UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2001
[ ] 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 0-17771
FRANKLIN CREDIT MANAGEMENT CORPORATION
(Exact name of small business issuer as specified in its charter)
Delaware 75-2243266
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) identification No.)
Six Harrison Street
New York, New York 10013
(212) 925-8745
(Address of principal executive offices, including zip code, and telephone
number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common
Stock, $0.01 par value.
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act of 1934 during the past 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 .
Check if there is no disclosure of delinquent filers pursuant to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. []
Issuer's revenues for its most recent fiscal year: $37,963,358
As of March 27, 2002 the issuer had 5,916,527 of shares of Common Stock, par
value $0.01 per share, outstanding. On that date, the aggregate market value of
the voting stock held by persons other than those who may be deemed affiliates
of the issuer was $1,676,499 (based on the average of the reported closing bid
and ask price on such date).
Check whether the issuer has filed all documents and reports required to be
filed by Section 12, 13 or 15(d) of the Exchange Act after the distribution of
securities under a plan confirmed by a court. Yes X No .
Transitional Small Business Disclosure Format: Yes No X
Portions of the registrant's definitive proxy statement, which will be filed
within 120 days of December 31, 2001, are incorporated by reference into Part
III.
PART I
ITEM 1. DESCRIPTION OF BUSINESS
BUSINESS OF REGISTRANT. Franklin Credit Management Corporation ("FCMC", and
together with its wholly-owned subsidiaries, the "Company") is a specialty
consumer finance and asset management company primarily engaged in the
acquisition, origination, servicing and resolution of performing,
sub-performing and non-performing residential mortgage loans and
residential real estate. The Company's portfolio consists primarily of
non-conforming subprime assets. Mortgage loans are purchased at a discount
relative to the aggregate unpaid principal balance of the loans and real
estate is acquired in foreclosure or otherwise at a discount relative to
the appraised value of the asset.
During 2001, the Company took advantage of market opportunities to increase
its volume of loan acquisitions, pursuing a strategy of acquiring primarily
higher coupon non-investment grade performing loans. Based on acquisition
volume the Company's portfolio grew 36% to $360 million at December 31,
2001 as compared to $264 million at December 31, 2000. The Company expects
to continue this strategy, as well as increase both the pace and amount of
acquisitions, during 2002.
The Company believes it has built a servicing infrastructure and developed
a servicing expertise, which permits the expansion of the Company's
portfolio with a minimal increase in incremental costs. In addition, the
Company believes that its ability to service and rehabilitate loans reduces
its reliance on secondary marketing of portfolios and may provide an
advantage as compared to competitors that rely on the secondary market as
their primary strategy.
In January 1997, the Company formed a wholly owned subsidiary, Tribeca
Lending Corp. ("Tribeca"), to originate primarily subprime residential
mortgage loans made to individuals whose credit histories, income and other
factors cause them to be classified as non-conforming borrowers. Management
believes that lower credit quality borrowers present an opportunity for the
Company to earn superior returns for the risks assumed. Tribeca provides
first and second mortgages that are originated on a retail basis through
marketing efforts that include utilization of the FCMC database. Tribeca is
currently licensed as a mortgage banker in Alabama, California, Colorado,
Connecticut, District of Columbia, Florida, Georgia, Kentucky, Illinois,
Maryland, Massachusetts, Michigan, Missouri, Mississippi, New York, New
Jersey, North Carolina, Ohio, Oklahoma, Oregon, Pennsylvania, South
Carolina, Tennessee, Texas, Virginia, Washington State, and West Virginia
and is a Department of Housing and Urban Development FHA Title I and Title
II approved lender. Tribeca originated loans are typically expected to be
sold in the secondary market through whole-loan, servicing-released sales.
Tribeca anticipates holding certain of its mortgages in its portfolio when
it believes that the return from holding the mortgage, on a risk-adjusted
basis, outweighs the return from selling the mortgage in the secondary
market.
Since commencing operations in 1990, the Company has purchased, in
aggregate, approximately 23,453 loans with a face value of approximately
$738 million from primarily private institutions. The Company seeks to
develop relationships with mortgage bankers, banks, and other specialty
finance companies which may, through on-going purchase arrangements,
provide additional sources of mortgage portfolios, individual mortgage
assets and real estate assets.
During the year ended December 31, 2001, the Company purchased 3,599 loans
with an aggregate face value of $184 million at an aggregate purchase price
of $162 million or 88% of face value. As of December 31, 2001, the
Company's portfolio included approximately 9,899 loans with an aggregate
face
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value of $332 million. An allowance for loan losses of approximately
$34 million has been recorded against this face value. At December 31,
2001, approximately 94% of the Company's loan portfolio consisted of first
mortgages, home equity/home improvement and second mortgages collateralized
by real estate, 4% consisted of loans collateralized by other assets, and
2% consisted of unsecured loans. Although the Company attempts to collect
on all loans in its portfolio, it is unlikely that the Company will be
successful in collecting the full amount due for each loan in its
portfolio. In addition, significant administrative and litigation expenses
are often incurred in its collection efforts. See "Item 6. Management's
Discussion and Analysis of Financial Condition and Results of Operations"
and "Item 7. Financial Statements".
The Company sells portfolios of performing, reperforming and nonperforming
loans on a whole loan basis. During 2001, the Company sold 125 performing
loans with an aggregate face value of $12.3 million, and 154 non-performing
loans with an aggregate face value of $11.9 million. During 2000 the
Company sold 94 performing loans with a face value of $8 million, and 39
non-performing loans with an aggregate face value of $5 million. The
Company expects to continue this strategy when the sale of assets generates
a greater cash flow than the risk adjusted net present value of cash flows
from holding the assets. The Company does not generally retain the
servicing rights on loans it sells.
As of December 31, 2001, the Company owed an aggregate of $314 million
("Senior Debt") to a bank (the "Senior Debt Lender"), which was incurred in
connection with the purchase of, and is secured by, the Company's loan and
OREO (Other Real Estate Owned) portfolios. In December 2001, the Company's
Senior Debt agreement was amended. Under the amendment interest on Senior
Debt accrues at variable rates based on the Federal Home Loan Bank of
Cincinnati (FHLB) thirty (30) day advance rate plus an additional spread of
3.25%. For all other Senior Debt, acquired prior to March 1, 2000, interest
will be based on the Prime Rate plus a margin of between 0% and 1.75%;
approximately $68 million of total senior debt falls into this category. At
December 31, 2001, the weighted average interest rate on Senior Debt was
5.25%. The Senior Debt Lender has advised the Company that as of December
31, 2001, there was $190 million of Senior Debt available to be used by the
Company to purchase additional portfolios of mortgage loans.
The Company employs standardized in-house servicing procedures in the
acquisition, origination, and collection of loans. The Company is divided
into five operating departments, which are described below:
ACQUISITION DEPARTMENT. The Acquisition Department is divided into the Bulk
purchase unit, which is responsible for acquisitions in excess of $1
million and a Flow Unit, which is responsible for acquisitions less than $1
million. The Acquisition Department identifies opportunities to purchase
portfolios of mortgage loans, performs due diligence, and assists in the
integration of the acquired assets into the Company's existing portfolio.
The due diligence process, includes an analysis of the majority of loans in
a portfolio, evaluating, among other things, lien position and value of
collateral, debt-to-income ratios, the borrower's creditworthiness,
employment stability, years of home ownership, education, credit bureau
reports and mortgage payment history. The Acquisition Department conducts
reviews of the loan files comprising the portfolio, and where appropriate
performs an on-site evaluation of the seller's loan servicing department.
This process provides the Company additional information critical to
properly evaluating the portfolio. The information derived from due
diligence is compared to the Company's historical statistical data base,
and coupled with the Company's cumulative knowledge of the sub-prime
mortgage industry enables the Acquisition Department to project a
collection strategy and estimate the collectibility and timing of cash
flows with respect to each loan. Based upon this information, the
Acquisition Department prepares a bid, which meets the Company's
established pricing and yield guidelines. When loans are acquired the
Acquisition Department, with the assistance of the Management
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Information Systems staff ("MIS"), monitors the electronic transfer of
loan data into the Company's data management system.
SERVICING DEPARTMENT. The Servicing Department manages the Company's
performing loans and seeks to provide quality customer service and secure
full payment of the total face value and accrued charges, by monitoring
monthly cash receipts, maintaining customer relations and, where
appropriate, entering into extension and modification agreements. The
Servicing Department is responsible for the maintenance of real estate tax
and insurance escrow accounts. Servicing Department members continuously
review and monitor the status of collections and individual loan payments
in order to proactively identify and solve potential collection problems as
well as identify potential loans for sale to third parties or refinance
though Tribeca. Upon acquisition of loan portfolios, the Servicing
Department: (i) issues introductory letters with information regarding the
change of ownership of the loan, payment information and a toll-free
Company information telephone number; (ii) conducts internal audits of
newly acquired loans to identify and address any disputes or problems
relating to the accounting for these loans; and (iii) issues an audit
letter advising the borrower of the outstanding balance, last payment date
and remaining term of the loan. As of December 31, 2001, the Servicing
Department managed approximately 7,392 accounts, with a total principal
outstanding balance of approximately $286 million.
LEGAL DEPARTMENT. The Legal Department manages and monitors the progress of
defaulted loans requiring a legal action and the loss mitigation area,
which negotiates legal settlement strategies. These loans are identified
and referred by the Acquisition or Service Departments to the Legal
Department, which prepares an analysis of each loan to determine a
litigation or collection strategy to maximize the amount and speed of
recovery and minimize costs. This strategy is based upon the individual
borrowers' past payment history, current ability to pay, collateral lien
position and current collateral value. The Legal Department sets the
collection strategy, negotiates settlements, modification and forbearance
agreements, and when appropriate retains outside counsel, manages their
costs, and monitors ensuing litigation to insure the optimal recovery of
the remaining principal and interest balance. The Legal Department monitors
each defaulted loan through the foreclosure process, recovery of a money
judgment or other settlement, and continues to monitor recovery of
deficiency balances after a foreclosure has been completed. As of December
31, 2001, the Legal Department managed approximately 2,469 loans, with a
total principal outstanding balance of approximately $74 million.
REAL ESTATE DEPARTMENT. The Real Estate Department manages all properties
in order to preserve their value, realize rental income and insure that
maximum returns are realized upon sale. The Real Estate Department is
responsible for both the sale of OREO as well as for the management of OREO
that are held as rental properties until such time as an economically
beneficial sale can be arranged. As Of December 31, 2001, the Real Estate
Department managed approximately 77 OREO properties, of which 16 were
rental properties. The Company seeks to rent those properties for which it
believes it can realize a higher return from such rental than from the
value expected to be realized in the sale of the property.
TRIBECA LENDING. Tribeca provides first and second mortgages to individuals
interested in purchasing or refinancing performing loans in the Company's
existing database. Tribeca focuses on developing an array of niche products
to fulfill needs such as high loan to value ("LTV"), sub-prime,
non-conforming and loss mitigation second mortgages. Loans are originated
by a retail sales force generates leads from the Company's database of
serviced loans, and external sources. The majority of loans are expected to
be warehoused until the inventory reaches the critical mass needed to
maximize profits through bulk sales in the secondary market. Tribeca's
staff processes, underwrites and closes all loans in its own name.
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During 2001, Tribeca originated 386 mortgages with an aggregate principal
balance of $41.5 million. During 2000, Tribeca originated 118 mortgages
with an aggregate principal balance of $8.2 million.
