreclosed assets of $91 was due to the impact of COVID-19.

 

12. Non-Interest Expense Detail

 

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

 

		For the Six Months Ended June 30,
		2020				2019
Selling, general and administrative expenses
Legal and accounting		$	181			$	174
Salaries and related expenses			484				784
Board related expenses			50				41
Advertising			36				50
Rent and utilities			23				25
Loan and foreclosed asset expenses			234				47
Travel			82				46
Other			79				77
Total SG&A		$	1,169			$	1,244

 

13. Subsequent Events

 

Management of the Company has evaluated subsequent events through August 6, 2020, the date these interim condensed consolidated financial statements were issued.

 

In July 2020, the Company purchased two loans at cost from Daniel M. Wallach (the Company’s Chief Executive Officer and Chairman of the board of managers) for approximately $198. Those loans had previously been purchased from the Company by Mr. Wallach.

 

Also, in July 2020, the Company reserved certain loan losses for loans issued to one of its largest borrowers. However, that borrower has agreed to repay most of the amounts written off, contingent upon the borrower receiving revenues from a construction management agreement it has with an unrelated party. Any revenue received from this arrangement will be income to the Company.

 

The Company is continuously monitoring the markets, builders, and the COVID-19 situation for the remaining loans which the Company has not yet released for construction. Management anticipates revisiting these lending parameters during the third quarter of 2020 as the COVID-19 situation continues to develop. However, due to the continued cases of the COVID-19 pandemic, there are still economic uncertainties that could negatively impact net income (loss). Other financial impacts could occur though such potential impact is unknown at this time.

 

 

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 (the “2019 Financial Statements”) included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019 (the “2019 Form 10-K”). See also “Cautionary Note Regarding Forward-Looking Statements” preceding Part I.

 

Overview

 

The Company has been impacted and continues to face risks related to COVID-19, which has caused disruptions to the economy and in all of the markets in which the Company lends. The Company’s operating results depend significantly on the homebuilding industry.

 

During March 2020, the Company made the decision due to the potential impact of COVID-19 to inform its borrowers that the Company would fund all loans where the underlying asset was currently under construction. Borrowers with loans in which the underlying asset was at a non-start position were informed to not start construction until told to do so by the Company.

 

During April 2020, as the Company continued to monitor market conditions overall and in the specific markets in which the Company lends, the Company observed that some markets had little to no impact from a housing perspective as a result of COVID-19; however, the Company’s borrowers in Pennsylvania and Michigan were significantly impacted due to the government shutting down home construction completely, and customers in Florida were significantly impacted by the changes in lending rules for end users and the high levels of unemployment caused by COVID-19. The Company made the decision to fund new loans to borrowers in stronger markets for the purpose of developing presold homes, which loans have reduced loan-to-value ratios. In addition, the Company continued to monitor funding spec loans in some markets on a case-by-case basis for loans with reduced loan-to-value ratios. The Company also stopped recognizing interest on loans issued to customers impacted by COVID-19 which continued through June and is expected to continue until those loans are paid off. Through June 2020, the amount of estimated unearned interest income due to COVID-19 that was not recognized for the second quarter was $402.

 

On May 7, 2020, the Company made the decision to reopen lending under normal, pre-COVID-19 terms for a limited group of certain of its customers. In addition, the decision was made to allow rehab loans to builders at terms that are less conservative than those established in April 2020 but more conservative than terms prior to the arrival of COVID-19. Currently, the Company is offering normal terms to approximately 40% of its customers, and restricted terms to approximately 60% of its customers. The Company averaged $2,251 in new loan originations in the first five months of 2020, but under these terms the Company originated $7,247 of loans in June 2020 and $6,374 of loans in July 2020. The fees from these originations is typically recognized over 12 months and has had little impact on our financial statements through June 2020; however, the new loan fees from these two months before deferred loan origination costs was $322 which we will recognize over 12 months. The Company attributes this increase in volume to many of its larger nonbank competitors going out of business or leaving the lending business.

 

 

Net income for the quarter and six months ended June 30, 2020 decreased $2,434 and $2,704, respectively, when compared to the same periods of 2019. The decrease in net income was primarily due to the economic effects stemming from the COVID-19 pandemic, which included the following:

 

	●	Interest income decreased $805 to $1,044 and $426 to $3,135 for the quarter and six months ended June 30, 2020, respectively, compared to the same periods of 2019. The decrease was due primarily to direct write offs of interest income of $469 for both the quarter and six months ended June 30, 2020. In addition, the Company estimated $402 in reduced interest income for both the quarter and six months ended June 30, 2020 due to non-performing loans not accruing interest due to COVID-19.
	●	Fee income decreased $293 to $312 and $529 to $796 for the quarter and six months ended June 30, 2020, respectively, compared to the same periods of 2019. Originations for the quarter and six months ended June 30, 2020 were $10,233 and $18,504, respectively, compared to $13,879 and $32,861 for the same periods of 2019. The decrease in originations was primarily due to the impact of the COVID-19 pandemic.
	●	Loan loss provision increased $1,409 to $1,560 and $1,397 to $1,595 for the quarter and six months ended June 30, 2020, respectively, compared to the same periods of 2019. The increase was due primarily to impairment on loans related to COVID-19.
	●	Impairment loss on foreclosed assets due to COVID-19 increased $91 for both the quarter and six months ended June 30, 2020.

 

The Company anticipates a moderate profit in the third quarter of 2020 and an increase in profit in the fourth quarter of 2020 compared to the third quarter of 2020. To achieve these increases in profits, the Company is focused on the following three things:

 

	1.	First, the Company is focused on reducing the number of assets currently not paying interest. Due primarily to the impact of COVID-19, the Company transferred the loan receivables balance of $9,728 for one of our largest borrowers into a non-performing asset. The Company’s reduction of non-performing assets is expected to be achieved by a combination of the selling of foreclosed assets and the payoff of nonperforming loans;
	2.	Second, the Company is focused on continuing the higher level of new loan originations that the Company has seen in June and July 2020; and
	3.	Third, the Company seeks to have the cash to fund new originations through new financing and the potential reduction of nonperforming assets.

