UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 1997
[ ] 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 Identification No.)
incorporation or organization)
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)
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 whether the registrant 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 [ ]
As of November 18, 1997, 5,516,527 shares of the issuer's Common Stock,
par value $.01 per share were outstanding.
<PAGE>
FRANKLIN CREDIT MANAGEMENT CORPORATION
FORM 10-QSB
September 30, 1997
C O N T E N T S
---------------
PART I. FINANCIAL INFORMATION Page
----
Item 1. Financial Statements
Consolidated Balance Sheets September 30, 1997 (unaudited)
and December 31, 1996 3
Consolidated Statements of Income (unaudited) for the three months
and nine months ended September 30, 1997 and 1996 4
Consolidated Statement of Cash Flows (unaudited) for the nine months
ended September 30, 1997 and 1996 5
Consolidated Statements of Stockholders' Equity 6
Notes to consolidated Financial Statements 7-11
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 12-22
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 23
Item 2. Changes in Securities 23
Item 3. Defaults Upon Senior Securities 23
Item 4. Submission of Matters to a Vote of Security Holders 23
Item 5. Other Information 23
Item 6. Exhibits and Reports on Form 8-K 24
SIGNATURES 25
Page 2
<PAGE>
ITEM 1. FINANCIAL STATEMENTS
FRANKLIN CREDIT MANAGEMENT CORPORATION AND AFFILIATES
CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
30-SEP-97 31-DEC-96
(UNAUDITED) (AUDITED)
============ ============
<S> <C> <C>
Cash 3,352,808 1,967,964
Restricted cash 1,238,541 828,845
Notes receivable:
Principal amount 117,657,061 113,610,782
Joint venture participations (362,914) (360,395)
Purchase discount (16,940,164) (18,160,403)
Allowance for loan losses (30,185,751) (23,604,810)
------------ ------------
NET NOTES RECEIVABLE 70,168,231 71,485,174
Accrued Interest receivable 914,332 1,132,370
Other real estate owned 11,197,788 4,737,085
Other receivables (20,574) 421,392
Other assets 247,760 704,695
Building, furniture & fixtures, net 697,886 640,749
Deferred financing costs 1,023,154 1,358,874
------------ ------------
TOTAL ASSETS 88,819,925 83,277,148
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Accounts payable and accrued expenses 2,126,224 1,874,267
Lines of credit 559,618 583,916
Notes payable 78,667,587 73,538,865
Escrow 557,741
Subordinated debentures 929,362 1,025,000
Notes payable, affiliates and stockholders 125,630 373,218
Deferred income taxes 1,135,116 1,778,862
------------ ------------
TOTAL LIABILITIES 84,101,278 79,174,128
Commitments and Contingencies 0
STOCKHOLDER'S EQUITY:
Common Stock, $.01 par value, 10,000,000 authorized
shares; issued and outstanding 1997 and 1996:
5,516,527 55,167 11,022
Additional paid-in capital 6,489,969 6,534,113
Accumulated deficit (1,826,489) (2,442,115)
------------ ------------
Total stockholders' equity 4,718,647 4,103,020
------------ ------------
Total liabilities and stockholders' equity 88,819,925 83,277,148
============ ============
</TABLE>
See accompanying notes to financial statements.
Page 3
<PAGE>
ITEM 1. FINANCIAL STATEMENTS
FRANKLIN CREDIT MANAGEMENT CORPORATION AND AFFILIATES
CONSOLIDATED STATEMENTS OF INCOME
PERIOD ENDED SEPTEMBER 30, 1997 AND 1996
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
30-SEP-97 30-SEP-96 30-SEP-97 30-SEP-96
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
============================= ================================
REVENUE:
<S> <C> <C> <C> <C>
Interest Income $1,505,860 $1,475,203 $4,666,408 $4,652,253
Purchase discount earned 2,198,879 1,696,808 5,293,710 4,786,394
Gain on sale of portfolios 404,119 0 1,377,454 977,519
Gain on sale of other real estate owned 76,443 0 759,882 36,563
Other 115,634 69,210 238,020 218,352
============================= ================================
4,300,936 3,241,221 12,335,475 10,671,081
============================= ================================
OPERATING EXPENSES:
Interest expense 2,085,835 1,943,095 6,209,639 5,730,346
Collection, general and administrative 1,565,531 1,000,300 3,746,062 2,815,565
Provision for loan losses (16,938) 138,727 86,915 578,918
Banking service fees (reductions) (0) 96,439 31,395 292,953
Amortization of deferred financing costs 126,007 108,902 435,337 445,541
Depreciation 15,922 16,035 47,266 49,429
============================= ================================
3,776,357 3,303,498 10,556,614 9,912,752
============================= ================================
OPERATING INCOME (LOSS ) 524,579 (62,277) 1,778,861 758,329
============================= ================================
Special Charge (1,500,000) 0 (1,500,000) 0
Settlement Income 295,000 55,500 295,000 75,500
Income (loss) before benefit (provision) (680,421) (6,777) 573,861 833,829
============================= ================================
Benefit (provision) for income taxes 764,530 (41,364) 41,765 (161,722)
============================= ================================
NET INCOME (LOSS) 84,109 (48,141) 615,626 672,107
============================= ================================
Earnings per common share:
============================= ================================
Net income (loss) 0.01 (0.01) 0.11 0.12
============================= ================================
Weighted average number of shares outstanding 5,823,529 5,733,969 5,823,529 5,733,969
============================= ================================
</TABLE>
See accompanying notes to financial statements.
Page 4
<PAGE>
ITEM 1. FINANCIAL STATEMENTS
FRANKLIN CREDIT MANAGEMENT CORPORATION AND AFFILIATES
CONSOLIDATED STATEMENT OF CASH FLOWS
FISCAL NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996
<TABLE>
<CAPTION>
(UNAUDITED) (UNAUDITED)
09/30/97 09/30/96
===================================================================================================================
CASH FLOWS FROM OPERATING ACTIVITIES
<S> <C> <C>
Net income (loss) $ 615,626 $ 672,107
Adjustments to reconcile net income to net
cash used in operating activities:
Special Charge 1,500,000
Depreciation, depletion, amortization and valuation provisions 483,193 494,970
Purchase discount earned (5,293,711) (4,822,957)
(Gain) Loss on sale of assets (1,402,685) 0
Provision for loan losses 86,915 578,918
Deferred tax provision (benefit) (359,892) 161,722
Changes in assets and liabilities:
(Increase) decrease in:
Accrued interest receivable 222,165 16,572
Accounts receivable (220,610) 29,632
Inventory-repossessions (4,002,990) (1,420,094)
Other assets 293,714 45,869
Increase (decrease) in:
Accounts payable and accrued expenses 1,400,295 832,517
Due to affiliates 16,400 851
Income tax payable 294,127
---------------- ----------------
Net cash used in operating activities (6,367,453) (3,409,892)
CASH FLOWS FROM INVESTING ACTIVITIES
Distributions 0 0
Additional capital contributed 0 0
Acquisition and loan fees (289,277)
Purchase of property and equipment 0 19,886
Principal collections on notes receivable 13,272,488 21,219,046
Acquisition of notes receivable (19,986,365) (10,362,046)
Proceeds from sale of notes 7,428,649
Foreclosures on real estate 2,127,308
Joint venture participation 6,486 (116,945)
Advances to subsidiaries 877,431
Acquisition of furniture & equipment (104,403) (191,254)
(Increase) in restricted cash (306,169) (142,595)
---------------- ----------------
Net cash used in investing activities 3,026,148 10,426,092
CASH FLOWS FROM FINANCING ACTIVITIES
Payments on debenture notes payable (73,438) (176,250)
Capital contributions 0 0
Proceeds from lines of credit 533,458 474,711
Payments on lines of credit (395,606) (1,049,920)
Proceeds from long-term debt 22,803,560 10,336,175
Principal payments of long-term debt (18,141,826) (16,553,967)
---------------- ----------------
Net cash provided by financing activities 4,726,148 (6,969,251)
---------------- ----------------
Net increase (decrease) in cash 1,384,843 46,949
CASH:
Beginning 1,967,965 1,335,800
---------------- ----------------
Ending $3,352,808 $1,382,748
================ ================
See accompanying notes to financial statements.