FORMATION OF THE COMPANY. The Company was organized in Delaware in 1990, by
Thomas J. Axon, and Frank B. Evans, Jr., for the purpose of acquiring
consumer loan portfolios from the RTC and the FDIC. In March 1993, the
Company completed the private placement of $2,000,000 of 15% Debentures
(the "15% Debentures") and warrants for the purchase of the Company's
Common Stock, the proceeds of which were used to acquire interests in loan
portfolios and for operations. In December 1994, the Company merged with
Miramar Resources, Inc., a public oil and gas company organized in Delaware
that had emerged from bankruptcy proceedings on December 6, 1993.
COMPETITION. The Company faces significant competition in the acquisition
of loan portfolios. Many of the Company's competitors have financial
resources, acquisition departments and servicing capacity considerably
larger than the Company's. Among the Company's largest competitors are
Residential Funding Corporation and Bayview Financial Trading Group.
Competition for acquisitions is generally based on price, reputation of the
purchaser, funding capacity and timing. See "Item 6. Management's
Discussion and Analysis of Financial Condition and Results of Operations:
General - Cost of Funds".
The market for subprime loan origination is also highly competitive.
Tribeca competes with savings banks, mortgage brokers, and mortgage bankers
for the origination of mortgages. Among the largest of these competitors
are Greenthal Realty Partner, New Century Mortgage, Amquest Mortgage, and
Household Financial Service. Many of Tribeca's competitors possess greater
financial resources, longer operating histories, and lower costs of capital
than Tribeca. Competition for mortgage originations is based upon marketing
efforts, loan processing capabilities, funding capacity, loan product
desirability and the ability to sell the loans for a premium in the
secondary market.
The Company also experiences competition from mortgage and finance
companies in the sale of reperforming and newly originated loan portfolios.
Important characteristics which impact competition in this market are
price, loan-to-value, size of pools and the integrity of portfolio data.
CUSTOMERS. The Company's revenue is derived from interest and purchase
discount recognized from the collection of loans, origination fees, rental
income, gains recorded from the bulk sale of performing, non-performing and
originated loans to banks and other financial institutions, and the result
recorded from the sale of OREO. The Company's borrowers are a diverse
population and no single borrower represents a significant portion of the
Company's loans. The Company sells bulk portfolios of performing and
non-performing loans, when such sales are economically beneficial to the
Company. While the Company has previously been successful in marketing loan
portfolios, which it has sold, and believes there are sufficient buyers for
its products no assurance that the Company will be able to successfully
market loan portfolios in the future.
SUPPLIERS. The Company acquires its loans through a variety of sources
including private and public auctions, negotiated sales, ongoing purchase
agreements, and joint-bids with other institutions. The supply of assets
available for purchase by the Company is influenced by a number of factors
including knowledge by the seller of the Company's interest in purchasing
assets, the general economic climate, financial industry regulation, and
new loan origination volume. While the Company continues to pursue
additional sources for purchasing assets, there can be no assurance that
existing and future sources will provide sufficient opportunities for the
Company to purchase assets at favorable prices. Prior to 1996 the RTC, and
the FDIC, represented the source of the majority of the Company's loan
purchases. During the past year, several institutions supplied the Company
with its portfolio acquisitions, as measured by
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purchase price. The Company's sources of loan acquisition have varied from
year to year and the Company expects that this will continue to be the
case. During the year the Company continued to grow it's niche of
purchasing small individual assets, or pools of assets under a million
dollars from various sources. The Company believes that this market is
under served and will open up additional opportunities to establish
relationships with a continuous supply of loans that would not be available
through periodic bulk purchases.
REGULATION. The Company's lending activities are subject to the Federal
Truth-in-Lending Act ("TILA") and Regulation Z (including the Home
Ownership and Equity Protection Act of 1994), the Equal Credit Opportunity
Act of 1974, as amended ("ECOA") and Regulation B, the Fair Credit
Reporting Act of 1970, as amended, the Real Estate Settlement Procedures
Act of 1974, as amended ("RESPA") and Regulation X, the Home Mortgage
Disclosure Act ("HMDA") and Regulation C, the Federal Debt Collection
Practices Act and the Fair Housing Act, as well as other federal and state
statutes and regulations affecting the Company's activities. Failure to
comply with these requirements can lead to loss of approved status, demands
for indemnification or mortgage loan repurchases, certain rights of
recision for mortgage loans, class action lawsuits and administrative
enforcement actions.
The Company is subject to the rules and regulations of, and examinations
by, the Department of Housing and Urban Development ("HUD"), the Federal
Trade Commission and other federal and state regulatory authorities with
respect to originating, underwriting, funding, acquiring, selling and
servicing mortgage loans. In addition, there are other federal, State and
City statutes and regulations affecting such activities. These rules and
regulations, among other things, impose licensing obligations on the
Company, establish eligibility criteria for loans, prohibit discrimination,
provide for inspection and appraisals of properties, require credit reports
on prospective borrowers, regulate payment features and, in some cases, fix
maximum interest rates, fees and loan amounts. The Company is required to
submit annual audited financial statements to various governmental
regulatory agencies that require the maintenance of specified net worth
levels.
Regulation Z requires a written statement showing an annual percentage rate
of finance charges and requires that other information be presented to
debtors when consumer credit contracts are executed. RESPA requires written
disclosure concerning settlement fees and charges, mortgage-servicing
transfer practices and escrow or impound account practices. It also
prohibits the payment or receipt of "kickbacks" or referral fees in
connection with the performance of settlement services. The Fair Credit
Reporting Act requires certain disclosures to applicants concerning
information that is used as a basis for denial of credit. HMDA requires
collection and reporting of statistical data concerning borrower
demographics. ECOA prohibits discrimination against applicants with respect
to any aspect of a credit transaction on the basis of sex, marital status,
race, color, religion, national origin, age, derivation of income from
public assistance programs, or the good faith exercise of a right under the
Federal Consumer Credit Protection Act. The Fair Housing Act prohibits
discrimination in mortgage lending on the basis of race, color, religion,
sex, handicap, familial status or national origin.
The interest rates which the Company may charge on its loans are subject to
Federal and State usury laws, which specify the maximum rate, which may be
charged to consumers. In addition, both federal and state truth-in-lending
regulations require that the Company disclose to its borrowers prior to
execution of the loans all material terms and conditions of the financing,
including the payment schedule and total obligation under the loans. The
Company believes that it is in compliance in all-material respects with
such regulations.
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Failure to comply with any of the foregoing federal and state laws and
regulations could result in the imposition of civil and criminal penalties
on the Company, class action lawsuits and administrative enforcement
actions. The Company does not expend material amounts of financial
resources complying with federal, state or local laws and regulations.
ENVIRONMENTAL MATTERS. In the course of its business the Company has
acquired, and may acquire in the future, properties securing loans that are
in default. It is possible that hazardous substances or waste,
contamination, pollutants or sources thereof could be discovered on such
properties after acquisition by the Company. In such event, the Company
would seek to have such loans repurchased by the prior seller, as this
discovery would constitute a breach of contract. In rare cases, the Company
may retain the property the Company may be required by law to remove such
substances from the affected properties at its sole cost and expense. There
can be no assurance that (i) the cost of such removal would not
substantially exceed the value of the affected properties or the loans
secured by the properties, (ii) the Company would have adequate remedies
against the prior owner or other responsible parties, or (iii) the Company
would not find it difficult or impossible to sell the affected properties
either prior to or following such removal.
Employees. As of December 31, 2001, the Company had 97 full-time employees,
including 7 in the Acquisitions Department, 23 in the Service Department, 8
in the Legal Department, 2 in the Real Estate Department, 7 in the
Accounting Department, 5 in the MIS Department, and 3 in the Marketing
Department, 6 clerical employees, 11 managerial employees, and 25 employees
in Tribeca.
The Company has never experienced a material work stoppage or slowdown due
to labor disagreements. The Company believes that its relations with all
employees are satisfactory. None of the Company's employees are covered by
a collective bargaining agreement.
ITEM 2. DESCRIPTION OF PROPERTIES
Properties. The Company owns a 6,600 square foot office condominium unit
located on the sixth floor of Six Harrison Street, New York, New York,
which houses its principal offices. See "Item 12. Certain Relationships and
Related Transactions." In addition, the Company leases approximately 6,400
square feet of office space at 99 Hudson Street, New York, New York, which
houses the Loan Servicing Department. The lease expires on January 31, 2009
and is at an approximate annual rent of $126,000. In November of 2000 the
Company sub-leased additional office space located on the fifth floor of
Six Harrison Street, New York, which now houses Tribeca Lending's sales
force. The lease expires on September 1, 2004 and is at an approximate
annual rent of $49,300. In November 2001 the Company leased office space on
two floors located at 185 Franklin Street for its Accounting and Tribeca
Operations departments. The lease expires in November 2003 and is at an
average approximate annual rent of $120,000.
OREO Properties. The Company owns OREO in various parts of the country that
were acquired through acquisition, foreclosure or a deed in lieu. These
properties are 1-4 family residences, coops, condos, and commercial
property. The Company acquires or forecloses on property primarily with the
intent to sell such property at a profit, or rents the property until an
economically beneficial sale can be made. From time to time OREO properties
may be in need of repair or improvements. The OREO property is then
evaluated independently and a decision is made on whether the additional
investment would generate an additional return.
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ITEM 3. LEGAL PROCEEDINGS
ASSET PURCHASE AGREEMENT DISPUTE. On August 19, 1997, the Company commenced
a civil action in the United States District Court for the Southern
District of New York against Preferred Credit Corporation ("PCC") and
certain individuals alleging fraud, breach of contract, and unjust
enrichment in connection with the purchase by the Company of $3.7 million
in face value of notes receivable from PCC for $1.8 million. Through the
Complaint, the Company sought rescission of the asset purchase agreement or
damages incurred in connection with the purchase.
By an order dated September 22, 1999, the Court dismissed one of the
Company's fraud claims against PCC and all of the Company's claims against
the individual Defendants. On October 22, 1998, PCC filed an answer and
counterclaim alleging a breach of the purchase agreement and seeking its
costs and fees incurred in connection with the proceeding.
Trial in this matter was held on the remaining claims during January 2000.
On February 10, 2000, the Court entered judgment in favor of the Company
and against PCC in the amount of $1.7 million plus interest from May 7,
1997. With interest, the amount due under the judgment is approximately $2
million as of February 10, 2000. The Company has collected in excess of
$70,000 from a bank account maintained by PCC and has also obtained an
order allowing the Company to attach PCC interest in mortgage loans
originated by PCC which have a face value in excess of $200,000.
After FCMC commenced its action against PCC, NJK Holdings, Inc. ("NJK")
purchased all of PCC's issued and outstanding stock and all option rights
to acquire any of PCC's stock. Prior to the time FCMC obtained the
Judgment, NJK apparently decided to terminate the business operations of
PCC and began to liquidate the assets of PCC.
As part of FCMC's collection activities, FCMC obtained evidence that
suggested that NJK was converting to its own use assets belonging to PCC.
However, before completing a complete transfer of the same, FCMC was able
to exercise a lien on a claim under an E&O Policy maintained by PCC.
Subsequently, the claim was liquidated at approximately $1 million dollars.
The E&O carrier refused to issue the check directly to NJK due to the
existence of FCMC's claims.
In response, NJK sued FCMC seeking a determination that FCMC had no
interest in the E&O proceeds. FCMC counterclaimed against NJK asserting
that NJK did not have a lien against the proceeds of the E&O policy; that
monies transferred from PCC to NJK were accomplished through illegal
distributions and a fraudulent transfer and that NJK was the alter ego of
PCC and as such was liable for the judgment FCMC obtained against PCC.
