10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
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þ |
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended June 30, 2010
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o |
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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 HOLDING CORPORATION
(Exact name of Registrant as specified in its charter)
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Delaware
(State or other jurisdiction of
incorporation or organization)
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26-3104776
(IRS Employer
Identification No.) |
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101 Hudson Street
Jersey City, New Jersey
(Address of Principal
Executive Offices)
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07302
(Zip code) |
(201) 604-1800
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months
(or for such shorter period that the registrant was required to
submit and post such files).
Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer or a smaller reporting company. See the definitions of large accelerated
filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
(Check one)
Large accelerated filer o |
Accelerated filer o |
Non-accelerated filer o
(Do not check if a smaller reporting company) | Smaller reporting company þ
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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o No
þ |
Number of shares of the registrants common stock, par value $0.01 per share, outstanding as of
August 11, 2010: 8,029,795
FRANKLIN CREDIT HOLDING CORPORATION
FORM 10-Q
INDEX
FRANKLIN CREDIT HOLDING CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
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June 30, 2010 |
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December 31, 2009 |
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ASSETS |
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Cash and cash equivalents |
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$ |
17,883,434 |
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$ |
15,963,115 |
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Restricted cash |
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2,542,820 |
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2,611,640 |
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Investment in REIT securities |
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477,316,409 |
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477,316,409 |
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Investment in trust certificates at fair value |
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57,973,017 |
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69,355,735 |
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Mortgage loans and real estate held for sale |
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288,747,674 |
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345,441,865 |
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Notes receivable held for sale, net |
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2,965,481 |
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3,575,323 |
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Accrued interest receivable |
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37,649 |
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|
41,337 |
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Deferred financing costs, net |
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7,223,844 |
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7,287,536 |
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Other receivables |
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4,422,164 |
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3,233,676 |
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Building, furniture and equipment, net |
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1,261,253 |
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1,529,418 |
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Income tax receivable |
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2,113,054 |
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5,592,370 |
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Other assets |
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1,032,838 |
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692,730 |
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Total assets |
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$ |
863,519,637 |
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$ |
932,641,154 |
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LIABILITIES AND STOCKHOLDERS (DEFICIT) |
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Liabilities: |
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Notes payable, net of debt discount of $189,825 at June 30, 2010
and $191,511 at December 31, 2009 |
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$ |
1,372,482,944 |
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$ |
1,367,199,323 |
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Financing agreements |
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1,000,000 |
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1,000,000 |
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Nonrecourse liability |
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288,747,674 |
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345,441,865 |
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Accounts payable and accrued expenses |
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4,385,865 |
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4,466,779 |
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Derivative liabilities, at fair value |
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9,958,645 |
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13,144,591 |
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Terminated derivative liability |
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8,200,000 |
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8,200,000 |
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Total liabilities |
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1,684,775,128 |
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1,739,452,558 |
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Commitments and Contingencies |
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Stockholders (Deficit): |
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Preferred stock, $0.001 par value; authorized 3,000,000;
issued and outstanding: none |
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Common stock and additional paid-in capital, $0.01 par value,
22,000,000 authorized shares; issued and outstanding: 8,029,795
at June 30, 2010 and 8,012,795 at December 31, 2009 |
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22,091,338 |
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22,067,763 |
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Noncontrolling interest in subsidiary |
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1,771,408 |
|
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1,657,275 |
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Accumulated other comprehensive (loss) |
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|
(7,092,924 |
) |
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|
(12,310,764 |
) |
Retained (deficit) |
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|
(838,025,313 |
) |
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|
(818,225,678 |
) |
|
|
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|
|
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Total stockholders (deficit) |
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|
(821,255,491 |
) |
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|
(806,811,404 |
) |
|
|
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Total liabilities and stockholders (deficit) |
|
$ |
863,519,637 |
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$ |
932,641,154 |
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See Notes to Consolidated Financial Statements.
3
FRANKLIN CREDIT HOLDING CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
THREE AND SIX MONTHS ENDED JUNE 30, 2010 AND 2009
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Three Months Ended June 30, |
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Six Months Ended June 30, |
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2010 |
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2009 |
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2010 |
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2009 |
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Revenues: |
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Interest income |
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$ |
10,876,369 |
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$ |
16,676,815 |
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$ |
22,351,597 |
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$ |
33,131,140 |
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Dividend income |
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10,629,300 |
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10,629,299 |
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21,258,599 |
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10,629,299 |
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Purchase discount earned |
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392,127 |
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Gain on recovery from contractual loan purchase rights |
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30,550,000 |
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30,550,000 |
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(Loss) on mortgage loans and real estate held for sale |
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|
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|
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(282,593,653 |
) |
(Loss) on valuation of investments in trust certificates
and notes receivable held for sale |
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|
|
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|
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|
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|
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(62,651,940 |
) |
Fair valuation adjustments |
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(10,900,755 |
) |
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|
(14,393,966 |
) |
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(14,671,797 |
) |
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|
(14,393,966 |
) |
Gain on sale of other real estate owned |
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|
|
|
|
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|
374,344 |
|
Servicing fees and other income |
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1,530,379 |
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1,717,609 |
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2,708,936 |
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4,227,166 |
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Total revenues/(losses) |
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12,135,293 |
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45,179,757 |
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31,647,335 |
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(280,335,483 |
) |
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Operating Expenses: |
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Interest expense |
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16,789,474 |
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17,117,236 |
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35,808,717 |
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34,800,392 |
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Collection, general and administrative |
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8,132,344 |
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6,905,713 |
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15,000,327 |
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25,598,708 |
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Provision for loan losses |
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|
169,479 |
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Amortization of deferred financing costs |
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29,055 |
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|
288,577 |
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63,692 |
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|
|
455,345 |
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Depreciation |
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142,289 |
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|
157,892 |
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|
287,801 |
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314,540 |
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Total expenses |
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25,093,162 |
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24,469,418 |
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51,160,537 |
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61,338,464 |
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|
|
|
|
|
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|
|
|
|
|
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(Loss)/income before provision for income taxes |
|
|
(12,957,869 |
) |
|
|
20,710,339 |
|
|
|
(19,513,202 |
) |
|
|
(341,673,947 |
) |
Income tax |
|
|
74,000 |
|
|
|
433,165 |
|
|
|
172,300 |
|
|
|
433,165 |
|
|
|
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|
|
|
|
|
|
|
|
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|
Net (loss)/income |
|
|
(13,031,869 |
) |
|
|
20,277,174 |
|
|
|
(19,685,502 |
) |
|
|
(342,107,112 |
) |
Net income attributed to noncontrolling interest |
|
|
48,802 |
|
|
|
|
|
|
|
114,133 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
Net (loss)/income attributed to common stockholders |
|
$ |
(13,080,671 |
) |
|
$ |
20,277,174 |
|
|
$ |
(19,799,635 |
) |
|
$ |
(342,107,112 |
) |
|
|
|
|
|
|
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|
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|
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Net (loss)/income per common share: |
|
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|
|
|
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|
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|
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Basic and diluted |
|
$ |
(1.63 |
) |
|
$ |
2.53 |
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|
$ |
(2.47 |
) |
|
$ |
(42.78 |
) |
|
|
|
|
|
|
|
|
|
|
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Weighted average number of shares outstanding: |
|
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|
|
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|
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|
|
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|
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|
|
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|
Basic and diluted |
|
|
8,021,295 |
|
|
|
8,000,295 |
|
|
|
8,020,731 |
|
|
|
7,997,170 |
|
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See Notes to Consolidated Financial Statements.
4
FRANKLIN CREDIT HOLDING CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS (DEFICIT)
SIX MONTHS ENDED JUNE 30, 2010
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Accumulated |
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Common Stock and |
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Noncontrolling |
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Other |
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Retained |
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Additional Paid-in Capital |
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Interest |
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Comprehensive |
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(Deficit)/ |
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Shares |
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Amount |
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in Subsidiary |
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Loss |
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Earnings |
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Total |
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BALANCE, JANUARY 1, 2010 |
|
|
8,012,795 |
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|
$ |
22,067,763 |
|
|
$ |
1,657,275 |
|
|
$ |
(12,310,764 |
) |
|
$ |
(818,225,678 |
) |
|
$ |
(806,811,404 |
) |
|
|
|
|
|
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|
|
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Stock-based compensation |
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17,000 |
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|
23,575 |
|
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|
|
|
|
|
|
|
|
|
|
|
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|
23,575 |
|
Net income attributed to minority interest |
|
|
|
|
|
|
|
|
|
|
114,133 |
|
|
|
|
|
|
|
|
|
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|
114,133 |
|
Amortization unrealized loss on derivatives |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5,217,840 |
|
|
|
|
|
|
|
5,217,840 |
|
Net (loss) attributed to common shareholders |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(19,799,635 |
) |
|
|
(19,799,635 |
) |
|
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BALANCE, JUNE 30, 2010 |
|
|
8,029,795 |
|
|
$ |
22,091,338 |
|
|
$ |
1,771,408 |
|
|
$ |
(7,092,924 |
) |
|
$ |
(838,025,313 |
) |
|
$ |
(821,255,491 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
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For the three months ended June 30, 2010, the total comprehensive loss amounted to $11.1
million, which was comprised of the net loss of $13.1 million and amortization of unrealized loss
on derivatives of $2.0 million. For the three months ended June 30, 2009, the total comprehensive
income amounted to $16.6 million, which was comprised of the net income of $20.3 million and
amortization of unrealized loss on derivatives of $3.7 million.
For the six months ended June 30, 2010, the total comprehensive loss amounted to $14.6
million, which was comprised of the net loss of $19.8 million and amortization of unrealized loss
on derivatives of $5.2 million. For the six months ended June 30, 2009, the total comprehensive
loss amounted to $334.5 million, which was comprised of the net loss of $342.1 million and
amortization of unrealized loss on derivatives of $7.6 million.
See Notes to Consolidated Financial Statements.
5
FRANKLIN CREDIT HOLDING CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED JUNE 30, 2010 AND 2009
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|
|
|
|
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|
|
Six Months Ended June 30, |
|
|
|
2010 |
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|
2009 |
|
CASH FLOWS FROM OPERATING ACTIVITIES: |
|
|
|
|
|
|
|
|
Net (loss) attributed to common shareholders |
|
$ |
(19,799,635 |
) |
|
$ |
(342,107,112 |
) |
Adjustments to reconcile net loss to net cash provided by operating activities: |
|
|
|
|
|
|
|
|
Gain on sale of other real estate owned |
|
|
|
|
|
|
(374,344 |
) |
Depreciation |
|
|
287,801 |
|
|
|
314,540 |
|
Amortization of deferred costs and fees on originated loans, net |
|
|
|
|
|
|
48,215 |
|
Loss on mortgage loans and real estate held for sale |
|
|
|
|
|
|
282,593,653 |
|
Loss on value of investment in trust certificates and notes receivable held for sale |
|
|
|
|
|
|
62,651,940 |
|
Fair valuation adjustments |
|
|
14,671,797 |
|
|
|
14,393,966 |
|
Principal collections on mortgage loans and real estate held for sale, net |
|
|
10,123,940 |
|
|
|
28,992,711 |
|
Paid in kind interest |
|
|
18,925,333 |
|
|
|
6,938,945 |
|
Proceeds from the sale of real estate held for sale |
|
|
7,781,706 |
|
|
|
22,251,806 |
|
Amortization of deferred financing costs |
|
|
63,692 |
|
|
|
455,345 |
|
Amortization of debt discount |
|
|
1,686 |
|
|
|
15,065 |
|
Stock-based compensation |
|
|
23,575 |
|
|
|
132,029 |
|
Purchase discount earned |
|
|
|
|
|
|
(392,127 |
) |
Provision for loan losses |
|
|
|
|
|
|
169,479 |
|
Net income attributed to noncontrolling interest |
|
|
114,133 |
|
|
|
|
|
Changes in operating assets and liabilities: |
|
|
|
|
|
|
|
|
Accrued interest receivable |
|
|
3,688 |
|
|
|
1,611,839 |
|
Other receivables |
|
|
(1,188,488 |
) |
|
|
(9,589,412 |
) |
Income tax receivable |
|
|
3,479,316 |
|
|
|
78,955 |
|
Other assets |
|
|
(340,106 |
) |
|
|
(293,227 |
) |
Transfer to fixed assets |
|
|
|
|
|
|
(127,190 |
) |
Accounts payable and accrued expenses |
|
|
1,950,980 |
|
|
|
(12,312,666 |
) |
Terminated derivative liability |
|
|
|
|
|
|
8,200,000 |
|
|
|
|
|
|
|
|
Net cash provided by operating activities |
|
|
36,099,418 |
|
|
|
63,652,410 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM INVESTING ACTIVITIES: |
|
|
|
|
|
|
|
|
(Increase)/decrease in restricted cash |
|
|
68,820 |
|
|
|
26,619,011 |
|
Principal collections on notes receivable |
|
|
408,018 |
|
|
|
10,813,027 |
|
Principal collections on loans held for investment |
|
|
|
|
|
|
5,857,079 |
|
Proceeds from sale of other real estate owned |
|
|
|
|
|
|
19,227,015 |
|
Purchase of building, furniture and equipment |
|
|
(19,639 |
) |
|
|
(6,201 |
) |
|
|
|
|
|
|
|
Net cash provided by investing activities |
|
|
457,199 |
|
|
|
62,509,931 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
CASH FLOWS FROM FINANCING ACTIVITIES: |
|
|
|
|
|
|
|
|
Principal payments of notes payable |
|
|
(13,643,399 |
) |
|
|
(82,109,940 |
) |
Payments on nonrecourse liability |
|
|
(20,992,899 |
) |
|
|
(51,244,519 |
) |
Principal payments of financing agreements |
|
|
|
|
|
|
(2,975,063 |
) |
Proceeds from financing agreements |
|
|
|
|
|
|
2,017,052 |
|
|
|
|
|
|
|
|
Net cash (used in) financing activities |
|
|
(34,636,298 |
) |
|
|
(134,312,470 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NET CHANGE IN CASH AND CASH EQUIVALENTS |
|
|
1,920,319 |
|
|
|
(8,150,129 |
) |
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD |
|
|
15,963,115 |
|
|
|
21,426,777 |
|
|
|
|
|
|
|
|
CASH AND CASH EQUIVALENTS, END OF PERIOD |
|
$ |
17,883,434 |
|
|
$ |
13,276,648 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: |
|
|
|
|
|
|
|
|
Cash payments for interest |
|
$ |
16,511,709 |
|
|
$ |
23,349,263 |
|
|
|
|
|
|
|
|
Cash payments for taxes |
|
$ |
368,145 |
|
|
$ |
268,154 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NON-CASH INVESTING AND FINANCING ACTIVITY: |
|
|
|
|
|
|
|
|
Transfer from notes receivable and loans held for investment to OREO |
|
$ |
|
|
|
$ |
20,566,413 |
|
|
|
|
|
|
|
|
See Notes to Consolidated Financial Statements.
6
FRANKLIN CREDIT HOLDING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BUSINESS
As used herein, references to the Company, Franklin, we, our and us refer to
Franklin Credit Holding Corporation, collectively with its subsidiaries.
Overview
Recent Developments
Sale of Trusts Loans, Loan Sale Servicing Agreement, New Trust Servicing Agreement, Amendment to
Licensing Credit Agreement and Other Agreements with The Huntington National Bank
On July 16, 2010, Franklin Credit Holding Corporation (Franklin Holding) and its servicing
business subsidiary, Franklin Credit Management Corporation (FCMC), entered into a letter
agreement (the Letter Agreement) with The Huntington National Bank (the Bank or Huntington),
Franklin Mortgage Asset Trust 2009-A, an indirect subsidiary of the Bank (the Trust) and, for
certain limited purposes, Thomas J. Axon. The Letter Agreement was entered into in connection with
and in anticipation of the Trusts then-proposed sale, on a servicing released basis (the Loan
Sale), of substantially all of the first-lien residential mortgage loans serviced by FCMC under
the servicing agreement by and among the Trust and FCMC dated March 31, 2009 (the Legacy Servicing
Agreement).
The Loan Sale closed on July 20, 2010 (the Loan Sale Closing Date) and, on July 20, 2010,
the Loan Sale purchaser (the Purchaser) entered into a loan servicing agreement with FCMC (the
Loan Sale Servicing Agreement), pursuant to which FCMC will continue to service what is expected
to be 75% of the first-lien residential mortgage loans acquired by Purchaser in the Loan Sale. The
Purchaser, which is now the second largest servicing client of FCMC, has the right, and has
indicated, that it intends to exercise its right on or about September 1, 2010, to move the
servicing of the other 25% of the loans acquired (based on unpaid principal balance), which FCMC is
continuing to service on an interim-only basis, to a servicer affiliated with Purchaser without
further notice and without the payment of a termination fee. Approximately 4,300 residential
mortgage loans, consisting principally of first-lien mortgage loans, with an unpaid principal
balance of approximately $626 million were included in the Loan Sale.
The Letter Agreement included terms amending, or committing the Bank, FCMC, the Company, and
related parties to amend certain of the restructuring agreements entered into in connection with
the Companys restructuring with the Bank on March 31, 2009, including the existing relationships
under the Legacy Servicing Agreement, the syndicated legacy amended and restated credit agreement
(the Legacy Credit Agreement), and the amended and restated licensing credit agreement (the
Licensing Credit Agreement), and commitments by FCMC to make certain payments to the Bank.
Additionally, the Letter Agreement set forth certain mutual commitments of the parties with respect
to the Companys consideration of a restructuring or spin-off of its ownership of FCMC (a
Potential Restructuring), as well as certain guaranties of Thomas J. Axon, the Chairman of the
Company and FCMC.
7
Letter Agreement with the Bank. Under the Letter Agreement with the Bank:
|
|
|
FCMC made a $1 million payment to the Bank as reimbursement for certain expenses of
the Bank in connection with the Loan Sale, which the Company expects will result in a
pre-tax $1 million charge to earnings in the third quarter ending September 30, 2010; |
|
|
|
|
FCMC released all claims under the Legacy Servicing Agreement as of the loan sale
date (other than those for unpaid servicing advances for services incurred prior to
June 30, 2010) with respect to the loans sold in the Loan Sale; |
|
|
|
|
FCMC refunded to the Trust an estimated $400,000 for servicing fees paid in advance
to FCMC under the Legacy Servicing Agreement in respect of July 2010 to the extent
attributable to the loans sold in the Loan Sale; |
|
|
|
|
The Legacy Servicing Agreement was terminated as to the loans sold, except with
respect to FCMCs obligations to assist in curing documentary issues or deficiencies
relating to the loans sold; and, |
|
|
|
|
FCMC and the Trust entered into an amended and restated servicing agreement (the
New Trust Servicing Agreement or Servicing Agreement) on July 30, 2010 and
effective August 1, 2010, relating to the servicing of the loans previously serviced
under the Legacy Servicing Agreement, other than those sold in the Loan Sale (see
below). |
On the Loan Sale Closing Date, the Company and FCMC entered into Amendment No. 2 to the
Licensing Credit Agreement with the Bank and an affiliate of the Bank, Huntington Finance, LLC
(Amendment No. 2).
Amendment No. 2 to the Licensing Credit Agreement with the Bank. Under Amendment No. 2 to the
Licensing Credit Agreement with the Bank:
|
|
|
FCMC used $1 million in unpledged cash to repay the amount outstanding under its
revolving line of credit with the Bank; and, |
|
|
|
|
Available credit under the revolving loan facility was reduced from $2 million to $1
million and the cash collateral securing the revolving loan and letter of credit
facilities was reduced from $8.5 million to $7.5 million, with the released collateral
applied as a voluntary payment against the debt outstanding of certain subsidiaries of
the Company under the Legacy Credit Agreement, which the Company expects will result in
a $1 million reduction of stockholders equity in the third quarter ending September
30, 2010. |
Loan Sale Servicing Agreement with Purchaser. On July 20, 2010, but effective as of July 1,
2010, FCMC entered into a loan servicing agreement with the Purchaser, pursuant to which FCMC will
continue to provide servicing for what is expected to be approximately 75% of the loans acquired by
the Purchaser in the Loan Sale (based on unpaid principal balance). The Purchaser, which is now
the second largest servicing client of FCMC, has the right to terminate the servicing of any of
such loans without cause upon ninety (90) calendar days prior written notice, subject to the
payment of a termination fee for each such loan terminated. Pursuant to the Loan Sale Servicing
Agreement, FCMC will service the loans subject to customary terms, conditions and servicing
practices for the mortgage servicing industry.
8
FCMC as servicer will receive a monthly servicing fee per loan per month with the amount
dependent upon loan status at the end of each month, resolution and disposition fees based on the
unpaid principal balance of loans collected from borrowers or gross proceeds from the sales of a
properties, as applicable, and a contingency fee for unpaid principal balance collected on loans
designated by the Purchaser, in addition to various ancillary fees and reimbursement of certain
third-party expenses.
Due to the ultimate retention of the servicing for what is expected to be approximately 75% of
the loans sold to Purchaser (based on unpaid principal balance) and the servicing fee rates under
the Loan Sale Servicing Agreement, the Company expects that the servicing fees to be paid by
Purchaser will be substantially less than the servicing fees that had been paid by the Trust for
such loan servicing, resulting in significantly reduced revenues for FCMC and the Company.