</TABLE>
Page 5
<PAGE>
ITEM 1. FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
FRANKLIN CREDIT MANAGEMENT CORPORATION AND AFFILIATES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
Common Stock Additional Retained
========================= Paid-In Earnings
Shares Amount Capital (Deficit) Total
==================================================================================================================================
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1995 5,503,896 $ 55,040 $6,470,952 $(3,271,268) $3,254,724
Conversion of warrants 10,225 102 20,348 -- 20,450
One-for-five reverse stock split (4,411,297) (44,113) 44,113 -- --
Purchase of fractional shares in
connection with reverse stock split (747) (7) (1,300) -- (1,307)
Net income 829,153 829,153
--------------------------------------------------------------------------------
Balance, December 31, 1996 1,102,077 11,022 6,534,113 (2,442,115) 4,103,020
Four-for-one stock Dividend 4,414,450 44,144.50 (44,145)
Net Income 615,626 615,626
================================================================================
Balance, September 30, 1997 5,516,527 $ 55,167 $6,489,969 $(1,826,489) $4,718,646
================================================================================
</TABLE>
See accompanying notes to financial statements.
Page 6
<PAGE>
PART I
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Nature of Business and Significant Accounting Policies
Significant Accounting Policies
The accounting policies followed by the Company are set forth in Note 1 to the
Company's financial statements included in its Annual Report on Form 10-KSB for
the fiscal year ended December 31, 1996.
Nature of business
Franklin Credit Management Corporation (the "Company"), incorporated under the
laws of the State of Delaware, acquires non-performing, non-conforming and
sub-performing notes receivable, promissory notes, and real estate from
financial institutions, mortgage and finance companies and the Federal Deposit
Insurance Corporation ("FDIC"). The Company services and collects such notes
receivable through enforcement of terms of the original note, modification of
original note terms, and, if necessary, liquidation of the underlying
collateral.
In January, 1997 a new wholly owned subsidiary, Liberty Lending Corp.
("Liberty") was formed, to originate or purchase, through wholesale agreements
with correspondents, sub-prime residential mortgage loans to individuals whose
borrowing needs are generally not being served by traditional financial
institutions. Liberty is currently licensed as a mortgage banker in the states
of Connecticut, Massachusetts, New York, New Jersey, Washington DC, Maryland,
Pennsylvania and Florida. Additionally, Liberty has received approval from the
US Housing and Urban Development ("HUD") Administration to originate Federal
Housing Administration ("FHA") Title II loans. Liberty's application as a
licensed mortgage banker in the state of Virginia is currently pending approval
with the Virginia State Banking Commissioner.
A summary of the Company's significant accounting policies follow:
Basis of financial statement presentation
The financial statements have been prepared in accordance with generally
accepted accounting principles and general practices similar to those of a
consumer finance company. In preparing the financial statements, management is
required to make estimates and assumptions that affect the reported amounts of
assets and liabilities as of the date of the balance sheet and revenue and
expenses for the period. Actual results could differ from those estimates and
the differences could be significant.
Basis of consolidation
The consolidated financial statements include the accounts of the Company and
wholly-owned subsidiaries controlled by the Company. By terms outlined in the
various agreements that are in effect, the Company is specifically afforded full
power and authority on behalf of its subsidiaries to manage, control, administer
and operate the business and affairs of the subsidiaries. All significant
intercompany accounts and transactions have been eliminated in consolidation.
Statement of Cash Flows
For purposes of reporting cash flows, the Company includes all cash accounts
(excluding restricted cash) and money market accounts held at financial
institutions. The Company maintains balances due from banks which,
Page 7
<PAGE>
at times, may exceed federally insured limits. The Company has not experienced
any losses from such concentrations.
The Company's notes receivable portfolio consists primarily of secured
consumer and real estate mortgage loans purchased from financial institutions,
mortgage and finance companies and the FDIC. Such notes receivable are generally
non-performing or under-performing at the time of purchase and accordingly are
usually purchased at a substantial discount from the principal balance
remaining.
Notes receivable are stated at the amount of unpaid principal, reduced by the
purchase discount and an allowance for loan losses. The Company has the ability
to hold its notes receivable until maturity, payoff, liquidation of collateral
or sale.
On January 1, 1995, the Company adopted Statement of Financial Accounting
Standards No. 114, "Accounting by Creditors for Impairment of a Loan," as
amended by Statement No. 118, "Accounting by Creditors for Impairment of a Loan
- - Income Recognition and Disclosures." The method utilized by the Company to
measure impairment of notes receivable prior to the adoption of Statement No.
114 was essentially equivalent to the method prescribed by Statement No. 114.
The effect of adopting Statement 114 was not significant to the operations of
the Company based on the composition of the notes receivable in the Company's
portfolio. Impaired notes are stated 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 secured. 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. Approximately 17% of the Company's note receivable portfolio
consists of smaller balance, homogeneous notes receivable which are collectively
evaluated for impairment and approximately 83% consists of larger balance notes
receivable secured by real estate which are individually evaluated for
impairment.
In general, interest on the notes receivable is calculated based on contractual
interest rates applied to daily balances of the 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 borrower's 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
non-accrual note is restored to accrual status when it is no longer delinquent
and collectibility of interest and principal is no longer in doubt. 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 and
the 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 that 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 uncollectability is recognized.
Page 8
<PAGE>
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
notes purchase discount based on management's assessment of the portion of
purchase discount that represents uncollectible 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 Company's portfolio of notes
receivable.
Management's judgment in determining the adequacy of the allowance is based on
the evaluation of individual notes receivable within the Company's portfolio,
the known and inherent risk characteristics and size of the 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 real estate notes receivable are collateralized by real estate
located throughout the United States with a concentration in the Northeast and
California. 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.
