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 March 31, 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 incorporation or organization) (I.R.S. Employer 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)
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
As of May 15, 197, 1,103,483 shares of the issuer's Common Stock, par value
$.01 per share were outstanding.
<PAGE>
FRANKLIN CREDIT MANAGEMENT CORPORATION
FORM 10-QSB
MARCH 31, 1997
C O N T E N T S
PART I. FINANCIAL INFORMATION Page
Item 1. Financial Statements
Consolidated Balance Sheets March 31, 1996 (unaudited)
and December 31, 1996 3
Consolidated Statements of Income (unaudited) for the
three months ended March 31, 1997 and 1996 4
Consolidated Statement of Cash Flows (unaudited) for the
three months ended March 31, 1997 and 1996 5
Consolidated Statements of Stockholders' Equity 6
Notes to Consolidated Financial Statements 7-12
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 13-19
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 20
Item 2. Changes in Securities 20
Item 3. Defaults Upon Senior Securities 20
Item 4. Submission of Matters to a vote of Security-Holders 20
Item 5. Other Information 20
Item 6. Exhibits and Reports on Form 8-K 20
SIGNATURES 21
Page 2
<PAGE>
Item 1. Financial Statements
FRANKLIN CREDIT MANAGEMENT CORPORATION AND AFFILIATES
<TABLE>
<CAPTION>
CONSOLIDATED BALANCE SHEETS
<S> <C> <C>
31-Mar-97 31-Dec-96
ASSETS (unaudited) (audited)
- ------------------------------------------------------------------------------- -----------------
Cash $ 3,164,721 $ 1,967,964
Restricted cash 706,767 828,845
Notes Receivable:
Principal amount 113,576,198 113,610,782
Joint venture participations (354,809) (360,395)
Purchase discount (16,917,055) (18,160,403)
Allowance for loan losses (23,082,598) (23,604,810)
----------- -----------
Net notes receivable 73,221,736 71,485,174
Accrued interest receivable 857,836 1,132,370
Other real estate owned 6,325,978 4,737,085
Other receivables 400,471 421,392
Other assets 683,936 704,695
Building, furniture & fixtures, net 630,938 640,749
Deferred financing costs 1,310,936 1,358,874
----------- -----------
$87,303,318 $83,277,148
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
- -------------------------------------------------------------------------------
Liabilities:
Accounts payable and accrued
expenses $ 2,017,733 $ 1,874,267
Lines of credit 873,079 583,916
Notes payable 77,716,367 73,538,865
Subordinated debentures 1,039,687 1,025,000
Notes payable, affiliates and
stockholders 245,839 373,218
Deferred income taxes 1,495,008 1,778,862
---------- -----------
Total liabilities 83,387,714 79,174,128
Commitments and contingencies
Stockholder's Equity:
Common Stock, $.01 par value,
10,000,000 authorized shares,
issued and outstanding 1997 and 1996:
1,102,077 11,022 11,022
Additional paid-in capital 6,534,113 6,534,113
Accumulated deficit (2,629,532) (2,442,115)
----------- -----------
Total stockholders' equity 3,915,603 4,103,020
Total liabilities and ----------- -----------
stockholders' equity $87,303,318 $83,277,148
=========== ===========
</TABLE>
See Notes to Consolidated Financial Statements.
Page 3
<PAGE>
Item 1. Financial Statements
FRANKLIN CREDIT MANAGEMENT CORPORATION AND AFFILIATES
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENTS OF INCOME
Period ended March 31, 1997 and 1996
<S> <C> <C>
Three Months Ended
31-Mar-97 31-Mar-96
(unaudited) (unaudited)
- --------------------------------------------------------------------------------
Revenue:
Interest income $1,275,264 $1,808,679
Purchase discount earned 1,583,225 1,303,367
Gain on sale of other real
estate owned 34,268 -
Other 68,396 76,697
---------- ----------
2,961,152 3,188,743
---------- ----------
Operating expenses:
Interest Expense 1,955,355 1,891,120
Collection, general
and administrative 994,876 854,390
Provision for loan losses 96,012 206,726
banking service fees 31,395 216,317
Amortization of deferred
financing costs 55,259 98,928
Depreciation 15,672 15,796
---------- ----------
3,148,569 3,283,277
---------- ----------
Operating loss (187,417) (94,534)
---------- ----------
Provision for income taxes - -
---------- ----------
Net loss $ (187,417) $ (94,534)
========== ==========
Earnings per common share:
Net loss $ (0.16) $ (0.08)
---------- ----------
Weighted average number of shares
outstanding 1,164,706 1,128,294
========== =========
</TABLE>
See Notes to Consolidated Financial Statements.