 

We anticipate that the housing market in most of the areas in which we do business will be strong despite the impact of COVID-19, and that doing business with our best customers in those markets will provide good performing loans for our balance sheet. We also anticipate that the losses we incurred in principal related to COVID-19 will not continue, and that the lack of interest due to nonperforming assets from COVID-19 will decrease significantly over the course of the rest of 2020.

 

During the quarter ended June 30, 2020, the Company purchased $10,000 of life insurance covering Daniel M. Wallach for the benefit of the Company as a beneficiary, which renews annually.

 

We had $49,797 and $55,369 in loan assets as of June 30, 2020 and December 31, 2019, respectively. In addition, as of June 30, 2020, we had 223 construction loans in 20 states with 64 borrowers and eight development loans in four states with five borrowers.

 

Cash used in operations decreased $1,413 for six months ended June 30, 2020 as compared to the same period of 2019. Our decrease in operating cash flow was due primarily to impairment loss related to impacts of the COVID-19 pandemic.

 

 

Critical Accounting Estimates

 

To assist in evaluating our interim condensed 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 2019 Form 10-K, 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, 2019 unless listed below.

 

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.

 

Change in Fair Value Assumption		June 30, 2020 Loan Loss Provision Higher/(Lower)
Increasing fair value of the real estate collateral by 35%*		$	–
Decreasing fair value of the real estate collateral by 35%**		$	6,153

 

* 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 $49,797.

 

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).

 

Change in Fair Value Assumption		June 30, 2020 Foreclosed Assets Higher/(Lower)
Increasing fair value of the foreclosed assets by 35%*		$	-
Decreasing fair value of the foreclosed assets by 35%**		$	(1,757	)

 

* 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.

 

** Assumes a book amount of the foreclosed assets of $5,022.

 

 

Interest Spread

 

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

 

		Three Months Ended																Six Months Ended
		June 30,																June 30,
		2020								2019								2020								2019
Interest Income								*								*								*								*
Estimated Interest income on loans due to COVID-19		$	1,915				14	%		$	1,849				14	%		$	4,006				14	%		$	3,561				14	%
Estimated unearned interest income due to COVID-19			(402	)			(3	)%			-				-				(402	)			(1	)%			-				-
Write-offs due to COVID-19			(469	)			(3	)%			-				-				(469	)			(2	)%			-				-
Interest income on loans		$	1,044				8	%		$	1,849				14	%		$	3,135				11	%		$	3,561				14	%
Fee income on loans			312				2	%			605				5	%			796				3	%			1,325				5	%
Interest and fee income on loans			1,356				10	%			2,454				19	%			3,931				14	%			4,886				19	%
Interest expense unsecured			735				5	%			673				5	%			1,463				5	%			1,258				5	%
Interest expense secured			810				6	%			769				5	%			1,627				6	%			1,450				5	%
Amortization offering costs			39				-	%			43				1	%			79				-	%			83				1	%
Interest expense			1,584				11	%			1,485				11	%			3,169				11	%			2,791				11	%
Net (loss) interest income (spread)			(228	)			(1	)%			969				8	%			762				3	%			2,095				8	%
Weighted average outstanding loan asset balance		$	53,716							$	53,620							$	55,736							$	52,253

 

* Annualized amount as percentage of the weighted average outstanding gross loan balance.

 

There are three main components that can impact our interest spread:

 

● 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 7%. For most loans, the margin is fixed at 3%; however, for our development loans the margin is fixed at 7%. This component is also impacted by the lending of money with no interest cost (our equity).

 

Interest income on loans decreased to 8% and 11% for the quarter and six months ended June 30, 2020, respectively, compared to 14% for both the quarter and six months ended June 30, 2019. The Company expensed $469 in interest income for both the quarter and six months ended June 30, 2020 due to impairment of loans associated with four of our borrowers directly related to COVID-19. In addition, interest not earned during the quarter ended June 30, 2020 related to those borrowers was approximately $402.

 

The difference between estimated interest income on loans due to COVID-19 and the interest paid was 3% for both the quarter and six months ended June 30, 2020 compared to the same periods of 2019, which is our standard margin.

 

We anticipate our standard margin to be 3% on all future construction loans and 7% on all development loans which yields a blended margin of approximately 3.4%.

 

● Fee income. Our construction loan fee is 5% on the amount we commit to lend, which is amortized over the expected life of each loan. We do not recognize a loan fee on our development loans. When loans terminate before than their expected life, the remaining fee is recognized at the termination of the loan.

 

 

During the quarter and six months ended June 30, 2020, fee income on loans decreased 3% and 2%, respectively, compared to the same periods of 2019. During the quarter ended June 30, 2020, our lower origination of new loans was primarily due to the impact of the COVID-19 pandemic. During the six months ended June 30, 2020, our lower originations of new loans was partly due to competition and partly due to the impact of the COVID-19 pandemic. We anticipate that higher originations and a reduction in the balance of old loans would result in the fee income returning to 5%.

 

● Amount of nonperforming assets. Generally, we can have two types of nonperforming assets that negatively affect interest spread: loans not paying interest and foreclosed assets.

 

As of June 30, 2020 and 2019, we had 46 impaired loans in the aggregate amount of $12,993 and eight impaired loans in the aggregate amount of $1,663 that were not paying interest, respectively. Non-performing assets not related to the impact of COVID-19 were $1,504; however, due to the impact of COVID-19, the Company transferred the loan receivables balance of $9,728 for one of our largest borrowers into a non-performing asset.

 

Foreclosed assets do not provide a monthly interest return. As of June 30, 2020 and 2019, foreclosed assets were $5,022 and $7,964, respectively, which resulted in a negative impact on our interest spread in both years.

 

The amount of nonperforming assets is expected to decrease in the third quarter of 2020 as we continue to sell our assets when construction is complete.