Other real estate owned
Other real estate owned ("OREO") consists of properties acquired through, or in
lieu of, foreclosure or other proceedings or portfolio acquisitions, and is
initially recorded at fair market value less estimated costs of disposal at the
date of foreclosure which establishes a new cost basis. After foreclosure, the
properties are held for sale and are carried at the lower of cost or fair market
value less estimated costs of disposal. If the OREO is acquired through a
portfolio purchase, the asset is carried at the lower of acquisition cost plus
any capital improvements or the fair market value less estimated costs of
disposal. Any write-down to fair market 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 market value of the underlying collateral. Property is evaluated regularly
to ensure that the recorded amount is supported by current fair market values
and valuation allowances are recorded as necessary to reduce the carrying amount
to fair market value less estimated cost to dispose. Revenue and expenses from
the operation of OREO 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 market value of the collateral,
while costs relating to holding the property are expensed. Gains or losses are
included in operations upon disposal.
Page 9
<PAGE>
Building, property and equipment
Building, property and equipment 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 adopted Statement of Financial Accounting Standards No. 122,
"Accounting for Mortgage Servicing Rights," on January 1, 1996. Statement No.
122 requires an entity which acquires mortgage servicing rights through either
purchase or origination of mortgage loans and subsequent sale or securitization
with servicing rights retained, to allocate the total cost of the mortgage
loans, 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.
Pension plan
The Company has a defined contribution retirement plan (the "Plan") covering all
full-time employees who have completed one year of service. Contributions to the
Plan are made in the form of payroll reductions based on employees' pretax
wages. Currently, the Company does not offer a matching provision for the Plan.
Income taxes
The Company recognizes income taxes under an asset and liability method. Under
this method, deferred tax assets are recognized for deductible temporary
differences and operating loss or tax credit carry forwards and deferred tax
liabilities are recognized for taxable temporary differences. Temporary
differences are the differences between the financial statement carrying amounts
of existing assets and liabilities and their respective bases. 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 enactment.
Earnings per common share
Primary earnings per share amounts are computed by dividing net income by the
weighted average number of shares actually outstanding plus the shares that
would be outstanding assuming the exercise of dilutive stock options and
warrants, which are considered common stock equivalents. The number of shares
that would be issued from the exercise of stock options and warrants has been
reduced by the number of shares that could have been purchased from the proceeds
at the average market price of the Company's stock. Earnings per common share
has been retroactively restated for the effects a one-for-five reverse stock
split consummated in 1996 and
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a four-for-one stock dividend (as a result of which stockholders held five
shares for each previously held share.) consummated in September of 1997.
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:
CASH, RESTRICTED CASH, ACCRUED INTEREST RECEIVABLE, OTHER RECEIVABLES AND
ACCRUED INTEREST PAYABLE: The carrying values reported in the balance
sheet are a reasonable estimate of fair value.
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.
SHORT-TERM BORROWINGS: The carrying amounts of the line of credit and
other short-term borrowings approximate their fair value.
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.
Recent accounting pronouncements
The Financial Accounting Standards Board has issued Statement No. 125,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishment
of Liabilities," effective for transfers and servicing of financial assets and
extinguishment of liabilities occurring after December 31, 1996. This Statement
provides financial reporting standards for the derecognition and recognition of
financial assets, including the distinction between transfers of financial
assets which should be recorded as sales and those which should be recorded as
secured borrowings. Certain provisions of Statement No. 125 are effective
beginning January 1, 1997, while other provisions are effective January 1, 1998.
The Company has adopted Statement No. 125 for transfers and servicing of
financial assets and extinguishment of liabilities during the year ended
December 31, 1997.
The Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 128, "Earnings per Share" in February, 1997. This
pronouncement establishes standards for computing and presenting earnings per
share, and is effective for the Company=s 1997 year-end financial statements.
The Company's management has determined that this standard will have no impact
on the Company's computation or presentation of net income per common share.
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ITEM 2. 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 management of 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 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,
business conditions and interest rates and 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 primary sources for loan
purchases, the status of relations between the Company and its primary Senior
Debt lender 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
undertakes no obligation to publicly release the results on any events or
circumstances after the date hereof or to reflect the occurrence of
unanticipated events.
LOAN AND OREO ACQUISITIONS. The Company purchased nine portfolios of
notes receivable, with an aggregate face value of $35,365,660 and a purchase
price of $17,503,609 or 49.5% of aggregate face value, and one portfolio of OREO
with a purchase price of $3,911,840 during the nine months ended September 30,
1997, as compared with purchases of five portfolios of notes receivable, with an
aggregate face value of $17,771,004 for an aggregate purchase price of
$10,360,46 or 58.2% of aggregate face value, and no portfolios of OREO, during
the nine months ended September 30, 1996. The Company believes that this 121%
increase in total acquisitions reflects the more competitive bids submitted by
the Company as a result of the reduction in its cost of funds. See"-Cost of
Funds." The Company did not acquire any portfolios of notes receivable during
the three months ended September 30, 1997 as compared with the purchases of two
portfolios of notes receivable with an aggregate face value of $8,883,055 for an
aggregate purchase price of $4,760,040 or 53.6% of aggregate face value during
the three months ended September 30, 1996. The Company believes that this
decrease reflected the availability of fewer portfolio offerings for bid during
the three months ended September 30, 1997 as compared with the three months
ended September 30, 1996. The Company acquired two portfolios of notes
receivable with an aggregate face value of $4,798,131 for aggregate purchase of
$2,753,886 or 57.4% of aggregate face value subsequent to the close of quarter
ended September 30, 1997. Based upon this acquisition and its historical fourth
quarter experience, the Company believes that acquisition activity will increase
during the fourth quarter of 1997.
In May 1997, the Company purchased a portfolio of $3.7 principal amount
of notes receivable from Preferred Credit Corporation ("PCC") for $1.8 million.
Although the Company conducted its own review of each loan file, it has come to
believe since the closing of the acquisition that certain information was
intentionally omitted or removed from such files or kept in another repository
of files which were not made available to the Company and that PCC intentionally
and materially misrepresented the status and quality of the notes receivable
included in the portfolio. Although, its estimate will be refined as the
purchased portfolio is seasoned, the Company currently believes that as much as
approximately 90% of the principal amount of the portfolio may be uncollectable,
due to debtor bankruptcies or senior credit foreclosures of the underlying
collateral. The Company has recorded, on its Consolidated Statement of Income a
Special Charge reflecting its current estimate of the uncollectable portion of
the purchase price of such portfolio.
The Company has initiated a suit and is seeking recision of the asset
purchase agreement or damages incurred in connection with the purchase. See
"Part II Item 1. Legal Proceedings." The Company's litigation
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counsel has advised the Company that it believes the Company has a substantial
probability of prevailing in such suit.
During the nine months ended September 30, 1997 and 1996 acquisitions
were funded through a term debt facility from a financial institution (the
"Senior Debt") of $21,415,449 and $10,366,175, respectively. The Senior Debt
facility provided for maximum availability of approximately $100 million at
September 30, 1997, of which approximately $78 million had been drawn down as of
such date. The Senior Debt lender has verbally informed the Company that it will
not deem approximately $11 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 $33 million available to purchase additional portfolios of notes
receivable.
The Company believes its continuing acquisitions will increase the
level of operating income during future periods. However, during the initial
period following acquisitions, the Company incurs the carrying costs of the
related Senior Debt and the administrative costs related to the new portfolios,
while payment streams are only generated once the loans are incorporated into
the Company's computerized loan tracking system and contact is made with the
borrower. Non-performing loans generate payment streams once such loans are
restructured or collection litigation is settled or successfully concluded.