Page 4
<PAGE>
Item 1. Financial Statements
FRANKLIN CREDIT MANAGEMENT CORPORATION AND AFFILIATES
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENT OF CASH FLOWS
Fiscal Three Months ended March 31, 1997 and 1996
<S> <C> <C>
31-Mar-97 31-Mar-96
(unaudited) (unaudited)
- --------------------------------------------------------------------------------
Cash Flows From Operating Activities
Net loss $ (187,417) $ (94,534)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation, depletion, amortization 70,931 114,724
Purchase discount earned (1,583,225) (1,303,367)
Provision for loan losses 96,012 206,726
Changes in assets and liabilities:
(Increase) decrease in:
Accrued interest receivable 274,535 21,699
Accounts receivable 28,422 (1,165,624)
Inventory repossessions (1,502,595) (1,532,550)
Other assets 8,427 40,707
Increase (decrease) in:
Accounts payable and accrued expenses 221,871 713,455
Due to affiliates (80,548) (74,500)
------------ -----------
Net cash used in operating activities (2,653,586) (3,073,264)
Cash Flows From Investing Activities
Purchase of property and equipment (5,861) 30,794
Purchase of notes receivable (5,813,924) -
Principal collections on notes receivable 5,207,348 8,145,629
Joint venture participation (12,928) (63,859)
Acquisition fees paid (66,206) -
(Increase) in restricted cash 122,079 (11,122)
------------ -----------
Net cash used in investing activities (569,492) 8,101,442
Cash Flows From Financing Activities
Payments on debenture notes payable - (58,750)
Proceeds from lines of credit 362,298 235,733
Payments on lines of credit (73,135) (858,086)
Proceeds from long-term debt 7,813,050 -
Principal payments of long-term debt (3,682,379) (2,730,966)
------------ -----------
Net cash provided by financing activities 4,419,834 (3,412,069)
------------ -----------
Net increase in cash 1,196,756 1,616,109
Cash:
Beginning 1,967,965 1,335,800
------------ -----------
Ending $ 3,164,721 $ 2,951,909
============ ===========
</TABLE>
See Notes to Consolidated Financial Statements.
Page 5
<PAGE>
Item 1. Financial Statements
FRANKLIN CREDIT MANAGEMENT CORPORATION AND AFFILIATES
<TABLE>
<CAPTION>
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
<S> <C> <C> <C> <C> <C>
Common Stock Additional Retained
------------------ Paid-In Earnings
Shares Amount Capital (Deficit) Total
- -------------------------------------------------------------------------------
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 - -
Net income 829,153 829,153
---------------------------------------------------------
Balance,
December 31, 1996 1,102,077 11,022 6,534,113 (2,442,115) 4,103,020
Net loss (187,417) (187,417)
---------------------------------------------------------
Balance,
March 31, 1997 1,514,151 $11,022 $6,534,113 $(2,629,532) $3,915,603
===================================================
</TABLE>
See Notes to Consolidated Financial Statements.
Page 6
<PAGE>
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 and promissory notes 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 original note, modification of original note
terms, and, if necessary, liquidation of the underlying collateral.
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
its 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 amounts due from banks which at times may
exceed federally insured limits. The Company has not experienced any losses from
such concentrations.
Page 7
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Notes Receivable and Income Recognition
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
purchase discount and an allowance for loan losses. The Company has the ability
and intent to hold its notes until maturity, payoff, liquidation of collateral
or sale of the notes receivable.
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 effect of adopting Statement 114 was
not significant to the operations of the Company based on the composition of the
notes receivable portfolio and because 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.
Impaired notes are measured based on the present value of expected future cash
flows dcounted 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 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
non-accrual 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
Page 8
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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.
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 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 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 real estate 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.
Other real estate owned
Other real estate owned ("OREO") consists of properties acquired through, or in
lieu of, foreclosure or other proceedings and is initially recorded at fair
value at 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 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.
Page 9
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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.
Page 10
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 of the 1996 one-for-five reverse
stock split.
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.
Page 11
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Recent accounting pronouncement
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 believes that the effect of the adoption of Statement No. 125 will
not be material to its financial position or results of operations.