Potential Restructuring. In the Letter Agreement, the parties agreed that in connection with
a potential restructuring (the Potential Restructuring), if the Potential Restructuring is
acceptable to the Bank and the required lenders, in each partys sole discretion, and the Potential
Restructuring does not result in material tax, legal, regulatory, or accounting impediments or
issues for Franklin Holding or FCMC, then:
|
|
|
The Bank would use its reasonable efforts to assist Franklin Holding and FCMC in
connection with such Potential Restructuring in obtaining the approval of the required
lenders for the Potential Restructuring and consenting to any change of control in
connection with the Potential Restructuring to the extent required under the Legacy
Credit Agreement, and FCMC or Franklin Holding would reimburse and hold the Bank and
the required lenders harmless from any reasonable expense incurred by them in
connection with any such Potential Restructuring; |
|
|
|
|
FCMC would make semi-annual payments to the Bank under the Legacy Credit Agreement
(the EBITDA Payment) equal to (i) 50% of FCMCs EBITDA, in accordance with generally
accepted accounting principles (GAAP), for each period for the first 18 months from
the Loan Sale Closing Date, and (ii) 70% of FCMCs GAAP EBITDA for each period
thereafter, up to a maximum aggregate of $3 million; |
|
|
|
|
Thomas J. Axons existing personal guaranty to the Bank would be extended to the
EBITDA Payment pursuant to an amendment to the guarantee, which will also provide that
to the extent that the EBITDA Payment in respect of any period is less than $500,000,
Mr. Axon will pay such shortfall. Mr. Axons obligations pursuant to the guaranty
would be secured and continue to be secured by the collateral he had pledged to the
Bank on March 31, 2009; and, |
|
|
|
|
Any payments by FCMC or Mr. Axon in respect of the EBITDA Payment would go to reduce
the obligation of the other in respect of the obligations to make such payment, or the
guaranty in respect of such payment, as the case may be; and, any payments in respect
of the EBITDA Payments, and application of payments to the Bank in respect of
distributions by FCMC to its stockholders (in accordance with the March 2010 amendment
to the Licensing Credit Agreement and with the requirement under the Legacy Credit
Agreement that all such distributions to stockholders be accompanied by such
application such that such applications are not less than 70% of the total amounts of
such applications and distributions for any semi-annual period), would each serve as a
credit against the other, which could have the effect of reducing the impact of the $3
million maximum amount of the EBITDA Payments otherwise payable as described above.
See Note 7 Notes Payable and Financing Agreements. |
9
However, the form or structure of any Potential Restructuring is uncertain and as of the date
of this filing it is not known if any Potential Restructuring can be accomplished or even be
successfully completed.
New Trust Servicing Agreement. On July 30, 2010, FCMC entered into the New Trust Servicing
Agreement, effective August 1, 2010, with the Trust to replace the servicing agreement (the Prior
Agreement or Legacy Servicing Agreement) that had been entered into with the Trust as part of the
Companys March 31, 2009 restructuring with the Bank.
The New Trust Servicing Agreement, which contains terms that are generally similar to those
included in FCMCs Prior Agreement does, however, include the following material changes: (i) the
servicing fees for the second lien mortgage loans are based predominately on the percentage of
principal and interest collected and a per unit monthly service fee for only contractually
performing loans and loans in the early stages of bankruptcy (ii) the servicing fees for the first
lien mortgages and REO properties not sold to the Purchaser are based on a fee schedule from the
Loan Sale Servicing Agreement FCMC had entered into with Purchaser (as described above) (iii) the
servicing agreement is terminable without penalty and without cause on 90 days prior written
notice, or 30 days prior written notice in connection with a sale of some or all of the assets by
the Trust (iv) the consent process for hiring vendors was replaced with a general restriction that
vendors may not be engaged to perform a substantial portion of the primary day-to-day servicing
obligations of FCMC (v) minimum gross collection targets that could trigger a termination of the
agreement under certain circumstances were removed and (vi) the restrictions on entering into new
servicing agreements that could reasonably likely impair the ability of the FCMC to perform its
obligations were eliminated.
The Company anticipates that servicing revenues from the New Trust Servicing Agreement will be
significantly lower than those that had been earned under the Prior Agreement for those assets that
were not sold in the Loan Sale. In addition, the Bank has communicated to the Company that it is
committed to selling in the near future the second -lien mortgage loans owned by the Trust, and, if
and when it does, there is no assurance that the loans will be sold to a party that retains FCMC as
servicer.
See Note 11 Subsequent Events for a fuller description of the Loan Sale, Loan Sale
Servicing Agreement, New Trust Servicing Agreement, Amendment to Licensing Credit Agreement and
other agreements with the Bank, and for the Companys accounting treatment for the sale of the
loans by the Trust.
Investment in Huntington REIT Securities
The Companys investment in REIT securities includes preferred and common stocks of a REIT of
the Bank. On or about June 14, 2010, the REIT, in which the Company owned 4,724 shares of Class C
preferred stock and seven shares of common stock, was merged with another REIT of the Bank, with
the Company receiving, in exchange for preferred stock and common stock held in the initial REIT,
4,724 shares of Class C preferred stock and 154 shares of common stock of the combined REIT, which
did not constitute a change in the approximate fair value or carrying value of the Companys
investment. In addition, the terms of the new Class C shares of the combined REIT mirror the terms
of the Class C shares of the initial REIT. On July 23, 2010, the Company was verbally notified by
the Bank that due to losses recognized by the new combined REIT from a write down of the carrying
value of the mortgage loans owned by the Trust, the board of directors of the new combined REIT
decided not to declare any preferred dividends for the third and fourth calendar quarters of 2010.
The Bank indicated that the suspension of preferred dividends is temporary and that the new
combined REIT is expected to declare and pay dividends commencing in January 2011, including the
cumulative dividends for the third and fourth quarters of 2010. The Companys expected revenue
loss for the third and fourth quarters of 2010, therefore, is approximately $10.6 million (pre tax)
per quarter. Because the preferred stock is cumulative and unpaid dividends are, therefore,
accumulated, the suspended dividends may be recovered in 2011should the REIT then declare
dividends. The non payment of dividends will result in increased stockholders deficit for the
three months ended September 30 and December 31, 2010.
10
As a direct result of the new combined REIT not declaring dividends throughout the remainder
of 2010, the Company will be unable to pay its monthly interest due on Tranche A debt under the
Legacy Credit Agreement with the Bank. Accordingly, the Company, under the terms of the Legacy
Credit Agreement, anticipates that it will elect to accrue interest on Tranche A debt, to the extent
not paid (due to the temporary deferral of preferred dividends by the REIT), through distributions
made on the Companys investment in the trust certificates of the Trust, by adding the amount
unpaid to the outstanding principal balance of the Tranche A debt.
The Companys Business
March 2009 Restructuring
Effective March 31, 2009, Franklin Credit Holding Corporation (Franklin Holding), and
certain of its consolidated subsidiaries, including FCMC, entered into a series of agreements
(collectively, the Restructuring Agreements) with the Bank pursuant to which (i) the Companys
loans, pledges and guarantees with the Bank and its participating banks were substantially
restructured pursuant to the Legacy Credit Agreement, (ii) substantially all of the Companys
portfolio of subprime mortgage loans and owned real estate was transferred to the Trust (with the
loans and owned real estate transferred to the Trust collectively referred to herein as the
Portfolio) in exchange for trust certificates, with certain trust certificates, representing an
undivided interest in approximately 83% of the Portfolio, transferred in turn by the Company to
Huntington Capital Financing, LLC (the Initial REIT), a real estate investment trust wholly-owned
by the Bank, (iii) FCMC and Franklin Holding entered into the Licensing Credit Agreement, and (iv)
FCMC entered into the Legacy Servicing Agreement with the Bank (the Restructuring). See Note 7
Notes Payable and Financing Agreements and Note 11 Subsequent Events.
The Restructuring did not include a portion of the Companys debt (the Unrestructured Debt),
which as of June 30, 2010 totaled approximately $39.1 million, which remains subject to the
original terms of the Franklin forbearance agreement and subsequent amendments (the Franklin
Forbearance Agreement) and the Franklin 2004 master credit agreement, and most recently on June
28, 2010 was further extended until September 30, 2010. See Note 7 Notes Payable and Financing
Agreements Forbearance Agreements with Lead Lending Bank.
Expiration of Draw Facility under the Licensing Credit Agreement. On March 26, 2010, the
Company entered into an amendment to the Licensing Credit Agreement with the Bank, which renewed
and extended the Licensing Credit Agreement entered into with the Bank on March 31, 2009 as part of
the March 31, 2009 restructuring. The amendment included a reduction of the draw credit facility
(Draw Facility) from $5.0 million to $4.0 million and an extension of the termination date to May
31, 2010 for the Draw Facility and to March 31, 2011 for the $2.0 million revolving line of credit
and $6.5 million letter of credit facilities.
On May 31, 2010, the $4.0 million Draw Facility, an unused credit line that had been available
for working capital needs of FCMC, expired unrenewed. Additionally, on July 20, 2010, as part of
Amendment No. 2 to the Licensing Credit Agreement, the revolving credit facility, which is only
available to assure that all state licensing requirements of FCMC are met and to pay approved
expenses of Franklin Holding, was reduced from $2 million to $1 million.
11
For a complete description of the Amendment and Extension of the Licensing Credit Agreement
see Note 7 Notes Payable and Financing Agreements Restructuring Agreements with Lead Lending
Bank.
December 2008 Corporate Reorganization and Holding Company Structure
On December 19, 2008, the Company engaged in a series of transactions (the Reorganization)
in which the Company (i) adopted a holding company form of organizational structure, with Franklin
Holding serving as the new public-company parent, (ii) transferred all of the equity and membership
interests in FCMCs direct subsidiaries to other entities in the reorganized corporate structure of
the Company, (iii) assigned legal record ownership of any loans in the Companys portfolios held
directly by FCMC and Tribeca to other entities in the reorganized corporate structure of the
Company, and amended its loan agreements with the Bank.
Franklin Credit Holding Corporation is the successor issuer to Franklin Credit Management
Corporation, and FCMC ceased to have portfolios of loans and real estate properties and the related
indebtedness to the Bank under the Legacy Credit Agreement.
Going Concern Uncertainty Franklin Holding
The Company has been and continues to be operating in an extraordinary and difficult
environment and since September 30, 2007 has been operating with significant operating losses and
stockholders deficit. The Company has been, since the latter part of 2007, expressly prohibited
by the Bank from acquiring or originating loans. In addition, the Companys restructuring
agreements with the Bank contain affirmative covenants that the Companys servicing subsidiary,
FCMC, be licensed, qualified and in good standing, where required, and that it maintain material
licenses to service mortgage loans and real estate owned properties serviced under the Servicing
Agreement entered into in connection with the Restructuring and as amended. Any event of default
under the March 31, 2009 Restructuring Agreements, as amended, or failure to successfully renew
these Restructuring Agreements or enter into new credit facilities with Huntington prior to their
scheduled maturity, could entitle Huntington to declare the Companys indebtedness immediately due
and payable and result in the transfer of the remaining loans pledged to Huntington to a third
party. Moreover, certain events of default under the Restructuring Agreements, including defaults
under provisions relating to enforceability, bankruptcy, maintenance of collateral and lien
positions, and certain negative covenants typical for agreements of this nature, breaches under its
Servicing Agreement with the Bank or defaults under the Licensing Credit Agreement could result in
the termination of the Companys largest sub-servicing contract. Without the continued cooperation
and assistance from Huntington, the consolidated Franklin Holdings ability to continue as a viable
business is in substantial doubt, and it may not be able to continue as a going concern. At June
30, 2010 and December 31, 2009 the Companys stockholders deficit was $821.3 million and $806.8
million, respectively.
Operating Losses Franklin Holding
The Company had a net loss attributed to common stockholders of $13.1 million for the three
months ended June 30, 2010, compared with net income of $20.3 million for the three months ended
June 30, 2009. In the second quarter of 2009, the Company realized a nonrecurring gain on
recoveries from contractual loan purchase rights in the aggregate amount of $30.6 million received
in the second quarter of 2009. The Company had a loss per common share for the three months ended
June 30, 2010 of $1.63 both on a diluted and basic basis, compared to earnings per common share of
$2.53 on both a diluted and basic basis for the three months ended June 30, 2009. The Company had
a net loss attributed to common stockholders of $19.8 million for the six months ended June 30,
2010, compared with net loss of $342.1 million for the six months ended June 30, 2009. The Company
had a loss per common share for the six months ended June 30, 2010 of $2.47 both on a diluted and
basic basis, compared to a loss per common share of $42.78 on both a diluted and basic basis for
the six months ended June 30, 2009.
12
Licenses to Service Loans
By letter dated April 12, 2010, the New York State Banking Department (the Banking
Department) advised FCMC that in connection with its review of its financial statements and
mortgage servicing volume, its application for registration as a mortgage servicer in that state,
which FCMC had filed during the transitional period allowed by the state for registration of
mortgage servicers doing business in New York State on June 30, 2009, cannot be accepted for
processing until FCMC addresses its net worth, which as adjusted (Adjusted Net Worth) and
calculated by the Banking Department was determined to be below the minimum Adjusted Net Worth
requirement for mortgage servicers established under applicable regulations adopted through
emergency rule making.
The emergency regulations, which were adopted by the New York State Superintendent of Banks
and which implement the statutory registration requirement for mortgage servicers in New York State
that went into effect on July 1, 2009, require (i) an Adjusted Net Worth of at least 1% of the
outstanding
principal balance of aggregate mortgage loans serviced (whether or not in New York), but in
any event not less than $250,000; and, (ii) a ratio of Adjusted Net Worth to the outstanding
principal balance of New York mortgage loans serviced of at least 5%. Although the latest version
of the emergency regulations is effective until September 5, 2010, the Banking Department has
indicated that it expects to propose permanent regulations in substantially similar form as the
emergency regulations for public comment in the near future.
Adjusted Net Worth, as defined under the Superintendents emergency regulations, consists of
total equity capital at the end of the reporting period as determined by GAAP less: goodwill,
intangible assets (excluding mortgage servicing rights), any assets pledged to secure obligations
of a person other than the applicant, any assets due from officers or stockholders of the applicant
or related companies; that portion of any marketable securities (listed or unlisted) not shown at
lower of cost or market; any amount in excess of the lower of cost or market value of mortgages in
foreclosure, construction loans or property acquired through foreclosure, and any amount shown on
the balance sheet as investments in unconsolidated joint ventures, subsidiaries, affiliates, and/or
other related companies that is greater than the value of such investments accounted for using the
equity method of accounting.
At March 31, 2010, FCMC serviced mortgage loans (as defined under the Superintendents
emergency regulations) throughout the United States with an outstanding principal balance of
approximately $1.61 billion, serviced New York mortgage loans with an outstanding principal balance
of approximately $158.2 million, and had an Adjusted Net Worth of approximately $8.0 million (with
net worth under GAAP of $19.9 million). Although the ratio of Adjusted Net Worth of FCMC to the
outstanding principal balance of New York mortgage loans is greater than the required 5%, the
Adjusted Net Worth of FCMC fell short of the 1% of the outstanding principal balance of aggregate
mortgage loans serviced in the United States by approximately $8.1 million. Accordingly, the
Banking Department required that FCMC provide a written capital plan acceptable to the Banking
Department, which among other prerequisites addresses how FCMC intends to achieve compliance, on an
ongoing basis with the regulatory net worth requirements, and commits FCMC to maintaining a minimum
Adjusted Net Worth of 0.25% of aggregate loans serviced in the United States (which is lower than
the requirement under the emergency regulations) and 5% of New York mortgage loans serviced,
whichever is higher while it seeks to restore such compliance.
13
The capital plan as proposed by FCMC and submitted to the Banking Department on May 12, 2010
includes in relevant part a commitment, until FCMC is in full compliance with the net worth
requirements for mortgage servicers in New York State, to (i) meet regulatory net worth
requirements as soon as practicable but in no event later than December 31, 2012 through the
retention of net earnings and dividend restrictions, (ii) maintain an interim Adjusted Net Worth
until FCMC complies with regulatory net worth requirements of not less than approximately $7.9
million (Minimum Level), and not less than 5% of the principal balance of New York mortgage loans
serviced by FCMC and 0.25% of the aggregate mortgage loans serviced in the United States, (iii)
not, without the prior written consent of the Banking Department, service additional mortgage loans
secured by 1-4 family residential homes located in New York State, (iv) not declare or pay any
dividends upon the shares of its capital stock, and (v) submit quarterly reports on the total
number of and principal balance of loans serviced and its Adjusted Net Worth.
There is no assurance that the New York State Banking Department will find the written capital
plan of FCMC acceptable and not request modifications to the capital plan or deny FCMCs
application for registration as a mortgage servicer or that FCMC will be able to regain compliance
with regulatory net worth requirements in New York State. There is also no assurance that (i) the
Bank will not restrict FCMCs ability to comply with its capital plan, (ii) the Bank or other
servicing client will not terminate FCMC as a servicer of New York mortgage loans, or (iii) the
Bank will not sell the remaining New York mortgage loans owned by the Trust to an entity that
chooses not to retain FCMC as a servicer.
If FCMCs application is denied by the Banking Department, or FCMC is unable or fails to
comply with a written capital plan approved by the Banking Department, FCMC will no longer be able
to service mortgage loans secured by 1-4 family residential homes located in New York State.
Under the Servicing Agreement entered into on March 31, 2009 as part of the Restructuring with the
Bank and as amended, the Bank with notice could terminate the Servicing Agreement if FCMC failed to
maintain all material licenses and approvals required and necessary in each state where any
mortgaged property, other real estate property serviced under the Servicing Agreement, or borrowers
are located and such failure continues unremedied for five (5) business days. In addition, such a
failure to obtain or maintain our license to service mortgages loans as a registered mortgage
servicer in New York would be a default under the Licensing Credit Agreement and under the Legacy
Credit Agreement and, with notice, the Bank could also call an event of default under those
agreements entered into in connection with the Restructuring, which, among other remedies, would
entitle the Bank to foreclose on the assets of the Company pledged to the Bank, including on
Franklin Holdings pledge of 70% of the common stock of FCMC.
At June 30, 2010, FCMCs Adjusted Net Worth was approximately $11.1 million, or approximately
.72% of the aggregate principal balance of loans serviced nationwide. On July 20, 2010, due to
payments required under the Letter Agreement with the Bank, FCMCs Adjusted Net Worth is expected
to be reduced to an estimated $9.3 million, or approximately .60% of the aggregate principal
balance of loans serviced nationwide. In addition, if the Potential Restructuring is agreed to by
the Bank and the Company as per the Letter Agreement, FCMCs Adjusted Net Worth will be further
reduced by an estimated $1.8 million to $3.0 million. However, the Loan Sale and implementation of
the Letter Agreement are not expected to reduce Adjusted Net Worth to a level below that which was
committed to under the capital plan proposed by FCMC. See Note 11 Subsequent Events.
FCMC expects to curtail the pro rata distributions or payments to the Bank and dividends to
its shareholders that are ordinarily required under the terms of the Licensing Credit Agreement, as
amended. Pursuant to such terms, the distributions are not required where they would give rise to
a default under the Licensing Credit Agreement, which would occur if FCMC is unable to increase its
Adjusted Net Worth, and as a result, fails to obtain or maintain a license as a registered mortgage
servicer in New York.
14
However, in connection with the Letter Agreement entered into July 20, 2010,
the Company and FCMC have agreed that in connection with the Potential Restructuring, if the
Potential Restructuring is acceptable to the Bank and the required lenders, in each partys sole
discretion, and the Potential Restructuring does not result in material tax, legal, regulatory, or
accounting impediments or issues for Franklin Holding or FCMC, then FCMC or Franklin Holding would
reimburse and hold the Bank and the required lenders harmless from any reasonable expense incurred
by them in connection with any such Potential Restructuring and FCMC would make semi-annual
payments to the Bank under the Legacy Credit Agreement equal to (i) 50% of FCMCs EBITDA, in
accordance with GAAP, for each period for the first 18 months from the Loan Sale Closing Date, and
(ii) 70% of FCMCs GAAP EBITDA for each period thereafter, up to a maximum aggregate of $3 million.
See Note 11 Subsequent Events.
Franklins Business Franklin Credit Management Corporation (FCMC)
As a result of the March 2009 Restructuring and the Reorganization that took effect December
19, 2008, the Companys operating business is conducted solely through FCMC, a specialty consumer
finance company primarily engaged in the servicing and resolution of performing, reperforming and
nonperforming residential mortgage loans, including specialized loan recovery servicing, and in the
due diligence, analysis, pricing and acquisition of residential mortgage portfolios, for third
parties. As a result, FCMC, the servicing company within the Franklin consolidated group of
companies, has positive net worth, has been profitable since January 1, 2009, and 30% of its equity
is free from the pledges to the Bank.
At June 30, 2010, FCMC had total assets of $27.3 million and had stockholders equity of $20.6
million. FCMC recognized income before tax of approximately $1.9 million and $3.9 million,
respectively, for the six months ended June 30, 2010 and 2009, principally from servicing the
portfolio of loans and assets for the Bank and a related party (Bosco). Inter-company servicing
revenues allocated to FCMC during the first quarter of 2009 were based principally on the servicing
contract entered into as part of the Restructuring, which became effective on March 31, 2009. FCMC charges its sister
companies a management fee that is estimated based on internal services rendered by its employees
to those companies. Inter-company allocations, the Federal provision for income taxes, and cash
servicing revenues received from the Bank for servicing its loans during the six months ended June
30, 2010 and 2009 have been eliminated in deriving the consolidated financial statements of
Franklin. Servicing revenues were eliminated in the consolidated financial statements of Franklin
due to the accounting treatment for the transfer of the trust certificates as a financing under
GAAP Codification of Accounting Standards Codification (ASC) Topic 860, Transfers and Servicing.
Loan Servicing
The Companys servicing business is conducted through FCMC, a specialty consumer finance
company primarily engaged in the servicing and resolution of performing, reperforming and
nonperforming residential mortgage loans, including specialized loan recovery servicing, for third
parties.
We have invested to create a loan servicing capability that is focused on collections, loss
mitigation and default management. In general, we seek to ensure that the loans we service for
others are repaid in accordance with the original terms or according to amended repayment terms
negotiated with the borrowers and in accordance with the terms of our servicing contracts with our
servicing clients. Because the loans we service generally experience above average delinquencies,
erratic payment patterns and defaults, our servicing operation is focused on maintaining close
contact with borrowers and as a result, is more labor-intensive than traditional mortgage servicing
operations. Through frequent communication we are able to encourage positive payment performance,
quickly identify those borrowers who are likely to move into seriously delinquent status and
promptly apply appropriate loss mitigation and recovery strategies. Our servicing staff employs a
variety of collection strategies that we have developed to successfully manage serious
delinquencies, bankruptcy and foreclosure. Additionally, we maintain a real estate department with
experience in property management and the sale of residential properties.
15
As of June 30, 2010, FCMC had two significant servicing contracts with third parties to
service 1-4 family mortgage loans and owned real estate, Huntington and Bosco Credit LLC (Bosco).