NJK filed a Motion for Summary Judgment in late 2001. FCMC filed a response
and a hearing on the Motion for Summary Judgment was held on January 30,
2002. The matter is currently under advisement.
Trial is currently scheduled to commence on March 25, 2002. It is currently
anticipated that the trial will last approximately two weeks.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
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PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Market Information. The Company's Common Stock is quoted on the National
Association of Securities Dealers, Inc. Automated Quotation System
("Nasdaq") under the symbol "FCSC" since December 26, 1996 and "FCMC" from
December 30, 1994 until such date.
The following table sets forth the bid prices for the common stock on
Nasdaq Bulletin Board, for the periods indicated trading during these
periods was limited and sporadic. Therefore, the following quotes may not
accurately reflect the true market value of the securities. Such prices
reflect inter-dealer prices without retail markup or markdown or
commissions and may not represent actual transactions. Information for 2001
and 2000 was compiled from information representing the daily inter-dealer
bid activity during the period.
2001 Bid 2000 Bid
-------- --------
High Low High Low
---- --- ---- ---
First Quarter $ 0.33 $ 0.33 $ 0.75 $ 0.55
Second Quarter $ 1.20 $ 1.20 $ 0.75 $ 0.75
Third Quarter $ 1.10 $ 1.01 $ 0.45 $0.375
Fourth Quarter $ .75 $ .70 $ 0.50 $0.375
As of March 30, 2002, there were approximately 525 record holders of the
Company's Common Stock.
Dividend Policy. The Company intends to retain all future earnings that may
be generated from operations to help finance the operations and expansion
of the Company and accordingly does not plan to pay cash dividends to
holders of the Common Stock during the reasonably foreseeable future. Any
decisions as to the future payment of dividends will depend on the earnings
and financial position of the Company and such factors as the Company's
Board of Directors deem relevant.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
Forward-Looking Statements. When used in this report, press releases and
elsewhere by the Company from time to time, the words "believes",
"anticipates", and "expects" and similar expressions are intended to
identify forward-looking statements that involve certain risks and
uncertainties. Additionally, certain statements contained in this
discussion and the Form 10-KSB, may be deemed forward-looking statements
that involve a number of risks and uncertainties. Among the factors that
could cause actual results to differ materially are the following:
unanticipated changes in the U.S. economy, including changes in business
conditions and interest rates and changes in the level of growth in the
finance and housing markets, the availability for purchases of additional
loans, the status of relations between the Company and its Senior Debt
Lender, the status of relations between the Company and its sources for
loan purchases, unanticipated difficulties in collections under loans in
the Company's portfolio and other risks detailed from time to time in the
Company's SEC reports. Readers are cautioned not to place undue reliance on
these forward-looking statements, which speak only as of the date thereof.
The Company
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undertakes no obligation to release publicly the results on any events or
circumstances after the date hereof or to reflect the occurrence of
unanticipated events.
CRITICAL ACCOUNTING POLICIES
The following management's discussion and analysis of financial condition
and results of operations is based on the amounts reported in the Company's
consolidated financial statements. These financial statements are prepared
in accordance with accounting principles generally accepted in the United
States of America. In preparing the financial statements, management is
required to make various judgments, estimates and assumptions that affect
the reported amounts. Changes in these estimates and assumptions could have
a material effect on the Company's financial statements. The following is a
summary of the Company's accounting policies that are the most affected by
management judgments, estimates and assumptions:
Notes Receivable-The Company purchases real estate mortgage loans to be
held as long-term investments. Loan purchase discounts are established at
the acquisition date. Management must periodically evaluate each of the
purchase discounts to determine whether the projection of cash flows for
purposes of amortizing the purchase loan discount has changed
significantly. Changes in the projected payments are accounted for as a
change in estimate and the periodic amortization is prospectively adjusted
over the remaining life of the loans. Should projected payments not exceed
the carrying value of the loan, the periodic amortization is suspended and
either the loan is written down or an allowance for uncollectibility is
recognized. The allowance for loan losses, a material estimate which could
change significantly in the near-term, is initially established by an
allocation of the purchase loan discount based on the management's
assessment of the portion of purchase discount that represents
uncollectable principal. Subsequently, increases to the allowance are made
through a provision for loan losses charged to expense. Given the nature of
the Company's loan portfolio and the underlying real estate collateral
significant judgment is required in determining periodic amortization of
purchase discount, and allowance for loan losses. The allowance is
maintained at a level that management considers adequate to absorb
potential losses in the loan portfolio.
LOAN AND OREO ACQUISITIONS. During the year ended December 31, 2001
("fiscal 2001") the Company purchased 3,599 loans consisting primarily of
first and second mortgages, with an aggregate face value of $184 million at
an aggregate purchase price of $162 million or 88% of the face value
compared with the purchase during the year ended December 31, 2000 ("fiscal
2000") of 2,907 loans consisting primarily of second mortgages, with an
aggregate face value of $113 million at an aggregate purchase price of $96
million or 85% of the face value. Acquisition of these 2001 portfolios was
fully funded through Senior Debt in the amount equal to the purchase price
plus a 1% loan origination fee.
The Company believes these acquisitions of loans will result in substantial
increases in the level of interest income during future periods. Payment
streams are generated once the loans are incorporated into the Company's
loan tracking system.
Management intends to continue to expand the Company's earning asset base
through the acquisition of additional portfolios including performing and
non-performing real estate secured loans. The Company believes that its
current infrastructure is adequate to service additional loans without any
material increases in expenses.
COST OF FUNDS. During the year 2001 there were several decreases in the
prime rate, the benchmark rate for the Company's costs of funds on Senior
Debt used to fund loan portfolio acquisitions. As of December 31, 2001, the
Company had Senior Debt outstanding under several loans with an aggregate
principal balance of $314 million. Additionally the Company has financing
agreements, which had an outstanding balance of $7,542,511 at December 31,
2001.
10
The majority of the loans purchased by the Company bear interest at a fixed
rate, while the Senior Debt is at a variable rate. Consequently, changes in
market interest rate conditions have caused direct corresponding changes in
interest expense. On December 31, 2001 the Company and its Senior Debt
Lender agreed to a long term interest rate agreement pursuant to which the
interest rate for Senior Debt incurred after March 1, 2000, will be the
Federal Home Loan Bank of Cincinnati (FHLB) thirty (30) day advance rate
plus an additional spread of 3.25%. Under the amendment Senior Debt
incurred prior to March 1, 2000 will accrue interest at a rate equal to the
prime rate plus a margin of between 0% and 1.75%; approximately $68 million
of total loans fall into this category. The Company believes that this new
agreement will provide additional acquisition opportunities and ongoing
competitiveness in the market. Decreases in the prime rate during the year
positively impacted the net income of the Company. The weighted average
interest rate on borrowed funds for the Senior Debt based on the balances
as of December 31, 2001 and December 31, 2000 was 5.25% and 9.16%,
respectively.
The impact of inflation on the Company's operations during both fiscal 2001
and 2000 was immaterial.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000
Total revenue, comprised of interest income, purchase discount earned,
gains recognized on the bulk sale of notes, gain on sale of OREO, gain on
sale of loans originated, rental income and other income, increased by
$8,915,968 or 31%, to $37,963,358 during fiscal 2001, from $29,047,390
during fiscal 2000.
Total revenue as a percentage of notes receivable in the Company's
portfolio as of the last day of the fiscal year, net of allowance for loan
losses during fiscal 2001 was 12.7% as compared with 12.6% during fiscal
2000. Interest income on notes receivable increased by $7,951,120 or 38%,
to $28,824,624 during fiscal 2001 from $20,873,504 during fiscal 2000. The
Company recognizes interest income on notes included in its portfolio based
upon three factors: (i) interest on performing notes, (ii) interest
received with settlement payments on non-performing notes and (iii) the
balance of settlements in excess of the carried face value. This increase
resulted primarily from the purchase of $184 million of performing loans
during 2001, which increased the size of the Company's outstanding
portfolio of notes receivable by 30%.
Purchase discount earned increased by $198,464 or 5%, to $3,986,498 during
fiscal 2001 from $3,788,034 during fiscal 2000. The increase in purchase
discount earned reflected the growth in size of the portfolio. Purchase
discount increased at a lower rate than the growth in the portfolio due to
the maturation of the portfolio, and the purchase of performing assets for
yield spread as opposed to purchase discount during the year.
Gains from the bulk sale of loans decreased by $688,537 or 41%, to $986,570
during fiscal 2001 from $1,675,107 during fiscal 2000. This decrease
reflected the change in mix of loans sold to include a significantly
greater proportion of non-performing loans in 2001, which resulted in lower
margins. The Company sold approximately $24 million in face value notes
receivable during 2001 as compared to $13 million during 2000.
11
Gain on sale of originated notes by Tribeca increased by $565,140 or 204%,
to $842,051 during 2001 from $276,911 during fiscal 2000. This increase was
due to an increase in the number of loans sold during 2001 as compared to
2000. Tribeca had loan sales of $15 million during 2001 as compared to $5
million of loans during 2000.
Gain on sale of OREO increased by $747,609 or 107% to $1,448,548 during
fiscal 2001 from $ 700,939 during fiscal 2000. The increase resulted from
the sale of OREO properties during the year that had appreciated in value
in the Company's portfolio. The Company sold 140 OREO properties during
2001 as compared to 120 OREO properties during 2000.
Rental income decreased by $342,498 or 51% to $330,250 during fiscal 2001,
from $672,748 during fiscal 2000. Rental income decreased due to the sale
of several rental properties where it was more advantageous to sell than
continue to hold for rent during the year. The Company held 17 rental
properties at December 31, 2001 as compared to 47 at December 31, 2000.
Other income increased by $484,670 or 46%, to $1,544,817 during fiscal 2001
from $1,060,147 during fiscal 2000. The increase was due primarily to
increases in the number of prepayment penalties due to an increase in
prepayments during 2001, late charges resulting primarily from the growth
in the size of the portfolio and increased loan fees from loan
originations.
Total operating expenses increased by $6,160,483 or 22% to $34,637,210
during fiscal 2001 from $28,476,727 during fiscal 2000. Total operating
expenses include interest expense, collection, general and administrative
expenses, provisions for loan losses, service fees, amortization of loan
commitment fees and depreciation expense.
Interest expense increased by $1,972,749 or 11%, to $20,754,281 during
fiscal 2001 from $18,781,532 during fiscal 2001. This increase resulted
primarily from the increase in debt reflecting the Company's 37 % increase
in notes receivable and loans held at the end of fiscal 2001 over those
held at the end of fiscal 2000. Total debt increased by $88 million or 38%,
to $321 million as of December 31, 2001 as compared with $233 million as of
December 31, 2000. Interest expense was partially offset by decreases in
the Company's costs of funds. Total debt includes Senior Debt, debentures,
financing agreements and loans from affiliates.
Collection, general and administrative expenses increased by $1,896,270 or
22% to $10,411,012 during fiscal 2001 from $8,514,742 during fiscal 2000.
The primary components of collection, general and administrative expense
are personnel expense, OREO related expense, litigation expense, office
expense, and collection expense.