In the ordinary course of business, the Company acquires properties
either from portfolio acquisitions or via foreclosures. Such properties are
classified as OREO and are evaluated regularly to ensure that recorded amounts
are supported by current fair market values.
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 and OREO portfolios. The Company
believes that its current infrastructure is adequate to service additional notes
receivable in its core business without any material increases in expenses.
There can be no assurance the Company will be able to acquire any additional
notes receivable or that it may do so on favorable terms. While management
believes that the acquisition of additional portfolios of notes receivable would
be beneficial, management does not believe that current operations would be
materially impacted if additional loan portfolios were not acquired during 1997.
COST OF FUNDS. Senior Debt accrues interest at a variable rate based
upon the prime rate. The weighted average interest rate on borrowed funds, which
include interest, amortization of origination fees, and service fees on Senior
Debt, decreased by approximately .85% to approximately to 8.85% for the nine
months ended September 30, 1997 from 9.70% for the nine months ended September,
30 1996. Management believes that any future decreases in the prime rate will
positively impact the net income of the Company, while increases may be expected
to negatively impact such net income.
The Company's decreased cost of funds reflects a reduction in interest
rates and fees negotiated with the Senior Debt lender in March 1997. Pursuant to
such reduction, effective February 28, 1997, Senior Debt incurred to finance
portfolio acquisitions after December 31, 1996 bears interest at the prime rate
and Senior Debt incurred prior to such date bears interest at the prime rate
plus 1.75% rather the prime rate plus 2.125%.
During the nine months ended September 30, 1996 and the first three
months of 1997 the Company incurred additional financing costs in the form of
service fees and loan commitment fees. The service fees were calculated as a
percentage of gross collections on four specific portfolios while loan
commitment fees are points based upon origination of Senior Debt. During March
1997 the Company negotiated the prospective elimination of such fees and payment
of a 1% exit fee upon completing repayment of the Senior Debt outstanding as of
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December 31, 1996, or approximately $700,000. If the funds collected from the
notes receivable underlying such Senior Debt are insufficient to satisfy the
related Senior Debt and exit fee, any shortfall up to the amount of the exit fee
will be forgiven.
The Company's portfolio included Senior Debt of approximately $78.6
million as of September 30, 1997 compared to $73.5 million as of September 30,
1996.
INFLATION. The impact of inflation on the Company's operations was
immaterial during both the nine months ended September 30, 1997 and the nine
months ended September 30, 1996.
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 1997 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 1996
Total revenue, comprised of interest income, purchase discount earned,
gain on sale of portfolios, gain of sale of other real estate owned and other
revenue, increased by $1,059,715 or 33% to $4,300,936 for the three months ended
September 30, 1997, from $3,241,221 for the three months ended September 30,
1996.
The Company recognizes as interest income on notes receivable included
in its portfolio interest on performing notes, interest received with settlement
payments on non-performing notes and the balance of settlements in excess of the
carried principal balance. Revenues from interest income on notes receivable
increased by $30,657 or 2%, to $1,505,860 for the three months ended September
30, 1997 from $1,475,203 for the three months ended September 30, 1996. This
increase resulted primarily from restructuring and rehabilitation of certain
non-performing and sub-performing notes receivable and the acquisitions of notes
receivable since the third quarter of 1996, which were only partially offset by
the sale of certain performing notes receivable sold since the third quarter of
1996. The majority of the loans purchased by the Company bear interest at a
fixed rate; consequently, changes in market interest rates to not directly
materially affect interest income. A bulk sale of notes receivable with a face
principal amount of $2,744,262 was consummated on the last day of the quarter
ended September 30, 1997 and, therefore, did not impact interest income during
the three months ended September 30, 1997.
Purchase discount earned increased by $502,071 or 30%, to $2,198,879
for the three months ended September 30, 1997 from $2,198,879 for three months
ended September 30, 1996. This increase reflected the acquisition of additional
of notes receivable since the last quarter of 1996, which was only partially
offset by the aging of the portfolio and sales of performing notes receivable
during the second and third quarters of 1997.
Gain on sale of portfolios increased by $404,119 for the three months
ended September 30, 1997 from $0 for the three months ended September 30, 1996.
This increase resulted from the increased frequency of notes receivable sales as
the Company continues to pursue its policy of restructuring non-performing loan
to performing status, seasoning them and selling them at economically
advantageous prices.
Gain on sale of OREO increased by $76,443 to $76,443 for the three
months ended September 30, 1997 from $0 for the three months ended September 30,
1996. This increase resulted from the Company's more aggressive marketing of its
OREO properties and the larger inventory of OREO available for sale resulting
form increased foreclosure activity and OREO portfolio acquisition.
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Total revenue as a percentage of net notes receivable included in the
Company's portfolio as of the last day of the respective quarters, net of
allowance for loan losses, was 5.9% for the three months ended June 30, 1997
from 5.4% for the three months ended June 30, 1996. This increase reflected the
increase in revenue generating activities, described above, which outpaced the
growth in total net notes receivable for such time periods.
Total operating expenses increased by $472,859 or 14%, to $3,776,357
for the three months ended September 30, 1997 from $3,303,498 for the three
months ended September 30, 1996. Total operating expenses includes interest
expense, collection, general and administrative costs, provisions for loan
losses, service fees, amortization of loan commitment fees and depreciation
expense.
Interest expense increased by $142,740 or 7.3%, to $2,085,835 for the
three months ended September 30, 1997 from $1,943,095 for the three months ended
September 30, 1996. This increase reflected increased average total debt
outstanding of $9.4 million, or 14.2%, to $76 million for the three months
September 30, 1997, as compared with $66.6 million for the three months ended
September 30, 1996, which was only partially offset by a reduction in the
weighed average interest rate of the Company's total outstanding debt. Total
debt includes Senior Debt, debentures, lines of credit and loans from
affiliates. The increase in total debt and interest expense reflected increased
borrowings to purchase portfolios of notes receivable and OREO.
Amortization of loan origination fees increased by $17,105 for the
three months ended September 30, 1997 or 16% to $126,007 from $108,902 for the
three months ended September 30, 1996. This increase reflected the increased
principal collection from the Company's borrowers in the three months ended
September 30, 1997.
Service fee expenses decreased by $96,439 for the three months ended
September 30, 1997 to $0 from 96,439 for the three months ended September 30,
1996. This reflects the renegotiation of the Company's Senior Debt obligations.
See "- General - Cost of Funds".
Collection, general and administrative expenses increased by $543,845
or 57%, to $1,565,531 for the three months ended September 30, 1997 from
$1,000,300 for the three months ended September 30, 1996. Collection, general
and administrative expenses include personnel expenses, OREO related expenses,
litigation expenses and all other overhead expenses.
Personnel expenses increased by $161,583 or 59%, to $434,436 for three
months ended September 30, 1997 from $272,853 for three months ended September
30, 1996. This increase reflected the staffing of Liberty Lending, an upgrade in
staffing for existing positions and the commensurate increase in salary for
those positions.