 

SG&A Expenses

 

The following table displays our SG&A expenses:

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2020				2019				2020				2019
Selling, general and administrative expenses
Legal and accounting		$	42			$	47			$	181			$	174
Salaries and related expenses			206				422				484				784
Board related expenses			25				25				50				41
Advertising			15				31				36				50
Rent and utilities			10				16				23				25
Loan and foreclosed asset expenses			99				27				234				47
Travel			23				14				82				46
Other			42				38				79				77
Total SG&A		$	462			$	620			$	1,169			$	1,244

 

Our SG&A expense decreased $158 and $75 for the quarter and six months ended June 30, 2020, respectively, compared to the same periods of 2019 due significantly to the following:

 

	●	Salaries and related expenses decreased for the quarter and six months ended June 30, 2020 by $216 and $300, respectively, compared to the same periods of 2019. The decrease was due to the increase in deferred originations costs of $87 to $181 and $50 to $314 for the quarter and six months ended June 30, 2020, compared to the same periods of 2019 directly related to the reduction of the number of loan originations. In addition, profit sharing expense decreased to $0 for both the quarter and six months ended June 30, 2020. During the quarter and six months ended June 30, 2019 profit sharing expense was $70 and $144, respectively.
	●	Loan and foreclosed asset expenses increased for the quarter and six months ended June 30, 2020 by $72 and $187, respectively, compared to the same periods of 2019 due to additional real estate owned asset expenses for taxes and insurance.

 

 

Impairment Loss on Foreclosed Assets

 

For the quarter and six months ended June 30, 2020, impairment loss on foreclosed assets increased $64 to $91 and $93 to $200, respectively, compared to the same periods of 2019 primarily due to charges as a result of the impact of the COVID-19 pandemic.

 

We do not anticipate significant losses on the sale of foreclosed assets in the future; however, this may be subject to change based on the final selling price of the foreclosed assets.

 

Loan Loss Provision

 

Our loan loss provision increased $1,409 to 1,560 and $1,397 to $1,595 for the quarter and six months ended June 30, 2020, respectively, compared to the same periods of 2019. The increase in loan loss provision was primarily due to specific reserves for loan assets impaired due to the impact of the COVID-19 pandemic of $1,152 and special mention assets of $340.

 

Consolidated Financial Position

 

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 as we have new loan originations.

 

The following is a summary of our loan portfolio to builders for home construction loans as of June 30, 2020:

 

State		Number  of Borrowers				Number of Loans				Value of Collateral(1)				Commitment Amount				Gross Amount Outstanding				Loan to Value Ratio(2)				Loan Fee
Arizona			1				1			$	1,345			$	807			$	341				60	%			5	%
Connecticut			1				1				343				226				68				66	%			5	%
Colorado			1				1				630				425				426				67	%			5	%
Florida			16				108				30,974				22,735				18,229				73	%			5	%
Georgia			3				3				1,760				1,151				774				65	%			5	%
Illinois			1				1				1,245				747				368				60	%			5	%
Indiana			1				1				347				243				233				70	%			5	%
Michigan			3				5				1,774				1,196				906				67	%			5	%
New Jersey			3				5				1,676				1,255				1,138				75	%			5	%
New York			2				4				1,835				1,262				1,169				69	%			5	%
North Carolina			5				18				4,534				3,094				1,860				68	%			5	%
Ohio			2				7				2,700				1,754				1,376				65	%			5	%
Oregon			2				3				1,290				834				607				65	%			5	%
Pennsylvania			3				25				22,000				13,411				10,450				61	%			5	%
South Carolina			8				17				5,669				4,267				2,356				75	%			5	%
Tennessee			3				4				1,367				1,069				615				78	%			5	%
Texas			5				8				2,584				1,809				612				70	%			5	%
Utah			2				7				3,006				2,190				1,522				73	%			5	%
Washington			1				3				1,009				706				594				70	%			5	%
Wisconsin			1				1				539				332				285				62	%			5	%
Total			64				223			$	86,627			$	59,513			$	43,929				69	%(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.

 

The following is a summary of our loan portfolio to builders for home construction loans as of December 31, 2019:

 

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				1			$	630			$	425			$	424				67	%			5	%
Connecticut			1				1				340				224				55				66	%			5	%
Florida			17				112				32,259				24,031				16,826				74	%			5	%
Georgia			3				4				2,085				1,343				917				64	%			5	%
Idaho			1				1				310				217				173				70	%			5	%
Indiana			2				3				1,687				1,083				383				64	%			5	%
Michigan			4				11				3,696				2,566				1,820				69	%			5	%
New Jersey			3				6				1,925				1,471				1,396				76	%			5	%
New York			2				3				1,370				940				743				69	%			5	%
North Carolina			6				20				5,790				4,009				2,471				69	%			5	%
Ohio			3				9				4,117				2,664				2,153				65	%			5	%
Oregon			1				2				1,137				796				739				70	%			5	%
Pennsylvania			3				24				20,791				13,322				11,772				64	%			5	%
South Carolina			11				25				8,809				6,419				4,786				73	%			5	%
Tennessee			3				4				1,367				1,069				503				78	%			5	%
Texas			3				4				1,984				1,270				843				64	%			5	%
Utah			2				4				1,862				1,389				1,000				75	%			5	%
Virginia			1				3				1,245				815				734				65	%			5	%
Washington			1				2				1,040				728				445				70	%			5	%
Wisconsin			1				1				539				332				285				62	%			5	%
Wyoming			1				1				228				160				143				70	%			5	%
Total			70				241			$	93,211			$	65,273			$	48,611				70	%(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 June 30, 2020:

 

State		Number of Borrowers				Number of Loans				Value of Collateral(1)				Commitment Amount(2)				Gross Amount Outstanding				Loan to Value Ratio(3)				Interest Spread
Pennsylvania			1				3			$	8,725			$	8,200			$	7,493				86	%			7	%
Florida			2				2				843				898				730				87	%			7
North Carolina			1				1				400				260				135				34	%			7
South Carolina			1				2				1,055				1,250				618				58	%			7
Total			5				8			$	11,023			$	10,608			$	8,976				81	%(4)			7	%

 

(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 $1,520 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 commitment amount does not include unfunded letters of credit.
(3)	The loan to value ratio is calculated by taking the outstanding amount and dividing by the appraised value calculated as described above.
(4)	Represents the weighted average loan to value ratio of the loans.