Personnel expenses increased by $1,409,613 or 35%, to $5,438,283 during
fiscal 2001 from $4,028,669 during fiscal 2000. This increase resulted from
the growth in size of the Company's loan production staff, salary
increases, increased commissions due to increased loan production and bonus
accruals. OREO related expenses decreased by $386,066 to $876,441 during
fiscal 2001 from $1,262,506 during fiscal 2000 due to the selling of OREO
properties. Office expenses increased by $258,080 or 49%, to $ 789,711
during fiscal 2001 from $531,631 due to an increase in office space for
Tribeca on the fifth floor of 6 Harrison Street and new office space at 185
Franklin Street for the file room, Accounting and Tribeca operations. Other
general and administrative expenses increased $614,644 or 23% to $3,306,577
during fiscal 2001 from $2,691,933 during fiscal 2000. This increase
resulted primarily from increased travel for marketing, due diligence,
increased legal expenses for asset protection, and professional fees.
12
Provisions for loan losses increased by $1,776,448 or 432%, to $2,187,453
during fiscal 2001 from $411,005 during fiscal 2000. This increase was
primarily due to reserve increases on two large loans that are in
litigation, the write off a $873,000 loan that was deemed uncollectable and
reserve increases in portfolios that no longer have purchase discount. Bad
debt expense expressed as a percentage of face value of notes receivable
and loans held as of the last day of such years for fiscal 2001 and fiscal
2000 were approximately 0.60% and 0.15%, respectively. Provisions for loan
losses are incurred as soon as the valuation of the asset diminishes and
there is no unamortized discount remaining associated with that asset.
Amortization of deferred financing costs increased by $438,551 or 71%, to
$1,058,443 during fiscal 2001 from $619,892 during fiscal 2000. This
increase resulted primarily from the growth in size of the portfolio,
increased prepayments, collections, and an increase in the aggregate amount
of assets sold, which sales generally accelerate the amortization of
financing costs. On December 31, 2001 and December 31, 2000, deferred
financing costs, as a percentage of Senior Debt outstanding was 1.02 % and
1.05%, respectively.
Depreciation expense increased by $76,465 or 51%, to $226,021 during fiscal
2001 from $149,556 during fiscal 2000. This increase resulted primarily the
purchase of computer equipment.
The Company's operating income increased by $2,311,485 to $2,882,148 during
fiscal 2001 from $570,663 during fiscal 2000 for the reasons set forth
above.
During 2001, the Company had a provision for income taxes of $444,000 after
utilizing all available net operating losses and removed the valuation
allowance. The Company did not record a provision in 2000 since available
net operating losses exceeded taxable income. A valuation reserve was
established against excess net operating losses.
LIQUIDITY AND CAPITAL RESOURCES
General. During fiscal 2001 the Company purchased 3,599 loans with an
aggregate face value of $184 million at an aggregate purchase price of
$162.3 million or 88% of the face value. During fiscal 2000, the Company
purchased 2,907 loans with an aggregate face value of $113 million at an
aggregate purchase price of $96 million or 85% of face value. This increase
reflected the Company's enhanced marketing efforts, which generated
increased market penetration.
Liquidity. The Company's portfolio of notes receivable at December 31,
2001, had a face value of $332 million and included net notes receivable of
approximately $276 million. Net notes receivable are stated at the amount
of unpaid principal, reduced by purchase discount and allowance for loan
losses. The Company has the ability and intent to hold its notes until
maturity, payoff or liquidation of collateral or sale if it is economically
advantageous to do so.
During fiscal 2001, the Company used cash in the amount of $25.3 million in
its operating activities primarily for interest expense, overhead,
litigation expense incidental to its collections and for the foreclosure
and improvement of OREO. The Company used $62.4 million in its investing
activities, which reflected primarily the use of $162.3 million for the
purchase of note receivable offset by principal collections of its notes
receivable of $72.9 million and proceeds from sales of OREO of $8.6
million. Net cash provided by financing activities was $88.3 million
primarily from an increase in Senior Debt of $83 million. The above
activities resulted in a net increase in cash at December 31, 2001 over
December 31, 2000 of $571,816.
13
In the ordinary course of its business, the Company accelerates its
foreclosures of real estate securing non-performing notes receivable
included in its portfolio. As a result of such foreclosures and selective
direct purchases of OREO, at December 31, 2001 and 2000, the Company held
OREO recorded in the financial statements at $3.8 million and $5.3 million,
respectively. OREO is recorded on the financial statements of the Company
at the lower of cost or fair market value less estimated costs of disposal.
The Company believes that the OREO inventory held at December 31, 2001 has
a net realizable value (market value less estimated commissions and legal
expenses associated with the disposition of the asset) of approximately
$4.1 million based on market analyses of the individual properties less the
estimated closing costs. The Company generally holds OREO as rental
property or sells such OREO in the ordinary course of business when it is
economically beneficial to do so.
Operating Expenses of Tribeca. During 2001, Tribeca recorded income of
$396,788 compared to a loss of $165,740 during 2000. This increase stemmed
from a change in management in Tribeca. The Company hired a new Vice
President who along with a new sales force increased production in Tribeca;
this was responsible for a 406% increase in loan originations, a 200 %
increase in loans sold and a 339% increase in net income. The Company
funded the start-up of Tribeca with $1.1 million of proceeds from the
refinancing of two loan portfolios through its Senior Debt Lender.
Additionally, such lender has provided Tribeca with a warehouse financing
agreement of $7 million. There can be no assurances that Tribeca will earn
a profit in the future, however, management believes that Tribeca's
existing cash balances, credit lines, and anticipated cash flow from
operations will provide sufficient working capital resources for Tribeca's
anticipated operating needs. During fiscal 2001 Tribeca negotiated with the
Senior Debt Lender to allow Tribeca to convert debt incurred under it's
warehouse line into senior debt each time the aggregate amount outstanding
hit $7 million dollars. This has allowed Tribeca to hold its loans while
continuing its origination activity and thereby allowing Tribeca greater
flexibility to time its bulk sales in the secondary market to its greatest
advantage. The Senior Debt generally accrues interest at a variable rate
based on the FHLB rate of Cincinnati plus a premium of 3.25%.
CASH FLOWS FROM OPERATING AND INVESTING ACTIVITIES
Substantially all of the assets of the Company are invested in its
portfolios of notes receivable. The Company's primary source of cash flow
for operating and investing activities is collections on notes receivable
and gains on sale notes and OREO properties.
At December 31, 2001, the Company had unrestricted cash, cash equivalents
and marketable securities of $7.8 million. A portion of the Company's
available funds may be applied to fund acquisitions of companies or assets
of companies in complementary or related fields, which may cause the
Company to incur additional capital expenditures, outside the acquisitions
of additional notes receivable. Although the Company from time to time
engages in discussions and negotiations, it currently has no agreements
with respect to any particular acquisition.
CASH FLOW FROM FINANCING ACTIVITIES
Senior Debt. As of December 31, 2001, the Company owed an aggregate of $314
million to the Senior Debt Lender, under several loans.
The Senior Debt is collateralized by first liens on the respective loan
portfolios for the purchase of which the debt was incurred and is
guaranteed by the Company. The monthly payments on the Senior Debt have
been, and the Company intends for such payments to continue to be, met by
the collections from the respective loan portfolios. The loan agreements
for the Senior Debt call for contractual interest and
14
principal payments each month and accelerated payments based upon the
collection of the notes receivable securing the debt during the preceding
month. The Senior Debt accrues interest at a variable rate based on the
FHLB rate of Cincinnati plus a premium of 3.25% for all new Senior Debt and
debt incurred after March 1, 2000, and prime plus between 0% and 1.75% debt
incurred before such date, of which there was approximately $68 million at
December 31, 2001. At December 31, 2001, the weighted average interest rate
on Senior Debt was 5.25%. The accelerated payment provisions are generally
of two types: the first requires that all collections from notes
receivable, other than a fixed monthly allowance for servicing operations,
be applied to reduce the Senior Debt, and the second requires a weekly
additional principal reduction from cash collected before scheduled
principal and interest payments have been made. As a result of the
accelerated payment provisions, the Company is repaying the amounts due on
the Senior Debt at a rate faster than the contractual scheduled payments.
While the Senior Debt remains outstanding, these accelerated payment
provisions may limit the cash flow that is available to the Company.
In December 2001, the Company negotiated with its Senior Debt Lender a
modification to the Senior Debt obligation, pursuant to which the Senior
Debt Lender has provided the Company with cash of $1,345,000 per month for
the year. Management believes that this modification will reduce irregular
periods of cash flow shortages arising from operations. Management believes
that sufficient cash flow from the collection of notes receivable will be
available to repay the Company's secured obligations and that sufficient
additional cash flows will exist, through collections of notes receivable,
the sale of loans, sales and rental of OREO, or additional borrowing, to
repay the current liabilities arising from operations and to repay the long
term indebtedness of the Company.
Certain Senior Debt credit agreements required establishment of restricted
cash accounts, funded by an initial deposit at the loan closing and
additional deposits based upon monthly collections up to a specified dollar
limit. The Company is no longer required to maintain these restricted
accounts but has continued to under the prior agreement. The Company
typically uses these funds to place deposits on loan portfolio bids. The
restricted cash is maintained in an interest bearing account, with the
Company's Senior Debt Lender. The aggregate balance of restricted cash in
such accounts was $541,443 on December 31, 2001 and $932,574 on December
31, 2000. The decrease in restricted cash at December 31, 2001 was due to
cash deposits placed on portfolio bids, which funds are returned to the
restricted account by the Senior Debt Lender once funding takes place.
Total Senior Debt funding capacity was $500 million at March 29, 2002 of
which approximately $314 million had been drawn down as of such date.
Additionally the Senior Debt Lender has verbally informed the Company that
it will not deem approximately $4 million of Senior Debt that it had
syndicated to other banks as of such date as outstanding for purposes of
determining availability under the Senior Debt Facility. As a result, the
Company has approximately $190 million available to purchase additional
portfolios of notes receivable.
The Company's Senior Debt Lender has provided Tribeca with a warehouse
financing agreement of $7 million. At December 31, 2001, Tribeca had drawn
down $6.8 million on the line. The warehouse line accrues interest based a
variable rate of prime plus 2%.
Harrison First Corporation 12% Debentures. In connection with the
acquisition of a loan portfolio during 1995, the Company offered to
investors $800,000 of subordinated debentures of which $555,000 were
issued. As of December 31, 2001 and 2000, $24,262 and $72,525 respectively,
of these debentures were outstanding. The Harrison First 12% Debentures
bear interest at the rate of 12% per annum and were payable in quarterly
installments. The principal was repaid over three years in ten equal
quarterly
15
installments of $22,200 which payments commenced on September 30, 1997 with
the remaining balloon payment of $333,000 due June 30, 2000. On June 30,
2000, the Company made a balloon payment of $232,952 funded (through the
incurrence of Senior Debt) and agreed with the holders of $97,048 of 12%
Debentures to the extension of payment of such principal amount to December
31, 2001 which was later extended to March 31, 2002. The Harrison First 12%
Debentures are secured by a lien on the Company's interest in certain notes
receivable and are subordinated to the Senior Debt encumbering the loan
portfolio.
Financing Agreement. The Company has a financing agreement with the Senior
Debt Lender permitting it to borrow a maximum of approximately $1,500,000
at a rate equal to the bank's prime rate plus two percent per annum.
Principal repayment of the line is due six months from the date of each
cash advance and interest is payable monthly. The total amounts outstanding
under the financing agreement as of December 31, 2001 and December 31,
2000, were $647,791 and $117,600 respectively. Advances made under the
financing agreement were used to satisfy senior lien positions and fund
capital improvements on certain real estate assets owned by the Company.