Page 12
<PAGE>
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 Acquisitions. During the three months ended March 31, 1997
("1st Quarter 1997") bids submitted by the Company to acquire six loan
portfolios in an aggregate principal amount of $19,471,285, at an average
acquisition price of approximately 64% of aggregate principal amount were
accepted. Purchases of three of the six portfolios, or $7,359,655 of notes
receivable for an aggregate purchase price of $5,851,515, were consummated
during 1st Quarter 1997. Purchases of the remaining three portfolios, or
$12,111,630 of notes receivable for an aggregate purchase price of $6,564,806,
were consummated during April 1997. During the three months ended March 31, 1996
("1st Quarter 1996") the Company did not acquire any loan portfolios.
Acquisition of the six portfolios was funded through term debt facilities from a
financial institution (the "Senior Debt") of approximately $12,700,000. Total
Senior Debt funding capacity was approximately $100,000,000 at March 31, 1997,
of which approximately $77,300,000 had been drawn down as of such date.
The Company believes these acquisitions will increase the level of interest
income and purchase discount income during future periods. During the initial
period following acquisitions, the Company incurs the carrying costs of the
related Senior Debt and administrative costs of new portfolios. Payment streams
are only generated once the loans are incorporated into the Company's
proprietary 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. The Company believes that its current
infrastructure is adequate to service additional loans without any material
increases in expenses. There can be no assurance the Company will be able to
acquire any additional loans or that it may do so on favorable terms. While
management believes that the acquisition of additional loan portfolios would be
beneficial, management does not believe that current operations would be
materially impacted if additional loan portfolios were not acquired during 1997.
Page 13
<PAGE>
Cost of Funds. The Company's cost of funds on Senior Debt during 1st
Quarter 1997 decreased as compared with previous periods. As of March 31, 1997,
the Company had twenty five loans outstanding with a financial institution with
an aggregate principal balance of approximately $77,300,000. References herein
to the Company's Senior Debt lender or lending arrangements refer to such
continuing lender or such continuing lender's lending arrangements. The Senior
Debt accrues interest at a variable rate based upon prime rate.
The majority of the loans purchased by the Company bear interest at a
fixed rate; consequently, there is little corresponding change in interest
income due to changes in market interest rate conditions. The weighted average
interest rate on borrowed funds for the Senior Debt decreased to approximately
10.07% in 1st Quarter 1997 from 10.53% in 1st Quarter 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 has renegotiated its interest rates with its Senior Debt lender
effective February 28, 1997. Pursuant to the new arrangement, Senior Debt
incurred to finance portfolio acquisitions after December 31, 1996, will bear
interest at the prime rate. Additionally, the Senior Debt lender agreed in March
1997 to a reduction in interest rate of .375% to prime plus 1.75% from prime
plus 2.125% on all Senior Debt outstanding as of December 31, 1996.
During 1st Quarter 1997 and 1st Quarter 1996 the Company also 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. Under the new arrangement the Company will cease
to pay service fees and will pay a 1% exit fee on all Senior Debt outstanding as
of December 31, 1996, or approximately $700,000. This exit fee is payable after
the underlying Senior Debt has been repaid in full. If the funds collected from
the underlying notes receivable are insufficient to satisfy the related
Senior Debt and exit fee, any shortfall up to the amount of the exit fee shall
be forgiven.
The impact of inflation on the Company's operations during both 1st Quarter
1997 and 1st Quarter 1996 was immaterial.
Results of Operations
Three Months Ended March 31, 1997 Compared to Three Months Ended March 31, 1996
Total revenue, comprised of interest income and purchase discount earned,
decreased by $227,591 or 7% to $2,961,152 in the 1st Quarter 1997, from
$3,188,743 in the 1st Quarter 1996. The Company recognizes interest income on
notes included in its portfolio based upon three factors: 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.
Page 14
<PAGE>
Revenues from interest income on notes receivable decreased by $533,415 or
29%, to $1,275,264 in 1st Quarter 1997 from $1,808,679 in 1st Quarter 1996. This
decline resulted primarily from the increased age of loans in the Company's
portfolios, which results in a larger portion of payments on such loans being
credited to principal rather than interest, and the bulk sale in June 1996 of
$6,311,404 in face amount of performing loans, which loans, had they continued
to perform, could have been expected to produce approximately $160,000 of
interest income during 1st Quarter 1997. Purchase discount earned increased by
$279,858 or 21%, to $1,583,225 in 1st Quarter 1997 from $1,303,367 during 1st
Quarter 1996. The increase in purchase discount earned reflects both an
increased size in the Company's portfolio of loans and the improved collection
experience of certain notes included in the portfolio. Total revenue as a
percentage of notes receivable included in the Company's portfolio as of the
last day of the relevant quarter, net of allowance for loan losses during 1st
Quarter 1997 was 3.3% as compared with 3.8% during 1st Quarter 1996.