The portfolios serviced for Huntington (loans previously acquired and originated by Franklin and
transferred to the Trust), primarily consist of first and second-lien loans secured by 1-4 family
residential real estate that generally fell outside the underwriting standards of Fannie Mae and
Freddie Mac. See Note 11 Subsequent Events.
At June 30, 2010, we serviced and provided recovery collection services on a total population
of approximately 34,000 loans for Huntington and Bosco, and relatively small pools of loans under
recovery collection contracts, whereby we receive fees based solely on a percentage of amounts
collected, for a few other entities. The unpaid principal balance of loans serviced for Huntington
represented approximately 80% of the total loans serviced for third parties at June 30, 2010.
See Note 11 Subsequent Events for a fuller description of the Loan Sale, Loan Sale
Servicing Agreement, New Trust Servicing Agreement, Amendment to Licensing Credit Agreement and
other agreements with the Bank.
Loan Servicing and Collection Operations
At June 30, 2010, our servicing business consisted of 97 employees who managed approximately
34,000 loans, including approximately 2,400 home equity loans for Bosco. Our servicing operations
are conducted in the following departments:
Loan Boarding and Administration. The primary objective of the loan boarding
department is to ensure that newly acquired loans under contracts to service for others are
properly transitioned from the prior servicer and are accurately boarded onto our servicing
systems. Our loan boarding department
audits loan information for accuracy to ensure that the loans conform to the terms provided in
the original note and mortgage. The information boarded onto our systems provides us with a file
that we use to automatically generate introductory letters to borrowers summarizing the terms of
the servicing transfer of their loan, among other standard industry procedures.
The loan administration department performs typical duties related to the administration of
loans, including incorporating modifications to terms of loans. The loan administration department
also ensures the proper maintenance and disbursement of funds from escrow accounts and monitors
non-escrow accounts for delinquent taxes and insurance lapses. For loans serviced with adjustable
interest rates, the loan administration group ensures that adjustments are properly made and
identified to the affected borrowers in a timely manner.
Customer Service. The primary objective of our customer service department is to
obtain timely payments from borrowers, respond to borrower requests and resolve disputes with
borrowers. Within 10 days of boarding newly acquired loans onto our servicing system, our customer
service representatives contact each new borrower to welcome them to FCMC and to gather and/or
verify any missing information, such as loan balance, interest rate, contact phone numbers, place
of employment, insurance coverage and all other pertinent information required to properly service
the loan. The customer service group responds to all inbound customer calls for information
requests regarding payments, statement balances, escrow balances and taxes, payoff requests,
returned check and late payment fees. In addition, our customer service representatives process
payoff requests and reconveyances.
16
Client Relations. The principal objective of the client relations group is to
interface with our servicing clients regarding the servicing performance of their loans, and for
invoicing servicing clients. In addition, our client relations group oversees the boarding of new
loans for servicing and/or recovery collections.
Collections. The main objective of our collections department is to ensure loan performance
through maintaining customer contact. Our collections group continuously reviews and monitors the
status of collections and individual loan payments in order to proactively identify and solve
potential collection problems. When a loan becomes seven days past due, our collections group
begins making collection calls and generating past-due letters. Our collections group attempts to
determine whether a past due payment is an aberration or indicative of a more serious delinquency.
If the past due payment appears to be an aberration, we emphasize a cooperative approach and
attempt to assist the borrower in becoming current or arriving at an alternative repayment
arrangement. Upon a serious delinquency, by which we mean a delinquency of sixty-one days by a
borrower, or the earlier determination by our collections group based on the evidence available
that a serious delinquency is likely, the loan is typically transferred to our loss mitigation
department. We employ a range of strategies to modify repayment terms in order to enable the
borrower to make payments and ultimately cure the delinquency, or focus on expediting the
foreclosure process so that loss mitigation can begin as promptly as practicable.
Loss Mitigation. Our loss mitigation department, which consists of staff experienced in
collection work, manages and monitors the progress of seriously delinquent loans and loans which we
believe will develop into serious delinquencies. In addition to maintaining contact with borrowers
through telephone calls and collection letters, this department utilizes various strategies in an
effort to reinstate an account or revive cash flow on an account. The loss mitigation department
analyzes each loan to determine a collection strategy to maximize the amount and speed of recovery
and minimize costs. The particular strategy is based upon each individual borrowers past payment
history, current credit profile, current ability to pay, collateral lien position and current
collateral value. Loss mitigation agents qualify borrowers for relief programs appropriate to the
borrowers hardship and finances. Loss mitigation agents process borrower applications for
Temporary Relief programs (deferments and rate reductions), Expanded Temporary Relief programs (pay
and interest accrue and repayment plans), Homeowner Relief programs (pre-foreclosure home sale) and
Permanent Relief programs (long-term modifications, including those sponsored by the U.S.
Treasurys Home Affordable Modification Program (HAMP)), as well as for settlements, short sales,
and deeds-in-lieu.
Seriously delinquent accounts not resolved through the loss mitigation activities described
above are foreclosed or a judgment is obtained, if potential collection warrants the cost, against
the related borrower in accordance with state and local laws, with the objective of maximizing
asset recovery in the most expeditious manner possible. This is commonly referred to as loss
management. Foreclosure timelines are managed through a timeline report built into the loan
servicing system. The report schedules milestones applicable for each state throughout the
foreclosure process, which enhances our ability to monitor and manage the process. Properties
acquired through foreclosure are transferred to our real estate department to manage eviction and
marketing or renting of the properties. However, until foreclosure is completed, efforts at loss
mitigation generally are continued.
In addition, our loss mitigation department manages loans by borrowers who have declared
bankruptcy. The primary objective of the bankruptcy group within our loss mitigation department,
which utilizes outside legal counsel, is to proactively monitor bankruptcy assets and outside legal
counsel to ensure compliance with individual plans and to ensure recovery in the event of
non-compliance.
17
Real Estate. The real estate-owned (REO) department is responsible for managing and
or disposing of properties, located throughout the country, acquired through foreclosure in an
orderly, timely, and cost-efficient manner in order to maximize our clients return on assets.
These properties include 1-4 family residences, cooperative apartment and condominium units. We
foreclose on property primarily with the intent to sell it at fair market value to recover a
portion of the outstanding balance owed by the borrower. From time to time, foreclosed properties
may be in need of repair or improvement in order to either increase the value of the property or
reduce the time that the property is on the market. In those cases, the property is evaluated
independently and we make a determination of whether the additional investment might increase the
return upon sale or rental of the property.
Deficiency Recovery & Judgment Processing Department (Recovery). The Recovery
department pursues principally hard-to-collect consumer debt on a first, second, or third-placement
basis. Our recovery departments primary objective is to maximize the recovery of unpaid principal
on each seriously delinquent account by offering borrowers multiple workout solutions and/or
negotiated settlements. The recovery unit performs a complete analysis of the borrowers financial
situation, taking into consideration lien status, in order to determine the best course of action.
Based on the results of our analysis, we determine to either continue collection efforts and a
negotiated workout of settlement or seek judgment. Agents may qualify borrowers for Temporary
Relief and Expanded Temporary Relief programs where appropriate. Agents will seek to perfect a
judgment against a borrower and may seek wage garnishment, if economically justified by the
borrowers finances and if provided by the clients servicing agreement.
Face to Face Home Solutions (Face to Face). The Face to Face department seeks to
reestablish connection with incommunicative borrowers and advise borrowers of available loss
mitigation opportunities. Whether successful in meeting with a borrower or not, Face to Face
agents confirm occupancy and report property conditions as well as any evidence of code violation
or additional liens on the property.
Training. Our training department works with all departments of our servicing
operations to ensure that the employees of all departments are fully informed of the procedures
necessary to complete their required tasks. The department ensures all loan servicing employees
are trained in the tenents of the Fair Debt Collection Act as well as in effective communication
skills.
Quality Control. Our quality control department monitors all aspects of loan
servicing from boarding through foreclosure. It is the departments responsibility to ensure that
FCMCs policies and procedures are followed. Collection calls are monitored to ensure quality and
compliance with the requirements of the federal Fair Debt Collection Practices Act and state
collection laws. Monthly meetings with staff to discuss individual quality control scores are held
and, in certain cases, further training is recommended. Reviews of the controls for privacy and
information safeguarding and document removal are conducted monthly.
Home Affordable Modification Program
On September 11, 2009, FCMC voluntarily entered into an agreement to actively participate as a
mortgage servicer in the Federal governments HAMP for first lien mortgage loans that are not owned
or guaranteed by Fannie Mae or Freddie Mac. HAMP is a program, with borrower, mortgage servicer,
and mortgage loan owner incentives, designed to enable eligible borrowers to avoid foreclosure
through a more affordable and sustainable loan modification made in accordance with HAMP
guidelines, procedures, directives, and requirements. If a borrower is not eligible for HAMP, FCMC
considers other available loss mitigations options, as appropriate for the owner of the loans
serviced. The Bank, as certificate trustee of the Trust, has consented to FCMC modifying eligible
mortgage loans in accordance with HAMP.
18
Bosco Servicing Agreement
On May 28, 2008, Franklin entered into various agreements (the Bosco Servicing Agreements)
to service on a fee-paying basis for Bosco approximately $245 million in residential home equity
line of credit mortgage loans. Bosco was organized by FCMC, and the membership interests in Bosco
include the Companys Chairman and President, Thomas J. Axon, and a related company of which Mr.
Axon is the chairman of the board and three of the Companys directors serve as board members of
that entity. FCMC began servicing the Bosco portfolio in June 2008. Included in the Companys
consolidated revenues were servicing fees recognized from servicing the Bosco portfolio of $230,000
and $626,000 for the three months ended June 30, 2010 and 2009, respectively. Included in the
Companys consolidated revenues were servicing fees recognized from servicing the Bosco portfolio
of $474,000 and $1.4 million for the six months ended June 30, 2010 and 2009, respectively. See
Note 10 Related Party Transactions Bosco Servicing Agreement.
The amount and timing of certain ancillary fees for non-servicing services performed by FCMC
for Bosco and owed to the Company is the subject of a good faith dispute between FCMC and the
Managing Member of Bosco, Thomas J. Axon (the Chairman and President of the Company and FCMC).
FCMC has not, since June 1, 2009, accrued fees for providing accounting services to Bosco and Bosco
has not paid FCMC for any such services, and FCMC in 2009 wrote off all internal accounting, legal,
loan analysis, due diligence and other services previously accrued or incurred relating to
non-servicing services provided by FCMC to Bosco. See Note 10 Related Party Transactions
Bosco Servicing Agreement.
Due Diligence Services
During 2008, capitalizing on our portfolio acquisition experience with residential mortgage
loans, FCMC began providing services for third parties not related to us or the Bank, on a
fee-paying basis. During the first half of 2010, we were engaged in due diligence assignments
principally for two third parties.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation The unaudited consolidated financial statements include the accounts
of the Company and its subsidiaries. All significant intercompany accounts and transactions have
been eliminated in consolidation. The accompanying unaudited consolidated financial statements
have been prepared in accordance with instructions to Form 10-Q. Accordingly, they do not include
all of the information and footnotes required by GAAP for complete financial statements. However,
these unaudited consolidated financial statements include all normal and recurring adjustments that
management believes necessary for a fair statement of results for the periods. These unaudited
consolidated financial statements do not necessarily indicate the results that may be expected for
the full year; the interim financial information should be read in conjunction with our Annual
Report on Form 10-K for the year ended December 31, 2009.
The preparation of financial statements in conformity with GAAP requires management to make
estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure
of contingent assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results could differ from
those estimates. The Companys estimates and assumptions primarily arise, effective as of the
March 31, 2009 Restructuring, from uncertainties and changes associated with interest rates, credit
exposure and fair market values of its investment in trust certificates and mortgage loans and real
estate held for sale. Although management is not currently aware of any factors that would
significantly change its estimates and assumptions in the near term, future changes in market
trends, market values and interest rates and other conditions may occur which could cause actual
results to differ materially. For additional information refer to the Companys Annual Report on
Form 10-K for the year ended December 31, 2009, filed with the Securities and Exchange Commission,
and Quarterly Reports on Form 10-Q, which the Company urges investors to consider.
19
Basic and diluted net loss per share is calculated by dividing net loss attributed to common
shareholders by the weighted average number of common shares outstanding during the period. The
effects of warrants, restricted stock and stock options are excluded from the computation of
diluted earnings per common share in periods in which the effect would be antidilutive. Dilutive
potential common shares are calculated using the treasury stock method. For the six months ended
June 30, 2010 and 2009, 273,000 and 582,000 stock options, respectively, were not included in the
computation of net loss per share because they were antidilutive.
Recent Accounting Pronouncements
The FASB has issued Accounting Standards Update (ASU) 2009-16, Transfers and Servicing
(Topic 860) Accounting for Transfers of Financial Assets (ASU 2009-16). ASU 2009-16 requires
more information about transfers of financial assets, including securitization transactions,
eliminates the concept of a qualifying special-purpose entity and changes the requirements for
derecognizing financial assets. ASU 2009-16 is effective at the start of a reporting entitys
first fiscal year beginning after November 15, 2009. The adoption of this standard did not have
any impact on the Companys consolidated financial position and results of operations.
On July 21, 2010, the FASB issued ASU No. 2010-20, Disclosures About the Credit Quality of
Financing Receivables and the Allowance for Credit Losses, which amends ASC 310, Receivables, by
requiring more robust and disaggregated disclosures about the credit quality of an entitys
financing receivables and its allowance for credit losses. The objective of enhancing these
disclosures is to improve financial statement users understanding of (1) the nature of an entitys
credit risk associated with its financing receivables and (2) the entitys assessment of that risk
in estimating its allowance for credit losses as well as changes in the allowance and the reasons
for those changes.
The new and amended disclosures that relate to information as of the end of a reporting period
will be effective for the first interim or annual reporting periods ending on or after December 15,
2010. That is, for calendar-year-end public entities, like the Company, most of the new and
amended disclosures in the ASU would be effective for this year-end reporting season. However, the
disclosures that include information for activity that occurs during a reporting period will be
effective for the first interim or annual periods beginning after December 15, 2010. Those
disclosures include (1) the activity in the allowance for credit losses for each period and (2)
disclosures about modifications of financing receivables. For calendar-year-end public entities,
like the Company, those disclosures would be effective for the first quarter of 2011. The adoption
of this standard is not expected to have a material impact on the Companys consolidated financial
position and results of operations.
In April 2010, the FASB issued ASU 2010-18, Receivables (Topic 310): Effect of a Loan
Modification When the Loan is Part of a Pool That Is Accounted for as a Single Asset A Consensus
of the FASB Emerging Task Force. The amendments in this update are effective for modifications of
loans accounted for within pools under Subtopic 310-30 occurring in the first interim or annual
period ending
on or after July 15, 2010. The amendments to the FASB Accounting Standards Codification
provide that modifications of loans that are accounted for within a pool under Subtopic 310-30 do
not result in the removal of those loans from the pool even if the modification of those loans
would otherwise be considered a troubled debt restructuring. An entity will continue to be
required to consider whether the pool of assets in which the loan is included is impaired if
expected cash flows for the pool change. The amendments are to be applied prospectively. Early
adoption is permitted. The adoption of this standard is not expected to have a material impact on
the Companys consolidated financial position and results of operations.
20
In April 2010, the FASB issued ASU 2010-12, Income Taxes, (Topic 740) Accounting for Certain
Tax Effects of the Health Care Reform Acts. On March 30, 2010, the President of the United States
signed the Health Care and Education Reconciliation Act of 2010, which is a reconciliation bill
that amends the Patient Protection and Affordable Act that was signed on March 23, 2010
(collectively, the Acts). ASU 2010-12 allows entities to consider the two Acts together for
accounting purposes. The Company does not expect the adoption of this standard to have any impact
on the Companys consolidated financial position and results of operations.
In March 2010, the FASB issued ASU No. 2010-11, which is included in the Codification under
ASC 815, Derivatives and Hedging. This update clarifies the type of embedded credit derivative
that is exempt from embedded derivative bifurcation requirements. Only an embedded credit
derivative that is related to the subordination of one financial instrument to another qualifies
for the exemption. This guidance is effective for interim and annual reporting periods beginning
January 1, 2010. The adoption of this standard did not have any impact on the Companys
consolidated financial position and results of operations.
In February 2010, the FASB issued ASU 2010-10, Consolidation (Topic 810) (Topic 810). The
amendments to the consolidation requirements of Topic 810 resulting from the issuance of Statement
167 are deferred for a reporting entitys interest in an entity (1) that has all the attributes of
an investment company or (2) for which it is industry practice to apply measurement principles for
financial reporting purposes that are consistent with those followed by investment companies. An
entity that qualifies for the deferral will continue to be assessed under the overall guidance on
the consolidation of variable interest entities in Subtopic 810-10 (before the Statement 167
amendments) or other applicable consolidation guidance, such as the guidance for the consolidation
of partnerships in Subtopic 810-20. The deferral is effective as of the beginning of a reporting
entitys first annual period that begins after November 15, 2009, and for interim periods within
that first annual reporting period, which coincides with the effective date of Statement 167.
Early application is not permitted. The adoption of this standard did not have any impact on the
Companys consolidated financial position and results of operations.
In February 2010, the FASB issued ASU 2010-09, Subsequent Events (Topic 855) Amendments to
Certain Recognition and Disclosure Requirement (ASU 2010-09). ASU 2010-09 requires an entity
that is an SEC filer to evaluate subsequent events through the date that the financial statements
are issued and removes the requirement that an SEC filer disclose the date through which subsequent
events have been evaluated. ASC 2010-09 was effective upon issuance. The adoption of this
standard had no effect on the Companys consolidated financial position or results of operations.
In February 2010, the FASB issued ASU 2010-08, Technical Corrections to Various Topics. This
amendment eliminated inconsistencies and outdated provisions and provided the needed clarifications
to various topics within Topic 815. The amendments are effective for the first reporting period
(including interim periods) beginning after issuance (February 2, 2010), except for certain
amendments. The amendments to the guidance on accounting for income taxes in reorganization
(Subtopic 852-740) should be applied to reorganizations for which the date of the reorganization is
on or
21
after the beginning of the first annual reporting period beginning on or after December 15,
2008. For those reorganizations reflected in interim financial statements issued before the
amendments in this Update are effective, retrospective application is required. The clarifications
of the guidance on the embedded derivates and hedging (Subtopic 815-15) are effective for fiscal
years beginning after
December 15, 2009, and should be applied to existing contracts (hybrid instruments) containing
embedded derivative features at the date of adoption. The adoption of this standard did not have
any impact on the Companys consolidated financial position and results of operations.
In January 2010, the FASB issued ASU 2010-06, Fair Value Measurements and Disclosures (Topic
820): Improving Disclosures about Fair Value Measurements (ASU 2010-06). This ASU requires some
new disclosures and clarifies some existing disclosure requirements about fair value measurement as
set forth in Codification Subtopic 820-10. ASU 2010-06 amends Codification Subtopic 820-10 and now
requires a reporting entity to use judgment in determining the appropriate classes of assets and
liabilities and to provide disclosures about the valuation techniques and inputs used to measure
fair value for both recurring and nonrecurring fair value measurements. ASU 2010-06 is effective
for interim and annual reporting periods beginning after December 15, 2009. As this standard
relates specifically to disclosures, the adoption did not have an impact on the Companys
consolidated financial position and results of operations.
In January 2010, the FASB issued ASU 2010-01, Equity (Topic 505): Accounting for Distributions
to Shareholders with Components of Stock and Cash (ASU 2010-01). This ASU clarifies that the
stock portion of a distribution to shareholders that allows them to elect to receive cash or stock
with a potential limitation on the total amount of cash that all shareholders can elect to receive
in the aggregate is considered a share issuance that is reflected in earnings per share
prospectively and is not a stock dividend. ASU 2010-01 is effective for interim and annual periods
ending on or after December 15, 2009, and should be applied on a retrospective basis. The adoption
of this standard did not have any impact on the Companys consolidated financial position and
results of operations.
In December 2009, the FASB issued ASU 2009-17, Consolidations (Topic 810) Improvements to
Financial Reporting by Enterprises Involved with Variable Interest Entities (ASU 2009-17). ASU
2009-17 changes how a reporting entity determines when an entity that is insufficiently capitalized
or is not controlled through voting (or similar rights) should be consolidated. This determination
is based on, among other things, the other entitys purpose and design and the Companys ability to
direct the activities of the other entity that most significantly impact the other entitys
economic performance. ASU 2009-17 is effective at the start of the Companys first fiscal year
beginning after November 15, 2009. The adoption of this standard did not have any impact on the
Companys consolidated financial position and results of operations.
22
3. INVESTMENT IN TRUST CERTIFICATES AT FAIR VALUE, MORTGAGE LOANS AND REAL ESTATE HELD FOR
SALE, AND NOTES RECEIVABLE HELD FOR SALE
Investment in Trust certificates, carried at estimated fair value, as of June 30, 2010,
consists principally of the trust certificates not transferred to the Banks REIT as of the
Restructuring (representing approximately 17% of the Portfolio as of March 31, 2009). Activity for
the six months ended June 30, 2010 is as follows:
|
|
|
|
|
|
|
Six Months Ended |
|
|
|
June 30, 2010 |
|
Balance, January 1 |
|
$ |
69,355,735 |
|
|
|
|
|
|
Trust distributions |
|
|
(6,120,529 |
) |
Transfers (out) |
|
|
(1,566,985 |
) |
Fair value adjustments, net |
|
|
(3,695,204 |
) |
|
|
|
|
|
|
|
|
|
Balance, June 30 |
|
$ |
57,973,017 |
|
|
|
|
|
The fair value adjustments include a reduction in the estimated market value of the pro
rata percentage of loans underlying the Trust certificates of approximately $8.9 million and a gain
on the Trust distributions of approximately $5.2 million.