OREO expenses increased by $83,386 or 94%, to $171,990 for the three
months ended September 30, 1997 from $88,604 for the three months ended
September 30, 1996. This increase resulted from the increased carrying costs
associated with the increase in OREO properties. Properties held as OREO as of
September 30, 1997, increased by $6,460,703 or 136%, to $11,197,788 from
$4,737,085 as of December 31, 1996. This increase reflected increased
foreclosure activity resulting from the growth in size of the Company's
portfolio and the Company's OREO acquisitions.
Litigation expenses increased by $97,759 or 31%, to $414,951 for the
three months ended September 30, 1997 from $317,192 for the three months ended
September 30, 1996. This increase reflected both an increase in the quantity of
notes receivable purchased by the Company and a decreased loan-to-value ratio of
notes receivable purchased by the Company. The Company believes that the latter
decrease gave rise to a more
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assertive legal defense by borrowers attempting to preserve their collateral,
thereby increasing the Company's legal expense.
Direct collection expenses decreased by $3,126 or 9% to $31,452 for the
three months ended September 30, 1997 from $34,578 for the three months ended
September 30, 1996. This decrease reflected a decrease in the number of
performing notes receivable as a result of bulk sales as well as more efficient
collection methods which lead to improved payment patterns of the Company's
borrowers.
Provisions for loan losses decreased by $155,665 or 112%, to a negative
$16,938 for three months ended September 30, 1997 from $138,727 for three months
ended September 30, 1996. Provisions for loan losses, for the three months ended
September 30, 1997 and three months ended September 30, 1996, expressed as a
percentage of net notes receivable as of the last day of the respective periods,
was approximately -0.02% and 0.23%, respectively. A negative provision for loan
loss typically represents an improved performance or settlements on seasoned
loans, which have had their loss provision established and fixed.
Operating income increased by $589,856 to $524,579 for the three months
ended September 30, 1997 from an operating loss of $62,277 for the three months
ended September 30, 1996 for the reasons set forth above.
Settlement income increased by $239,500 to $295,000 for the three
months ended September 30, 1997 from $55,500 for the three months September 30,
1996. This increase reflects an improvement the performance of a receivable
arising in connection with certain claims of the Company against certain
principals of its corporate predecessor.
In connection with what the Company believes is its having been
defrauded in its purchase during May, 1997 of a portfolio of notes receivable
from Preferred Credit Corporation, the Company has taken a $1.5 million charge
to income during the three months ended September 30, 1997 in order to create a
reserve for what it has discovered to be the impaired value of such portfolio.
See "General- Pending Litigation." The portfolio was purchased for approximately
$1.8 million and the Company currently expects approximately $300,000 of the
notes receivable in the portfolio to be collectible. The Company is currently
vigorously pursuing legal remedies from PCC and has been advised by its
litigation counsel that it has a substantial probability of prevailing in such
suit. See "Part II. Item 1. Legal Proceedings."
Provisions for income taxes decreased by $805,894 to a benefit $764,530
for the three months ended September 30, 1997 from a provision of $41,364 for
the three months ended September 30, 1996. This decrease resulted from the
Company's overestimation of its tax liabilities during the first six months of
1997, as a result its overly-conservative assumption that its available loss
carry forwards would be exhausted in its 1996 tax return, which was filed on
September 15, 1997.
Net income, exclusive of the special charge and tax benefits arising
from such event, increased by $901,750 to $853,609 in the three months ended
September 30, 1997 from a loss of $48,141 for the three months ended September
30, 1996. Net income, increased by $132,250 to $84,109 for the three months
ended September 30, 1997 from a loss of $48,141 for the three months ended
September 30,1996.
NINE MONTHS ENDED SEPTEMBER 30, 1997 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
1996
Total revenue increased by $1,664,394 or 16% to $12,335,475 for the
nine months ended September 30, 1997, from $10,671,081 for the nine months ended
September 30, 1996.
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Revenues from interest income on notes receivable increased by $14,155
or .2%, to $4,666,408 for the nine months ended September 30, 1997 from
$4,652,253 for the nine months ended September 30, 1996. This increase resulted
primarily from restructuring and rehabilitation of certain non-performing and
sub-performing notes receivable and the acquisitions of notes receivable since
the third quarter of 1996 which were only partially offset by the sale of
certain performing notes receivable sold since the third quarter of 1996. A bulk
sale of notes receivable with a face principal amount of $2,744,262 was
consummated on the last day of the quarter ended September 30, 1997 and,
therefore, did not impact interest income during the nine months ended September
30, 1997.
Purchase discount earned increased by $507,316 or 11%, to $5,293,710
for the nine months ended September 30, 1997 from $4,786,394 for the nine months
ended September 30, 1996. This increase reflected the acquisition of additional
notes receivable since the last quarter of 1996, which was only partially offset
by the aging of the portfolio and sales of performing notes receivable during
the second and third quarters of 1997.
Gain on sale of portfolios increased by $399,935, or 41%, to $1,377,454
for the nine months ended September 30, 1997 from $977,519 for the nine months
ended September 30, 1996. This increase resulted from the increased frequency of
loan sales as the Company continues to pursue its policy of restructuring
non-performing loan to performing status, seasoning them and selling them at
economically advantageous prices.
Gain on sale of OREO increased by $723,319 to $759,882 for the nine
months ended September 30, 1997 from $36,563 for the nine months ended 30, 1996.
This increase resulted from the Company's more aggressive marketing of its OREO
properties and the larger inventory of OREO available for sale resulting form
increased foreclosure activity and OREO portfolio acquisition.
Total revenue as a percentage of net notes receivable included in the
Company's portfolio as of the last day of the nine months ended September 30,
1997 increased to 17.0% for the nine months ended September 30, 1997 from 17.8%
for the nine ended September 30, 1996. This decrease resulted primarily from the
increase in net notes receivable, which outpaced the increase in revenue
generating activities for such periods.
Total operating expenses increased by $643,862 or 6%, to $10,556,614 in
the nine months ended September 30, 1997 from $9,912,752 in the nine months
ended September 30, 1996.
Interest expense increased by $479,293 or 8.4%, to $6,209,639 in the
nine months ended September 30, 1997 from $5,730,346 for nine months ended
September 30, 1996. This increase reflected increased average total debt of
outstanding of $9.4 million, or 14.8% to $76 million for the nine months ended
September 30, 1997 as compared with $66.6 million for the nine months ended
September 30, 1996, which was only partially offset by a reduction in the
weighed average interest rate of the Company's total outstanding debt.
Service fees decreased by $261,558 or 89%, to $31,395 for the nine
months ended September 30, 1997 from $292,953 for the nine months ended
September 30, 1996. This decrease resulted from a reduction in service fees
negotiated with the Company's Senior Debt lender in September 1996 and the
elimination of service fees negotiated with the Company's Senior Debt lender
effective February 28, 1997 See "General - Cost of Funds."
Amortization of loan origination fees decreased $10,204 for the nine
months ended September 30, 1997 or 2% to $435,337 from $445,541 for the nine
months ended September 30, 1996. Amortization of loan origination fees related
to bulk notes receivable sales gain on sale of notes receivable rather than
included in amortization of loan origination fees.
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Collection, general and administrative expenses increased by $930,497
or 33%, to $3,746,062 for the nine months ended September 30, 1997 from
$2,815,565 for the nine months ended September 30, 1996.