Total operating expenses decreased by $134,708 or 4%, to $3,148,569 in
1st Quarter 1997 from $3,283,277 in 1st Quarter 1996. Total operating expenses
includes collection, general and administrative costs, provisions for loan
losses, interest expense, service fees, amortization of loan commitment fees and
depreciation expense.
Collection, general and administrative expenses increased by $140,486 or
16%, to $994,876 in 1st Quarter 1997 from $854,390 in 1st Quarter 1996.
Collection, general and administrative expenses include personnel expenses, OREO
related expenses, litigation expenses and all other overhead expenses. Personnel
expenses increased by $37,859 or 13%, to $327,476 for 1st Quarter 1997 from
$289,617 for 1st Quarter 1996. This increase reflected the staffing of Liberty
Lending and salary increases granted to existing personnel. OREO related
expenses decreased by $26,628 or 34%, to $52,455 in 1st Quarter 1997 from
$79,083 in 1st Quarter 1996. This decrease reflected the increased quality of
properties securing the loans being purchased by the Company, which decreased
the cost of rehabilitating the properties following foreclosure. Properties held
as OREO as of March 31, 1997, increased by $1,586,854 or 33%, to $6,323,939 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. Litigation expenses increased by $129,129 or 66%, to $324,294 in 1st
Quarter 1997 from $195,165 in 1st Quarter 1996. This increase reflected both an
increase in 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 increase 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 $126 or 0.04%, to $290,651 for 1st
Quarter 1997 from $290,525 for 1st Quarter 1996. This decrease reflected
economies of scale resulting from the growth in size of the Company's portfolio.
Provisions for loan losses decreased by $110,714 or 54%, to $96,012 for
1st Quarter 1997 from $206,726 for 1st Quarter 1996. This decrease reflected the
improved performance in 1st Quarter 1997 of certain notes receivable. Bad debt
expense expressed as a percentage of gross notes receivable during 1st Quarter
1997 and 1st Quarter 1996, as of the last day of the appropriate quarter, was
approximately 0.1 % and 0.2 %, respectively.
Interest expense increased by $64,235 or 3%, to $1,955,355 in 1st Quarter
1997 from $1,891,120 in 1st Quarter 1996. Total debt was $79,874,972 as of March
31, 1997 as compared with $68,618,969 as of March 31, 1996, which was
substantially offset by a reduction of 460 basis points in the weighed average
interest rate. Total debt includes Senior Debt, debentures, lines of
credit and loans from affiliates.
Page 15
<PAGE>
Service fees decreased by $184,922 or 85%, to $31,395 in 1st Quarter 1997
from $216,317 in 1st Quarter1996. This decrease resulted from a reduction in
service fees negotiated with the Company's Senior Debt lender in June 1996, and
the elimination of service fees negotiated with the Company's Senior Debt lender
effective February 28, 1997.
Operating loss increased by $92,883 or 98%, to $187,417 in 1st Quarter 1997
from $94,534 in 1st Quarter 1996. This decrease resulted primarily from the
reduction in interest income upon notes receivable which was only partially
offset by the increase in purchase discount earned, the reduction of service
fees, the improved performance and the resolution of notes receivable.
Loss before taxes increased by $92,883 or 98%, to $187,417 in 1st
Quarter 1997 from $94,534 in 1st Quarter 1996. Net loss increased by $92,883 or
98%, to $187,417 in 1st Quarter 1997 from $94,534 in 1st Quarter 1996, for the
reasons described above.
Liquidity and Capital Resources
General. During 1st Quarter 1997, the Company purchased notes receivable
with a face value of $7,359,655 at a cost of $5,851,515 as compared with
purchases of no notes receivable during 1st Quarter 1996. The Company believes
that this increase reflected increased market opportunities, the reduction in
the Company's cost of funds, redirection to private negotiated purchases from
independent financial institutions from the FDIC/RTC competitive bid auctions,
the re-organization of the Company's senior management during the 1st Quarter
1996 and the increased name recognition of the Company achieved by the hiring of
a public relations firm in the fourth quarter on 1996.