Mortgage loans and real estate held for sale, carried at lower of cost or estimated fair
value, as of June 30, 2010 consists principally of the trust certificates transferred to the Banks
REIT as of the Restructuring (representing approximately 83% of the Portfolio as of March 31,
2009). Activity for the six months ended June 30, 2010 is as follows:
|
|
|
|
|
|
|
Six Months Ended |
|
|
|
June 30, 2010 |
|
Balance, January 1 |
|
$ |
345,441,865 |
|
|
|
|
|
|
REO sales |
|
|
(7,781,706 |
) |
Principal payments |
|
|
(14,773,555 |
) |
Loans written off |
|
|
(23,016 |
) |
Fair value adjustments, net |
|
|
(34,115,914 |
) |
|
|
|
|
|
|
|
|
|
Balance, June 30 |
|
$ |
288,747,674 |
|
|
|
|
|
The fair value adjustments include a reduction in the estimated market value of the pro
rata percentage of loans underlying the mortgage loans and real estate held for sale of
approximately $44.2 million and a gain on the REO sales proceeds and the principal payments of
approximately $10.1 million.
23
Notes receivable held for sale, carried at lower of cost or estimated fair value, as of June
30, 2010 consists principally of the Companys loans securing the Unrestructured Debt. Activity
for the six months ended June 30, 2010 is as follows:
|
|
|
|
|
|
|
Six Months Ended |
|
|
|
June 30, 2010 |
|
Balance, January 1 |
|
$ |
3,575,323 |
|
|
|
|
|
|
Principal payments |
|
|
(408,018 |
) |
Loans written off |
|
|
(13,395 |
) |
Fair value adjustments, net |
|
|
(188,429 |
) |
|
|
|
|
|
|
|
|
|
Balance, June 30 |
|
$ |
2,965,481 |
|
|
|
|
|
The fair value adjustments include a reduction in the estimated market value of the notes
receivable held for sale of approximately $532,000 and a gain on the principal payments of
approximately $344,000.
4. FAIR VALUATION ADJUSTMENTS
Fair valuation adjustments include amounts subsequent to March 31, 2009 related to adjustments
in the fair value of the investment in trust certificates, the nonrecourse liability, and
adjustments to the lower of cost or market related to mortgage loans and real estate held for sale,
and for losses on sales of real estate owned.
The following table sets forth the activity since the Restructuring affecting the fair
valuation adjustments during the three and six months ended June 30, 2010 and June 30, 2009:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30, |
|
|
Six Months Ended June 30, |
|
|
|
2010 |
|
|
2009 |
|
|
2010 |
|
|
2009 |
|
Valuation gain/(loss) on OREO sold |
|
$ |
2,576,120 |
|
|
$ |
(11,564,907 |
) |
|
$ |
4,349,020 |
|
|
$ |
(11,564,907 |
) |
Valuation (loss) on mortgage loans and OREO |
|
|
(36,091,212 |
) |
|
|
(17,046,415 |
) |
|
|
(34,115,914 |
) |
|
|
(17,046,415 |
) |
Valuation (loss) on nonrecourse liability |
|
|
36,091,212 |
|
|
|
17,046,415 |
|
|
|
34,115,914 |
|
|
|
17,046,415 |
|
Valuation gain/(loss) on trust certificates |
|
|
(5,701,040 |
) |
|
|
733,601 |
|
|
|
(3,695,204 |
) |
|
|
733,601 |
|
Valuation (loss) on notes receivable |
|
|
(204,613 |
) |
|
|
|
|
|
|
(188,429 |
) |
|
|
|
|
Other adjustments |
|
|
(7,571,222 |
) |
|
|
(3,562,660 |
) |
|
|
(15,137,184 |
) |
|
|
(3,562,660 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
(Loss) on valuation |
|
$ |
(10,900,755 |
) |
|
$ |
(14,393,966 |
) |
|
$ |
(14,671,797 |
) |
|
$ |
(14,393,966 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Other adjustments during the three months ended June 30, 2010 and June 30, 2009 include
estimated fair market value adjustments to offsets to the other real estate owned (or OREO)
gains/(losses) of approximately $3.5 million and $6.0 million and offsets to the interest and other
income recorded on the mortgage loans of approximately $4.1 million and $9.6 million, respectively.
Other adjustments during the six months ended June 30, 2010 and June 30, 2009 include
estimated fair market value adjustments to offsets to the other real estate owned (or OREO)
gains/(losses) of approximately $5.9 million and $6.0 million and offsets to the interest and other
income recorded on the mortgage loans of approximately $9.3 million and $9.6 million, respectively.
5. DERIVATIVES
As part of the Companys interest-rate risk management process, the Company entered into
interest rate swap agreements in 2008. In accordance with ASC Topic 815, Derivatives and Hedging
(Topic 815), as amended and interpreted, derivative financial instruments are reported on the
consolidated balance sheets at their fair value.
24
The Companys management of interest-rate risk predominantly includes the use of plain-vanilla
interest-rate swaps to synthetically convert a portion of its London Interbank Offered Rate
(LIBOR)-based
variable-rate debt to fixed-rate debt. In accordance with Topic 815, derivative
contracts hedging the risks associated with expected future cash flows are designated as cash flow
hedges. The Company formally documents at the inception of its hedges all relationships between
hedging instruments and the related hedged items, as well as its interest risk management
objectives and strategies for undertaking various accounting hedges. Additionally, we use
regression analysis at the inception of the hedge and for each reporting period thereafter to
assess the derivatives hedge effectiveness in offsetting changes in the cash flows of the hedged
items. The Company discontinues hedge accounting if it is determined that a derivative is not
expected to be or has ceased to be highly effective as a hedge, and then reflects changes in the
fair value of the derivative in earnings. All of the Companys interest-rate swaps qualify for
cash flow hedge accounting, and are so designated.
As of June 30, 2010, the notional amount of the Companys fixed-rate interest rate swaps
totaled $390 million, representing approximately 32% of the Companys outstanding variable rate
debt. The fixed-rate interest rate swaps are expected to reduce the Companys exposure to future
increases in interest costs on a portion of its borrowings due to increases in one-month LIBOR
during the remaining terms of the swap agreements. All of our interest rate swaps were executed
with the Bank.
In conjunction with the Restructuring, and at the request of the Bank, effective March 31,
2009, the Company exercised its right to terminate two non-amortizing fixed-rate interest rate
swaps with the Bank, one with a notional amount of $150 million and the other with a notional
amount of $240 million. The total termination fee for cancellation of the swaps was $8.2 million,
which is payable only to the extent cash is available under the waterfall provisions of the Legacy
Credit Agreement, and only after the first $759.1 million of debt (the amount designated as Tranche
A debt remaining at June 30, 2010) owed to the Bank has been paid in full. The carrying value
included in accumulated other comprehensive loss (AOCL) within stockholders equity at June 30,
2010 and December 31, 2009, which is related to the terminated hedges, is amortized to earnings
over time.
As of December 31, 2008, the Company removed the hedge designations for its cash flow hedges.
As a result, the Company continues to carry the December 31, 2008 balance related to these hedges
in AOCL unless it becomes probable that the forecasted cash flows will not occur. The balance in
AOCL as of March 31, 2010 is amortized to earnings as part of interest expense in the same period
or periods during which the hedge forecasted transaction affects earnings. During the three months
ended June 30, 2010, the net impact of the cash flow hedges was an increase of $2.7 million to
interest expense, inclusive of $2.0 million of amortization of the AOCL balance and reclassified
from AOCL into earnings, and the cost of the hedges in the amount of $3.2 million, which was
somewhat offset by an increase of $2.5 in the fair value of the existing swaps. During the three
months ended June 30, 2009, the net impact of the cash flow hedges was an increase of $2.8 million
to interest expense, inclusive of $3.7 million of amortization of the AOCL balance and reclassified
from AOCL into earnings, and the cost of the hedges in the amount of $2.9 million, which was
somewhat offset by an increase of $3.8 million in the fair value of the existing swaps. During the
six months ended June 30, 2010, the net impact of the cash flow hedges was an increase of $8.2
million to interest expense, inclusive of $5.2 million of amortization of the AOCL balance and
reclassified from AOCL into earnings, and the cost of the hedges in the amount of $6.2 million,
which was somewhat offset by an increase of $3.1 million in the fair value of the existing swaps.
During the six months ended June 30, 2009, the net impact of the cash flow hedges was an increase
of $10.9 million to interest expense, inclusive of $7.6 million of amortization of the AOCL balance
and reclassified from AOCL into earnings, and the cost of the hedges in the amount of $8.0 million,
which was somewhat offset by an increase of $4.7 million in the fair value of the existing swaps.
Changes in the fair value of the remaining interest-rate swaps are accounted for directly in
earnings.
25
The following table presents the notional and fair value amounts of the interest rate swaps at
June 30, 2010.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Notional Amount |
|
|
Term |
|
Maturity Date |
|
|
Fixed Rate |
|
|
Estimated Fair Value |
|
$ |
275,000,000 |
|
|
3 years |
|
March 5, 2011 |
|
|
3.47 |
% |
|
$ |
(6,751,931 |
) |
|
70,000,000 |
|
|
3 years |
|
March 5, 2011 |
|
|
3.11 |
% |
|
|
(1,244,467 |
) |
|
45,000,000 |
|
|
4 years |
|
March 5, 2012 |
|
|
3.43 |
% |
|
|
(1,962,247 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
390,000,000 |
|
|
|
|
|
|
|
|
|
|
|
|
$ |
(9,958,645 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest rate swaps increased our interest expense for the three months ended June 30,
2010 and 2009 by $2.7 million and $2.8 million, respectively. Interest rate swaps increased our
interest expense for the six months ended June 30, 2010 and 2009 by $8.2 million and $10.9 million,
respectively. The estimated fair value of the swaps at June 30, 2010 was a negative $10.0 million.
The net changes in the fair value of the Companys derivatives, which is reflected in
derivative liabilities, at fair value, for the six months ended June 30, 2010 is as follows:
|
|
|
|
|
|
|
Six Months Ended |
|
|
|
June 30, 2010 |
|
Balance, January 1 |
|
$ |
(13,144,591 |
) |
|
|
|
|
|
Cash settlements |
|
|
6,227,116 |
|
Fair value adjustments |
|
|
(3,041,170 |
) |
|
|
|
|
|
|
|
|
|
Balance, June 30 |
|
$ |
(9,958,645 |
) |
|
|
|
|
6. FAIR VALUE MEASUREMENTS
Topic 820, Fair Value Measurements and Disclosures, establishes a three-tier hierarchy for
fair value measurements based upon the transparency of the inputs to the valuation of an asset or
liability and expands the disclosures about instruments measured at fair value. A financial
instrument is categorized in its entirety and its categorization within the hierarchy is based upon
the lowest level of input that is significant to the fair value measurement. The three levels are
described below.
|
|
|
Level 1 Inputs to the valuation methodology are quoted prices (unadjusted) for
identical assets or liabilities in active markets. |
|
|
|
|
Level 2 Inputs to the valuation methodology include quoted prices for similar
assets and liabilities in active markets and inputs that are observable for the asset
of liability, either directly or indirectly, for substantially the full term of the
financial instrument. Fair values for these instruments are estimated using pricing
models, quoted prices of securities with similar characteristics, or discounted cash
flows. |
|
|
|
|
Level 3 Inputs to the valuation methodology are unobservable and significant to
the fair value measurement. Fair values are initially valued based upon transaction
price and are adjusted to reflect exit values as evidenced by financing and sale
transactions with third parties. |
Fair values for over-the-counter interest rate contracts are determined from market observable
inputs, including the LIBOR curve and measures of volatility, used to determine fair values are
considered Level 2, observable market inputs.
26
Fair values for certain investments (Level 3 assets) are determined using pricing models,
discounted cash flow methodologies or similar techniques and at least one significant model
assumption or input is unobservable.
The carrying value of derivative and financial instruments on the Companys financial
statements at June 30, 2010 are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Level 1 |
|
|
Level 2 |
|
|
Level 3 |
|
|
Level 3 |
|
Interest-rate swaps |
|
$ |
|
|
|
$ |
(9,958,645 |
) |
|
$ |
|
|
|
$ |
|
|
Investment in trust certificates |
|
|
|
|
|
|
|
|
|
|
57,973,017 |
|
|
|
|
|
Nonrecourse liability |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(288,747,674 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
|
|
|
$ |
(9,958,645 |
) |
|
$ |
57,973,017 |
|
|
$ |
(288,747,674 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
The changes in items classified as Level 3 during the six months ended June 30, 2010 are
as follows:
|
|
|
|
|
|
|
|
|
|
|
Investments |
|
|
Liabilities |
|
Balance, January 1, 2010 |
|
$ |
69,355,735 |
|
|
$ |
(345,441,865 |
) |
|
|
|
|
|
|
|
|
|
Total unrealized gains/(losses) |
|
|
(3,695,204 |
) |
|
|
24,738,007 |
|
Transfers in/(out) |
|
|
(1,566,985 |
) |
|
|
23,015 |
|
Distributions/payments |
|
|
(6,120,529 |
) |
|
|
31,933,169 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, June 30, 2010 |
|
$ |
57,973,017 |
|
|
$ |
(288,747,674 |
) |
|
|
|
|
|
|
|
Unrealized gains included in earnings during the three and six months ended June 30, 2010
related to investments held at June 30, 2010 amounted to
$5.7 million and $3.7 million,
respectively.
The carrying value of assets measured at the lower of cost or market value at June 30, 2010 is
as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Level 1 |
|
|
Level 2 |
|
|
Level 3 |
|
Mortgage loans and real estate held for sale |
|
$ |
|
|
|
$ |
|
|
|
$ |
288,747,674 |
|
|
|
|
|
|
|
|
|
|
|
7. NOTES PAYABLE AND FINANCING AGREEMENTS
As of June 30, 2010, the Company had total borrowings, Notes payable and financing agreements,
of $1.37 billion under the Restructuring Agreements, of which $1.33 billion was subject to the
Legacy Credit Agreement and $39.1 million remained under a credit facility excluded from the
Restructuring Agreements (the Unrestructured Debt). Substantially all of the debt under these
facilities was incurred in connection with the Companys purchase and origination of residential
1-4 family mortgage loans prior to December 2007. We ceased to acquire and originate loans in
November 2007, and under the terms of the Restructuring Agreements, the Company cannot originate or
acquire mortgage loans or other assets without the prior consent of the Bank. These borrowings are
shown in the Companys financial statements as Notes payable (referred to as term loans or
term debt herein).
At June 30, 2010, FCMC owed $1.0 million under the revolving line of its Licensing Credit
Agreement with the Bank, which is shown in the Companys financial statements as Financing
agreement. See Note 11 Subsequent Events.
27
Restructuring Agreements with Lead Lending Bank
Prior to the March 31, 2009 restructuring agreements that we entered into with Huntington, our
indebtedness was governed by forbearance agreements and prior credit and warehousing agreements
with Huntington. Effective as of March 31, 2009, all of our borrowings, with the exception of the
Unrestructured Debt in the current amount of $39.1 million, are governed by credit agreements
entered into as part of the Restructuring Agreements.
July 20, 2010 Amendment to Restructuring Agreements
To implement the agreements reached in the Letter Agreement, on July 20, 2010, the Company and
FCMC entered into an amendment to the Licensing Credit Agreement with the Bank (as Administrative
Agent and Issuing Bank) and an affiliate of the Bank, Huntington Finance, LLC as Lender and Risk
Participant (Amendment No. 2). Specifically, under Amendment No. 2, as agreed to under the
Letter Agreement, available credit under the revolving loan facility was reduced from $2 million to
$1 million and the cash collateral securing the revolving loan and letter of credit facilities was
reduced from $8.5 million to $7.5 million, with the released collateral applied as a voluntary
payment against the debt outstanding of certain subsidiaries of the Registrant under the Legacy
Credit Agreement. In addition, FCMC agreed to use $1 million in unpledged cash on the Loan Sale
Closing Date to repay the amount outstanding under its revolving line of credit with the Bank under
the Licensing Credit Agreement. See Note 11 Subsequent Events.
March 2009 Restructuring
On March 31, 2009, Franklin Holding, and certain of its direct and indirect subsidiaries,
including Franklin Credit Management Corporation and Tribeca Lending Corp., entered into a series
of agreements (collectively, the Restructuring Agreements) with the Bank, successor by merger to
Sky Bank, pursuant to which the Companys loans, pledges and guarantees with the Bank and its
participating banks were substantially restructured, and approximately 83% of the Portfolio was
transferred to Huntington Capital Financing, LLC (the REIT), a real estate investment trust
wholly-owned by the Bank.
The Restructuring did not include a portion of the Companys debt (the Unrestructured Debt),
which as of March 31, 2009 totaled approximately $40.7 million. The Unrestructured Debt remains
subject to the original terms of the Franklin Forbearance Agreement entered into with the Bank in
December 2007 and subsequent amendments thereto and the Franklin 2004 master credit agreement. On
June 28, 2010, Franklin Holding, and certain of its direct and indirect subsidiaries, including
FCMC and Franklin Asset entered into another amendment to the Franklin Forbearance Agreement and
Franklin 2004 master credit agreement with the Bank relating to the Unrestructured Debt that
extends the term of the forbearance period until September 30, 2010. See Note 7
Notes Payable and Financing Agreements Forbearance Agreement with Lead Lending Bank.
The Franklin Forbearance Agreement and the Tribeca forbearance agreement that had been entered
into with the Bank were, except for approximately $39.1 million of the Companys debt outstanding
at June, 2010, replaced effective March 31, 2009 by the Restructuring Agreements.
In conjunction with the Restructuring, and at the request of the Bank, effective March 31,
2009, the Company exercised its right to terminate two non-amortizing fixed-rate interest rate
swaps with the Bank, one with a notional amount of $150 million and the other with a notional
amount of $240 million. The total termination fee for cancellation of the swaps was $8.2 million,
which is payable only to the extent cash is available under the waterfall provisions of the Legacy
Credit Agreement, and only after the first $837.9 million (the amount designated as Tranche A debt
as of March 31, 2009) of term debt has
been paid in full. At June 30, 2010, $759.1 million of this tranche of debt remained to be
paid off before payment of the swap termination fee is triggered. The Company has other
non-amortizing fixed-rate interest rate swaps with the Bank, which have not been terminated.
28
On June 25, 2009, also in connection with the Restructuring and with the approval of the
holders of more than two-thirds of the shares of Franklin Holding entitled to vote at an election
of directors, the Certificate of Incorporation of FCMC was amended to delete the provision, adopted
pursuant to Section 251(g) of the General Corporation Law of the State of Delaware in connection
with the Companys December 2008 corporate reorganization, that had required the approval of the
stockholders of Franklin Holding in addition to the stockholders of FCMC for any action or
transaction, other than the election or removal of directors, that would require the approval of
the stockholders of FCMC.
Background to the Restructuring. The severe deterioration in the U.S. housing market and the
nearly complete shutdown of the mortgage credit market for most borrowers in the latter part of
2007 and throughout 2008, coupled with the severe economic slowdown and rapidly rising unemployment
during 2008, resulted in increased delinquencies, provisions for loan losses, operating losses, and
decreased cash flows for the Company. The impact on the Companys operations was severe, and
included (i) a substantial and growing shortfall in cash collections from the portfolio of mortgage
loans and real estate owned relative to the Companys debt service obligations owed to the Bank,
(ii) a substantial and growing shortfall in the value of the Companys assets, relative to the
amounts owed to the Bank, (iii) concern by potential servicing customers and other constituencies
over the continued viability of the Company, including the viability of FCMC, the Companys
servicing platform, and (iv) concern that the Bank was increasingly likely to: (a) cease granting
necessary waivers and forbearances with respect to defaults under the Companys various credit
facilities; and, (b) declare a default with respect to the credit facilities and foreclose on the
assets of the Company, substantially all of which were pledged to the Bank, especially in light of
communications from the Bank indicating that it was seeking greater and more direct control over
the collection guidelines related to the assets in the Portfolio and may have needed to foreclose
on the Portfolio if it were not able to consummate a transaction like the Restructuring in which it
was able to gain control over the Portfolio while keeping the credit facilities outstanding. Such
a foreclosure would have left no value for the Companys stockholders.
In order to address these issues, accommodate the concerns of the Bank to take advantage of
what the Company believes is the best option to preserve value for its stockholders, the Company
negotiated and entered into the Restructuring, which was approved by the Companys Board of
Directors.