Personnel expenses increased by $250,503 or 30%, to $1,087,805 for the
nine months ended September 30, 1997 from $837,302 for the nine months ended
September 30, 1996. This increase reflected the staffing of Liberty Lending, an
upgrade in staffing for existing positions and the commensurate increase in
salary for those positions.
OREO expenses increased by $143,644 or 60%, to $347,491 for the nine
months ended September 30, 1997 from $203,847 for the nine months ended
September 30, 1996. This increase resulted from the increased carrying costs
associated with the increase in OREO properties. Properties held as OREO as of
September 30, 1997, increased by $6,460,703 or 136%, to $11,197,788 from
$4,737,085 as of December 31, 1996. This increase reflected increased
foreclosure activity resulting from the growth in size of the Company's
portfolio and the Company's OREO acquisitions.
Litigation expenses increased by $146,091 or 17%, to $994,560 for the
nine months ended September 30, 1997 from $848,469 for the nine months ended
September 30, 1996. This increase reflected both an increase in the quantity of
notes receivable purchased by the Company and a decreased loan-to-value ratio of
notes receivable purchased by the Company. The Company believes that the latter
decrease gave rise to a more assertive legal defense by borrowers attempting to
preserve their collateral, thereby increasing the Company's legal expense.
Direct collection expenses relating to credit reports and repossession
fees, decreased by $35,059 or 16%, to $188,654 for the nine months ended
September 30, 1997 from $223,713 for the nine months ended September 30, 1996.
This decrease reflected a decrease in the number performing notes receivable as
a result of bulk sales as well as more efficient collection methods which lead
to improved payment patterns of the Company's borrowers.
Operating income increased by $1,020,532 or 135%, to $1,778,861 for the
nine months ended September 30, 1997 from income of $833,829 for the nine months
ended September 30, 1996.
Settlement income increased by $219,500 to $295,000 for the nine months
ended September 30, 1997 from $75,500 for the nine months September 30, 1996.
This increase reflects an improvement the performance of a receivable arising in
connection with certain claims of the Company against certain principals of its
corporate predecessor.
In connection with what the Company believes is its having been
defrauded in its purchase during May, 1997 of a portfolio of notes receivable
from Preferred Credit Corporation, the Company has taken a $1.5 million charge
to income during the three months ended September 30, 1997 in order to create a
reserve for what it has discovered to be the impaired value of such portfolio.
See "General- Pending Litigation." The portfolio was purchased for approximately
$1.8 million and the Company currently expects approximately $300,000 of the
notes receivable in the portfolio to be collectible. The Company is currently
vigorously pursuing legal remedies from PCC and has been advised by its
litigation counsel that it has a substantial probability of prevailing in such
suit. See "Part II. Item 1. Legal Proceedings."
The Provision for income taxes decreased by $203,487 to a benefit of
$41,765 for the nine months ended September 30, 1997 from $161,722 for the nine
months ended September 30, 1996. This increase resulted from higher taxable
income.
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Net income, exclusive of the special charge and tax benefits arising
from such event, increased by $713,019 to $1,385,126 for the nine months ended
1997 from $672,107 for the three months ended 1996. Net income, decreased by
$56,481 to $615,626 for the three months ended September 30, 1997 from a loss of
$672,107 for the three months ended September 30,1996.
LIQUIDITY AND CAPITAL RESOURCES
GENERAL. The Company purchased nine portfolios of notes receivable,
with an aggregate face value of $35,365,660 and a purchase price of $17,503,609
or 49.5% of aggregate face value, and one portfolio of OREO with a purchase
price of $3,911,840 during the nine months ended September 30, 1997, as compared
with purchases of five portfolios of notes receivable, with an aggregate face
value of $17,771,004 for an aggregate purchase price of $10,336,175 or 58.2% of
aggregate face value, and no portfolios of OREO, during the nine months ended
September 30, 1996. The Company believes that its increased purchases reflected
attractive market opportunities, the reduction in the Company's cost of funds,
redirection of portfolio acquisition efforts to private negotiated purchases
from independent financial institutions from the FDIC/RTC competitive bid
auctions, and the increased name recognition of the Company achieved as a result
of its hiring of a public relations firm in the fourth quarter of 1996.
During the nine months ended September 30, 1997, the Company
renegotiated its credit arrangements with its Senior Lender thereby reducing its
cost of funds and increasing its price competitiveness. See "- General - Cost of
Funds". The Company believes that the redirection of its marketing efforts and
the reduction in its cost of funds have enhanced its competitiveness.
The Company's portfolio of notes receivable at September 30, 1997 had a
face value of approximately $117.9 million and net of purchase discount,
allowance for loan losses, and joint venture participation included net notes
receivable of approximately $72.4 million. The Company's portfolio of notes
receivable at September 30, 1996 had a face value of approximately $103.7
million and included net notes receivable of approximately $59.8 million. The
Company has the ability to hold its notes receivable until maturity, payoff or
liquidation of collateral or sale, however, the Company's strategy is to
restructure its notes to performing status, then arrange an economically
beneficial sale of these assets.
During the nine months ended September 30, 1997, the Company used cash
in the amount of $6,367,453 in its operating activities primarily for interest
expense, ordinary litigation expense incidental to its collection efforts and
for the foreclosure and improvement of OREO and overhead. The Company generated
$23,012,513 from its investment activities, primarily from the principal
collection of $13.3 million, sale of performing notes receivable for $7.4
million and the sale of OREO for $2.1 million, which were only partially offset
by uses of $20,606,206 primarily from the acquisitions of notes receivable for
$19.9 million, resulting in net sources of cash from investing activities of
$3,026,148. The Company generated $23,337,018 from its financing activities
primarily from Senior Debt of $22.8 million which was only partially offset by
uses of $18,618,870 primarily from the principal repayment of $18.1 million
resulting in source of $4,726,148. The above activities resulted in a net
increase of cash for the nine months ended September 30, 1997 of $1,384,843.
In the ordinary course of its business, the Company accelerates and
forecloses upon real estate securing non-performing notes receivable included in
its portfolio. As a result of such foreclosures and the direct purchase of OREO
portfolios, at September 30, 1997 and September 30, 1996, the Company held OREO
having a net value of $11,197,788 and $6,239,973, respectively. OREO is recorded
on the financial statements of the
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Company at the lower of cost or fair market value less estimated costs of
disposal. The Company generally holds OREO as rental property or sells such OREO
in the ordinary course of business when it believes such sales to be
economically beneficial. The Company has implemented a strategy of capitalizing
on the OREO processing capabilities developed in its notes receivable business
by purchasing portfolios of OREO when it believes that they may be purchased at
a discount to the value of the properties when purchased individually and
processing such OREO as it would an OREO acquired upon foreclosure of notes
receivable.
On September 30, 1997 and 1996, the Company held no automobile
inventory. The approximate face amount of notes receivable collateralized by
automobiles was $251,563, or .20% of total notes receivable, with an estimated
collectable balance of $146,154, or .15% of total collectable balances, at
September 30, 1997. The Company has ceased to purchase notes receivable secured
by automobiles. Management believes that any additional automobile inventory
acquired in the ordinary course of business from the Company's remaining
automobile loans will be sold.