Management believes the ultimate sale of these properties will satisfy the
related outstanding financing agreement. Management has reached an
agreement in principal with its Senior Debt Lender to increase the
availability under this credit facility to cover additional properties
foreclosed upon by the Company, which the Company may be required to hold
as rental property to maximize its return.
Aggregate maturities of all long-term debt at currently effective principal
payment requirements for the next five years, at December 31, are as
follows:
2002 $ 30,700,721
2003 22,772,822
2004 59,903,471
2005 177,356,311
2006 20,206,261
Thereafter 10,570,794
------------
$321,510,380
============
ITEM 7. FINANCIAL STATEMENTS
See the financial statements and notes related thereto, beginning on
page F-1, included elsewhere in this report.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not Applicable.
16
--------------------------------------------------------------------------------
PART III
INFORMATION WITH RESPECT TO ITEMS 9, 10, 11, 12 AND ON FORM 10KSB IS SET FORTH
IN THE DEFINITIVE PROXY STATEMENT, WHICH WILL BE FILED WITHIN 120 DAYS OF
DECEMBER 31, 2001, THE COMPANY'S MOST RECENT FISCAL YEAR. SUCH INFORMATION IS
INCORPORATED HEREIN BY REFERENCE.
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
WITH SECTION 16(a) OF EXCHANGE ACT
ITEM 10. EXECUTIVE COMPENSATION
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTION
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
17
PART IV
(a) EXHIBIT TABLE
EXHIBIT NO. DESCRIPTION
----------- -----------
3(a) Restated Certificate of Incorporation. Previously filed
with, and incorporated herein by reference to, the
Company's 10-KSB, filed with the Commission on December 31,
1994.
(b) Bylaws of the Company. Previously filed with, and
incorporated herein by reference to, the Company's
Registration Statement on Form S-4, No. 33-81948, filed
with the Commission on November 24, 1994.
10(d) Employment Agreement dated December 4, 1996, between the
Company and Joseph Caiazzo. Previously filed with, and
incorporated herein by reference to, the Company 10KSB,
filed with the Commission on March 31,1997.
10(i) Promissory Note between Thomas J. Axon and the Company
dated December 31,1998. Previously filed with, and
incorporated herein by reference to, the Company's 10-KSB,
filed with the Commission on April 14, 1999.
10(j) Promissory Note between Steve Leftkowitz, board member, and
the Company dated March 31,1999. Previously filed with, and
incorporated herein by reference to, the Company's 10-KSB,
filed with the Commission on March 30, 2000.
10(k) Loan Purchase Agreement dated March 31,1999 between the
Company and Steve Leftkowitz, board member. Previously
filed with, and incorporated herein by reference to, the
Company's 10-KSB, filed with the Commission on March 30,
2000.
10(l) Employment Agreement dated July 17, 2000 between the
Company and Seth Cohen. Previously filed with, and
incorporated herein by reference to, the Company's 10-KSB,
filed with the Commission on March 31, 2001.
11 Earnings per Share. Filed herewith.
18
SIGNATURES
In accordance with Section 13 or 15 (d) of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
March 29, 2002 FRANKLIN CREDIT MANAGEMENT
CORPORATION
By: /s/ THOMAS J. AXON
-----------------------------------------
Thomas J. Axon
Chairman
In accordance with the Exchange Act, this report has been signed below
by the following persons on behalf of the registrant and in the capacities and
on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ SETH COHEN President, Chief Executive Officer March 29, 2002
------------------------
Seth Cohen
(Principal executive
officer)
/s/ JOSEPH CAIAZZO Executive Vice President, Chief March 29, 2002
------------------------ Operating Officer, Secretary and
Joseph Caiazzo Director
(Secretary)
/s/ KIMBERLEY SHAW Vice President, March 29, 2002
------------------------ Chief Financial Officer
Kimberley Shaw
(Principal financial
and accounting officer)
19
FRANKLIN CREDIT MANAGEMENT CORPORATION AND SUBSIDIARIES
TABLE OF CONTENTS
--------------------------------------------------------------------------------
PAGE
INDEPENDENT AUDITORS' REPORT F-1
FINANCIAL STATEMENTS FOR THE YEARS ENDED
DECEMBER 31, 2001 AND 2000:
Consolidated Balance Sheets F-2
Consolidated Statements of Income F-3
Consolidated Statements of Stockholders' Equity F-4
Consolidated Statements of Cash Flows F-5 - F-6
Notes to Consolidated Financial Statements F-7 - F-23
INDEPENDENT AUDITORS' REPORT
To the Board of Directors
Franklin Credit Management Corporation and Subsidiaries
We have audited the consolidated balance sheets of Franklin Credit Management
Corporation and Subsidiaries (the "Company") as of December 31, 2001 and 2000,
and the related consolidated statements of income, stockholders' equity, and
cash flows for the years then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of the Company as of December 31, 2001
and 2000, and the results of its operations and its cash flows for the years
then ended in conformity with accounting principles generally accepted in the
United States of America.
New York, New York
March 27, 2002
FRANKLIN CREDIT MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2001 AND 2000
--------------------------------------------------------------------------------
ASSETS 2001 2000
------------- -------------
CASH AND CASH EQUIVALENTS $ 7,784,162 $ 7,212,346
RESTRICTED CASH 541,443 932,574
NOTES RECEIVABLE:
Principal 331,643,076 255,055,677
Purchase discount (22,248,344) (23,392,400)
Allowance for loan losses (33,490,456) (24,021,479)
Net notes receivable 275,904,276 207,641,798
LOANS HELD FOR SALE-Net 28,203,047 8,605,848
ACCRUED INTEREST RECEIVABLE 4,795,789 3,396,405
OTHER REAL ESTATE OWNED 3,819,673 5,290,053
OTHER RECEIVABLES 5,305,409 1,934,443
DEFERRED TAX ASSET 1,567,588 3,481,002
OTHER ASSETS 1,894,052 1,442,687
BUILDING, FURNITURE AND EQUIPMENT - Net 1,151,171 868,471
DEFERRED FINANCING COSTS- Net 3,195,891 2,429,661
------------- -------------
TOTAL ASSETS $ 334,162,501 $ 243,235,288
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Accounts payable and accrued expenses $ 4,230,203 $ 2,934,797
Financing agreements 7,542,511 2,021,334
Notes payable 313,943,808 231,050,485
Subordinated debentures 24,262 72,525
Notes payable, affiliates and stockholders -- 146,835
Tax liability
Current 225,000 --
Deferred 1,866,318 3,561,061
------------- -------------
Total liabilities 327,832,102 239,787,037
------------- -------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Common stock, $.01 par value, 10,000,000 authorized shares;
issued and outstanding: 5,916,527 59,167 59,167
Additional paid-in capital 6,985,968 6,985,968
Accumulated deficit (714,736) (3,596,884)
------------- -------------
Total stockholders' equity 6,330,399 3,448,251
------------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 334,162,501 $ 243,235,288
============= =============
See notes to consolidated financial statements.
F-2
FRANKLIN CREDIT MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 2001 AND 2000
--------------------------------------------------------------------------------
2001 2000
------------ ------------
REVENUES:
Interest income $ 28,824,624 $ 20,873,504
Purchase discount earned 3,986,498 3,788,034
Gain on sale of notes receivable 986,570 1,675,107
Gain on sale of loans held for sale 842,051 276,911
Gain on sale of other real estate owned 1,448,548 700,939
Rental income 330,250 672,748
Other 1,544,817 1,060,147
------------ ------------
37,963,358 29,047,390
------------ ------------
OPERATING EXPENSES:
Interest expense 20,754,281 18,781,532
Collection, general and administrative 10,411,012 8,514,742
Provision for loan losses 2,187,453 411,005
Amortization of deferred financing costs 1,058,443 619,892
Depreciation 226,021 149,556
------------ ------------
34,637,210 28,476,727
------------ ------------
INCOME BEFORE PROVISION FOR INCOME TAXES 3,326,148 570,663
PROVISION FOR INCOME TAXES 444,000 --
------------ ------------
NET INCOME $ 2,882,148 $ 570,663
============ ============
NET INCOME PER COMMON SHARE:
Basic $ 0.49 $ 0.10
============ ============
Dilutive $ 0.49 $ 0.10
============ ============
WEIGHTED AVERAGE NUMBER OF SHARES
OUTSTANDING, BASIC AND DILUTIVE 5,916,527 5,916,527
============ ============
See notes to consolidated financial statements.
F-3
FRANKLIN CREDIT MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2001 AND 2000
--------------------------------------------------------------------------------
COMMON STOCK ADDITIONAL
---------------------------- PAID-IN ACCUMULATED
SHARES AMOUNT CAPITAL DEFICIT TOTAL
----------- ----------- ----------- ----------- -----------
BALANCE, JANUARY 1, 2000 5,916,527 $ 59,167 $ 6,985,968 $(4,167,547) $ 2,877,588
Net Income -- -- -- 570,663 570,663
----------- ----------- ----------- ----------- -----------
BALANCE, DECEMBER 31, 2000 5,916,527 59,167 6,985,968 (3,596,884) 3,448,251
Net Income -- -- -- 2,882,148 2,882,148
----------- ----------- ----------- ----------- -----------
BALANCE, DECEMBER 31, 2001 5,916,527 $ 59,167 $ 6,985,968 $ (714,736) $ 6,330,399
=========== =========== =========== =========== ===========
See notes to consolidated financial statements.
F-4
FRANKLIN CREDIT MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2001 AND 2000
--------------------------------------------------------------------------------
2001 2000
------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 2,882,148 $ 570,663
Adjustments to reconcile income (loss) to net cash used in
operating activities:
Gain on sale of notes receivable (986,570) (1,675,107)
Gain on sale of other real estate owned (1,448,548) (700,939)
Depreciation 226,021 149,556
Amortization of deferred financing costs 1,058,443 619,892
Purchase discount earned (3,986,498) (3,788,034)
Provision for loan losses 2,187,453 411,005
Changes in assets and liabilities:
Increase in accrued interest receivable (1,399,384) (971,047)
(Increase) decrease in other receivables (3,370,966) 892,858
Decrease in deferred tax asset 1,913,414 --
(Increase) in other assets (451,365) (287,590)
(Increase) in loans held for sale (19,597,199) (5,382,123)
Foreclosures on real estate (2,066,784) (216,689)
(Decrease) in deferred tax liability (1,469,743) --
Increase (decrease) in accounts payable and accrued expenses 1,295,406 (182,542)
(Decrease) increase in notes payable, affiliates and stockholders (146,835) 37,485
------------- -------------
Net cash used in operating activities (25,361,007) (10,089,234)
------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
(Decrease) increase in restricted cash 391,131 (544,602)
Purchase of notes receivable (162,340,435) (95,738,251)
Principal collections on notes receivable 72,930,175 43,610,229
Acquisition and loan fees (1,420,254) (1,405,446)
Proceeds from sale of other real estate owned 8,609,271 7,522,394
Proceeds from sale of notes receivable 19,905,420 10,974,326
Purchase of building, furniture and fixtures (508,722) (133,125)
------------- -------------
Net cash used in investing activities (62,433,414) (35,714,475)
------------- -------------
Continued on next page
F-5
FRANKLIN CREDIT MANAGEMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2000 AND 2001
--------------------------------------------------------------------------------
2001 2000
------------- -------------
CONTINUED FROM PREVIOUS PAGE
Net cash used in investing activities (from previous page) (62,433,414) (35,714,475)
------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from notes payable 176,562,187 98,024,623
Principal payments of notes payable (93,668,864) (51,993,943)
Proceeds from financing agreements 38,495,144 8,296,532
Payments on financing agreements (32,973,967) (7,066,273)
Principal payments of subordinated debentures (48,263) (260,451)
------------- -------------
Net cash provided by financing activities 88,366,237 47,000,488
------------- -------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 571,816 1,196,779
CASH AND CASH EQUIVALENTS BEGINNING OF YEAR 7,212,346 6,015,567
------------- -------------
CASH AND CASH EQUIVALENTS END OF YEAR $ 7,784,162 $ 7,212,346
============= =============
SUPPLEMENTAL DISCLOSURES OF CASH
FLOW INFORMATION:
Cash payments for interest $ 18,931,784 $ 18,116,762
============= =============
Cash payments for taxes $ 56,875 $ 43,584
============= =============
See notes to consolidated financial statements.