During 1st Quarter 1997, the Company renegotiated its credit
arrangements with its senior lenders thereby reducing its cost of funds and
increasing its price competitiveness. See "- General - Cost of Funds". All of
the loans acquired by the Company during 1996 were acquired after the second
quarter. The Company believes that the redirection of its marketing efforts and
the reduction in its cost of funds has enhanced its competitiveness.
The Company's portfolio of notes receivable at March 31, 1997 had a face
value of approximately $113.3 million and net of joint venture participation,
purchase discount and allowance for loan losses, had net notes receivable of
approximately $73.2 million. The Company's portfolio of notes receivable at
March 31, 1996 had a face value of approximately $105.7 million and had net
notes receivable of approximately $60.1 million. The Company has the ability and
intent to hold its notes until maturity, payoff or liquidation of collateral.
During 1st Quarter 1997, the Company used cash in the amount of $2,653,586
in its operating activities primarily for interest expense, ordinary litigation
expense incidental to its collections and for the foreclosure and improvement of
OREO and overhead. The Company used $5,776,840 in its investing activities,
primarily for the purchase of notes receivable which was only partially offset
by principal collections of $5,207,348 upon its notes receivable, resulting in a
net use of $569,492 in investing activities. The amount of cash used in
operating and investing activities was funded by $4,419,834 of net cash provided
by financing activities, primarily from a net increase in Senior Debt of
$7,813,050. The above activities resulted in a net increase in cash during 1st
Quarter 1997 of $1,196,756.
Page 16
<PAGE>
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, at the end of 1st Quarter 1997
and 1st quarter 1996, the Company held OREO having a net realizable value of
$6,325,978 and $5,318,201, respectively. OREO is recorded on the financial
statements of the Company at the lower of cost or fair market value. 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.
Management believes that the net increase in OREO Properties held as inventory
at March 31, 1997 is not material to the operations of the Company.
On March 31, 1997, the Company held no automobile inventory. Management
believes that any additional automobile inventory acquired in the ordinary
course of business from the Company's remaining automobile loans will be sold.
The Company has ceased to purchase notes receivable secured by automobiles.
Approximately $562,000 or 0.5 % of the Company's gross loan portfolio at March
31, 1997 was secured by automobiles.
On March 31, 1996, the Company held as inventory automobiles having a net
realizable value of $279,036 which it obtained through repossessions. Such
automobiles were recorded in the financial statements of the Company at the
lower of cost or fair market value.
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 operating needs. The Company has
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.
Cash Flow From Operating and Investing Activities
Substantially all of the assets of the Company are invested in its
portfolio of notes receivable. The Company's primary source of cash flow for
operating and investing activities is collections on notes receivable.See -
"General". At March 31, 1997, the Company had cash, cash equivalents and
marketable securities ofapproximately $2.1 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.
Page 17
<PAGE>
From time to time, the Company seeks merger and acquisition opportunities
of companies in the specialty financing industry. The Company through its wholly
owned subsidiary Liberty Lending Corporation ("Liberty"), recently entered into
a letter of intent (the "Letter of Intent") with K Mortgage Corporation ("K"),
an originator of certain classes of Federal Housing Administration
mortgages ("Qualified Products"). The Company believes that this transaction
will enable Liberty, subject to receipt of appropriate licenses and other
contingencies, to integrate K's existing network of mortgage brokers, Realtors
and potential home buyers as well as its remaining infrastructure, thereby
accelerating Liberty's entry into the mortgage loan origination industry.
Pursuant to the Letter of Intent, Liberty will acquire the right to certain
trademarks associated with K's business, enter into an employment agreement with
a two year term and a one year renewal term with one principal of K and into
consulting agreements with five year terms with the three additional principals
of K. In exchange, Liberty will pay to such principals an aggregate of 50% of
its Gross Profits (as defined in the Letter of Intent) on all Qualified Products
brought to the Company by such principals, payable quarterly for five years,
assume certain scheduled liabilities of K, not to exceed $350,000, which amount
shall be credited against the Gross Profit payments due to such principals, and
pay to the principal retained as an employee a salary of $104,000 per annum plus
benefits. The Company is currently completing its due diligence and expects to
complete this transaction during the third quarter of 1997. While, the Company
does not have a commitment to purchase any other companies, management is in the
process of reviewing certain opportunities. Depending upon circumstances this
may not 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 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 March 31, 1997, the Company and its wholly owned
subsidiaries owed an aggregate amount of approximately $77.3 million, under
twenty five loans, from a financial institution.