Management believes that the Company's existing cash balances, credit
lines, and anticipated cash flow from operations will provide sufficient working
capital resources for its anticipated short-term operating needs. In the first
quarter of 1997 the Company negotiated with its Senior Debt lender a
modification of the terms of its funding of cash flows for operation, which may
improve cash flows. See "Cash Flow from Financing Activities". The modifications
permit the Company to retain operating cash flows in connection with budgeted
expenditures to operate the Company after the current principal, interest and
escrow obligations are met. Funds remaining after such obligations have been met
are used first to fund the Company's budgeted operating cash flows, and then to
fund certain reserve agreements, with any remaining funds to be applied toward
the prepayment of Senior Debt. During October, 1997, the Company negotiated with
its Senior Debt lender an adjustment to the amortization of its outstanding
Senior Debt to take into account the fact that as a result of the interaction of
the required payment provisions of the Senior Debt and the Company's sale or
collection of certain notes receivable had resulted in the Company repaying the
Senior Debt far more quickly than provided for under the minimum payment
provisions. The expected impact of the adjusted amortization will be to reduce
the required minimum principal payments under the Senior Debt. Management
estimates that the impact of such reduction for October 1997 will be to reduce
the required minimum monthly payment by approximately 24%.
In order to expand its capacity to fund Liberty and to support
increases in its borrowing for the purchase of portfolios of notes receivable,
the Company, on June 2, 1997 entered into a letter of intent (the "Letter of
Intent") for a best efforts private offering by the Company of a minimum of $4.0
million and a maximum of $6.3 million of the Company's equity securities to
accredited investors. There can be no assurance that the offering will be
successful and that any of the offered securities will be sold, and if sold,
that such sale will be on terms favorable to the Company. In the event that the
offering is consummated, the securities offered thereby will not have been
registered with or approved or disapproved by the Securities and Exchange
Commission or any state securities commission or will the Securities and
Exchange Commission or any state commission have passed upon the accuracy or
adequacy of any documentation under which such securities are sold. Any
representation to the contrary will be a criminal offense.
In the event that such offering is not consummated, the Company will
consider other alternatives for financing its medium-term growth. There can be
no assurance that such alternative sources of financing will be available, and
if available, that such availability will be on terms favorable to the Company.
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CASH FLOW FROM OPERATING AND INVESTING ACTIVITIES
Substantially all of the assets of the Company are invested in its
portfolio of notes receivable and OREO. The Company's primary source of cash
flow for operating and investing activities is collections on notes receivable
and the sale of OREO. See "General". At September 30, 1997, the Company had
cash, cash equivalents and marketable securities of approximately $4.6 million.
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 bulk sale of performing loan portfolios, continued modifications
to the secured debt credit agreements or additional borrowing, to repay the
current liabilities arising from operations and to repay the long term
indebtedness of the Company.
From time to time, the Company seeks merger and acquisition
opportunities of companies in the specialty financing industry. For example, in
May, 1997, the Company through its wholly owned subsidiary Liberty Lending
Corporation ("Liberty"), entered into a letter of intent (the "Letter of
Intent") to acquire certain assets and retain a principal of K Mortgage
Corporation ("K"), an originator specializing in Federal Housing Administration
mortgages under the FHA/203K program. Although this acquisition may not be fully
consummated due to the resignation of K's principal, Liberty continues to seek
to enter the market for 203K and other mortgage products. In addition to seeking
candidates for merger and acquisitions in specialty finance areas, the Company
engaged an executive search firm to assist it in identifying and retaining
experienced personnel to add such specialty products to Liberty's mortgage
product line. Although the Company from time to time engages in discussions and
negotiations with respect to acquisitions, except as discussed herein, it
currently has no agreements with respect to any material acquisition.
CASH FLOW FROM FINANCING ACTIVITIES
SENIOR DEBT. As of September 30, 1997, the Company and its wholly owned
subsidiaries owed an aggregate amount of approximately $78 million of Senior
Debt.
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, bulk sales of performing notes receivable and sales
of OREO. The loan agreements for the Senior Debt call for minimum interest and
principal payments each month; a fixed monthly allowance for operating expenses
and accelerated payments based upon the collection of the notes receivable
securing the debt during the preceding month. During October, 1997, the Company
negotiated with its Senior Debt lender an adjustment to the amortization of its
outstanding Senior Debt to take into account the fact that as a result of the
interaction of the required payment provisions of the Senior Debt and the
Company's sale or collection of certain notes receivable had resulted in the
Company repaying the Senior Debt far more quickly than provided for under the
minimum payment provisions. The expected impact of the adjusted amortization
will be to reduce the required minimum principal payments under the Senior Debt.
Management estimates that the impact of such reduction for October 1997 will be
to reduce the required minimum monthly payment by approximately 24%. The Senior
Debt accrues interest at variable rates ranging from the prime rate to 1.75%
over the prime rate. See "General - Cost of Funds." 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; the second requires a further
amount to be applied toward additional principal reduction from available cash
after scheduled principal and interest payments have been made.
The first quarter of 1996 the Company negotiated with its Senior Debt
lender the elimination of service fees, reduce the interest rates and increase
the portion of collections retained by the Company for operations after
Page 21
<PAGE>
payment of its contractual principal, interest and escrow payments, rather than
applied to payment of its Senior Debt. Management believes this may reduce
periods of irregular cash flows, however, there can be no assurance that the
Company will not encounter periods of cash flow shortages. See "- General - Cost
of Funds".
Certain of the Senior Debt loan 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 restricted cash is maintained in an interest bearing account, with
the Senior Debt lender. Restricted cash may be accessed by the lender only upon
the Company's failure to meet the minimum monthly payments due if collections
from notes receivable securing the loan are insufficient to satisfy the
installment due. Historically, these reserves have not been called on for this
purpose. The aggregate balance of restricted cash on December 31, 1997 was
$1,238,541, which included $262,450 in escrow balances held by Liberty on behalf
of borrowers or other lenders, the balance compares to restricted cash on
September 30, 1996 of $828,845.
LINES OF CREDIT. The Company has a line of credit 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 lines is due six months from the date of each cash advance and interest
is payable monthly. The total amounts outstanding under the lines of credit as
of September 30, 1997 and December 31, 1996, were $559,618 and $583,916,
respectively. Advances made under the line of credit were used to satisfy senior
lien positions and fund property capital improvements in connection with
foreclosures of certain real estate loans financed by the Company. Management
believes the ultimate sale of these properties will satisfy the related
outstanding lines of credit and accrued interest, as well as surpass the
collectible value of the original secured notes receivable. Management has an
agreement in principal with its Senior Debt lender to increase 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.
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 at
September 30, 1997 $532,800 of these debentures were outstanding and at December
31, 1996, $555,000 of these debentures were outstanding. The Harrison 1st 12%
Debentures bear interest at the rate of 12% per annum payable in quarterly
installments. The principal is to be repaid over three years in ten equal
quarterly installments of $22,200 commencing September 30, 1997 with the
remaining balloon payment of $333,000 due September 30, 2000. The Harrison 1st
12% Debentures are secured by a lien on the Company's interest in certain notes
receivable and are subordinated to the Senior Debt encumbering its portfolio of
notes receivable.