F-6
FRANKLIN CREDIT MANAGEMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2001 AND 2000
--------------------------------------------------------------------------------
1. NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
NATURE OF BUSINESS - Franklin Credit Management Corporation (the
"Company"), incorporated under the laws of the State of Delaware, acquires
performing, nonperforming, nonconforming and subperforming notes
receivable and promissory notes from financial institutions, and mortgage
and finance companies. The Company services and collects such notes
receivable through enforcement of terms of original note, modification of
original note terms and, if necessary, liquidation of the underlying
collateral.
In January 1997, a wholly owned subsidiary was formed, to originate or
purchase, sub prime residential mortgage loans to individuals whose credit
histories, income and other factors cause them to be classified as
nonconforming borrowers.
A summary of the Company's significant accounting policies follows.
BASIS OF CONSOLIDATION - The consolidated financial statements include the
accounts of the Company and its wholly-owned subsidiaries. All significant
intercompany accounts and transactions have been eliminated in
consolidation.
ESTIMATES - The preparation of financial statements in conformity with
generally accepted accounting principles in the United States of America
requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and the
reported amounts of revenue and expenses during the period. Actual results
could differ from those estimates.
CASH AND CASH EQUIVALENTS - Cash and cash equivalents include all cash
accounts, with the exception of restricted cash, and money market funds.
The Company maintains accounts at banks, which at times may exceed
federally insured limits. The Company has not experienced any losses from
such concentrations.
NOTES RECEIVABLE AND INCOME RECOGNITION - The notes receivable portfolio
consists primarily of secured real estate mortgage loans purchased from
financial institutions, and mortgage and finance companies. Such notes
receivable are generally nonperforming or underperforming at the time of
purchase and, accordingly, are usually purchased at a discount from the
principal balance remaining.
Notes receivable are stated at the amount of unpaid principal, reduced by
purchase discount and an allowance for loan losses. The Company has the
ability and intent to hold its notes until maturity, payoff or liquidation
of collateral. Impaired notes are measured based on the present value of
expected future cash flows discounted at the note's effective interest
rate or, as a practical expedient, at the observable market price of the
note receivable or the fair value of the collateral if the note is
collateral dependent. A note receivable is impaired when it is probable
the Company will be unable to collect all contractual principal and
interest payments due in accordance with the terms of the note agreement.
F-7
In general, interest on the notes receivable is calculated based on
contractual interest rates applied to daily balances of the collectible
principal amount outstanding using the simple-interest method.
Accrual of interest on notes receivable, including impaired notes
receivable, is discontinued when management believes, after considering
economic and business conditions and collection efforts, that the
borrowers' financial condition is such that collection of interest is
doubtful. When interest accrual is discontinued, all unpaid accrued
interest is reversed. Subsequent recognition of income occurs only to the
extent payment is received subject to management's assessment of the
collectibility of the remaining interest and principal. A nonaccrual note
is restored to an accrual status when it is no longer delinquent and
collectibility of interest and principal is no longer in doubt and past
due interest is recognized at that time.
Loan purchase discount is amortized to income using the interest method
over the period to maturity. The interest method recognizes income by
applying the effective yield on the net investment in the loans to the
projected cash flows of the loans. Discounts are amortized if the
projected payments are probable of collection and the timing of such
collections is reasonably estimable. The projection of cash flows for
purposes of amortizing purchase loan discount is a material estimate,
which could change significantly, in the near term. Changes in the
projected payments are accounted for as a change in estimate and the
periodic amortization is prospectively adjusted over the remaining life of
the loans. Should projected payments not exceed the carrying value of the
loan, the periodic amortization is suspended and either the loan is
written down or an allowance for uncollectibility is recognized.
ALLOWANCE FOR LOAN LOSSES - The allowance for loan losses, a material
estimate which could change significantly in the near-term, is initially
established by an allocation of the purchase loan discount based on the
management's assessment of the portion of purchase discount that
represents uncollectable principal. Subsequently, increases to the
allowance are made through a provision for loan losses charged to expense
and the allowance is maintained at a level that management considers
adequate to absorb potential losses in the loan portfolio.
Management's judgment in determining the adequacy of the allowance is
based on the evaluation of individual loans within the portfolios, the
known and inherent risk characteristics and size of the note receivable
portfolio, the assessment of current economic and real estate market
conditions, estimates of the current value of underlying collateral, past
loan loss experience and other relevant factors. Notes receivable,
including impaired notes receivable, are charged against the allowance for
loan losses when management believes that the collectibility of principal
is unlikely based on a note-by-note review. Any subsequent recoveries are
credited to the allowance for loan losses when received. In connection
with the determination of the allowance for loan losses, management
obtains independent appraisals for significant properties, when considered
necessary.
The Company's notes receivable are collateralized by real estate located
throughout the United States with a concentration in the Northeast.
Accordingly, the collateral value of a substantial portion of the
Company's real estate notes receivable and real estate acquired through
foreclosure is susceptible to changes in market conditions.
Management believes that the allowance for loan losses is adequate. While
management uses available information to recognize losses on notes
receivable, future additions to the allowance or write-downs may be
necessary based on changes in economic conditions.
F-8
LOANS HELD FOR SALE - The loans held for sale consists primarily of
secured real estate first and second mortgages originated by the Company.
Such loans held for sale are performing and are carried at lower of cost
or market.
OTHER REAL ESTATE OWNED - Other real estate owned consisting of properties
acquired through, or in lieu of, foreclosure or other proceedings are held
for sale and are carried at the lower of cost or fair value less estimated
costs of disposal. Any write-down to fair value, less cost to sell, at the
time of acquisition is charged to the allowance for loan losses.
Subsequent write-downs are charged to operations based upon management's
continuing assessment of the fair value of the underlying collateral.
Property is evaluated regularly to ensure that the recorded amount is
supported by current fair values and valuation allowances are recorded as
necessary to reduce the carrying amount to fair value less estimated cost
to dispose. Revenue and expenses from the operation of other real estate
owned and changes in the valuation allowance are included in operations.
Costs relating to the development and improvement of the property are
capitalized, subject to the limit of fair value of the collateral, while
costs relating to holding the property are expensed. Gains or losses are
included in operations upon disposal.
BUILDING, FURNITURE AND FIXTURES - Building, furniture and fixtures are
recorded at cost net of accumulated depreciation. Depreciation is computed
using the straight-line method over the estimated useful lives of the
assets, which range from 3 to 40 years. Gains and losses on dispositions
are recognized upon realization. Maintenance and repairs are expensed as
incurred.
DEFERRED FINANCING COSTS - Debt financing costs, which include loan
origination fees incurred by the Company in connection with obtaining
financing, are deferred and are amortized based on the principal reduction
of the related loan.
MORTGAGE SERVICING RIGHTS - The Company allocates the total cost of the
mortgage loans purchased or originated, proportionately, to the mortgage
servicing rights and the loans based on the relative fair value. The
servicing rights capitalized are amortized in proportion to and over the
period of, estimated net servicing income including prepayment assumptions
based upon the characteristics of the underlying loans. Capitalized
servicing rights are periodically assessed for impairment based on the
fair value of the rights with any impairment recognized through a
valuation allowance. The Company does not generally retain servicing
rights on loans sold.
RETIREMENT PLAN - The Company has a defined contribution retirement plan
(the "Plan") covering all full-time employees who have completed one month
of service. Contributions to the Plan are made in the form of payroll
deductions based on employees' pretax wages. Currently, the Company offers
a company match of 50% of the first 3% of the employees' contribution. The
Company made contributions of $28,536 and $0 in 2001 and 2000
respectively.
INCOME TAXES - The Company recognizes income taxes under an asset and
liability method. This method provides for deferred income tax assets or
liabilities based on the temporary difference between the income tax basis
of assets and liabilities and their carrying amount in financial
statements. Deferred tax assets and liabilities are measured using enacted
tax rates expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled. Deferred
tax assets are reduced by a valuation allowance when management determines
that it is more likely than not that some portion or all of the deferred
tax assets will not be realized. Deferred tax assets and liabilities are
adjusted for the effects of changes in tax laws and rates on the date of
the enactment.
F-9
FAIR VALUE OF FINANCIAL INSTRUMENTS - Statement of Financial Accounting
Standards No. 107, Disclosures About Fair Value of Financial Instruments,
requires disclosure of fair value information about financial instruments,
whether or not recognized in the balance sheet for which it is practicable
to estimate that value. In cases where quoted market prices are not
available, fair values are based on estimates using present value or other
valuation techniques. Those techniques are significantly affected by the
assumptions used, including the discount rate and estimates of future cash
flows. In that regard, the derived fair value estimates cannot be
substantiated by comparison to independent markets and, in many cases,
could not be realized in immediate settlement of the instruments.
Statement No. 107 excludes certain financial instruments and all
nonfinancial assets and liabilities from its disclosure requirements.
Accordingly, the aggregate fair value amounts do not represent the
underlying value of the Company.
The following methods and assumptions were used by the Company in
estimating the fair value of its financial instruments:
A. CASH, RESTRICTED CASH, ACCRUED INTEREST RECEIVABLES, OTHER RECEIVABLE
AND ACCRUED INTEREST PAYABLE - The carrying values reported in the
balance sheet are a reasonable estimate of fair value.
B. NOTES RECEIVABLE - Fair value of the net note receivable portfolio is
estimated by discounting the future cash flows using the interest
method. The carrying amounts of the notes receivable approximate fair
value.
C. SHORT-TERM BORROWINGS - The carrying amounts of the financing
agreements and other short-term borrowings approximate their fair
value.
D. LONG-TERM DEBT - Fair value of the Company's long-term debt
(including notes payable, subordinated debentures and notes payable,
affiliate) is estimated using discounted cash flow analysis based on
the Company's current incremental borrowing rates for similar types
of borrowing arrangements. The carrying amounts reported in the
balance sheet approximate their fair value.
COMPREHENSIVE INCOME - SFAS No. 130, Reporting Comprehensive Income
defines comprehensive income as the change in equity of a business
enterprise during a period from transactions and other events and
circumstances, excluding those resulting from investments by and
distributions to stockholders. The Company had no items of other
comprehensive income in 2001 and 2000, therefore net income was the same
as its comprehensive income.
RECENT PRONOUNCEMENTS - Statement of Financial Accounting Standards (SFAS)
No. 133, Accounting for Derivative Instruments and Hedging Activities, as
amended, establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts and for hedging activities. Under SFAS 133, certain contracts
that were not formerly considered derivatives may now meet the definition
of a derivative. The Company adopted SFAS 133 effective January 1, 2001.
The adoption of SFAS 133 did not have a significant impact on the
financial position, results of operations, or cash flows of the Company.