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
minimum interest and 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 variable rates ranging from
prime rate to 1.75% over the prime rate. 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. 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 minimum scheduled payments. While the
Senior Debt remains outstanding, these accelerated payment provisions may limit
the cash flow available to the Company.
The Company has negotiated with its Senior Debt lender to eliminate service
fees, reduce the interest rates and increase the portion of collections retained
by the Company for operations after 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".
Page 18
<PAGE>
Certain of the 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 restricted cash is maintained in a interest bearing account, with its
Senior Debt lender. Restricted cash may be accessed by the lender only upon the
Company's failure to meet the minimum monthly payment due if collections from
notes receivable securing the loan are insufficient to satisfy the installment
due. Historically, the Company has not called upon these reserves. The aggregate
balance of restricted cash in such accounts was $706,767 on March 31, 1997 and
$828,845 on December 31, 1996. During 1st Quarter 1997, in an effort to expedite
the new portfolio acquisitions, the Company was permitted by its Senior Debt
lender to use $196,672 of the reserve funds for a deposit upon a future
acquisition, and which deposit was recorded as "other assets" upon the financial
statements. The Company redeposited the amount in the reserve fund immediately
upon financing of the new deal.
Lines of Credit. This credit facility provides the Company the ability 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 are 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 March 31, 1997 and
1996, were $873,079 and $701,775, respectively. Advances made available to the
Company by its Senior Debt lender were used to satisfy senior lien positions and
fund property repair costs 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. Historically the Senior Debt
lender has provided extensions and the Company believes the Senior Debt lender
will continue to do so.
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. As of each of March 31, 1997 and March 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 June 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 the loan
portfolio.
12% Debentures. In connection with the acquisition of a loan portfolio
during 1994, the Company offered to investors $750,000 of subordinated
debentures. As of March 31, 1997 and March 31, 1996, $484,687 and $646,250,
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 19
<PAGE>
Item 1. Legal Proceedings
None
Item 2. Changes in Securities
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
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.
10(f) Letter of Intent between K Mortgage Corporation and
Liberty Lending Corporation.
(b) No reports on Form 8-K were filed during the first quarter of 1997.
Page 20
<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.
May 15, 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.
Signature Title Date
THOMAS J. AXON President, Chief Executive Officer May 15, 1997
Thomas J. Axon and Director
(Principal executive officer)
FRANK B. EVANS, Jr. Vice President, Treasurer, May 15, 1997
Frank B. Evans, Jr. Chief Financial Officer and Director
Secretary (Principal financial and accounting officer)
JOSEPH CAIAZZO Vice President, Chief Operating May 15, 1997
Joseph Caiazzo Officer and Director
Page 21
<PAGE>
Exhibit 11
<TABLE>
<CAPTION>
Computation of earnings per share first quarter 1996.
<S> <C> <C> <C> <C> <C>
Restated for
effect of
No. Of Shares Weight stock split
12/31/95 Common Stock 5,503,896
O/S warrants 137,674
5,641,470 50.00% 2,820,735 564,147.0
3/31/96 Common stock 5,503,896
O/S warrants 127,349
warrants exercised 10,225
5,641,470 50.00% 2,820,735 564,147.0
Weighted average number of shares 5,641,470 1,128,294
Earnings per Common share:
Net loss $94,534 $0.02 $0.08
</TABLE>
Page 22
<PAGE>
Exhibit 11
<TABLE>
<CAPTION>
Computation of earnings per share first Quarter 1997.
<S> <C> <C> <C> <C> <C>
Restated for
effect of
No. Of Shares Weight stock split
12/31/96 Common stock 5,503,896
O/S warrants
(Extended for 1 year) 110,133
Stock options 209,500
5,823,529 50.00% 2,911,765 582,352.9
3/31/97 Common stock 5,503,896
O/S warrants
(Extended for 1 year) 110,133
Stock options 209,500
5,823,529 50.00% 2,911,765 582,352.9
Weighted average number of shares 5,823,529 1,164,706
Earnings per Common share:
Net loss $259,271 $0.04 $0.22
</TABLE>
Page 23
<PAGE>
Exhibit 10(f)
LETTER AGREEMENT
The parties, K Mortgage Corporation ("K") and Liberty Lending Corporation
("Liberty") agree as follows:
1. On or prior to the effective date of this agreement, K shall deliver to
Liberty any and all training manuals, brochures, proprietary software,
methodologies and any other materials in its possession or control concerning
the processing, underwriting and similar materials relative to 203(k) lending
and processing.