12% DEBENTURES. In connection with the acquisition of a loan portfolio
during 1994, the Company offered to investors $750,000 of subordinated
debentures of which $705,000 were issued. As of September 30, 1997 and December
31, 1996, $440,625 and $396,562, respectively, of these debentures were
outstanding. The 12% Debentures bear interest at the rate of 12% per annum
payable in quarterly installments. The principal is to be repaid over four years
in sixteen equal installments of $44,062 which payments commenced on March 31,
1996. The 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.
Page 22
<PAGE>
PART II
ITEM 1. LEGAL PROCEEDINGS
On August 19, 1997 the Company filed suit in the United States District
Court for the Southern District of New York against Preferred Credit
Corporation, and Todd Rodriguez and Lori Cartwright, each of whom is alleged to
be or have been a director or employee of PCC. In its complaint, the Company
alleges common law fraud and negligent misrepresentation, unjust enrichment and
breach of contract, in connection with a purchase by it of a portfolio of notes
receivable from PCC in May, 1997. See "Part I Pending Litigation." The Company
is seeking recision of its purchase or compensatory, consequential and
incidental damages, as well as all of its costs, fees and interest. The Company
is currently seeking pretrial discovery.
The Company has been advised by its litigation counsel that it believes
that the Company has a substantial probability of prevailing and intends to
vigorously pursuing a recovery.
ITEM 2. CHANGES IN SECURITIES
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On June 11, 1997 at the Company's annual meeting the shareholders voted
to reelect the following persons as Directors to the Company expiring upon the
election and qualification of their successors at the annual meeting of the
Company in the year 2000 and to ratify the appointment of McGladrey & Pullen,
LLP as the Company's independent public auditors for fiscal year ending December
31, 1997. The vote tabulation does not reflect the effects of a stock dividend
consummated after the date of such meeting.
DIRECTOR FOR AGAINST NOT VOTING TOTAL
- ---------------------- ------- ------- ---------- ---------
Thomas J. Axon 970,088 158 133,213 1,103,459
Frank B. Evans, Jr. 970,088 158 133,213 1,103,459
Steven W. Lefkowitz 970,088 158 133,213 1,103,459
INDEPENDENT PUBLIC AUDITORS FOR AGAINST ABSTAIN NOT VOTING TOTAL
- --------------------------- ------- ------- ------- ---------- ---------
McGladrey & Pullen, LLP 969,948 100 198 133,213 1,103,459
ITEM 5. OTHER INFORMATION
None
Page 23
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) EXHIBIT TABLE
EXHIBIT
NO. DESCRIPTION
3(a) Restated Certificate of Incorporation. Previously
filed with, and incorporated 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.
4(a) 15% Convertible Subordinate Debentures. 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.
(b) Warrants associated with principal repayment of
the 15% Convertible Subordinated Debentures.
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.
(b) Reports on Form 8-K. None
Page 24
<PAGE>
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.
November 18, 1997 FRANKLIN CREDIT MANAGEMENT
CORPORATION
By: THOMAS J. AXON
-------------------------------------
Thomas J. Axon
President and Chief Executive Officer
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.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
<S> <C> <C>
THOMAS J. AXON President, Chief Executive Officer November 18, 1997
- -------------------- and Director -----------------
Thomas J. Axon (Principal executive officer)
FRANK B. EVANS, Jr. Vice President, Treasurer, November 18, 1997
- -------------------- Chief Financial Officer and Director ------------------
Frank B. Evans, Jr. Secretary (Principal financial and
accounting officer)
JOSEPH CAIAZZO Vice President, Chief Operating November 18, 1997
- --------------------- Officer and Director -----------------
Joseph Caiazzo
</TABLE>
Page 25
<PAGE>
EXHIBIT 11
COMPUTATION OF EARNINGS PER SHARE THIRD QUARTER 1996
<TABLE>
<CAPTION>
NO. OF SHARES WEIGHT
------------- ------
<S> <C> <C> <C>
12/31/95 Common stock 5,503,896
O/S warrants 137,674
--------------
5,641,570 25% 1,388,015
03/31/96 Common stock 5,503,896
O/S warrants 127,349
Warrants exercised 10,225
--------------
5,641,470 25% 1,387,965
06/30/96 Common stock 5,503,896
O/S warrants 127,349
Warrants exercised (17,216)
Stock options 209,500
--------------
5,823,529 25% 1,478,995
==============
==============
06/30/96 Common stock 5,503,896
O/S warrants 127,349
Warrants exercised (17,216)
Stock options 209,500
--------------
5,823,529 25% 1,478,995
---------------
==============
22,930,098
==============
WEIGHTED AVERAGE NUMBER OF SHARES 5,733,969
Earnings per Common share:
Net Income $ 672,107 $ 0.12
FOOTNOTE: THIS IS A REFLECTION OF THE STOCK SPLIT AND
THE 4 FOR 1 STOCK DIVIDEND.
Page 26
<PAGE>
COMPUTATION OF EARNINGS PER SHARE 3RD QUARTER 1997
NO. OF SHARES WEIGHT
------------- ------
12/31/96 Common stock 5,503,896
O/S warrants
(extended for 1 year) 110,133
Stock options 209,500
------------
5,823,529 25% 1,455,882
03/31/97 Common stock 5,503,896
O/S warrants 110,133
(extended for 1 year)
Stock options 209,500
------------
5,823,529 25% 1,455,882
06/30/97 Common stock 5,503,896
O/S warrants 110,133
(extended for 1 year)
Stock options 209,500
------------
5,823,529 25% 1,455,882
09/30/97 Common stock 5,503,896
O/S warrants 110,133
(extended for 1 year)
Stock options 209,500
------------
5,823,529 25% 1,455,882
--------------
============
23,294,116
============
WEIGHTED AVERAGE NUMBER OF SHARES 5,823,529
Earnings per Common share:
Net Income $ 615,626 $ 0.11
</TABLE>
FOOTNOTE: THIS IS A REFLECTION OF THE STOCK SPLIT AND
THE 4 FOR 1 STOCK DIVIDEND.
Page 27
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM
FRANKLIN CREDIT MANAGEMENT CORPORATION'S FINANCIAL STATEMENTS INCLUDED
IN ITS FORM 10QSB FOR THE FISCAL QUARTER ENDED SEPTEMBER 30, 1997 AND
IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<CURRENCY> U.S. Dollars
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<EXCHANGE-RATE> 1.00
<CASH> 3,352,808
<SECURITIES> 0
<RECEIVABLES> 118,571,393
<ALLOWANCES> 30,185,751
<INVENTORY> 11,197,780
<CURRENT-ASSETS> 5,753,441
<PP&E> 697,886
<DEPRECIATION> 47,226
<TOTAL-ASSETS> 88,819,925
<CURRENT-LIABILITIES> 5,753,441
<BONDS> 0
55,167
0
<COMMON> 0
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 88,819,925
<SALES> 0
<TOTAL-REVENUES> 12,335,475
<CGS> 0
<TOTAL-COSTS> 10,556,614
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 86,915
<INTEREST-EXPENSE> 6,209,639
<INCOME-PRETAX> 573,861
<INCOME-TAX> (41,765)
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 1,500,000
<NET-INCOME> 615,626
<EPS-PRIMARY> 0.11
<EPS-DILUTED> 0.11
</TABLE>