F-10
2. NOTES RECEIVABLE, LOANS HELD FOR SALE AND ALLOWANCE FOR LOAN LOSSES
Notes receivable consists principally of real estate mortgages as of
December 31, 2001 and 2000 and are as follows:
2001 2000
------------- -------------
Real estate secured $ 311,667,321 $ 239,860,880
Consumer unsecured 7,599,633 7,171,016
Mobile homes 12,211,946 5,601,175
Other 164,176 2,422,606
------------- -------------
331,643,076 255,055,677
Less:
Purchase discount (22,248,344) (23,392,400)
Allowance for loan losses (33,490,456) (24,021,479)
------------- -------------
$ 275,904,276 $ 207,641,798
============= =============
Loans held consists primarily of real estate mortgages as December 31,
2001 and 2000 and are classified as follows:
2001 2000
------------ ------------
Real estate secured $ 28,477,873 $ 8,670,691
Consumer unsecured 13,383 --
Mobile homes 33,370 --
------------ ------------
28,524,626 8,670,691
Less:
Purchase discount (97,899) --
Allowance for loa losses (223,680) (64,843)
------------ ------------
$ 28,203,047 $ 8,605,848
============ ============
F-11
As of December 31, 2001, contractual maturities of notes receivables and
loans held for sale net of the allowance for loan losses were as follows:
YEAR ENDING NOTES LOANS HELD
DECEMBER 31, RECEIVABLE FOR SALE
------------ ------------ ------------
2002 $ 41,656,212 479,292
2003 37,130,184 473,513
2004 33,257,489 499,195
2005 27,913,758 467,236
2006 18,692,471 366,670
Thereafter 114,651,837 26,015,039
------------ ------------
$273,301,951 $ 28,300,945
============ ============
Excluded from the contractual maturities reflected above are the notes
receivable acquired during the last two weeks of 2001 with $24,850,669 of
aggregate principal balances, net of allowance for loan losses. Management
is in the process of performing the analyses to determine the final
discount allocation and the initial determination of the allowance for
loan losses associated with these purchases that are necessary to develop
the related contractual maturities of the underlying notes receivable.
It is the Company's experience that a portion of the notes receivable
portfolio may be renewed or repaid before contractual maturity dates. The
above tabulation, therefore, is not to be regarded as a forecast of future
cash collections. During the years ended December 31, 2001 and 2000, cash
collections of principal amounts totaled approximately $72,900,000 and
$43,600,000, respectively, and the ratios of these cash collections to
average principal balances were approximately 23.3% and 18.8%,
respectively.
Changes in the allowance of loan losses on notes receivable for the years
ended December 31, 2001 and 2000 are as follows:
2001 2000
------------ ------------
Balance, beginning $ 24,086,322 $ 22,185,945
Initial allowance allocated on purchased portfolio
9,198,705 2,264,703
Loans charged to allowance (1,982,024) (840,174)
Provision for loan losses 2,187,453 411,005
------------ ------------
Balance, ending $ 33,490,456 $ 24,021,479
============ ============
F-12
At December 31, 2001 and 2000, principal amounts of notes receivable
included approximately $75,000,000 and $56,000,000, respectively, of notes
for which there was no accrual of interest income. At December 31, 2001,
approximately $26,231,465 of such notes at principal amounts relates to
recent portfolio acquisitions whose performance and collection
classification by management was in the process of being determined.
The following information relates to impaired notes receivable which
include all nonaccrual loans as of and for the year ended December 31,
2001 and 2000:
2001 2000
----------- -----------
Total impaired notes receivable $74,904,866 $56,069,711
=========== ===========
Allowance for loan losses related to impaired
notes receivable $25,022,497 $20,117,598
=========== ===========
Average balance of impaired notes receivable
during the year $64,049,206 $56,997,519
=========== ===========
Interest income recognized $ 2,223,530 $ 1,801,068
=========== ===========
In the normal course of business, the Company restructures or modifies
terms of notes receivable to enhance the collectability of certain notes
that were impaired at the date of acquisition and were included in certain
portfolio purchases.
3. BUILDING, FURNITURE AND EQUIPMENT
At December 31, 2001 and 2000, building , furniture and equipment
consisted of the following:
2001 2000
---------- ----------
Building and improvements $ 997,259 $ 907,890
Furniture and equipment 1,022,689 603,336
---------- ----------
2,019,948 1,511,226
Less accumulated depreciation 868,778 642,755
---------- ----------
$1,151,171 $ 868,471
========== ==========
4. NOTES PAYABLE
Notes payable consists primarily of loans made to the Company from a bank
("Senior Debt Lender") to acquire portfolios of notes receivable. The
Company has a credit facility with the Senior Debt Lender. The facility
was amended on December 31, 2001 and provides the Company with the ability
to borrow up to an aggregate of $500,000,000 at rates based on the Federal
Home Loan Bank of Cincinnati (FHLB)30 day advance rate plus an additional
spread of 3.25%. As of December 31, 2001 and 2000, the
F-13
Company had several loans outstanding to its Senior Debt Lender with an
aggregate principal balance of $313,670,618 and $230,760,549,
respectively. As a result, the Company has approximately $190,000,000
available to purchase additional portfolios of notes receivable. All
notes payable are secured by an interest in the notes receivable,
payments to be received under the notes and the underlying collateral
securing the notes. At December 31, 2001 approximately $ 68,000,000 loans
that were made prior to March 31, 2000, accrue at a rate of prime plus a
margin of 0% to 1.75%. The remaining $245,670,618 accrues interest at the
FHLB 30 day advance rate plus 3.25%.
At December 31, 2001 and 2000 the weighted average interest rate on the
Senior Debt was 5.25% and 9.16% respectively.
The above financing agreements also provide for additional monthly
principal reduction based on cash collections received by the Company.
The remaining note payable consists of a bank loan made to the Company to
acquire its principal offices. The note payable is secured by the
principal offices. As of December 31, 2001 and 2000, the Company had a
note payable of $273,189 and $289,937, respectively, which accrues
interest at 8.93%.
Certain agreements require that a non-interest bearing cash account be
established at the closing of the loan and may require additional
deposits based on a percentage of monthly collections up to a specified
dollar limit. The aggregate balance of restricted cash at December 31,
2001 and 2000 was $541,443 and $932,574, respectively.
Substantially all of the Company's outstanding financing with respect to
its notes receivable portfolio acquisition activities is provided by the
Senior Debt Lender.
Aggregate maturities of all notes payable debt at currently effective
principal payment requirements, at December 31, 2001 are as follows:
2002 $ 23,134,148
2003 22,772,822
2004 59,903,471
2005 177,356,311
2006 20,206,261
Thereafter 10,570,795
------------
$313,943,808
============
5. SUBORDINATED DEBENTURES
In connection with the acquisition of a notes receivable portfolio during
1995, the Company offered $800,000 in subordinated debentures. The
debentures bear interest at a rate of 12% per annum payable in quarterly
installments. The principal was payable over three years in 10 equal
quarterly installments of $22,200 commencing September 30, 1997 with the
remaining balance of $310,800 payable on June 30, 2000. On June 30, 2000,
the Company made a balloon payment of $232,952 funded (through the
incurrence of Senior Debt) and agreed with the holder of $97,048 of 12%
debentures to the extension of payment of such principal amount to
December 31, 2001, this agreement was subsequently extended to March 31,
2002.
F-14
The debentures are secured by a lien on the Company's interest in certain
notes receivable and are subordinate to a note payable with a December
31, 2001 balance of $2,232,445 encumbering the notes receivable
portfolio.
6. NOTES PAYABLE, AFFILIATES AND STOCKHOLDERS
Notes payable, affiliates and stockholders consist of the following at
December 31, 2001 and 2000:
2001 2000
-------- --------
Note payable to a company affiliated through certain common
ownership due on demand, with interest payable monthly at a
rate of 8.5% per annum $ -- $ 8,772
Note payable to a company affiliated through certain common
ownership due on demand, with interest payable monthly at a
rate of 8.5% per annum -- 138,063
-------- --------
$ -- $146,835
======== ========
7. FINANCING AGREEMENTS
The Company has a financing agreement with a bank. The agreement provides
the Company with the ability to borrow a maximum of $1,500,000 at a rate
equal to the bank's prime rate plus two percent per annum. The credit
facility is to be utilized through a series of loans made to purchase the
underlying collateral of certain nonperforming real estate secured loans.
Principal repayment of each resulting loan is due six months from the
date of each advance and interest is payable monthly. As of December 31,
2001 and 2000, $647,791 and $117,600, respectively, are outstanding on
this credit facility.
The financing agreement is secured by a first priority security interest
in the notes receivable, the individual real estate that may be
purchased, payments to be received under the notes receivable, an
unconditional guarantee by one of the stockholders of the Company, and
collateral securing the notes of certain loan portfolios.
The Company has an additional financing agreement with a bank. The
agreement provides the Company with a line of credit to borrow a maximum
of $150,000 at a rate equal to the bank's prime rate plus one percent per
annum. As of December 31, 2001, and 2000, $118,239 and $127,014,
respectively, are outstanding on the financing agreement.
In addition the Company has a warehouse financing agreement with another
bank. It provides the Company with the ability to borrow a maximum of
$7,000,000 at a rate equal to the bank's prime rate plus 2.00%. This
credit facility is to be utilized for the purpose of originating mortgage
loans. As of December 31, 2001 and 2000, $6,776,481 and $1,776,720,
respectively, are outstanding on the financing agreement and are secured
by loans held for sale.
F-15
8. INCOME TAX MATTERS
The components of income tax provision (benefit) for the years ended
December 31, 2001 and 2000 are as follows:
2001 2000
---------- ----------
Current provision:
Federal $ 146,000 $ --
State and local 79,000 --
---------- ----------
225,000 --
---------- ----------
Deferred provision (benefit):
Federal 671,000 217,000
State and local 588,000 68,000
---------- ----------
1,259,000 285,000
---------- ----------
Valuation allowance (1,040,000) (285,000)
---------- ----------
Provision (benefit) $ 444,000 $ --
========== ==========
A reconciliation of the anticipated income tax expense (computed by
applying the Federal statutory income tax rate of 35% to income before
income tax expense) to the provision for income taxes in the statements
of income for the years ended December 31, 2001 and 2000 follows:
2001 2000
----------- -----------
Tax (benefit) determined by applying U.S. statutory rate
to income (loss) $ 1,164,000 $ 194,000
Increase (decrease) in taxes resulting from:
State and local income taxes, net of Federal benefit 331,000 68,000
Meals and Entertainment (net of adjustments) 5,000 23,000
Valuation allowance (1,040,000) (285,000)
Other items, net (16,000) --
----------- -----------
$ 444,000 $ --
=========== ===========
F-16
A valuation allowance has been established for a portion of the deferred
tax asset because management could not assert that it is more likely than
not that, the total benefit of the deferred tax asset will be realized.
The tax effects of temporary differences that give rise to significant
components of deferred tax assets and deferred tax liabilities at
December 31, 2001 and 2000 are presented below:
2001 2000
----------- -----------
Deferred liabilities:
Purchase discount $ 1,866,318 $ 3,561,061
----------- -----------
Deferred tax liabilities $ 1,866,318 $ 3,561,061
=========== ===========
Deferred tax assets:
Inventory, repossessed collateral $ 116,357 $ 84,881
Special charge on purchased loans 575,042 598,205
Net operating loss carryforward 2,643,234
Bad Debt Reserve 876,189 1,195,104
----------- -----------
Gross deferred tax assets 1,567,588 4,521,424
Less valuation allowance (1,040,422)
----------- -----------
Deferred tax assets - net of valuation allowance $ 1,567,588 $ 3,481,002
=========== ===========
9. STOCK OPTION PLAN
During 1996, the Company adopted an incentive stock option plan (the
"Plan") for certain of its officers and directors. Under the terms of the
Plan, options to purchase an aggregate of up to 800,000 shares of the
Company's common stock may be granted. Each option has an exercise price
at least equal to the fair market value of the shares of common stock at
the time the option is granted. Options become exercisable at various
times after the date granted and expire ten years after the date granted.