 

The following is a summary of our loan portfolio to builders for land development as of December 31, 2019:

 

State		Number of Borrowers				Number of Loans				Value of Collateral(1)				Commitment Amount(2)				Gross Amount Outstanding				Loan to Value Ratio(3)				Interest Spread
Pennsylvania			1				3			$	10,191			$	7,000			$	7,389				73	%			7	%
Florida			2				3				1,301				1,356				891				68	%			7
North Carolina			1				1				400				260				99				25	%			7
South Carolina			1				2				1,115				1,250				618				55	%			7
Total			5				9			$	13,007			$	9,866			$	8,997				69	%(4)			7	%

 

(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 $1,470 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 commitment amount does not include unfunded letters of credit.
(3)	The loan to value ratio is calculated by taking the outstanding amount and dividing by the appraised value calculated as described above.
(4)	Represents the weighted average loan to value ratio of the loans.

 

Combined Loan Portfolio Summary

 

Financing receivables are comprised of the following as of June 30, 2020 and December 31, 2019:

 

		June 30, 2020				December 31, 2019
Loans receivable, gross		$	52,905			$	57,608
Less: Deferred loan fees			(725	)			(856	)
Less: Deposits			(965	)			(1,352	)
Plus: Deferred origination costs			276				204
Less: Allowance for loan losses			(1,694	)			(235	)
Loans receivable, net		$	49,797			$	55,369

 

The allowance for loan losses at June 30, 2020 was $1,694, of which $154 is related to loans without specific reserves. The Company recorded specific reserves for loans impaired due to the impact of COVID-19 of $1,152, special mention loans of $340, and impaired loans not due to the impact of COVID-19 of $47. As of December 31, 2019, the allowance was $235, of which $230 related to loans without specific reserves. During the quarter and six months ended June 30, 2020, we incurred $136 in direct charge-offs compared to $173 for the year ended December 31, 2019.

 

 

The following is a roll forward of combined loans:

 

		Six Months Ended June 30, 2020				Year Ended December 31, 2019				Six Months Ended June 30, 2019
Beginning balance		$	55,369			$	46,490			$	46,490
Additions			18,730				56,842				29,183
Principal collections			(22,293	)			(45,009	)			(23,154	)
Transferred to foreclosed assets			-				(3,352	)			(1,716	)
Transferred to real estate investments			(1,140	)			-				-
Change in builder deposit			387				157				(8	)
Change in loan loss provision			(1,459	)			(49	)			(198	)
Change in loan fees, net			203				290				(220	)
Ending balance		$	49,797			$	55,369			$	50,377

 

Finance Receivables – By risk rating:

 

		June 30, 2020				December 31, 2019
Pass		$	37,478			$	53,542
Special mention			2,434				2,571
Classified – accruing			–				–
Classified – nonaccrual			12,993				1,495
Total		$	52,905			$	57,608

 

Finance Receivables – Method of impairment calculation:

 

		June 30, 2020				December 31, 2019
Performing loans evaluated individually		$	18,108			$	26,233
Performing loans evaluated collectively			21,804				29,880
Non-performing loans without a specific reserve			-				1,467
Non-performing loans with a specific reserve to COVID-19			11,489				–
Other non-performing loans with a specific reserve			1,504				28
Total evaluated collectively for loan losses		$	52,905			$	57,608

 

As of June 30, 2020, and December 31, 2019, there were no loans acquired with deteriorated credit quality.

 

Impaired Loans

 

The following is a summary of our impaired nonaccrual commercial construction loans as of June 30, 2020 and December 31, 2019.

 

		June 30, 2020				December 31, 2019
Unpaid principal balance (contractual obligation from customer)		$	13,014			$	1,495
Charge-offs and payments applied			(21	)			-
Gross value before related allowance			12,993				1,495
Related allowance			(1,199	)			(8	)
Value after allowance		$	11,794			$	1,487

 

 

Below is an aging schedule of loans receivable as of June 30, 2020, on a recency basis:

 

		No. Loans				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)			185			$	39,912				75	%
60-89 days			42				11,489				22	%
90-179 days			-				-				-	%
180-269 days			4				1,504				3	%
Subtotal			231			$	52,905				100	%
Interest only accounts (Accounts on which interest, deferment, extension and/or default charges were received in the last 60 days)			-			$	-				-	%
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.)			-			$	-				-	%
Total			231			$	52,905				100	%

 

Below is an aging schedule of loans receivable as of June 30, 2020, on a contractual basis:

 

		No. Loans				Unpaid Balances				%
Contractual Terms - All current Direct Loans and Sales Finance Contracts with installments past due less than 60 days from due date.			185			$	39,912				75	%
60-89 days			42				11,489				22	%
90-179 days			-				-				-	%
180-269 days			4				1,504				3	%
Subtotal			231			$	52,905				100	%
Interest only accounts (Accounts on which interest, deferment, extension and/or default charges were received in the last 60 days)			-			$	-				-	%
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.)			-			$	-				-	%
Total			231			$	52,905				100	%

 

 

Below is an aging schedule of loans receivable as of December 31, 2019, on a recency basis:

 

		No. Loans				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)			246			$	56,113				97	%
60-89 days			–				–				–	%
90-179 days			4				1,495				3	%
180-269 days			–				–				–	%
Subtotal			250			$	57,608				100	%
Interest only accounts (Accounts on which interest, deferment, extension and/or default charges were received in the last 60 days)			–			$	–				–	%
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.)			–			$	–				–	%
Total			250			$	57,608				100	%

 

Below is an aging schedule of loans receivable as of December 31, 2019, on a contractual basis:

 

		No. Loans				Unpaid Balances				%
Contractual Terms - All current Direct Loans and Sales Finance Contracts with installments past due less than 60 days from due date.			246			$	56,113				97	%
60-89 days			-				-				-	%
90-179 days			4				1,495				3	%
180-269 days			-				-				-	%
Subtotal			250			$	57,608				100	%
Interest only accounts (Accounts on which interest, deferment, extension and/or default charges were received in the last 60 days)			-			$	-				-	%
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.)			-			$	-				-	%
Total			250			$	57,608				100	%

 

 

Foreclosed Assets

 

Below is a roll forward of foreclosed assets:

 

		Six Months Ended June 30, 2020				Year Ended December 31, 2019				Six Months Ended June 30, 2019
Beginning balance		$	4,916			$	5,973			$	5,973
Additions from loans			-				3,352				1,716
Additions for construction/development			686				763				456
Sale proceeds			(348	)			(4,543	)			–
Loss on sale			(35	)			(274	)			–
Gain on foreclosure			-				203				95
Gain on sale of foreclosed assets			3				-				-
Impairment loss due to COVID-19			(91	)			-				-
Impairment and loss on foreclosed assets			(109	)			(558	)			(276	)
Ending balance		$	5,022			$	4,916			$	7,964

 

During both the quarter and six months ended June 30, 2020, no new foreclosed assets were transferred from loans receivable, net, compared to 18 for both of the same periods of 2019.

 

During the quarter and six months ended June 30, 2020, we sold one and two foreclosed assets for proceeds of $163 and $347, respectively. The sale during the first quarter of 2020 resulted in a loss of $35 and the sale in the second quarter of 2020 resulted in a gain of $3.

 

During the quarter ended June 30, 2020, the Company recognized an impairment loss due to the impact of the COVID-19 pandemic of $91 and no similar loss was recorded for the same period of 2019.

 

Customer Interest Escrow

 

Below is a roll forward of interest escrow:

 

		Six Months Ended June 30, 2020				Year Ended December 31, 2019				Six Months Ended June 30, 2019
Beginning balance		$	643			$	939			$	939
Preferred equity dividends			74				136				66
Additions from Pennsylvania loans			713				1,107				853
Additions from other loans			82				768				295
Interest, fees, principal or repaid to borrower			(962	)			(2,307	)			(1,044	)
Ending balance		$	550			$	643			$	1,109

 

Related Party Borrowings

 

As of June 30, 2020, the Company had $1,249, $250, and $350 available to borrow against the line of credit from Daniel M. Wallach (our Chief Executive Officer and chairman of the board of managers) and his wife, the line of credit from the 2007 Daniel M. Wallach Legacy Trust, and the line of credit from William Myrick (our Executive Vice President of Sales), respectively. A more detailed description is included in Note 6 to the 2019 Financial Statements. These borrowings are in notes payable secured, net of deferred financing costs on the interim condensed consolidated balance sheet.

 

Secured Borrowings

 

Lines of Credit

 

As of June 30, 2020, the Company had borrowed $651 on its lines of credit from affiliates, which have a total limit of $2,500.

 

None of our lines of credit (including with related parties and non-related parties) have given us notice of nonrenewal, and the lines will continue to automatically renew unless notice is given by a lender.

 

Secured Deferred Financing Costs

 

The Company had secured deferred financing costs of $9 and $5 as of June 30, 2020 and December 31, 2019, respectively. Amortization expense for secured deferred financing costs was immaterial for the quarter and six months ended June 30, 2020 and for the year ended December 31, 2019.

 

 

Summary

 

The borrowings secured by loan assets are summarized below:

 

		June 30, 2020								December 31, 2019
		Book Value of Loans which Served as Collateral				Due from Shepherd’s Finance to Loan Purchaser or Lender				Book Value of Loans which Served as Collateral				Due from Shepherd’s Finance to Loan Purchaser or Lender
Loan Purchaser
Builder Finance, Inc.		$	10,804			$	7,918			$	13,711			$	9,375
S.K. Funding, LLC			8,730				5,815				10,394				6,771
Lender
Shuman			2,201				1,325				1,785				1,325
Jeff Eppinger			1,821				1,000				1,821				1,000
Hardy Enterprises, Inc.			1,141				800				1,684				1,000
Gary Zentner			642				250				472				250
R. Scott Summers			1,443				847				841				628
Paul Swanson			6,319				4,708				8,377				5,824
Total		$	33,101			$	22,663			$	39,085			$	26,173

 

Unsecured Borrowings

 

Unsecured Notes through the Public Offering (“Notes Program”)

 

On March 22, 2019, we terminated our second public offering and commenced our third public offering of fixed rate subordinated notes (the “Notes”). The effective interest rate on borrowings through our Notes Program at June 30, 2020 and December 31, 2019 was 10.48% and 10.56%, respectively, not including the amortization of deferred financing costs. We generally offer four durations at any given time, ranging from 12 to 48 months from the date of issuance. There are limited rights of early redemption. Our 36-month Note has a mandatory early redemption option, subject to certain conditions. The following table shows the roll forward of our Notes Program:

 

		Six Months Ended June 30, 2020				Year Ended December 31, 2019				Six Months Ended June 30, 2019
Gross Notes outstanding, beginning of period		$	20,308			$	17,348			$	17,348
Notes issued			5,668				11,127				5,818
Note repayments / redemptions			(5,199	)			(8,167	)			(3,925	)
Gross Notes outstanding, end of period		$	20,777			$	20,308			$	19,241
Less deferred financing costs, net			456				416				460
Notes outstanding, net		$	20,321			$	19,892			$	18,781

 

 

The following is a roll forward of deferred financing costs:

 

		Six Months Ended June 30, 2020				Year Ended December 31, 2019				Six Months Ended June 30, 2019
Deferred financing costs, beginning balance		$	786			$	1,212			$	1,212
Additions			119				365				331
Disposals			–				(791	)			–
Deferred financing costs, ending balance			905				786				1,543
Less accumulated amortization			(449	)			(370	)			(1,083	)
Deferred financing costs, net		$	456			$	416			$	460