2. Subject to K's compliance with its obligations under paragraphs 1, 3 and
11 hereof, as well as the due execution and delivery to Liberty of the
agreements described in paragraph 7 hereof, Liberty shall assume those
liabilities of K described in Schedule "A" annexed hereto. However, Liberty's
liabilities under Schedule "A" shall not exceed $350,000 and such $350,000 shall
be deemed an advance against the first profit distributions due K's principals
pursuant to paragraph 5 hereof. Liberty's undertakings thereunder are intended
solely for the benefit of K and nothing in this agreement is intended, nor shall
be construed, to give any of the creditors of K, including those listed in
Schedule "A" any right of action or claim against Liberty. K reserves the right,
but not the obligation, to undertake in negotiations with various creditors
listed in Schedule "A", and shall direct Liberty to make payments directly to
such creditors as agreements to satisfy such liabilities are made. Liberty
agrees to make such directed payments within seven days of receiving directions
from K.
3. On or prior to the effective date of this agreement, K shall transfer
the right to use the name, logo and trademarks associated with "K Mortgage".
4. Liberty agrees to use its best and reasonable efforts to process all
203(k), 203(b), Title I, HIML, CHIML and Small Project Program mortgages,
collectively known as the Qualified Products, wherever originated, as well as
any other mutually agreed upon Qualified Products brought to Liberty by the K
principals such that the revenue generated by the Qualified Products will be
computed as part of the gross profit formula stated herein.
5. Subject to their due execution and delivery to Liberty of the agreements
described in paragraph 7 hereof, the principals of K shall be entitled to a
payout equal to fifty (50%) percent of the Gross Profits derived from Qualified
Products including pooling, servicing, inspection fees, etc. or any other
mutually agreed upon Qualified Product, based on the following:
A. Gross Profit shall equal Gross Revenue minus (i) those direct costs
described on Schedule "B" hereto, (ii) one (1%) percent of the gross dollar
originations of Qualified Products, (iii) reserves required to be maintained by
Liberty under applicable laws, regulations or industry standards and (iv) losses
resulting from the sale of loans for less than Liberty's cost to originate same.
B. The Payout to K's principals shall aggregate fifty (50%) percent of
the Gross Profit.
C. The Payout Period shall begin on the first day of the calendar
quarter immediately following the effective date of this agreement and shall
extend for a period of five years.
D. The Payout shall occur on an annual basis, with estimated
quarterly Payouts made based on Liberty's internal non-audited financial
statements. The first four such quarterly Payouts shall be in the amount of
twenty (25%) percent of the amount then due to K. Liberty and K agree to
evaluate the cash flow characteristics of such Payouts and adjust the quarterly
Payout percent upward from twenty (25%) percent as warranted. The balance
Payments shall be made by Liberty to the K principals within thirty days of the
completion of Liberty's audited annual financial statements, but no later than
April 30th of each year.
Page 24
<PAGE>
E. Liberty shall supply quarterly financial reports to K.
F. The parties agree any operating losses resulting from the
calculation of the formula above shall be carried forward until recovered by
Liberty.
G. The parties agree any proposed change in the formula or its
components must be mutually agreed upon.
6. K Mortgage agrees to indemnify and hold Liberty harmless for any
claims, liabilities and expenses to third parties (including the liabilities
to K's creditors not expressly assumed by Liberty under paragraph 2 above)
resulting from the consummation of the transactions contemplated by this
agreement.
7. (a) On or prior to the effective date of this agreement, each of
Peter Ragan, Thomas R. Shane and Michael B. Shane shall execute a consulting
agreement with Liberty pursuant to which it shall agree to be available from
time to time to consult with, and not to compete with, Liberty in connection
with Qualified Products during the five year Payout Period. Liberty shall supply
drafts of such agreements to K within 14 days.
(b) Additionally, Liberty and James Ragan shall execute an
employment agreement for two years with an option for Liberty to extend the
employment for an additional one year thereafter, at a minimum of $104,000 per
annum salary plus a car, health insurance and all other benefits afforded other
Liberty employees. The employment agreement shall also contain James Ragan's
agreement not to compete with Liberty in connection with Qualified Products
during the five year Payout Period. Liberty shall supply a draft of such
agreement to K within 14 days.