During 2000, the Company granted 532,500 options to six members of the
Company's Board of Directors and 532,500 options to various management
employees within the Company. Also during 2000, 140,000 options were
forfeited by a former Company Officer. There were no options granted
during 2001.
The Company applies APB Opinion 25 and related interpretations in
accounting for stock options; accordingly, no compensation cost has been
recognized. Had compensation cost been determined upon the fair value of
the stock options at the grant date consistent with the method of SFAS
No.123, the Company's 2001 and 2000 net income and earnings per share
would have been reduced to the pro forma amounts indicated in the table
that follows.
F-17
2001 2000
----------- -----------
Net income - as reported $ 2,882,148 $ 570,663
Net income - pro forma $ 2,882,148 426,847
Net income per common share - basic - as reported 0.49 0.10
Net income per common share - basic - pro forma 0.49 0.07
Net income per common share - dilutive - as reported 0.49 0.10
Net income per common share - dilutive - pro forma 0.49 0.07
The fair value of each option grant is estimated on the date of the grant
using the Black-Scholes option pricing model with the following weighted
average assumptions used for grants in 2000:
Dividend yield 0%
Volatility 241%
Risk-free interest rate 3.62
Weighted average expected lives 3 years
Transactions in stock options under the Plan are summarized as follows:
WEIGHTED
AVERAGE
EXERCISE
SHARES PRICE
-------- --------
Options outstanding at January 1, 2000 320,000 $ 1.56
Granted 532,500 $ 0.75
Exercised -- --
Forfeitured (140,000) 1.56
-------- --------
Options outstanding at December 31, 2000 712,500 1.00
Granted -- --
Exercised -- --
Forfeitured -- --
Expired -- --
-------- --------
Options outstanding at December 31, 2001 712,500 $ 1.00
======== ========
As of December 31, 2001 and 2000, 712,500 options are exercisable.
F-18
10. BUSINESS SEGMENTS
The Company has two reportable operating segments: (i) portfolio asset
acquisition and resolution; and (ii) mortgage banking. The portfolio
asset acquisition and resolution segment acquires performing,
nonperforming, nonconforming and subperforming notes receivable and
promissory notes from financial institutions, mortgage and finance
companies, and services and collects such notes receivable through
enforcement of terms of original note, modification of original note
terms and, if necessary, liquidation of the underlying collateral. The
mortgage-banking segment originates or purchases, sub prime residential
mortgage loans for individuals whose credit histories, income and other
factors cause them to be classified as nonconforming borrowers.
The Company's management evaluates the performance of each segment based
on profit or loss from operations before unusual and extraordinary items
and income taxes. The accounting policies of the segments are the same as
those described in the summary of significant accounting policies (see
Note 1).
PORTFOLIO ASSET ACQUISITION AND RESOLUTION
2001 2000
----------- -----------
REVENUES:
Interest income $27,065,644 $20,292,305
Purchase discount earned 3,986,498 3,788,034
Gain on sale of notes receivable 986,570 1,675,107
Gain on sale of other real estate owned 1,448,548 700,939
Rental income 330,250 672,748
Other 1,327,927 1,039,037
----------- -----------
35,145,437 28,168,170
----------- -----------
OPERATING EXPENSES:
Interest expense 20,068,167 18,489,548
Collection, general and administrative 8,894,760 7,859,020
Provision for loan losses 2,077,588 370,674
Amortization of deferred financing costs 996,412 593,624
Depreciation 179,150 118,901
----------- -----------
32,216,077 27,431,767
----------- -----------
INCOME BEFORE PROVISION FOR INCOME
TAXES $ 2,929,360 $ 736,403
=========== ===========
F-19
MORTGAGE BANKING
2001 2000
------------- -------------
REVENUES:
Interest income $ 1,758,979 $ 581,199
Gain on sale of notes originated 842,051 276,911
Other 216,891 21,110
------------- -------------
2,817,921 879,220
------------- -------------
OPERATING EXPENSES:
Interest expense 686,114 291,984
Collection, general and administrative 1,516,252 655,722
Provision for loan loss 109,865 40,331
Amortization of deferred financing costs 62,031 26,268
Depreciation 46,871 30,655
------------- -------------
2,421,133 1,044,960
------------- -------------
INCOME (LOSS) BEFORE PROVISION FOR INCOME
TAXES $ 396,788 $ (165,740)
============= =============
CONSOLIDATED ASSETS:
Portfolio asset acquisition and resolution assets $ 303,705,008 $ 233,728,060
Mortgage banking assets 29,520,868 9,507,228
------------- -------------
Consolidated assets $ 333,225,876 $ 243,235,288
============= =============
TOTAL ADDITIONS TO BUILDING, FURNITURE
AND FIXTURES:
Portfolio asset acquisition and resolution assets $ 471,402 $ 68,419
Mortgage banking assets 37,320 64,706
------------- -------------
Consolidated additions to building,
furniture and fixtures $ 508,722 $ 133,125
============= =============
CONSOLIDATED REVENUE:
Portfolio asset acquisition and resolution assets $ 35,145,437 $ 28,168,170
Mortgage banking assets 2,817,921 879,220
------------- -------------
Consolidated Revenue $ 37,963,358 $ 29,047,390
============= =============
CONSOLIDATED NET INCOME (LOSS):
Portfolio asset acquisition and resolution asset $ 2,485,360 $ 736,403
Mortgage banking assets 396,788 (165,740)
------------- -------------
Consolidated Net Income $ 2,882,148 $ 570,663
============= =============
F-20
11. CERTAIN CONCENTRATIONS
Geographic Concentrations of Notes Receivable - Approximately 28% of the
Company's secured consumer real estate notes receivable are with
customers in the northeastern region of the U.S. Such real estate notes
receivable are collateralized by real estate with a concentration in this
region. Accordingly, the collateral value of a substantial portion of the
Company's real estate notes receivable and real estate acquired through
foreclosure is susceptible to changes in market conditions in this
region. In the event of sustained adverse economic conditions, it is
possible that the Company could experience a negative impact in its
ability to collect on existing loans, or liquidate foreclosed assets in
this region which could impact the Company's related loan loss estimates.
Financing - Substantially all of the Company's existing debt and
available credit facilities are with one financial institution. The
Company's purchases of new portfolios is contingent upon the continued
availability of these credit facilities.
12. COMMITMENTS AND CONTINGENCIES
Employment Agreement - Effective March 25, 1996, the Company entered into
a five-year employment agreement with its Chief Operating Officer. The
agreement provides for, among other things, a stipulated base salary, and
a bonus of up to 3.5% of the Company's net income in excess of $500,000.
This agreement has been extended through March 31, 2003.
Effective July 17, 2000, the Company entered into a three-year employment
agreement with its Chief Executive Officer. The agreement provides for,
among other things, a stipulated base salary, and a bonus of up to 3.5%
of the Company's net income in excess of $500,000.
Operating Leases - Certain secondary office and file space is leased
under operating leases. The combined future minimum lease payments are as
follows:
2002 $ 333,312
2003 334,373
2004 334,373
2005 140,158
Thereafter 280,316
----------
$1,422,532
==========
Other Legal Actions - The Company is also involved in legal proceedings
and litigation arising in the ordinary course of business. In the opinion
of management, the outcome of such proceedings and litigation currently
pending will not materially affect the Company's financial statements.
Sale of Notes Receivable with recourse-In June 1996, the Company sold
notes receivable with a net carrying value of approximately $5,400,000
for approximately $6,400,000 to the Company's primary lender and retained
the servicing rights. Such notes were sold with recourse. The recourse
provision amounted to approximately $600,000 and provides that should a
note become sixty days past due the Company must either buy it back or
replace it with a note that is approximately equivalent to the
outstanding principal and accrued interest. At December 31, 2001 and
2000, the remaining obligation
F-21
under the recourse provision is approximately $425,000. In addition,
the buyer of the notes has the right to proceed to foreclose on the
delinquent note and, after sale of the collateral, require the Company to
pay any deficiency balance on the note.
In June 1997, the Company sold notes receivable with a net carrying value
of approximately $3,900,000 for approximately $4,900,000 to the Company's
primary lender and retained the servicing rights. Such notes were sold
with recourse. The recourse provision amounted to approximately $500,000
and provides that should a note become sixty days past due the Company
must either buy it back or replace it with a note that is approximately
equivalent to the outstanding principal and accrued interest. At December
31, 2001 and 2000, the remaining obligation under the recourse provision
was approximately $28,938 and $48,183, respectively. In addition, the
buyer of the notes has the right to proceed to foreclose on the
delinquent note and, after sale of the collateral, require the Company to
pay any deficiency balance on the note.
As of December 31, 2001 and 2000, the unpaid balances of the above
mortgage loans being serviced by the Company were $2,622,362 and
$3,580,347, respectively. Mortgage loans serviced for others are not
included in the Company's consolidated balance sheet.
13. RELATED PARTY TRANSACTIONS
During 2000, Mr. Axon, the Company's Chairman, purchased from the Company
a New York condominium held by the Company in its other real estate owned
inventory available for sale. The consideration included the issuance by
Mr. Axon of a note to the Company in the amount of $165,000. The note
bears interest at a rate of 8% per annum, is secured by the condominium
property, and is due together with all accrued interest and other charges
on January 30, 2002. The note was extended by Mr. Axon for one year. The
note and accrued interest is included in other assets.
F-22
14. SUMMARY OF QUARTERLY RESULTS (UNAUDITED)
The table below sets forth selected unaudited financial information
for each quarter of the last two years.
1ST QUARTER 2ND QUARTER 3RD QUARTER 4TH QUARTER
----------- ----------- ----------- -----------
2001
Revenue $ 8,165,024 $ 9,329,718 $ 9,544,946 $10,923,670
Operating expenses 8,052,978 8,206,786 8,564,135 9,813,311
----------- ----------- ----------- -----------
Income before provision for
income taxes $ 112,046 $ 1,122,932 $ 980,811 $ 1,110,359
=========== =========== =========== ===========
Income per common share
Basic $ 0.02 $ 0.19 $ 0.17 $ 0.19
=========== =========== =========== ===========
Diluted $ 0.02 $ 0.19 $ 0.17 $ 0.19
=========== =========== =========== ===========
2000
Revenue $ 6,498,458 $ 6,669,756 $ 6,707,978 $ 9,171,198
Operating expenses 6,619,278 6,645,831 7,112,337 8,099,281
----------- ----------- ----------- -----------
(Loss) income before benefit
for income income taxes and
net (loss) income $ (120,820) $ 23,925 $ (404,359) $ 1,071,917
=========== =========== =========== ===========
(Loss) income per common share
Basic $ (0.02) $ 0.00 $ (0.07) $ 0.18
=========== =========== =========== ===========
Diluted $ (0.02) $ 0.00 $ (0.07) $ 0.18
=========== =========== =========== ===========
15. SUBSEQUENT EVENTS
Subsequent to year-end, the Company has purchased notes receivable with a
face amount of approximately $38,371,313 at a cost of approximately
$31,461,198. These purchases were financed by borrowing under the
Company's credit facility.
F-23