 

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

 

		Six Months Ended June 30, 2020				Year Ended December 31, 2019				Six Months Ended June 30, 2019
Accumulated amortization, beginning balance		$	370			$	1,000			$	1,000
Additions			79				161				83
Disposals			–				(791	)			–
Accumulated amortization, ending balance		$	449			$	370			$	1,083

 

Other Unsecured Debts

 

Our other unsecured debts are detailed below:

 

								Principal Amount Outstanding as of
Loan		Maturity Date		Interest Rate(1)				June 30, 2020				December 31, 2019
Unsecured Note with Seven Kings Holdings, Inc.		Demand(2)			9.5	%		$	500			$	500
Unsecured Line of Credit from Builder Finance, Inc.		January 2021			10.0	%			500				-
Unsecured Line of Credit from Paul Swanson		October 2020(6)			10.0	%			2,293				1,176
Subordinated Promissory Note		September 2020			9.5	%			563				563
Subordinated Promissory Note		December 2021			10.5	%			146				146
Subordinated Promissory Note		April 2024			10.0	%			100				100
Subordinated Promissory Note		April 2021			10.0	%			174				174
Subordinated Promissory Note		August 2022			11.0	%			200				200
Subordinated Promissory Note		March 2023			11.0	%			169				169
Subordinated Promissory Note		April 2020			6.5	%			-				500
Subordinated Promissory Note		February 2021			11.0	%			600				600
Subordinated Promissory Note		Demand			5.0	%			-				500
Subordinated Promissory Note		December 2020			5.0	%			3				3
Subordinated Promissory Note		December 2023			11	%			20				-
Subordinated Promissory Note		February 2024			11	%			20				-
Senior Subordinated Promissory Note		March 2022(3)			10.0	%			400				400
Senior Subordinated Promissory Note		March 2022(4)			1.0	%			728				728
Junior Subordinated Promissory Note		March 2022(4)			22.5	%			417				417
Senior Subordinated Promissory Note		October 2020(5)			1.0	%			279				279
Junior Subordinated Promissory Note		October 2020(5)			20.0	%			173				173
								$	7,285			$	6,628

 

 

(1)	Interest rate per annum, based upon actual days outstanding and a 365/366-day year.

 

(2)	Due six months after lender gives notice.

 

(3)	Lender may require us to repay $20 of principal and all unpaid interest with 10 days’ notice.

 

(4)	These notes were issued to the same holder and, when calculated together, yield a blended return of 11% per annum.

 

(5)	These notes were issued to the same holder and, when calculated together, yield a blended return of 10% per annum.

 

(6)	Amount due in October 2020 is $1,000 with the remainder due in November 2020.

 

Paycheck Protection Program Loan

 

On May 5, 2020 the Company entered into a loan agreement (the “PPP Loan”) with LCA Bank Corporation to borrow $361 pursuant to the Paycheck Protection Program (“PPP”), created under the Coronavirus Aid, Relief, and Economic Security Act, or CARES Act. The PPP is intended to provide loans to qualified businesses to cover payroll and certain other identified costs. The loan has an interest rate of 1.0% and a term of 24 months. No payments are due for the first six months, although interest accrues, and monthly payments, which include interest, are due over the next 18 months to pay off the loan. Funds from the loan may only be used for certain purposes, including payroll, benefits, rent, and utilities. All or a portion of the loan may be forgivable, as provided by the terms of the PPP. The loan is evidenced by a promissory note, which contains customary events of default relating to, among other things, payment defaults and breaches of representations. We may prepay the loan at any time prior to maturity with no prepayment penalties.

 

Economic Injury Disaster Loan Advance (the “EIDL Advance”)

 

The Economic Injury Disaster Loan Emergency Advance is a $10 grant for companies that successfully submit an EIDL (“Economic Injury Disaster Loan”) application. During April 2020, the Company received the grant (the “EIDL Advance”) which may be used for payroll and other certain operating expenses. The EIDL Advance will reduce the forgiveness of the PPP Loan depending on certain parameters required by the CARES Act.

 

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) loan assets, net. The ratio of redeemable preferred equity plus members’ capital to loan assets, net was 9.3% and 12.9% as of June 30, 2020 and December 31, 2019, respectively. The ratio decreased significantly due to losses related to COVID-19. We anticipate this ratio to increase as we retain earnings for the remainder of 2020.

 

Priority of Borrowings

 

The following table displays our borrowings and a ranking of priority. The lower the number, the higher the priority.

 

		Priority Rank				June 30, 2020				December 31, 2019
Borrowing Source
Purchase and sale agreements and other secured borrowings			1			$	23,651			$	26,806
Secured line of credit from affiliates			2				651				189
Unsecured line of credit (senior)			3				500				500
PPP Loan and EIDL Advance			3				371				-
Other unsecured debt (senior subordinated)			4				1,407				1,407
Unsecured Notes through our public offering, gross			5				20,777				20,308
Other unsecured debt (subordinated)			5				4,788				4,131
Other unsecured debt (junior subordinated)			6				590				590
Total						$	52,735			$	53,931

 

 

Liquidity and Capital Resources

 

Our primary liquidity management objective is to meet expected cash flow needs while continuing to service our business and customers. Combined loans outstanding as of June 30, 2020 and December 31, 2019 were 231 and 250, respectively. Gross loans receivable as of June 30, 2020 and December 31, 2019 totaled $52,905 and $57,608, respectively. Our unfunded commitments to extend credit, which have similar collateral, credit, and market risk to our outstanding loans, were $15,585 and $16,662 as June 30, 2020 and December 31, 2019, respectively.

 

We anticipate an increase in our gross loan receivables over the 12 months subsequent to June 30, 2020 by directly increasing originations by funding new loans to borrowers in stronger markets. Competition has declined and, therefore, we believe the ability to return to historical levels may be achieved through 2021.