Page 25
<PAGE>
(c) The consideration for their obligations under the foregoing
consulting agreements, each of Peter Ragan, Thomas R. Shane and Michael B. Shane
or their nominees shall be entitled to 25% of the Payout described in paragraph
5 above. As additional consideration for his undertakings contained in the
employment agreement, James Ragan shall be entitled to 25% of the Payout
described in paragraph 5 above.
8. K can, at its expense no more than once a year, and upon reasonable
notice, conduct an audit of Liberty's books and records.
9. Given the asset nature of this transaction, the parties agree no further
due diligence is required to proceed based on this letter agreement. However,
Liberty shall have the right to conduct due diligence prior to the effective
date of this agreement to verify the accuracy of the representations made in
paragraph 12 hereof as of such effective date.
10. The parties agree to bear its own costs in connection with this
agreement.
11. The effective date of this agreement shall be the day following
Liberty's becoming approved as a New York Mortgage Banker and its authorization
from HUD to originate Qualified Products. K represents that Liberty's New York
Mortgage Banking license will be obtained within 60 days from the date of this
agreement and that Liberty's HUD license will be obtained within 60 days of
Liberty's filing for such HUD license. Liberty agrees to file for its HUD
license immediately upon obtaining its first mortgage banking license from any
state. K acknowledges its receipt of copies of Liberty's application to the New
York and Connecticut State Banking Departments and Liberty's unfilled HUD
application.
12. K makes the following representations to Liberty, all of which
representations shall be true and complete as of the effective date of this
agreement:
(a) All existing material contracts and arrangements between k and its
sources of business (e.g., The Bank of New York, sales persons, brokers) are in
full force and effect and K has no knowledge of the existence of any facts,
cause or condition which will lead to the termination of any such arrangements;
(b) During the months of January, February and March, 1997, K has
originated approximately $10,500,000 of Qualified Product loans;
(c) During the month of April, 1997, K has originated approximately
$1,000,000 of Qualified Product loans;
(d) As of this day, K has no loans in inventory which it has closed
more than 10 days prior to the date hereof;
(e) K has no knowledge of the existence of any facts, cause or
condition which will lead to a decrease in the volume of 203(k) loan
originations; and
(f) K has no knowledge of the existence of any claims, liabilities,
lawsuits or governmental proceedings asserted or pending against it which K has
not expressly disclosed to Liberty, in writing signed by K's principals.
The parties hereto sign and seal this agreement this ninth day of May,
1997.
Liberty Lending Corporation K Mortgage Corporation
By: Marcia B. Vacacela By: James Ragan
Marcia Vacacela, President James Ragan, President
Page 26
<PAGE>
Schedule "A"
This schedule will be supplied to K and Liberty upon its availability.
_MV_ Initial (Liberty) _JR_ Initial (K Mortgage)
Page 27
<PAGE>
Schedule "B"
1. Interest cost of debt
2. Salaries and associated payroll taxes and expenses
3. Company fringe benefits, inclusive of auto insurance
4. All travel and entertainment expenses
5. Actual or allocated rent expense
6. Legal and account expenses
7. Supplies, equipment, postage and messenger expense
8. Marketing and public relation expense
9. Insurance and surety expense
10. Underwriting losses and/or loan loss reserves
11. Any other identifiable direct cost associated with originations
of Qualified Products.
12. Any monetary costs or losses caused in seeking recourse to K
based on its indemnification of Liberty and representations to
Liberty under this agreement.
_MV_ Initial (Liberty) _JR_ Initial (K Mortgage)
Page 28
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM MARCH
31, 1997, 10-QSB AND IS QUAILIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<CURRENCY> U.S. Dollars
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> MAR-31-1997
<EXCHANGE-RATE> 3.75
<CASH> 3,164,721
<SECURITIES> 0
<RECEIVABLES> 113,576,198
<ALLOWANCES> (23,082,598)
<INVENTORY> 6,325,978
<CURRENT-ASSETS> 0
<PP&E> 630,938
<DEPRECIATION> 0
<TOTAL-ASSETS> 87,303,318
<CURRENT-LIABILITIES> 83,387,714
<BONDS> 0
<COMMON> 11,022
0
0
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 87,303,318
<SALES> 0
<TOTAL-REVENUES> 2,961,152
<CGS> 0
<TOTAL-COSTS> 3,148,569
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 96,012
<INTEREST-EXPENSE> 1,955,355
<INCOME-PRETAX> (187,417)
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (187,417)
<EPS-PRIMARY> (0.16)
<EPS-DILUTED> (0.16)
</TABLE>