Summary of the Restructuring. Key attributes of the Restructuring, as they relate to the
Companys legacy indebtedness to the Bank include:
|
(1) |
|
in exchange for the transfer of that part of the Portfolio underlying the Bank
Trust Certificates (as defined below), the Company received common membership interests
and Class C preferred membership interests in the REIT having in the aggregate a value
intended to approximate the fair market value of that portion of the Portfolio
transferred to the Bank, which as of March 31, 2009 was approximately $477.3 million
(the REIT Securities). The preferred membership interests have a liquidation value
of $100,000 per unit and an annual cumulative dividend rate of 9% of such liquidation
value. Any dividends on the preferred shares shall be payable only out of funds
legally available for the payment thereof; |
|
|
(2) |
|
principal and interest payments in respect of the Legacy Credit Agreement are
only due and payable to the extent of cash flow of the Company, which cash flow would
include dividends declared and paid in respect of the REIT Securities or any other
assets of the Company, other than the retained interest in FCMC (as discussed below);
and, |
29
|
(3) |
|
the Banks recourse in respect of the Legacy Credit Agreement is limited to the
assets and stock of Franklin Holdings subsidiaries, excluding the assets of FCMC
(except for a first lien of the Bank on an office condominium unit and a second
priority lien of the Bank on cash collateral held as security under the Licensing
Credit Agreement) and a portion of FCMCs stock, representing not less than twenty-five
percent (since Level 1 referenced below was not achieved) and not more than seventy
percent of FCMCs common equity, based on the amounts received by the Bank from the
cash collections from FCMCs servicing of the Portfolio as discussed in more detail
below. Under the terms and conditions of the Restructuring Agreements, FCMC may pay
dividends or other distributions in respect of its capital stock if FCMC delivers to
the Bank a payment to be applied to outstanding obligations under the Legacy Credit
Agreement equal to seventy percent of any such distribution or dividend that FCMC
elects to make or declare, which percentage share may be reduced to twenty-five percent
(since Level 1 referenced below was not achieved) based upon the Banks receipt of the
agreed amounts of net remittances from the Portfolio summarized below. |
From the perspective of the Company and its stockholders, the Restructuring accomplished a
number of overarching objectives, including:
|
(1) |
|
release of thirty percent of the equity in FCMC, ten percent of which has been
transferred to the Companys principal stockholder, Thomas J. Axon, from the Companys
pledges to the Bank in respect of its Legacy Credit Agreement, with the possibility of
release of up to an additional fifty percent (which is now forty-five percent due to
the failure to achieve Level 1 referenced below and of which a maximum of ten percent
would go to Thomas J. Axon), based upon the Banks receipt of the agreed amounts of net
remittances from the Portfolio, summarized below (the Net Remittances), from March
31, 2009, the effective date of the Legacy Credit Agreement (the Legacy Effective
Date), through the term of the Legacy Credit Agreement; the Bank shall reduce its
interest in the equity in FCMC, as collateral, in accordance with the following
collection levels; |
|
|
|
|
|
|
|
|
|
Minimum Amount |
|
|
|
|
|
|
of Net Remittances |
|
|
|
|
Level |
|
(Minimum Level Amount) |
|
Time Period |
|
Release of Equity Interests |
Level 1
|
|
$225 million*
|
|
1 year from the Legacy Effective Date*
|
|
10% (70% reduces to 60%)* |
Level 2
|
|
$475 million
|
|
3 years from the Legacy Effective Date
|
|
10% (60% reduces to 50%) |
Level 3
|
|
$575 million
|
|
No time period specified
|
|
10% (50% reduces to 40%) |
Level 4
|
|
$650 million
|
|
No time period specified
|
|
10% (40% reduces to 30%) |
Level 5
|
|
$750 million
|
|
No time period specified
|
|
10% (30% reduces to 20%) |
|
|
|
* |
|
Provided, however, (i) if Net Remittances do not reach the minimum Level 1 amount prior to
the first anniversary of the Legacy Effective Date (which is what occurred), but reach the
minimum Level 2 amount prior to the third anniversary of the Legacy Effective Date, the Bank
shall retain, as collateral, 55% of the FCMC equity instead of 50%, as currently scheduled,
and any subsequent reductions in the amount of FCMC equity pledged to the Bank shall be 10%;
and provided further that (ii) if Net Remittances do not reach the minimum Level 1 amount
prior to the first anniversary of the Legacy Effective Date and do not reach the minimum Level
2 amount prior to the third anniversary of the Legacy Effective Date, then the schedule for
release of the equity interests in FCMC currently pledged to the Bank shall be as follows: (x)
upon attaining the minimum Level 3 amount, the pledged equity interests in FCMC shall reduce
25% (from 70% to 45%); (y) upon attaining the minimum Level 4 amount, the pledged equity
interests in FCMC shall reduce an additional 10% (from 45% to 35%), and (z) upon attaining the
minimum Level 5 amount, the pledged equity interests in FCMC shall reduce an additional 10%
(from 35% to 25%). |
30
|
(2) |
|
entry into a servicing agreement enabling the Company to receive fee income in
respect of its continued servicing of the transferred Portfolio; and, |
|
|
(3) |
|
entry into amended credit facilities in the aggregate principal amount of $13.5
million, (which, effective June 20, 2010, is $7.5 million) including a $5 million
facility for working capital (which expired unrenewed on May 31, 2010) and to support
various servicer licenses, a $2 million revolving facility (which was reduced to $1
million on July 20, 2010) and a $6.5 million letter of credit facility to support
various servicer licenses. |
Among the most significant costs of accomplishing these objectives were:
|
(1) |
|
the possible transfer of ownership of a portion of FCMC, including a minimum of
twenty-five percent (since Level 1 was not achieved) and a maximum of seventy percent,
to the Bank at maturity of the Companys Legacy Credit Agreement with the Bank, unless
further extended if the Company is not otherwise able to satisfy or refinance the
Legacy Credit Agreement prior to maturity; |
|
|
(2) |
|
the transfer of ten percent of ownership of FCMC to Franklin Holdings
principal stockholder, Thomas J. Axon, as the cost of obtaining certain guarantees and
pledges required by the Bank as a condition of the restructuring, subject to increase
to an additional ten percent should the pledge of common shares of FCMC by Franklin
Holding to the Bank be reduced upon the attainment by FCMC of certain net collection
targets set by the Bank with respect to the Portfolio; |
|
|
(3) |
|
entry into a service agreement with respect to FCMCs continued servicing of
the Portfolio that allows the Bank to terminate such servicing and, concomitantly,
FCMCs fee income from servicing the Portfolio; and, |
|
|
(4) |
|
the Company may incur significant income tax liabilities as a result in part of
a tax basis transfer, at termination of the Legacy Credit Agreement, liquidation of the
Company or any of its direct or indirect subsidiary companies, or certain other Company
events such as a de facto liquidation. The amount of any tax liability that the
Company may incur is not certain since any such calculations need to be performed on a
company by company basis and are influenced by a number of factors including, but not
limited to, the ability to use prior year losses and future results of operations. |
Restructuring Agreements. In connection with the Restructuring, the Company and its
subsidiaries:
1. Transferred substantially the entire Portfolio in exchange for the REIT Securities.
Pursuant to the terms of a Transfer and Assignment Agreement, certain subsidiaries of the
Company (the Franklin Transferring Entities) transferred the Portfolio to a newly formed Delaware
statutory trust (the Trust) in exchange for the following trust certificates (collectively, the
Trust Certificates):
|
(a) |
|
an undivided 100% interest of the Banks portion of consumer mortgage loans
(the Bank Consumer Loan Certificate); |
31
|
(b) |
|
an undivided 100% interest in the Banks portion of consumer REO assets (the
Bank Consumer REO Certificate, and together with the Bank Consumer Loan Certificate,
the Bank Trust Certificates); |
|
|
(c) |
|
an undivided 100% interest in the portion of consumer mortgage loan assets
allocated to the M&I Marshall & Ilsley Bank (M&I) and BOS (USA) Inc. (BOS) (M&I and
BOS collectively, the Participants) represented by two certificates (the
Participants Consumer Loan Certificates); and, |
|
|
(d) |
|
an undivided 100% interest in Participants portion of the consumer REO assets
represented by two certificates (the Participants Consumer REO Certificates, and
together with the Participants Consumer Loan Certificate, the Participants Trust
Certificates). |
The Bank Trust Certificates represent approximately 83.27961% of the assets transferred to the
Trust considered in the aggregate (such portion, the Bank Contributed Assets) and the
Participants Trust Certificates represent approximately 16.72039% of the assets transferred to the
Trust considered in the aggregate.
Pursuant to the Transfer and Assignment Agreement, the Franklin Transferring Entities made
certain representations, warranties and covenants to the Trust related to the Portfolio. To the
extent any Franklin Selling Entity breaches any such representations, warranties and covenants and
the Franklin Transferring Entities are unable to cure such breach, the Trust has recourse against
the Franklin Transferring Entities (provided that recourse to FCMC is limited solely to instances
whereby FCMC transferred REO property FCMC did not own) (the Reacquisition Parties). In such
instances, the Reacquisition Parties are obligated to repurchase any mortgage loan or REO property
and indemnify the Trust, the Bank, the Administrator (as defined below), the holders of the Trust
Certificates and the trustees to the trust agreement. The Franklin Transferring Entities provided
representations and warranties, including but not limited to correct information, loans have not
been modified, loans are in force, valid lien, compliance with laws, licensing, enforceability of
the mortgage loans, hazardous substances, fraud, and insurance coverage. In addition, the Franklin
Transferring Entities agreed to provide certain collateral documents for each mortgage loan and REO
property transferred (except to the extent any collateral deficiency was disclosed to the Trust).
To the extent any collateral deficiency exists with respect to such mortgage loan or REO property
and the Franklin Transferring Entities do not cure such deficiency, the Reacquisition Parties shall
be obligated to repurchase such mortgage loan. In connection with the reacquisition of any asset,
the price to be paid by the Reacquisition Parties for such asset (the Reacquisition Price) shall
be as agreed upon by the Administrator and the applicable Reacquisition Party; provided, however,
should such parties not promptly come to agreement, the Reacquisition Price shall be as determined
by the Administrator in good faith using its sole discretion.
The subsidiaries then transferred the Trust Certificates to a newly formed Delaware limited
liability company, Franklin Asset, LLC, in exchange for membership interests in Franklin Asset,
LLC. Franklin Asset, LLC then contributed the Bank Trust Certificates to a newly formed Delaware
limited liability company, Franklin Asset Merger Sub, LLC, in exchange for membership interests in
Franklin Asset Merger Sub, LLC (Franklin Asset, LLC retained the Participant Trust Certificates).
Franklin Merger Sub, LLC merged with and into a Huntington National Bank wholly-owned subsidiary of
the REIT (REIT Sub) and Franklin Asset, LLC received the REIT Securities having in the aggregate
a value equal to the estimated fair market value of the loans underlying the Bank Trust
Certificates, which as of March 31, 2009 was approximately $477.3 million, in exchange for its
membership interests in Franklin Asset Merger Sub, LLC. The preferred REIT Securities have a
liquidation value of $100,000 per unit and an annual cumulative dividend rate of 9% of such
liquidation value. If there is a reacquisition required to be made by the Reacquisition Parties
under the Transfer and Assignment
Agreement, Franklin Asset, LLC will return such number of Class C Preferred Shares of REIT
Securities that is equal in value to the Reacquisition Price (as defined in the Transfer and
Assignment Agreement).
32
2.
Amended and restated substantially all of its outstanding debt.
Pursuant to the terms of the Amended and Restated Credit Agreement (Legacy) (the Legacy Credit
Agreement), the Company amended and restated substantially all of its indebtedness currently
subject to a certain First Amended and Restated Forbearance Agreement and Amendment to Credit
Agreements, dated December 19, 2008, and a certain First Amended and Restated Tribeca forbearance
agreement and Amendment to Credit Agreements, dated December 19, 2008 (the Forbearance
Agreements). As more fully described below, pursuant to the terms of the Legacy Credit Agreement,
(1) the Participant Trust Certificates were collaterally assigned to the Bank as collateral for the
loans as modified pursuant to the terms of the Legacy Credit Agreement (the Restructured Loans);
(2) all net collections received by the Trust in connection with the portion of the Portfolio
represented by the Bank Trust Certificates will be paid to the REIT Sub or its subsidiaries; (3)
the REIT Securities were pledged to the Bank as collateral for the Restructured Loans; (4) Franklin
Holding pledged seventy percent (70%) of the common equity in FCMC to the Bank as collateral for
the Restructured Loans; and (5) Franklin Holding and FCMC were released from existing guarantees of
the Restructured Loans, including Franklin Holdings pledge of 100% of the outstanding shares of
FCMC. In exchange, Franklin Holding and FCMC provided certain limited recourse guarantees relating
to the Restructured Loans, wherein the Bank agreed to exercise only limited recourse against
property encumbered by the pledge agreement (the Pledged Collateral) made in connection with the
Legacy Credit Agreement, provided Franklin Holding and FCMC, respectively, any designee acting
under the authority thereof or any subsidiary of either Franklin Holding or FCMC did not (i)
commission any act fraud or material misrepresentation in respect of the Pledged Collateral; (ii)
divert, embezzle or misapply proceeds, funds or money and/or other property relating in any way to
the Pledged Collateral; (iii) breach any covenant under Article IV of the Pledge Agreement entered
into by Franklin Holding; or (iv) conduct any business activities to perform diligence services, to
service mortgage Loans or REO Properties or any related activities, directly or indirectly, other
than by FCMC and Franklin Credit Loan Servicing, LLC (all of which are referred to as exceptions to
nonrecourse).
The terms of the Legacy Credit Agreement vary according to the three tranches of loans covered
by the Legacy Credit Agreement. At March 31, 2009, Tranche A included outstanding debt in the
approximate principal sum of $837.9 million bearing interest at a per annum rate equal to one-month
LIBOR plus 2.25% per annum, payable monthly in arrears on the outstanding principal balance of the
related advances; Tranche B included outstanding debt in the approximate principal sum of $407.5
million bearing interest at a per annum rate equal to one-month LIBOR plus 2.75% per annum, payable
monthly in arrears on the outstanding principal balance of the related advances; and, Tranche C
included outstanding debt in the approximate principal sum of $125 million bearing interest at a
per annum rate equal to 15%, payable monthly in arrears on the outstanding principal balance of the
related advances. In the event of a default, the applicable interest rate will increase to 5% over
the rate otherwise applicable to the respective tranche.
33
Terms of the Restructured Indebtedness Under the Legacy Credit Agreement. The following
table summarizes the principal economic terms of the Companys indebtedness under the Legacy Credit
Agreement immediately following the Restructuring.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding |
|
|
Outstanding |
|
|
|
|
|
|
|
|
|
Principal Amount |
|
|
Principal Amount |
|
|
Applicable Interest |
|
|
Required Monthly |
|
|
|
at March 31, 2009 |
|
|
at June 30, 2010 |
|
|
Margin Over LIBOR |
|
|
Principal |
|
|
|
Franklin Asset/Tribeca |
|
|
Franklin Asset/Tribeca |
|
|
(basis points) |
|
|
Amortization |
|
Tranche A |
|
$ |
838,000,000 |
|
|
$ |
759,000,000 |
|
|
|
225 |
|
|
None |
Tranche B |
|
$ |
407,000,000 |
|
|
|
424,000,000 |
|
|
|
275 |
|
|
None |
Tranche C |
|
$ |
125,000,000 |
|
|
|
151,000,000 |
|
|
|
N/A |
(1) |
|
None |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrestructured Debt |
|
$ |
41,000,000 |
|
|
$ |
39,000,000 |
|
|
|
|
(2) |
|
None |
|
|
|
(1) |
|
The applicable interest rate is fixed at 15% per annum. Interest will be paid in kind
during the term of the Restructuring. |
|
(2) |
|
Interest margin over FHLB 30-day LIBOR advance rate plus 2.60%-2.75%. |
The interest rate under the terms of the Restructuring Agreements for Tranche A and
Tranche B indebtedness that is the basis, or index, for the Companys interest cost is the
one-month LIBOR plus applicable margins. In accordance with the terms of the Restructuring
Agreements, interest due and unpaid on Tranche B and Tranche C debt is accrued and added to the
debt balance. See Note 11 Subsequent Events.
All cash available for each tranche shall be used to pay cash interest to the extent cash is
available, and any accrued interest for which cash is not available will be added to the principal
sum of such tranche. Cash payments on each tranche will be made from: (i) any cash or other assets
of the borrowers (Tribeca and certain subsidiaries of Tribeca and Franklin Asset), (ii) dividends
and distributions on the REIT Securities, all of which shall be applied as a non pro rata
distribution solely to the Banks pro rata share of such tranche (until paid in full), (iii) all
distributions made by the Trust on the Participant Trust Certificates, all of which shall be
applied as a non pro rata distribution to the Participants pro rata shares of such tranche (until
paid in full), and (iv) from any proceeds received from any other collateral, which will be applied
pursuant to a waterfall provision described more fully in the Legacy Credit Agreement. The
borrowers will not be required to make scheduled principal payments, provided that all amounts
received by any borrower in excess of accrued interest, whether from collateral or otherwise, shall
be applied to reduce the principal sum. All remaining principal and interest will be due and
payable at maturity of the Legacy Credit Agreement on March 31, 2012. Based on the current cash
flows described above, it is not expected that that the Company will be able to repay remaining
principal and interest due on March 31, 2012. Under such circumstances, the Bank would have all
available rights and remedies under the Legacy Credit Agreement.
In accordance with the terms of the Legacy Credit Agreement, during the three months ended
June 30, 2010, the outstanding balance of Tranche B increased from $420.3 million to $423.5 million
and the outstanding balance of Tranche C increased from $145.4 million to $151.0 million, due to
the addition of accrued interest for which cash was not available to pay the interest due. During
the quarter ended June 30, 2010, the increases in the outstanding balances of Tranches B and C
resulted in the total balance of debt outstanding under the Legacy Credit Agreement to increase
slightly from $1.330 billion at March 31, 2010 to $1.334 billion at June 30, 2010.
34
The Legacy Credit Agreement contains representations, warranties, covenants and events of
default (the Legacy Credit Agreement Defaults) that are customary in transactions similar to the
restructuring. Some, but not all of the Legacy Credit Agreement Defaults (including defaults under
provisions relating to enforceability, bankruptcy, maintenance of collateral and lien
positions, and certain negative covenants typical for agreements of this nature) will create an
event of default under the Licensing Credit Agreement (subject to notice requirements) and entitle
the Bank to terminate the Servicing Agreement (as defined below). Under such circumstances, the
Bank would be entitled to foreclose on all of the assets of the Company pledged to the Bank,
including on Franklin Holdings pledge of 70% of the stock of FCMC.
The Legacy Credit Agreement is secured by a first priority security interest in (i) the REIT
Shares; (ii) the Participant Trust Certificates; (iii) an undivided 16.72039% interest in the
consumer mortgage loans and REO properties transferred to the Trust; (iv) 70% of all equity
interests in FCMC, and 100% equity interests in all other direct and indirect subsidiaries of
Franklin Holding, pledged by Franklin Holding (subject to partial releases of such equity interests
under Cumulative Collective Targets under the terms relating to the Servicing Agreement); (v) all
amounts owing pursuant to any deposit account or securities account of any Company entities bound
to the Legacy Credit Agreement (other than Franklin Holding), (vi) a first mortgage in real
property interests at 6 Harrison Street, Unit 6, New York, New York; (vii) all monies owing to any
borrower from any taxing authority; (viii) any commercial tort or other claim of FCMC, Holding, or
any borrower, including FCMCs right, title and interest in claims and actions with respect to
certain loan purchase agreements and other interactions of FCMC with various entities engaged in
the secondary mortgage market; (ix) certain real property interests of FCMC in respect to the
proprietary leases under the existing Forbearance Agreements if not transferred to the Trust; (x) a
second priority lien on cash collateral held as security for the Licensing Credit Agreement to
FCMC; and (xi) any monies, funds or sums due or received by any Borrower in respect of any program
sponsored by any Governmental Authority, any federal program, federal agency or quasi-governmental
agency, including without limitation any fees received, directly or indirectly, under the U.S.
Treasury Homeowners Affordability and Stability Plan. Any security agreement, acknowledgement or
other agreement in respect of a lien or encumbrance on any asset of the Trust shall be non-recourse
in nature and shall permit the Trust to distribute, without qualification, 83.27961% of all net
collections received by the Trust to the REIT Sub and its subsidiaries irrespective of any event or
condition in respect of the Legacy Credit Agreement.
All collections received by the Trust, provided that an event of default has not occurred and
is continuing, shall go first to the payment of monthly servicing fees under the Servicing
Agreement and then to (i) Administration Fees, expenses and costs (if any), (ii) pro rata to the
owner trustee, certificate trustee and each custodian for any due and unpaid fees and expenses of
such trustee and/or custodian, and (iii) to the pro rata ownership of the Trust Certificates. All
amounts received pursuant to the Participants Trust Certificates shall be distributed pursuant to
the applicable Waterfall provisions.
3. |
|
Entered into an amended and restated credit agreement to fund FCMCs licensing obligations
and working capital. |
On March 31, 2009, in connection with the Restructuring, Franklin Holding and FCMC entered
into an Amended and Restated Credit Agreement (Licensing) (the Licensing Credit Agreement) which
included a credit limit of $13,500,000, composed of a secured (i) revolving line of credit
(Revolving Facility) up to the principal amount outstanding at any time of $2,000,000, (ii) up to
the aggregate stated amount outstanding at any time for letters of credit of $6,500,000, and (iii)
a draw credit facility (Draw Facility) up to the principal amount outstanding at any time of
$5,000,000.
35
On March 26, 2010, Franklin Holding and FCMC entered into an amendment to the Licensing Credit
Agreement with the Bank, which renewed and extended the Licensing Credit Agreement entered into
with the Bank on March 31, 2009 as part of the Restructuring. The Amendment reduced the draw
credit facility (Draw Facility) from $5.0 million to $4.0 million and extended the termination
date to
May 31, 2010, which expired unrenewed, and extended the termination date for the $2.0 million
revolving line of credit (which, effective July 20, 2010, is $1 million), and $6.5 million letter
of credit facilities to March 31, 2011. The amendment further provided that FCMC shall, to the
extent permitted by applicable law, no less frequently than semi-annually, within forty-five days
after each June 30th and December 31st of each calendar year, make pro rata dividends,
distributions and payments to FCMCs shareholders and the Bank under the Legacy Credit Agreement.
In accordance with the Legacy Credit Agreement, the Bank is currently entitled to 70% of all
amounts distributed by FCMC. The payment of any dividends, distributions and payments to FCMCs
shareholders and the Bank would result in a reduction of FCMCs stockholders equity and cash
available for its operations. All other material terms and conditions of the Licensing Credit
Agreement remained the same, including the collateral, warranties, representations, covenants and
events of defaults.
The Revolving Facility and the letters of credit are used to assure that all state licensing
requirements of FCMC are met and to pay approved expenses of the Company. The Draw Facility was
available, although never utilized by the Company, for the purpose of providing working capital for
FCMC, if needed, and amounts drawn and repaid under this facility could not be re-borrowed. At
June 30, 2010, $1.0 million was outstanding under the revolving facility and approximately $6.5
million of letters of credit for various state licensing purposes were outstanding. There were no
amounts due under the Draw Facility when it expired unrenewed. For a description of Amendment No.
2 to the Licensing Credit Agreement with the Bank, see Note 11 Subsequent Events.
The principal sum shall be due and payable in full on the earlier of the date that the
advances under the Licensing Credit Agreement, as amended, are due and payable in full pursuant to
the terms of the agreement, whether by acceleration or otherwise, or at maturity. Advances under
the Revolving Facility shall bear interest at the one-month reserve adjusted LIBOR plus a margin of
8%. There is a requirement to make monthly payments of interest accrued on the Advances under the
Revolving Facility. After any default, all advances and letters of credit shall bear interest at
5% in excess of the rate of interest then in effect.
The Licensing Credit Agreement, as amended, contains warranties, representations, covenants
and events of default that are customary in transactions similar to the Restructuring.