 

To fund our combined loans, we rely on secured debt, unsecured debt, and equity, which are described in the following table:

 

Source of Liquidity		As of June 30, 2020				As of December 31, 2019
Secured debt, net of deferred financing costs		$	24,293			$	26,991
Unsecured debt, net of deferred financing costs			27,606				26,520
Equity			4,641				7,147

 

Secured debt, net of deferred financing costs decreased $2,698 to $24,293 as of June 30, 2020 compared to December 31, 2019 which consisted of a decrease in borrowings secured by loans of $3,159 offset by an increase in affiliate lines of $462. We anticipate increasing our secured debt by roughly half of the increase in loan asset balances over the 12 months subsequent to June 30, 2020 through our existing loan purchase and sale agreements and additional lines of credit.

 

We anticipate that the other half of the loan asset growth will come from a combination of decreases in nonperforming assets, many of which are not used as collateral in secured lines, and increases in our unsecured debt and equity. Unsecured debt, net of deferred financing costs increased $1,086 to $27,606 as of June 30, 2020 compared to December 31, 2019 due primarily to an increased participation in our Notes Program of $429 and other unsecured debts of $657.

 

In addition, in May 2020, we borrowed approximately $361 pursuant to the Paycheck Protection Program (“PPP”), created under the Coronavirus Aid, Relief, and Economic Security Act, or CARES Act. The PPP is intended to provide loans to qualified businesses to cover payroll and certain other identified costs. Funds from the loan may only be used for certain purposes, including payroll, benefits, rent, and utilities. All or a portion of the loan may be forgivable, as provided by the terms of the PPP.

 

Equity decreased $2,506 during the six months ended June 30, 2020 due primarily to the decrease in net income for Class A common equity of $2,495. We anticipate an increase in our equity during the 12 months subsequent to June 30, 2020, through retaining earnings and the issuance of additional Series C cumulative preferred equity (“Series C Preferred Units”). If we are not able to increase our equity through retained earnings or the issuance of additional Series C Preferred Units, we will rely more heavily on raising additional funds through the Notes Program.

 

 

 

If we anticipate the ability to not fund our projected increases in loan balances as discussed above, we may reduce new loan originations to reduce need for additional funds.

 

Contractual Obligations

 

The following table shows the maturity of outstanding debt as of June 30, 2020:

 

Year Maturing		Total Amount Maturing				Public Offering				Other Unsecured				Secured Borrowings
2020		$	28,532			$	1,381			$	3,830			$	23,321
2021			13,540				11,856				1,668				16
2022			5,526				3,661				1,849				16
2023			1,116				821				189				106
2024 and thereafter			4,021				3,058				120				843
Total		$	52,735			$	20,777			$	7,656			$	24,302

 

(1)

Other Unsecured includes our PPP Loan of $361 and EIDL Advance of $10 of which $21, $247, and $103, collectively, matures during 2020, 2021, and 2022, respectively. All or a portion of the PPP Loan may be forgiven.

 

The total amount maturing through the year ending December 31, 2020 is $28,532, which consists of secured borrowings of $23,321 and unsecured borrowings of $5,211.

 

Secured borrowings maturing through year ending December 31, 2020 significantly consist of loan purchase and sale agreements with two loan purchasers (Builder Finance, Inc. and S. K. Funding, LLC) and six lenders. Our secured borrowings are classified as maturing during 2020 primarily because the related collateral is demand loans. The following lists our secured facilities with maturity and renewal dates:

 

	●	Swanson – $4,708 due July 2021, will automatically renew unless notice is given;
	●	Shuman – $1,325 due July 2021, will automatically renew unless notice is given;
	●	S. K. Funding, LLC – $3,500 of the total due July 2021, will automatically renew unless notice is given;
	●	S. K. Funding, LLC – $2,316 with no expiration date;
	●	Builder Finance, Inc. – $7,918 with no expiration date;
	●	2019 LOC agreements – $2,896 generally one-month notice and six months to reduce principal balance to zero;
	●	William Myrick – $650 with no expiration date; and
	●	Mortgage payable – $8.

 

Unsecured borrowings due by December 31, 2020 consist of Notes issued pursuant to the Notes Program and other unsecured debt of $1,381 and $3,830, respectively. To the extent that Notes issued pursuant to the Notes Program are not reinvested upon maturity, we will be required to fund the maturities, which we anticipate funding through the issuance of new Notes in our Notes Program. Historically, approximately 80% of our Note holders reinvest upon maturity. Our other unsecured debt has historically renewed. For more information on other unsecured borrowings, see Note 6 – Borrowings. If other unsecured borrowings are not renewed in the future, we anticipate funding such maturities through investments in our Notes Program.

 

 

Summary

 

We have the funding available to address the loans we have today, including our unfunded commitments. We anticipate growing our assets through the net sources and uses (12-month liquidity) listed above as well as future capital increases from debt, redeemable preferred equity, and regular equity. Our expectation to grow loan asset balances is subject to changes due to changes in demand, competition, and COVID-19. Although our secured debt is almost entirely listed as currently due because of the underlying collateral being demand notes, the vast majority of our secured debt is either contractually set to automatically renew unless notice is given or, in the case of purchase and sale agreements, has no end date as to when the purchasers will not purchase new loans (although they are never required to purchase additional loans).

 

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 generally mean higher effective interest rates for us, as the recognition of fees we charge is spread over a shorter period. Slower sales generally mean lower effective interest rates for us. Slower sales also are likely to increase the default rate we experience.

 

Housing inflation generally 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. Our analysis of the COVID-19 impact on housing in the markets in which we do business is mixed. In many markets, our customers see demand as outpacing new housing starts. In Orlando, Florida (which is our second highest geographic concentration risk by borrower), there has been a significant lack of demand for housing sold by customers who sell more affordable homes, which has resulted in losses that we recognized in the second quarter of 2020. We note that nationwide, fewer first-time home buyers will qualify for government backed loans due to FICO score and other criteria changes.