The Licensing Credit Agreement, as amended, is secured by (i) a first priority security
interest in FCMCs cash equivalents in a controlled account maintained at the Bank in an amount
satisfactory to the Bank, but not less than $8,500,000 (which, effective June 20, 2010, is $7.5
million), (ii) blanket existing lien on all personal property of FCMC, (iii) a second mortgage in
real property interests at 6 Harrison Street, Unit 6, New York, New York, (iv) a first Mortgage in
certain real property interests at 350 Albany Street, New York, New York; and (v) any monies or
sums due FCMC in respect of any program sponsored by any Governmental Authority, including without
limitation any fees received, directly or indirectly, under the U.S. Treasury Homeowners
Affordability and Stability Plan. See Note 11 Subsequent Events.
The Draw Facility had been guaranteed by Thomas J. Axon, Chairman of the Board of Directors
and a principal stockholder of the Company. In consideration for his guaranty, the Bank and the
Companys Audit Committee each had consented in March 2009 to the payment to Mr. Axon equal to 10%
of FCMCs common shares, which has been paid, subject to a further payment of up to an additional
10% in FCMCs common shares should the pledge of common shares of FCMC by Franklin Holding to the
Bank be reduced upon attainment by FCMC of certain net collection targets set by the Bank with
respect to the Portfolio.
36
Mr. Axons personal guaranty was extended to secure FCMC semi-annual payments under the terms
of the Letter Agreement entered into with the Bank on July 16, 2010 of the EBITDA Payment pursuant
to an amendment to the guarantee, which will also provide that to the extent that the EBITDA
Payment in respect of any period is less than $500,000, Mr. Axon will pay such shortfall. Mr.
Axons obligations pursuant to the guaranty would be secured and continue to be secured by a first
priority and exclusive lien on commercial real estate he had pledged to the Bank on March 31, 2009.
On July 20, 2010, the Company and FCMC entered into Amendment No. 2 to the Licensing Credit
Agreement with the Bank and an affiliate of the Bank, Huntington Finance, LLC (Amendment No. 2).
See Note 11 Subsequent Events.
4. |
|
Entered into a servicing agreement with the Trust. |
The Servicing Agreement, which was entered into on March 31, 2009 and amended and restated as
of August 1, 2010, governs the servicing by FCMC, as the servicer (the Servicer) for the loans
and REO properties owned by the Trust. The Trust and/or the Bank as the administrator of the Trust
(the Administrator) have significant control over all aspects of the servicing by FCMC.
All collections by the Servicer are remitted to a collection account and controlled through
the Banks lockbox account. The Administrator shall transfer the collection amounts from the
lockbox account to a certificate account whereby the funds shall flow through the trust agreements
Waterfall as described above. The obligation of the Trust to pay the Servicers servicing fees
and servicing advance reimbursements are limited to the collections from the loans and REO
properties of the Trust. In addition, the Servicer will be indemnified by the Trust only for a
breach of corporate representations and warranties or if the Administrator forces the Servicer to
take an action that results in a loss to the Servicer.
The Servicer is required to maintain net worth of approximately $7.6 million and net income
before taxes of $800,000 for the most recent twelve-month period or a breach of the agreement will
be deemed to have occurred entitling the Bank with notice to terminate the agreement if the breach
continues unremedied for five (5) business days. In addition to typical events entitling the owner
to terminate the agreement with respect to some or all of the loans and REO properties, (i) certain
events of default under the Legacy Loan Agreement, and (ii) any event of default under the
Licensing Loan Agreement, would entitle the Trust to immediately terminate the Servicing Agreement.
In addition, the Servicing Agreement with respect to some or all of the loans and REO properties
is terminable without penalty and without cause on 90 days prior written notice, or 30 days prior
written notice in connection with a sale of some or all of the loans and REO properties by the
Trust. See Note 11 Subsequent Events.
Forbearance Agreements with Lead Lending Bank
On December 28, 2007, the Company entered into a series of agreements with the Bank, pursuant
to which the Bank agreed to forbear with respect to certain defaults of the Company relating to the
Companys indebtedness to the Bank and restructure approximately $1.93 billion of such indebtedness
to the Bank and its participant banks. However, the Forbearance did not relate to $44.5 million of
the Companys indebtedness under the Master Credit and Security Agreement, dated as of October 13,
2004, as amended, by and among Franklin Credit, certain subsidiaries of Franklin Credit and the
Bank. This amount remained subject to the original terms specified in the applicable agreements
(the Unrestructured Debt). For a description of the principal terms of all the Companys credit
agreements, including The Forbearance Agreements (the Forbearance), in effect prior to entering
into the Restructure Agreements on March 31, 2009 described above, which replaced such Forbearance
Agreements, except for the Unrestructured Debt, please see the Companys Form 10-K for the year
2009.
37
The Franklin forbearance agreement, however, remains in effect until September 30, 2010, but
only with respect to the Companys remaining Unrestructured Debt that was not restructured
effective March 31, 2009 under the Restructuring Agreements, which was approximately $39.1 million
at June 30, 2010.
The Unrestructured Debt remains subject to the original terms of the Franklin forbearance
agreement entered into with the Bank in December 2007 and subsequent amendments thereto (the
Franklin Forbearance Agreement) and the Franklin 2004 master credit agreement. On April 20,
August 10, November 13, 2009, March 26 and June 28, 2010, Franklin Holding, and certain of its
direct and indirect subsidiaries, including FCMC and Franklin Credit Asset Corporation (Franklin
Asset) entered into amendments to the Franklin Forbearance Agreement and Franklin 2004 master
credit agreement (the Amendments) with the Bank relating to the Unrestructured Debt whereby the
term of forbearance period, which had been previously extended by the Bank, was extended until
September 30, 2010. The Bank again agreed to forebear with respect to any defaults past or present
with respect to any failure to make scheduled principal and interest payments to the Bank
(Identified Forbearance Default) relating to the Unrestructured Debt. During the forbearance
period, the Bank, absent the occurrence and continuance of a forbearance default other than an
Identified Forbearance Default, will not initiate collection proceedings or exercise its remedies
in respect of the Unrestructured Debt or elect to have interest accrue at the stated rate
applicable after default. In addition, FCMC is not obligated to the Bank with respect to the
Unrestructured Debt and any references to FCMC in the Franklin 2004 master credit agreement
governing the Unrestructured Debt have been amended to refer to Franklin Asset.
Upon expiration of the forbearance period, in the event that the Unrestructured Debt with the
Bank remains outstanding, the Bank, with notice, could call an event of default under the Legacy
Credit Agreement, but not the Licensing Credit Agreement and the Servicing Agreement, which do not
include cross-default provisions that would be triggered by such an event of default under the
Legacy Credit Agreement. The Banks recourse in respect of the Legacy Credit Agreement is limited
to the assets and stock of Franklin Holdings subsidiaries, excluding the assets of FCMC (except
for a first lien of the Bank on an office condominium unit and a second priority lien of the Bank
on cash collateral held as security under the Licensing Credit Agreement) and the unpledged portion
of FCMCs stock.
The Franklin Forbearance Agreement is subject to a scheduled maturity date of September 30,
2010.
8. NONCONTROLLING INTEREST
For the Companys consolidated majority-owned subsidiary in which the Company owns less than
100% of the total outstanding common shares of stock (FCMC), the Company recognizes a
noncontrolling interest for the ownership interest of the noncontrolling interest holder, the
Companys President and Chairman, and principal stockholder, Thomas J. Axon. The noncontrolling
interest represents the minority stockholders proportionate share of the equity of FCMC. At June
30, 2010, the Company owned 90% of FCMCs capital stock, and Mr. Axon owned 10%. The 10% equity
interest of FCMC that is not owned by the Company is shown as noncontrolling interest in subsidiary
in the Companys consolidated financial statements.
38
The change in the carrying amount of the minority interest for the six months ended June 30,
2010 is as follows:
|
|
|
|
|
|
|
Six Months Ended |
|
|
|
June 30, 2010 |
|
Balance, January 1, 2010 |
|
$ |
1,657,275 |
|
|
Net income attributed to noncontrolling interest |
|
|
114,133 |
|
|
|
|
|
|
Balance, June 30, 2010 |
|
$ |
1,771,408 |
|
|
|
|
|
On March 31, 2009, the Company transferred ten percent of its ownership in common stock
of FCMC to its Chairman and President, Thomas J. Axon, as the cost of obtaining certain guarantees
and pledges from Mr. Axon, which were required by the Bank as a condition of the Restructuring
entered into by the Company and certain of its wholly-owned direct and indirect subsidiaries on
March 31, 2009. Mr. Axon is also entitled to a grant of up to an additional ten percent of the
common stock of FCMC from the Company should the pledge of common shares of FCMC by the Company to
the Bank, as part of the restructuring, be reduced upon the attainment by FCMC of certain net
collection targets set by the Bank. See Note 7 Notes Payable and Financing Agreements.
9. CERTAIN CONCENTRATIONS
Third Party Servicing Agreements As a result of the March 2009 Restructuring and the
Reorganization that took effect December 19, 2008, the Companys operating business is conducted
solely through FCMC, which is a specialty consumer finance company primarily engaged in the
servicing and resolution of performing, reperforming and nonperforming residential mortgage loans,
including specialized loan recovery servicing, for third parties. The portfolios serviced for
other entities, as of June 30, 2010, were heavily concentrated with loans serviced for Huntington
(loans previously acquired and originated by Franklin and transferred to the Trust). As of June
30, 2010, FCMC had two significant servicing contracts with third parties to service 1-4 family
mortgage loans and owned real estate, one with Huntington (through the Trust) and the other with
Bosco, a related party. At June 30, 2010, we serviced and provided recovery collection services on
a total population of approximately 34,000 loans for Huntington and Bosco, and relatively small
pools of loans under recovery collection contracts, whereby we receive fees based solely on a
percentage of amounts collected, for several other entities. The unpaid principal balance of loans
serviced for Huntington represented approximately 80% of the total loans serviced for third parties
at June 30, 2010. See Note 11 Subsequent Events.
Additionally, under the terms of the Servicing Agreement with the Bank, the Bank has the right
to replace FCMC as servicer for any reason without cause and without penalty with not less than 90
days prior written notice, and to sell, on a servicing released basis without an assignment of the
Servicing Agreement, the assets retained by the Trust without cause and without penalty with not
less than 30 days prior written notice.
Financing All of the Companys existing debt is with one financial institution, Huntington.
10. RELATED PARTY TRANSACTIONS
Restructuring On March 31, 2009, the Company transferred ten percent of its ownership in
common stock of FCMC to its Chairman and President, Thomas J. Axon, as the cost of obtaining
certain guarantees and pledges from Mr. Axon, which were required by the Bank as a condition of the
restructuring entered into by the Company and certain of its wholly-owned direct and indirect
subsidiaries on March 31, 2009. Mr. Axon is also entitled to a grant of up to an additional ten
percent of the common
stock of FCMC from the Company should the pledge of common shares of FCMC by the Company to
the Bank, as part of the restructuring, be reduced upon the attainment by FCMC of certain net
collection targets set by the Bank. See Note 7 Notes Payable and Financing Agreements.
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Bosco Servicing Agreement On May 28, 2008, FCMC entered into various agreements, including
a servicing agreement, to service on a fee-paying basis for Bosco approximately $245 million in
residential home equity line of credit mortgage loans. Bosco was organized by FCMC, and the
membership interests in Bosco include the Companys Chairman and President, Thomas J. Axon, and a
related company of which Mr. Axon is the chairman of the board and three of the Companys directors
serve as board members of that entity. The loans that are subject to the servicing agreement were
acquired by Bosco on May 28, 2008, and the Bank is the administrative agent for the lenders to
Bosco. FCMC also provided the loan analysis, due diligence and other services for Bosco on a
fee-paying basis for the loans acquired by Bosco. FCMCs servicing agreement was approved by its
Audit Committee.
FCMC began servicing the Bosco portfolio in June 2008. Included in the Companys consolidated
revenues were servicing fees recognized from servicing the Bosco portfolio of $230,000 and $626,000
for the three months ended June 30, 2010 and 2009, respectively, and $474,000 and $1.4 million for
the six months ended June 30, 2010 and 2009, respectively. In addition, included in the Companys
consolidated revenues were fees recognized for various administrative services provided to Bosco by
FCMC in the amount of $150,000 for the six months ended June 30, 2009. The Company did not
recognize any administrative fees for the six months ended June 30, 2010 and Bosco did not pay for
any fees for such services provided during the six months ended June 30, 2010. In June 2009, FCMC
wrote off as uncollectible the administrative fees recognized in the three months ended March 31,
2009.
On February 27, 2009, at the request of the Bosco lenders, FCMC adopted a revised fee
structure, which was approved by FCMCs Audit Committee. The revised fee structure provided that,
for the next 12 months, FCMCs monthly servicing fee would be paid only after a monthly loan
modification fee of $29,167 was paid to Boscos Lenders. Further, the revised fee structure
provided that, on each monthly payment date, if the aggregate amount of net collections was less
than $1 million, 25% of FCMCs servicing fee would be paid only after certain other monthly
distributions were made, including, among other things, payments made by Bosco to repay its
third-party indebtedness.
On October 29, 2009, at the additional request of the Bosco lenders in an effort to maximize
cash flow to the Bosco lenders and to avoid payment defaults by Bosco, the revised fee structure
relating to deferred fees was adjusted through an amendment to the loan servicing agreement with
Bosco (the Bosco Amendment), which was approved by FCMCs Audit Committee.
Under the terms of the Bosco Amendment, FCMC is entitled to a minimum monthly servicing fee of
$50,000. However, to the extent that the servicing fee otherwise paid for any month would be in
excess of the greater of $50,000 or 10% of the total cash collected on the loans serviced for Bosco
(such amount being the Monthly Cap), the excess will be deferred, without the accrual of
interest. The cumulative amounts deferred will be paid (i) with the payment of the monthly
servicing fee, to the maximum extent possible, for any month in which the servicing fee is less
than the applicable Monthly Cap, so long as the sum paid does not exceed the Monthly Cap or (ii) to
the extent not previously paid, on the date on which any of the promissory notes (Notes) payable
by Bosco to the Lenders, which were entered into to finance the purchase of and are secured by the
loans serviced by FCMC, is repaid, refinanced, released, accelerated, or the amounts owing
thereunder increased (other than by accrual or capitalization of interest). If the deferred
servicing fees become payable by reason of acceleration of the Notes, the Lenders right to payment
under such Notes shall be prior in right to FCMCs rights to such deferred fees.
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Further, the Bosco Amendment provides that FCMC will not perform or be required to perform any
field contact services for Bosco or make any servicing advances on behalf of Bosco that
individually or in the aggregate would result in a cost or expense to Bosco of more than $10,000
per month, without the prior written consent and approval of the Lenders. The Bosco Amendment did
not alter FCMCs right to receive a certain percentage of collections after Boscos indebtedness to
the Lenders has been repaid in full, the Bosco equity holders have been repaid in full the equity
investment in Bosco made prior to Bosco entering into the loan agreement with the Lenders, and the
Lenders and Boscos equity holders have received a specified rate of return on their debt and
equity investments.
The amount and timing of ancillary fees owed to the Company is the subject of a good faith
dispute between FCMC and the Managing Member of Bosco, Thomas J. Axon (Chairman and President of
the Company and FCMC). However, even if the parties can resolve their difference amicably, there
are no funds available to Bosco for payment for such services, since all funds from collections are
required by Boscos agreements with its lenders to repay such lenders, aside from specific amounts
required for servicing fees and other specifically excepted costs. On June 30, 2009, the Company
wrote off $90,000 in internal accounting costs associated with services provided by FCMC to Bosco.
On December 31, 2009, the Company wrote off $372,000 in additional aged receivables, due to
non-payment, consisting of (i) legal costs incurred by FCMC in 2008 related to the acquisition by
Bosco of its loan portfolio and entry into a servicing agreement with Bosco; (ii) expenses for loan
analysis, due diligence and other services performed for Bosco by FCMC in 2008 related to the
acquisition by Bosco of the loan portfolio; and (iii) additional internal accounting costs for
services provided to Bosco by FCMC through June 30, 2009. In addition, FCMC has not accrued fees
for accounting costs for these services since June 1, 2009.
FCMC determined to accept the deferrals and other amendments described above with respect to
its Bosco relationship in recognition of the performance of the Bosco loan portfolio, which has
been adversely impacted by general market and economic conditions, in an effort to maintain the
continued and future viability of its servicing relationship with Bosco, and in the belief that
doing so is in its best long-term economic interests in light of the fact that the Company believes
FCMCs servicing of the Bosco portfolio is profitable notwithstanding such deferrals and
amendments. FCMCs determination to not currently take legal action with respect to the
receivables it has written off as described above, which receivables have not been settled or
forgiven by FCMC, was made in light of these same considerations.
As of June 30, 2010, FCMC had $349,000 of accrued and unpaid servicing fees due from Bosco
(effective August 1, 2009, FCMCs servicing fee income is recognized when cash is received), and
$55,000 of reimbursable third-party expenses incurred by FCMC in the servicing and collection of
the Bosco loans.
On March 4, 2010, FCMC entered into an agreement with Bosco to provide ancillary services not
covered by the Bosco Servicing Agreement related to occupancy verification and the coordination of
on-sight visits with borrowers to facilitate the implementation of loss mitigation program
initiatives at fees ranging from $100-$140 per individual assignment. FCMC had performed such
services for Bosco on a trial basis under a pass-through cost arrangement, with total expenses
reimbursable by Bosco of approximately $26,030 outstanding at June 30, 2010 (included in the
$55,000 of reimbursable third-party expenses included above).
Other Significant Related Party Transactions with the Companys Chairman At June 30, 2010,
the Company had an outstanding receivable from an affiliate, RMTS Associates, of $3,000. This
receivable represents various operating expenses that are paid by the Company and then reimbursed
by RMTS.
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On August 18, 2008, FCMCs audit committee authorized a 5% commission to Hudson Servicing
Solutions, LLC (Hudson), a procurer of force-placed insurance products for the mortgage industry,
with respect to force-placed hazard insurance coverage maintained on FCMCs remaining portfolio of
mortgage loans and mortgage loans serviced for third parties. The sole member of Hudson is RMTS,
LLC, of which the Companys Chairman and President is the majority owner.
FCMC entered into a collection services agreement, effective December 23, 2009, pursuant to
which FCMC agreed to serve as collection agent in the customary manner in connection with
approximately 4,000 seriously delinquent and generally unsecured loans, with an unpaid principal
balance of approximately $56 million, which were acquired by two trusts set up by a fund in which
the Companys Chairman and President is a member, and contributed 50% of the purchase price and
agreed to pay certain fund expenses. Under the collection services agreement, FCMC is entitled to
collection fees consisting of 35% of the gross amount collected. The agreement also provides for
reimbursement of third-party fees and expenses incurred by FCMC. The collection fees earned by
FCMC under this collection services agreement during the three months ended June 30, 2010 were not
significant.
On February 1, 2010, FCMC entered into a collection services agreement, pursuant to which FCMC
agreed to serve as collection agent in the customary manner in connection with approximately 1,500
seriously delinquent and generally unsecured loans, with an unpaid principal balance of
approximately $85 million, which were acquired through a trust set up by a fund in which the
Companys Chairman and President is a member, and contributed twenty five percent of the purchase
price. Under the collection services agreement, FCMC is entitled to collection fees consisting of
33% of the amount collected, net of third-party expenses. The agreement also provides for
reimbursement of third-party fees and expenses incurred by FCMC in compliance with the collection
services agreement. The collection fees earned by FCMC under this collection services agreement
during the three months ended June 30, 2010 were not significant.
11. SUBSEQUENT EVENTS
Sale of Trusts Loans, Loan Sale Servicing Agreement, New Trust Servicing Agreement, Amendment to
Licensing Credit Agreement and Other Agreements with The Huntington National Bank
On July 16, 2010, Franklin Holding and its subsidiary, FCMC, entered into a letter agreement
(the Letter Agreement) with the Bank, Franklin Mortgage Asset Trust 2009-A, an indirect subsidiary
of the Bank (the Trust) and, for certain limited purposes, Thomas J. Axon. The Letter Agreement
was entered into in connection with and in anticipation of the Trusts then-proposed sale on a
servicing released basis (the Loan Sale), of substantially all of the first-lien residential
mortgage loans serviced by FCMC under the servicing agreement by and among the Trust and FCMC dated
March 31, 2009 (the Legacy Servicing Agreement).
The Loan Sale closed on July 20, 2010 (the Loan Sale Closing Date) and, on July 20, 2010, the
Loan Sale purchaser (the Purchaser) entered into a loan servicing agreement with FCMC (the Loan
Sale Servicing Agreement), pursuant to which FCMC will continue to service the first-lien
residential mortgage loans acquired in the Loan Sale. The Purchaser, however, has the right, and
has indicated that it intends to exercise such right on or about September 1, 2010, to move the
servicing of 25% of the loans acquired (based on unpaid principal balance) to a servicer affiliated
with Purchaser without further notice and without the payment of a termination fee. Although the
amount ultimately received by the Trust in respect of the sale, net of certain expenses, will count
towards the next applicable minimum net remittance level set by the Bank for a scheduled partial
release of an additional 15% of pledged equity interests in FCMC (see Note 7 Notes Payable and
Financing Agreements), it is not expected that the
net sale proceeds and, collections as of the date of this filing, will be sufficient to obtain
a partial release of equity interests from the Bank.
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The Letter Agreement included terms amending, or committing the Bank, FCMC, the Company, and
related parties to amend certain of the Restructuring Agreements entered into in connection with
the Restructuring with the Bank on March 31, 2009, including the existing credit relationships
under the Legacy Servicing Agreement, the syndicated legacy amended and restated credit agreement,
dated as of March 31, 2009 (the Legacy Credit Agreement), and the amended and restated licensing
credit agreement, dated as of March 31, 2009 (the Licensing Credit Agreement), and commitments by
FCMC to make certain payments to the Bank. Additionally, the Letter Agreement set forth certain
mutual commitments of the parties with respect to the Companys consideration of a restructuring or
spin-off of its ownership of FCMC (a Potential Restructuring), as well as certain guaranties of
Thomas J. Axon, the Chairman of the Company and FCMC.