 

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. The rates we are paying our investors are going down due to COVID-19, including the rate on our three-month Note which has additional redemption options but lower returns, because other alternative investments are paying lower rates. This in turn will lower the rates to our borrowers over time. We also anticipate some lower cost secured funding in the third quarter of 2020 which will also lower both our cost of funds and the rate we charge our customers.

 

 

  

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

 

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 June 30, 2020 and December 31, 2019, 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, management including our Chief Executive Officer (our principal executive officer) and Acting Chief Financial Officer (our 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 CEO (our principal executive officer) and Acting CFO (our 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 CEO (our principal executive officer) and Acting CFO (our principal financial officer), as appropriate to allow timely decisions regarding required disclosure.

 

 

Internal Control over Financial Reporting

 

There has been no change in our internal controls over financial reporting during the quarter ended June 30, 2020 that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.

 

PART II - OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

None.

 

ITEM 1A. RISK FACTORS

 

Not applicable.

 

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

 

(a)

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, we issued the following Series C Preferred Units on June 30, 2020:

 

Owner		Units				Amount
Daniel M. and Joyce S. Wallach			0.8743030			$	87,430.30
Gregory L. and Madeline M. Sheldon			0.2074158				20,741.58
BLDR, LLC			0.2828633				28,286.33
Schultz Family Living Trust			0.0703658				7,036.58
Jeffrey L. Eppinger			0.2424080				24,240.80
Fernando Ascencio and Lorraine Carol Ascencio			0.1316547				13,165.47
Total			1.8090106			$	180,901.06

 

The proceeds received from the sales of the partial Series C Preferred Units in these 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 of 1933 (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 he/she/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.   Issuance of Partial Series B Cumulative Preferred Units   We previously entered into an agreement with the Hoskins Group (consisting of Benjamin Marcus Homes, LLC, Investor’s Mark Acquisitions, LLC, and Mark L. Hoskins) pursuant to which we sell the Hoskins Group 0.1 Series B cumulative preferred units (“Series B Preferred Units”) upon the closing of certain lots. We issued 0.5 Series B Preferred Units to the Hoskins Group during the quarter ended June 30, 2020.   The proceeds received from the sales of the 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 buyers represented to us that they are 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.

 

 

	(b)	We registered up to $70,000,000 in Fixed Rate Subordinated Notes (“Notes”) in our current public offering, which is our third public offering of Notes (SEC File No. 333-224557, effective March 22, 2019). As of June 30, 2020, we had issued $13,191,000 in Notes pursuant to our current public offering. As of June 30, 2020, we incurred expenses of $470,000 in connection with the issuance and distribution of the Notes in our current public offering, 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 June 30, 2020 were $12,721,000, all of which was used to increase loan balances.
	(c)	None.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

 

None.

 

ITEM 4. MINE SAFETY DISCLOSURES

 

Not applicable.

 

ITEM 5. OTHER INFORMATION

 

	(a)	During the quarter ended June 30, 2020, 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 June 30, 2020, there were no material changes to the procedures by which members may recommend nominees to our board of managers.

 

ITEM 6. EXHIBITS

 

The exhibits required to be filed with this report are set forth on the Exhibit Index hereto and incorporated by reference herein.

 

EXHIBIT INDEX

 

The following exhibits are included in this report on Form 10-Q for the period ended June 30, 2020 (and are numbered in accordance with Item 601 of Regulation S-K).

 

Exhibit No.		Name of Exhibit
3.1		Certificate of Conversion, incorporated by reference to Exhibit 3.1 to the Registrant’s Registration Statement on Form S-1, filed on May 11, 2012, Commission File No. 333-181360
3.2		Certificate of Formation, incorporated by reference to Exhibit 3.2 to the Registrant’s Registration Statement on Form S-1, filed on May 11, 2012, Commission File No. 333-181360
3.3		Second Amended and Restated Operating Agreement of the Registrant, incorporated by reference to Exhibit 3.1 to the Registrant’s Form 8-K, filed on November 13, 2017, Commission File No. 333-203707

 

 

3.4		Amendment No. 1 to Second Amended and Restated Limited Liability Company Agreement of the Registrant, incorporated by reference to Exhibit 3.4 to the Registrant’s Quarterly Report on Form 10-Q, filed May 9, 2019, Commission File No. 333-203707
3.5		Amendment No. 2 to Second Amended and Restated Limited Liability Company Agreement of the Registrant, incorporated by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K, filed March 31, 2020, Commission File No. 333-224557
4.1		Indenture Agreement (including Form of Note) dated March 22, 2019, incorporated by reference to Exhibit 4.1 to the Registrant’s Post-Effective Amendment No. 1, filed on March 22, 2019, Commission File No. 333-224557
4.2		Amendment No. 1 to Indenture Agreement (including Form of Note) dated February 4, 2020, incorporated by reference to Exhibit 4.1 to the Registrant’s Post-Effective Amendment No. 4, filed on February 4, 2020, Commission File No. 333-224557
10.1		Loan Agreement dated May 5, 2020 by and between the Registrant and LCA Bank Corporation, incorporated by reference to Exhibit 10.1 to the Registrant’s Quarterly Report on Form 10-Q, filed on May 11, 2020, Commission File No. 333-224557
10.2		Note dated May 5, 2020 from the Registrant in favor of LCA Bank Corporation, incorporated by reference to Exhibit 10.2 to the Registrant’s Quarterly Report on Form 10-Q, filed on May 11, 2020, Commission File No. 333-224557
31.1*		Certification of Principal Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2*		Certification of Principal Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1*		Certification of Principal Executive Officer, pursuant to 18 U.S.C. Section 1350, as created by Section 906 of the Sarbanes-Oxley Act of 2002
32.2*		Certification of Principal Financial Officer, pursuant to 18 U.S.C. Section 1350, as created by Section 906 of the Sarbanes-Oxley Act of 2002
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.

 

 

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: August 6, 2020	By:	/s/ Catherine Loftin
		Catherine Loftin
		Acting Chief Financial Officer