Letter Agreement with the Bank. Under the Letter Agreement with the Bank:
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FCMC on the Loan Sale Closing Date made a $1 million payment to the Bank as
reimbursement for certain expenses of the Bank in connection with the Loan Sale, which
the Company expects will result in a pre-tax $1 million charge to earnings in the third
quarter ending September 30, 2010; |
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FCMC released all claims under the Legacy Servicing Agreement (other than those for
unpaid servicing advances for services incurred prior to June 30, 2010) with respect to
the loans sold in the Loan Sale; |
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FCMC refunded to the Trust on the Loan Sale Closing Date an estimated $400,000 of
the servicing fees paid in advance to FCMC under the Legacy Servicing Agreement in
respect of July 2010 to the extent attributable to the loans sold in the Loan Sale; |
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On the Loan Sale Closing Date, the Legacy Servicing Agreement was terminated as to
the loans sold, except with respect to FCMCs obligations to assist in curing
documentary issues or deficiencies relating to the loans sold; and, |
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FCMC and the Trust entered into an amended and restated servicing agreement (the New
Trust Servicing Agreement or Servicing Agreement) on July 30, 2010 and effective
August 1, 2010, relating to the servicing of the loans previously serviced under the
Legacy Servicing Agreement, other than those sold in the Loan Sale (see below). |
On the Loan Sale Closing Date, the Company and FCMC entered into an amendment to the Licensing
Credit Agreement with the Bank and an affiliate of the Bank, Huntington Finance, LLC (Amendment
No. 2).
Amendment No. 2 to the Licensing Credit Agreement. Under Amendment No. 2 to the Licensing
Credit Agreement with the Bank:
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FCMC used $1 million in unpledged cash to repay the amount outstanding under its
revolving line of credit with the Bank; and, |
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Available credit under the revolving loan facility was reduced from $2 million to $1
million and the cash collateral securing the revolving loan and letter of credit
facilities was reduced from $8.5 million to $7.5 million, with the collateral so
released applied as a voluntary
payment against the debt outstanding of certain subsidiaries of the Company under the
Legacy Credit Agreement, which the Company expects will result in a $1 million reduction
of stockholders equity in the third quarter ending September 30, 2010. |
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Loan Sale Servicing Agreement with Purchaser. On July 20, 2010, but effective as of July 1,
2010, FCMC entered into the Loan Sale Servicing Agreement with the Purchaser, pursuant to which
FCMC will continue to provide servicing for the loans acquired by the Purchaser in the Loan Sale.
However, the servicing of 25% of the loans acquired (based on unpaid principal balance) is to be
transferred by FCMC to an affiliate of the Purchaser, which is expected to occur on or about
September 1, 2010. With respect to the remaining 75% of the loans acquired, the Purchaser, which
is now the second largest servicing client of FCMC, has the right to terminate the servicing of any
of such loans without cause upon ninety (90) calendar days prior written notice, subject to the
payment of a termination fee for each such loan terminated.
Pursuant to the Loan Sale Servicing Agreement, FCMC will service the loans subject to
customary terms, conditions and servicing practices for the mortgage servicing industry.
Indemnification of FCMC by the Purchaser is limited to third-party claims and damages arising out
of or based upon any breach of any of the corporate representations or warranties or covenants of
Purchaser and FCMCs compliance with written instructions to the extent such instructions are not
in compliance with applicable requirements for the loan and accepted servicing practices, as such
terms are defined under the Loan Sale Servicing Agreement.
FCMC as servicer will receive a monthly servicing fee per loan per month with the amount
dependent upon loan status at the end of each month, resolution and disposition fees based on the
unpaid principal balance of loans collected from borrowers or gross proceeds from the sales of a
properties, as applicable, and a contingency fee for unpaid principal balance collected on loans
designated by the Purchaser, in addition to various ancillary fees and reimbursement of certain
third-party expenses.
Due to the ultimate retention of the servicing for only 75% of the loans sold to Purchaser
(based on unpaid principal balance) and the servicing fee rate to be paid under the Loan Sale
Servicing Agreement, the Company expects that the servicing fees to be paid by Purchaser will be
substantially less than the servicing fees that had been paid by the Trust for such loan servicing,
resulting in potentially significantly reduced revenues for FCMC and the Company.
Potential Restructuring. In the Letter Agreement, the parties agreed that in connection with
a potential restructuring (the Potential Restructuring), if the Potential Restructuring is
acceptable to the Bank and the required lenders, in each partys sole discretion, and the Potential
Restructuring does not result in material tax, legal, regulatory, or accounting impediments or
issues for Franklin Holding or FCMC, then:
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The Bank would use its reasonable efforts to assist Franklin Holding and FCMC in
connection with such Potential Restructuring in obtaining the approval of the required
lenders for the Potential Restructuring and consenting to any change of control in
connection with the Potential Restructuring to the extent required under the Legacy
Credit Agreement, and FCMC or Franklin Holding would reimburse and hold the Bank and
the required lenders harmless from any reasonable expense incurred by them in
connection with any such Potential Restructuring; |
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FCMC would make semi-annual payments to the Bank under the Legacy Credit Agreement
(the EBITDA Payment) equal to (i) 50% of FCMCs EBITDA, in accordance with generally
accepted accounting principles (GAAP), for each period for the first 18 months
from the Loan Sale Closing Date, and (ii) 70% of FCMCs GAAP EBITDA for each period
thereafter, up to a maximum aggregate of $3 million; |
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Thomas J. Axons existing personal guaranty to the Bank would be extended to the
EBITDA Payment pursuant to an amendment to the guarantee, which will also provide that
to the extent that the EBITDA Payment in respect of any period is less than $500,000,
Mr. Axon will pay such shortfall. Mr. Axons obligations pursuant to the guaranty
would be secured and continue to be secured by the collateral he had pledged to the
Bank on March 31, 2009; and, |
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Any payments by FCMC or Mr. Axon in respect of the EBITDA Payment would go to reduce
the obligation of the other in respect of the obligations to make such payment, or the
guaranty in respect of such payment, as the case may be; and, any payments in respect
of the EBITDA Payments, and application of payments to the Bank in respect of
distributions by FCMC to its stockholders (in accordance with the March 2010 amendment
to the Licensing Credit Agreement and with the requirement under the Legacy Credit
Agreement that all such distributions to stockholders be accompanied by such
application such that such applications are not less than 70% of the total amounts of
such applications and distributions for any semi-annual period), would each serve as a
credit against the other, which could have the effect of reducing the $3 million
maximum amount of the EBITDA Payments otherwise payable as described above. See Note 7
Notes Payable and Financing Agreements. |
However, the form or structure of any Potential Restructuring is uncertain and as of the date
of this filing it is not known if any Potential Restructuring can be accomplished or even be
successfully completed.
New Trust Servicing Agreement. On July 30, 2010, FCMC entered in the New Trust Servicing
Agreement with the Trust, dated and effective as of August 1, 2010, to replace the prior servicing
agreement (the Prior Agreement) that had been entered into with the Trust as part of the March 31,
2009 Restructuring with the Bank.
Pursuant to the New Trust Servicing Agreement, FCMC will continue to service the loans and REO
properties retained by the Trust (the Assets) that were not sold by the Trust in the Loan Sale
effective July 1, 2010 (which sale was previously disclosed by the Company in its disclosure on
Form 8-K filed July 22, 2010), under terms that are generally similar to those that previously
governed FCMCs provision of servicing under the Prior Agreement.
The New Trust Servicing Agreement did, however, include material changes in the following
areas:
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the servicing fees for second lien mortgage loans, which comprise substantially all
of the Assets serviced under the New Trust Servicing Agreement will be based
predominately on the percentage of principal and interest collected, with a contingency
rate dependent on the delinquency of the loan and a per unit monthly service fee for
only those loans less than 30 days delinquent or in a bankruptcy status during the 90
day period following a bankruptcy filing, rather than a per unit monthly service fee
for second lien mortgages loans up to 119 days delinquent and a contingency rate on the
earlier of foreclosure or liquidation of the REO or when such a loan is 120 days or
more delinquent; |
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the servicing fees for the first lien mortgages and REO properties will be based on
a fee schedule from the Loan Sale Servicing Agreement FCMC had entered into with the
third
party (the Purchaser) that had purchased substantially all of the first lien mortgage
loans from the Trust on July 20, 2010 and effective July 1, 2010, (with the exception of
a new incentive that would result in increased fees for REO properties should FCMC sell
50% of more of the REO properties of the Trust (calculated based on the number of
properties) within 180 days of the entry into the New Trust Servicing Agreement; |
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FCMCs services may be terminated with respect to some or all of the Assets without
cause and without penalty on 30 days prior written notice in connection with a sale of
some or all of the Assets by the Trust (otherwise, the 90 day prior written notice
period that was in effect for the Prior Agreement was retained); and, |
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under the New Trust Servicing Agreement, (i) the consent process for hiring vendors
was replaced with a general restriction that vendors may not be engaged to perform a
substantial portion of the primary day-to-day servicing obligations of FCMC; (ii)
minimum gross collection targets that could trigger a termination of the agreement
under certain circumstances were removed; and, (iii) the restrictions on entering into
new servicing agreements that could reasonably likely impair the ability of the FCMC to
perform its obligations were eliminated, but a customary servicing standard and
detailed servicer obligations are contained within the agreement. |
Overall, the Company anticipates that the fees earned under the New Trust Servicing Agreement
will be significantly less than those earned under the Prior Agreement. In addition, the Bank has
communicated to the Company that it is committed to selling in the near future the second -lien
mortgage loans owned by the Trust, and, if and when it does, there is no assurance that the loans
will be sold to a party that retains FCMC as servicer.
Franklin Accounting for the Sale of Loans by the Trust. Although the transfer of the trust
certificates on March 31, 2009, representing approximately 83% of the Portfolio, to the Banks REIT
was structured in substance as a sale of financial assets, the transfer, for accounting purposes,
has been treated as a secured financing in accordance with ASC Topic 860 because for accounting
purposes the requisite level of certainty that the transferred assets have been legally isolated
from the Company and put presumptively beyond the reach of the Company and its creditors, including
in a bankruptcy proceeding, was not achieved. As a result, the mortgage loans and real estate
assets have remained on the Companys balance sheet classified as mortgage loans and real estate
held for sale securing a nonrecourse liability in an equal amount. The treatment as a financing on
the Companys balance sheet, however, did not affect the cash flows of the transfer, and does not
affect the Companys cash flows or its reported net income nor would it, necessarily, dictate the
treatment of the assets in a bankruptcy.
As a result of the Loan Sale by the Trust as directed by the Bank to an independent
third-party purchaser (Purchaser), which included substantially all of the first-lien mortgage
loans except for the loans collateralizing the Unrestructured Debt, effective July 1, 2010 the
loans included in the Loan Sale, in which neither the Trust nor the Company have a residual
interest, and the net proceeds of which ultimately will pay down debt under the Legacy
Credit Agreement, are expected to be removed from the Companys balance sheet; the mortgage loans
and real estate held for sale securing the nonrecourse liability in an equal amount, as well as the
loans sold included in the Companys investment in trust certificates. Approximately 4,300 of
residential mortgage loans, consisting principally of first-lien mortgage loans, with an unpaid
principal balance of approximately $626 million were included in the Loan Sale.
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The Company estimates, based on available information, that approximately $282 million of
principally first-lien mortgage loans at estimated fair value will be removed from the consolidated
financial statements in the third quarter ending September 30, 2010. The Company estimates,
based on available information, that there will be minimal impact on the consolidated earnings in
the third quarter of 2010 from the Loan Sale as the loans involved in the Loan Sale, which are
carried by Franklin at estimated fair values, were valued at June 30, 2010 at a price estimated to
be paid by the Purchaser. See Note 3 Investment in trust certificates at fair value, mortgage
loans and real estate held for sale, and notes receivable held for sale and Note 4 Fair
valuation adjustments.
Investment in Huntington REIT Securities
The Companys investment in REIT securities includes preferred and common stocks of a REIT of
the Bank. On or about June 14, 2010, the REIT in which the Company owned 4,724 shares of Class C
preferred stock and seven shares of common stock, Huntington Capital Financing, LLC (the Initial
REIT) was merged into Huntington Preferred Capital II, Inc., another REIT of the Bank (the New
REIT, with the Company receiving, in exchange for preferred stock and common stock held in the
Initial REIT, 4,724 shares of Class C preferred stock and 154 shares of common stock of the New
REIT, which did not constitute a change in the Companys investment. In addition, the terms of the
new Class C shares of the combined REIT mirror the terms of the Class C shares of the Initial REIT.
On July 23, 2010, the Company was verbally notified by the Bank that due to losses recognized by
the New REIT from a write down of the carrying value of the mortgage loans owned by the Trust, the
board of directors of the New REIT decided not to declare any preferred dividends in the third and
fourth calendar quarters of 2010. The Bank indicated that the suspension of preferred dividends is
temporary and that the REIT is expected to declare and pay dividends commencing in January 2011,
including the cumulative dividends for the third and fourth quarters of 2010. The expected revenue
loss for the third and fourth quarters of 2010 is approximately $10.6 million (pre tax) per
quarter, which may be recovered in 2011. The non payment of such dividends will result in
increased stockholders deficit for the three months ended September 30 and December 31, 2010.
As a direct result of the New REIT not declaring dividends throughout the remainder of 2010,
the Company will be unable to pay its monthly interest due on Tranche A debt under the Legacy
Credit Agreement with the Bank. Accordingly, the Company, under the terms of the Legacy Credit
Agreement, anticipates that it will elect to accrue interest on the Tranche A debt, to the extent
not paid (due to the temporary deferral of preferred dividends by the New REIT), through
distributions made on the Companys investment in trust certificates of the Trust by adding the
amount unpaid to the outstanding principal balance of the Tranche A debt.
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ITEM
2. MANAGEMENTS DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
Safe Harbor Statements. Statements contained herein and elsewhere in this Quarterly Report on
Form 10-Q that are not historical fact may be forward-looking statements regarding the business,
operations and financial condition of Franklin Credit Holding Corporation (Franklin Holding, and
together with its consolidated subsidiaries, the Company, Franklin, we, us or our unless
otherwise specified or the context otherwise requires) within the meaning of Section 27A of the
Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as
amended (the Exchange Act). This information may involve known and unknown risks, uncertainties
and other factors which may cause our actual results, performance or achievements to be materially
different from our future results, performance or achievements expressed or implied by any
forward-looking statements. Forward-looking statements, which involve assumptions and describe our
future plans, strategies and expectations, and other statements that are not historical facts, are
generally identifiable by use of the words may, will, should, expect, anticipate,
estimate, believe, intend, plan, potential or project or the negative of these words or
other variations on these words or comparable terminology. These forward-looking statements are
based on assumptions that may be incorrect, and there can be no assurance that these projections
included in these forward-looking statements will come to pass. Our actual results could differ
materially from those expressed or implied by the forward-looking statements as a result of various
factors. These factors include, but are not limited to: (i) unanticipated changes in the U.S.
economy, including changes in business conditions such as interest rates, changes in the level of
growth in the finance and housing markets, such as slower or negative home price appreciation and
economic downturns or other adverse events in certain states; (ii) the Companys ability to
continue as a going concern; (iii) the Companys relations with the Companys lenders and such
lenders willingness to waive any defaults under the Companys agreements with such lenders; (iv)
the Companys ability to obtain renewals of its loans or alternative refinancing opportunities; (v)
increases in the delinquency rates of the Companys borrowers, (vi) the availability of or ability
to retain as clients third parties holding distressed mortgage debt for servicing by the Company on
a fee-paying basis; (vii) changes in the statutes or regulations applicable to the Companys
business or in the interpretation and enforcement thereof by the relevant authorities; (viii) the
status of the Companys regulatory compliance; (ix) our ability to meet collection targets under
the legacy credit agreement with the Bank in order to reduce the pledge of equity interest in
Franklin Credit Management Corporation (FCMC) from 70% to a minimum of 25%; (x) the risk that
legal proceedings could be brought against the Company which could adversely affect its financial
results; (xi) the Companys ability to adapt to and implement technological change; (xii) the
Companys ability to attract and retain qualified employees; and (xiii) other risks detailed from
time to time in the Companys Securities and Exchange Commission (SEC) reports and filings.
Additional factors that would cause actual results to differ materially from those projected or
suggested in any forward-looking statements are contained in the Companys filings with the SEC,
including, but not limited to, those factors discussed under the captions Risk Factors, Interest
Rate Risk and Real Estate Risk in the Companys Annual Report on Form 10-K for the year ended
December 31, 2009, filed with the SEC on March 31, 2010 and Quarterly Reports on Form 10-Q, which
the Company urges investors to consider. The Company undertakes no obligation to publicly release
the revisions to such forward-looking statements that may be made to reflect events or
circumstances after the date hereof or to reflect the occurrences of unanticipated events, except
as otherwise required by securities, and other applicable laws. Readers are cautioned not to place
undue reliance on these forward-looking statements, which speak only as of the date hereof. The
Company undertakes no obligation to release publicly the results on any events or circumstances
after the date hereof or to reflect the occurrence of unanticipated events.
48
Application of Critical Accounting Policies and Estimates
The Companys significant accounting policies, as of December 31, 2009 are described in Note 2
to the December 31, 2009 consolidated financial statements filed on the Annual Report on Form 10-K.
As of June 30, 2010 and December 31, 2009, we have identified the continuing assessment of the
fair value of the investment in (i) preferred and common stocks, or the REIT Securities, (ii) trust
certificates, (iii) because for accounting purposes the Restructuring is being treated as a
financing under ASC Topic 860, Transfers and Servicing (ASC Topic 860), mortgage loans and real
estate held for sale and the corresponding nonrecourse liability, and (iv) income taxes as the
Companys most critical accounting policies and estimates. The following discussion and analysis
of financial condition and results of operations is based on the amounts reported in our
consolidated financial statements, which are prepared in accordance with accounting principles
generally accepted in the United States of America, or GAAP. In preparing the consolidated
financial statements, management is required to make various judgments, estimates and assumptions
that affect the financial statements and disclosures. Changes in these estimates and assumptions
could have a material effect on our consolidated financial statements. Management believes that
the estimates and judgments used in preparing these consolidated financial statements were the most
appropriate at that time.
Serviced for Others Portfolio
As a result of the March 2009 Restructuring and the Reorganization that took effect December
19, 2008, FCMC, the Companys servicing business is conducted through FCMC, a specialty consumer
finance company primarily engaged in the servicing and resolution of performing, reperforming and
nonperforming residential mortgage loans, including specialized loan recovery servicing for third
parties.
As of June 30, 2010, FCMC had two significant servicing contracts with third parties to
service 1-4 family mortgage loans and owned real estate, Huntington, through a trust formed in
connection with the Restructuring (the Trust) and Bosco. The portfolios serviced for Huntington
(loans previously acquired and originated by Franklin and transferred to the Trust) primarily
consist of first and second-lien loans secured by 1-4 family residential real estate that generally
fell outside the underwriting standards of Fannie Mae and Freddie Mac. At June 30, 2010, we
serviced and provided recovery collection services on a total population of approximately 34,000
loans for Huntington and Bosco, and relatively small pools of loans under recovery collection
contracts, whereby we receive fees based solely on a percentage of amounts collected, for a few
other entities.
The loans serviced for Huntington represented approximately 80% of the unpaid principal
balance (75% of the number) of total loans serviced at June 30, 2010. On July 30, 2010, FCMC
entered into a new servicing agreement (the New Trust Servicing Agreement or Servicing
Agreement) with the Trust, dated and effective as of August 1, 2010, to replace the current
servicing agreement (the Prior Agreement or Legacy Servicing Agreement) that had been entered
into with the Trust as part of the March 31, 2009 Restructuring with the Bank. The New Trust
Servicing Agreement is terminable, with respect to some or all of the loans and REO properties,
without penalty and without cause on 90 days prior written notice, or 30 days prior written notice
in connection with a sale of some or all of the loans and REO properties by the Trust.
On July 20, 2010, effective July 1, 2010, Franklin Mortgage Asset Trust 2009-A (the Trust)
as directed by the Bank sold to a third party (the Purchaser) on a servicing released basis (the
Loan Sale) substantially all of the first-lien residential mortgage loans serviced by FCMC under
the servicing agreement by and among the Trust and FCMC (the Legacy Servicing Agreement). On July
20, 2010, but effective as of July 1, 2010, FCMC entered into a servicing agreement with the
Purchaser (the Loan Sale Servicing Agreement, pursuant to which FCMC will continue to provide
servicing for the loans acquired
by the Purchaser in the Loan Sale. However, the servicing of what is expected to be 25% of
the loans acquired is to be transferred by FCMC to an affiliate of the Purchaser, which is expected
to occur on or about September 1, 2010. With respect to what is expected to be the remaining 75%
of the loans acquired, the Purchaser, which is now the second largest servicing client of FCMC, has
the right to terminate the servicing of any of such loans without cause upon ninety (90) calendar
days prior written notice, subject to the payment of a termination fee for each such loan
terminated.
49
On May 28, 2008, FCMC entered into a servicing agreement to service for Bosco on a fee-paying
basis approximately $245 million in residential home equity line of credit mortgage loans. Bosco
was organized by FCMC, and the membership interests in Bosco include the Companys Chairman and
President, Thomas J. Axon, and a related company of which Mr. Axon is the chairman of the board and
three of the Companys directors serve as board members of that entity. The loans that are subject
to the servicing agreement were acquired by Bosco from an unrelated third party.
At June 30, 2010, the portfolio of residential mortgage loans serviced for other entities
consisted of 34,000 loans representing $1.831 billion of unpaid principal balance (UPB). The
following table sets forth information regarding the types of properties securing the serviced for
others portfolio at June 30, 2010.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2010 |
|
|
|
Number |
|
|
Unpaid |
|
|
Percentage of Total |
|
Property Types |
|
of Loans |
|
|
Principal Balance |
|
|
Principal Balance |
|
Residential 1-4 family |
|
|
20,104 |
|
|
$ |
1,291,875,045 |
|
|
|
70.55 |
% |
Condos, co-ops, PUD dwellings |
|
|
3,282 |
|
|
|
199,415,039 |
|
|
|
10.89 |
% |
Manufactured and mobile homes |
|
|
490 |
|
|
|
13,819,178 |
|
|
|
0.75 |
% |
Secured, property type unknown(1) |
|
|
1,397 |
|
|
|
22,630,616 |
|
|
|
1.24 |
% |
Commercial |
|
|
40 |
|
|
|
3,283,250 |
|
|
|
0.18 |
% |
Unsecured loans(2) |
|
|
8,822 |
|
|
|
300,045,421 |
|
|
|
16.39 |
% |
|
|
|
|
|
|
|
|
|
|
Total |
|
|
34,135 |
|
|
$ |
1,831,068,549 |
|
|
|
100.00 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
The loans included in this category are principally small balance (less than $10,000)
second-lien loans acquired, and are collateralized by residential real estate. |
|
(2) |
|
The loans included in this category are principally second-lien loans where the Company
is aware that residential real estate collateral has been foreclosed by the first-lien
holder. |
50
The following table provides a breakdown of the delinquency status of our portfolio of
residential mortgage loans serviced for other entities, as of June 30, 2010, by unpaid principal
balance.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2010 |
|
|
|
|
|
|
|
Contractual Delinquency |
|
|
|
Days Past Due |
|
|
Amount |
|
|
% |
|
Performing Current |
|
0 - 30 days |
|
$ |
229,534,744 |
|
|
|
12.54 |
% |
Delinquent |
|
31 - 60 days |
|
|
14,192,970 |
|
|
|
0.78 |
% |
|
|
61 - 90 days |
|
|
10,363,660 |
|
|
|
0.57 |
% |
|
|
90+ days |
|
|
766,545,921 |
|
|
|
41.86 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Modified Loans |
|
0 - 30 days |
|
|
207,056,261 |
|
|
|
11.31 |
% |
Delinquent |
|
31 - 60 days |
|
|
30,495,622 |
|
|
|
1.67 |
% |
|
|
61 - 90 days |
|
|
14,000,249 |
|
|
|
0.76 |
% |
|
|
90+ days |
|
|
51,354,897 |
|
|
|
2.80 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Bankruptcy |
|
0 - 30 days |
|
|
29,325,285 |
|
|
|
1.60 |
% |
Delinquent |
|
31 - 60 days |
|
|
4,971,486 |
|
|
|
0.27 |
% |
|
|
61 - 90 days |
|
|
3,115,488 |
|
|
|
0.17 |
% |
|
|
90+ days |
|
|
164,871,537 |
|
|
|
9.00 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreclosure |
|
0 - 30 days |
|
|
951,631 |
|
|
|
0.05 |
% |
Delinquent |
|
31 - 60 days |
|
|
786,717 |
|
|
|
0.04 |
% |
|
|
61 - 90 days |
|
|
2,718,056 |
|
|
|
0.15 |
% |
|
|
90+ days |
|
|
300,784,025 |
|
|
|
16.43 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
1,831,068,549 |
|
|
|
100.00 |
% |
|
|
|
|
|
|
|
|
|
|
|
All current loans |
|
0 - 30 days |
|
$ |
466,867,921 |
|
|
|
25.50 |
% |
|
|
|
|
|
|
|
|
|
|
|
Included
in the above table were second-lien mortgage loans in the amount of $1.14
billion, of which $239.1 million were current on a contractual basis. The legal status composition
of the second-lien mortgage loans at June 30, 2010 was: $881.2 million (including $707.7 million at
least 90 days contractually delinquent), or 77%, were performing; $109.2 million, or 10%, were
modified due to delinquency or the borrowers financial difficulty; $146.5 million, or 13%, were in
bankruptcy; and less than $3.0 million were in foreclosure.
51
The following table provides a breakdown of the delinquency status of our portfolio of
residential mortgage loans serviced for other entities, as of June 30, 2010, by loan count.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2010 |
|
|
|
|
|
|
|
Contractual Delinquency |
|
|
|
Days Past Due |
|
|
Number of Loans |
|
|
% |
|
Performing Current |
|
0 - 30 days |
|
|
5,643 |
|
|
|
16.53 |
% |
Delinquent |
|
31 - 60 days |
|
|
333 |
|
|
|
0.98 |
% |
|
|
61 - 90 days |
|
|
262 |
|
|
|
0.77 |
% |
|
|
90+ days |
|
|
18,610 |
|
|
|
54.52 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Modified Loans |
|
0 - 30 days |
|
|
2,479 |
|
|
|
7.26 |
% |
Delinquent |
|
31 - 60 days |
|
|
314 |
|
|
|
0.92 |
% |
|
|
61 - 90 days |
|
|
166 |
|
|
|
0.49 |
% |
|
|
90+ days |
|
|
753 |
|
|
|
2.21 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Bankruptcy |
|
0 - 30 days |
|
|
723 |
|
|
|
2.12 |
% |
Delinquent |
|
31 - 60 days |
|
|
105 |
|
|
|
0.31 |
% |
|
|
61 - 90 days |
|
|
81 |
|
|
|
0.24 |
% |
|
|
90+ days |
|
|
3,180 |
|
|
|
9.32 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreclosure |
|
0 - 30 days |
|
|
5 |
|
|
|
0.01 |
% |
Delinquent |
|
31 - 60 days |
|
|
7 |
|
|
|
0.02 |
% |
|
|
61 - 90 days |
|
|
19 |
|
|
|
0.06 |
% |
|
|
90+ days |
|
|
1,455 |
|
|
|
4.24 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
34,135 |
|
|
|
100.00 |
% |
|
|
|
|
|
|
|
|
|
|
|
All current loans |
|
0 - 30 days |
|
|
8,850 |
|
|
|
25.93 |
% |
|
|
|
|
|
|
|
|
|
|
|
Included in the above table were 27,745 second-lien mortgage loans, of which 6,856 were
current on a contractual basis. The legal status composition of the second-lien mortgage loans at
June 30, 2010 was: 21,698 loans (including 16,459 loans at least 90 days contractually delinquent),
or 78%, were performing; 2,445 loans, or 9%, were modified due to delinquency or the borrowers
financial difficulty; 3.563 loans, or 13%, were in bankruptcy; and 39 loans were in foreclosure.
The following table sets forth information regarding the lien position of the properties
securing the portfolio of residential mortgage loans (exclusive of real estate assets) serviced for
other entities at June 30, 2010:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2010 |
|
|
|
Number |
|
|
Unpaid |
|
|
Percentage of Total |
|
Lien Position |
|
of Loans |
|
|
Principal Balance |
|
|
Principal Balance |
|
1st Liens |
|
|
6,390 |
|
|
$ |
691,213,102 |
|
|
|
37.75 |
% |
2nd Liens |
|
|
27,745 |
|
|
|
1,139,855,447 |
|
|
|
62.25 |
% |
|
|
|
|
|
|
|
|
|
|
Total |
|
|
34,135 |
|
|
$ |
1,831,068,549 |
|
|
|
100.00 |
% |
|
|
|
|
|
|
|
|
|
|
52
The following table sets forth information regarding the geographic location of
properties securing the residential mortgage loans serviced for others at June 30, 2010:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2010 |
|
|
|
Number |
|
|
Unpaid |
|
|
Percentage of Total |
|
Location |
|
of Loans |
|
|
Principal Balance |
|
|
Principal Balance |
|
California |
|
|
5,533 |
|
|
$ |
468,287,841 |
|
|
|
25.57 |
% |
New York |
|
|
1,455 |
|
|
|
165,324,760 |
|
|
|
9.03 |
% |
Florida |
|
|
2,747 |
|
|
|
145,780,252 |
|
|
|
7.96 |
% |
New Jersey |
|
|
918 |
|
|
|
127,799,076 |
|
|
|
6.98 |
% |
Texas |
|
|
3,325 |
|
|
|
90,268,767 |
|
|
|
4.93 |
% |
Pennsylvania |
|
|
1,121 |
|
|
|
62,977,264 |
|
|
|
3.44 |
% |
Ohio |
|
|
1,770 |
|
|
|
56,357,953 |
|
|
|
3.08 |
% |
Illinois |
|
|
1,282 |
|
|
|
53,654,476 |
|
|
|
2.93 |
% |
Georgia |
|
|
1,275 |
|
|
|
51,304,964 |
|
|
|
2.81 |
% |
Maryland |
|
|
617 |
|
|
|
49,833,172 |
|
|
|
2.72 |
% |
All Others |
|
|
14,092 |
|
|
|
559,480,024 |
|
|
|
30.55 |
% |
|
|
|
|
|
|
|
|
|
|
Total |
|
|
34,135 |
|
|
$ |
1,831,068,549 |
|
|
|
100.00 |
% |
|
|
|
|
|
|
|
|
|
|
Real Estate Assets Serviced for Others
The following table sets forth the real estate assets serviced for other entities, and sales
of real estate assets during the three and six months ended June 30, 2010:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Six Months Ended |
|
|
|
June 30, 2010 |
|
|
June 30, 2010 |
|
|
|
Number of Assets |
|
|
Amount |
|
|
Number of Assets |
|
|
Amount |
|
Real estate assets at June 30, 2010 |
|
|
241 |
|
|
$ |
45,177,312 |
|
|
|
241 |
|
|
$ |
45,177,312 |
|
Real estate assets sold |
|
|
82 |
|
|
$ |
14,363,566 |
|
|
|
145 |
|
|
$ |
24,630,295 |
|
Results of Operations Franklin Credit Management Corporation (FCMC)
Through FCMC, we are actively seeking to (a) expand our servicing operations to provide
servicing and collection services to third parties, particularly specialized collection services,
and (b) capitalize on our experience to provide customized, comprehensive loan analysis and
in-depth end-to-end transaction and portfolio management services to the residential mortgage
markets. Since January 1, 2009, the Companys operating business has been conducted solely through
FCMC, a specialty consumer finance subsidiary company primarily engaged in the servicing and
resolution of performing, reperforming and nonperforming residential mortgage loans, including
specialized loan recovery servicing, and in the due diligence, analysis, pricing and acquisition of
residential mortgage portfolios, for third parties. Some of these services include, in addition to
servicing loans for others, performing 1-4 family residential portfolio stratification and
analysis, pricing, due diligence, closing, and collateral transfer. These new business activities
are subject to the consent of the Bank, and we may not be successful in entering into or
implementing any of these businesses in a meaningful way. See Note 7 Notes Payable and
Financing Agreements Restructuring Agreements with Lead Lending Bank.
The entities for whom the Company serviced residential mortgage loan portfolios, as of June
30, 2010, principally included Huntington (first and second-lien loans secured by 1-4 family
residential real estate previously acquired and originated by Franklin and transferred to the
Trust) and Bosco. The Companys consolidated financial statements, while including the results of
FCMC, include the results of
all its subsidiary companies, which includes all the assets and debt obligations that have
resulted from Franklins legacy business prior to the March 31, 2009 Restructuring.
53
As a result of the March 2009 Restructuring and the corporate reorganization that took effect
December 19, 2008, FCMC, the Companys servicing entity within the Franklin group of companies,
notwithstanding the substantial stockholders deficit of Franklin, has positive net worth and 30%
of its equity free from the pledges to the Bank. The Restructuring provided for the release of
thirty percent of the equity in FCMC, ten percent of which has been transferred to the Companys
principal stockholder, Thomas J. Axon, from the Companys pledges to the Bank in respect of its
Legacy Credit Agreement.
At June 30, 2010, FCMC had total assets of $27.3 million and had stockholders equity of $20.6
million. At December 31, 2009, FCMCs total assets amounted to $26.3 million and its stockholders
equity was $18.9 million. Inter-company payables and receivables were eliminated in deriving the
Consolidated Financial Statements of Franklin. FCMC had income before tax of approximately $1.9
million and $3.9 million, respectively, for the six months ended June 30, 2010 and 2009,
principally from servicing the portfolio of loans and assets for the Bank and Bosco. Inter-company
servicing revenues allocated to FCMC during the first quarter of 2009 were based principally on the
servicing contract entered into as part of the Restructuring, which became effective on March 31,
2009. FCMC charges its sister companies a management fee that is estimated based on internal
services rendered by its employees to those companies. Inter-company allocations, the Federal
provision for income taxes, and cash servicing revenues received from the Bank for servicing its
loans during the six months ended June 30, 2010 and 2009 have been eliminated in deriving the
Consolidated Financial Statements of Franklin. Servicing revenues were eliminated in the
Consolidated Financial Statements of Franklin due to the accounting treatment for the transfer of
the trust certificates as a financing under ASC Topic 860.
As of June 30, 2010, FCMC had two significant servicing contracts with third parties to
service 1-4 family mortgage loans and owned real estate, Huntington and Bosco. At June 30, 2010,
we serviced and provided recovery collection services on a total population of approximately 34,000
loans for Huntington and Bosco, and relatively small pools of loans under recovery collection
contracts, whereby we receive fees based solely on a percentage of amounts collected, for a few
other entities. While the loans serviced for Huntington represented approximately 75% of the total
number of loans serviced for third parties at June 30, 2010, the servicing revenues earned from
servicing the Huntington portfolio represented approximately 93% of the total servicing revenues
earned during the six months ended June 30, 2010.
On July 20, 2010, effective July 1, 2010, the Trust as directed by the Bank sold approximately
4,300 of residential mortgage loans, consisting principally of first-lien mortgage loans, with an
unpaid principal balance of approximately $626 million to a third party (the Purchaser) on a
servicing released basis (the Loan Sale), which loans were substantially all of the first-lien
residential mortgage loans that had been serviced by FCMC under the servicing agreement by and
among the Trust and FCMC (the Legacy Servicing Agreement). On July 20, 2010, but effective as of
July 1, 2010, FCMC entered into the Loan Sale Servicing Agreement with the Purchaser, pursuant to
which FCMC will continue to provide servicing for the loans acquired by the Purchaser in the Loan
Sale. However, the servicing of what is expected to be 25% of the loans acquired (based on unpaid
principal balance) is to be transferred by FCMC to an affiliate of the Purchaser, which is expected
to occur on or about September 1, 2010. With respect to what is expected to be the remaining 75%
of the loans acquired, the Purchaser, which is now the second largest servicing client of
FCMC, has the right to terminate the servicing of any of such loans without cause upon
ninety (90) calendar days prior written notice, subject to the payment of a termination fee for
each such loan terminated. As a result, FCMCs servicing revenues will be reduced substantially
from current levels, although servicing revenues will be more diversified.
54
On July 30, 2010, FCMC entered in the New Trust Servicing Agreement with the Trust, dated and
effective as of August 1, 2010, to replace the Prior Agreement that had been entered into with the
Trust as part of the March 31, 2009 restructuring with the Bank. The New Trust Servicing Agreement
is terminable, with respect to some or all of the loans and REO properties, without penalty and
without cause on 90 days prior written notice, or 30 days prior written notice in connection with a
sale of some or all of the loans and REO properties by the Trust. The Company anticipates that
FCMCs servicing revenues from the New Trust Servicing Agreement will be significantly lower than
those that had been earned under the Prior Agreement for those assets that were not sold in the
Loan Sale. In addition, the Bank has communicated to the Company that it is committed to selling
in the near future the second -lien mortgage loans owned by the Trust, and, if and when it does,
there is no assurance that the loans will be sold to a party that retains FCMC as servicer.
The Legacy Credit Agreement requires that each dividend by FCMC to its stockholders be
accompanied by payment of a distribution to the Bank of an amount such that the Bank receives 70%
of the combined amounts paid by FCMC. While FCMC is not a borrower under the Legacy Credit
Agreement or otherwise liable for the indebtedness thereunder it has pledged certain collateral in
support of the Legacy Credit Agreement, and a default under the Legacy Credit Agreement could
result in the Banks foreclosure on the assets and stock of Franklin Holdings subsidiaries,
excluding the assets of FCMC (other than an office condominium unit held by FCMC and certain cash
collateral which also serves as security under the Licensing Credit Agreement) and the unpledged
portion of FCMCs stock.
At the request of the Bank, FCMC made a distribution of $2,245,000 to the Bank on September
30, 2009. The distribution, which represented approximately 70% of the estimated net income of
FCMC for the six months ended September 30, 2009 after a holdback of $500,000, was made in
accordance with the provisions of the Legacy Credit Agreement currently entitling the Bank to 70%
of all amounts distributed by FCMC. The distribution was principally applied by the Bank to pay
down the debt obligations of certain of FCMCs sister companies as provided for by the terms of the
Legacy Credit Agreement with the Bank. The remaining 30%, or $962,000, was distributed in November
2009 as a dividend of $9,623.38 per share to the stockholders of FCMC, including $866,000 to
Franklin Holding in respect of its ownership of 90% of the outstanding stock of FCMC, and $96,000
to Thomas J. Axon, the Chairman and President of the Company, in respect of his ownership of 10% of
the outstanding stock of FCMC.
The Restructuring provided for the release of 30% of the equity in FCMC, 10% percent of which
has been transferred to the Companys principal stockholder, Thomas J. Axon, from the Companys
pledges to the Bank in respect of its Legacy Credit Agreement. The Legacy Credit Agreement also
provides for the possibility of release of up to an additional 50% (which, as of March 31, 2010, is
now forty-five percent due to the failure to achieve the first collection target identified in the
agreement, and of which a maximum of an additional ten percent would go to Thomas J. Axon), based
upon the Banks receipt of the agreed amounts of net remittances from the Portfolio, summarized
below (the Net Remittances), from March 31, 2009, the effective date of the Legacy Credit
Agreement (the Legacy Effective Date), through the term of the Legacy Credit Agreement pursuant
to and in accordance with the schedule of collection levels identified in the Legacy Credit
Agreement.
During the twelve-month period ended March 31, 2010 (the deadline for the first collection
level), the minimum amount of Net Remittances, referred to as Level 1, to achieve the release of
an additional 10% of pledged equity interests, from 70% to 60%, was $225 million. During the
twelve months ended March 31, 2010, the Company collected in aggregate approximately $203.6 million
from loans and real estate owned serviced for the Bank, of which $30.6 million was received from
contractual loan purchase rights. Net Remittances, as defined in the Legacy Credit Agreement
essentially as collections less expenses incurred by the Bank related to the Companys servicing of
the Banks loans and
real estate owned, amounted to approximately $147.4 million. Therefore, the Company did not
reach the minimum Level 1 amount of Net Remittances under the Restructuring Agreements by $77.6
million.
55
If Net Remittances reach the minimum Level 2 amount of $475 million prior to the third
anniversary date, the Bank will retain, as collateral, 55% of the FCMC equity instead of 50%, as
originally scheduled, and any subsequent reductions in the amount of FCMC equity pledged to the
Bank will be 10%; and provided further that if Net Remittances do not reach the minimum Level 2
amount prior to the third anniversary date, then the schedule for release of the equity interests
in FCMC currently pledged to the Bank will be as follows: (x) upon attaining the minimum Level 3
amount of $575 million, the pledged equity interests in FCMC will reduce 25% (from 70% to 45%); (y)
upon attaining the minimum Level 4 amount of $650 million, the pledged equity interests in FCMC
will reduce an additional 10% (from 45% to 35%), and (z) upon attaining the minimum Level 5 amount
of $750 million, the pledged equity interests in FCMC will reduce an additional 10% (from 35% to
25%). See Note 7 Notes Payable and Financing Agreements Forbearance Agreements with Lead
Lending Bank.
During the fifteen months ended June 30, 2010, the Company collected in aggregate
approximately $231.8 million from loans and real estate owned serviced for the Bank, of which $30.6
million was received from contractual loan purchase rights. Net Remittances, as defined in the
Legacy Credit Agreement essentially as collections less expenses incurred by the Bank related to
the Companys servicing of the Banks loans and real estate owned, amounted to approximately $162.7
million. Therefore, the Company needs to achieve $312 million of Net Remittances under the
Restructuring Agreements by March 31, 2012 in order to achieve the Level 2 required amount.
Although the amount ultimately received by the Trust in respect of the Loan Sale of July 20, 2010,
net of certain expenses, will count towards the minimum net remittance for Level 2 for a scheduled
partial release of an additional 15% of pledged equity interests in FCMC, it is not expected that
the net sale proceeds and collections to date will be sufficient to obtain a partial release of
equity interests from the Bank at that time.
On March 26, 2010, the Company entered into an amendment to the Licensing Credit Agreement
with the Bank, which renewed and extended the Licensing Credit Agreement. The amendment includes a
reduction of the draw credit facility (Draw Facility) from $5.0 million to $4.0 million and an
extension of the expiration date to May 31, 2010 for the Draw Facility and to March 31, 2011 for
the $2.0 million revolving line of credit and $6.5 million letter of credit facilities. The
amendment further provides that FCMC shall, to the extent permitted by applicable law, no less
frequently than semi-annually, within forty-five days after each June 30th and December 31st of
each calendar year, make pro rata dividends, distributions and payments to FCMCs shareholders and
the Bank under the Legacy Credit Agreement. In accordance with the Legacy Credit Agreement, the
Bank is currently entitled to 70% of all amounts distributed by FCMC. The payment of any dividend,
distribution or payment to FCMCs shareholders and the Bank would result in a reduction of FCMCs
stockholders equity and cash available for its operations.
The Draw Facility line of credit under the Licensing Credit Agreement expired unrenewed on May
31, 2010. On July 20, 2010, as part of Amendment No. 2 to the Licensing Credit Agreement, the
revolving credit facility, which is only available to assure that all state licensing requirements
of FCMC are met and to pay approved expenses of Franklin Holding, was reduced from $2 million to $1
million.
A letter agreement entered into by FCMC and the Bank on July 16, 2010 (the Letter Agreement)
regarding the Loan Sale included terms amending, or committing the Bank, FCMC, the Company, and
related parties to amend certain of the restructuring agreements entered into in connection with
the Restructuring with the Bank on March 31, 2009, including the existing credit relationships
under the Legacy Servicing Agreement, the syndicated legacy amended and restated credit agreement,
dated as of March 31, 2009 and as amended (the Legacy Credit Agreement), and the amended and
restated
licensing credit agreement, dated as of March 31, 2009 and as amended (the Licensing Credit
Agreement), and commitments by FCMC to make certain payments to the Bank. Additionally, the
Letter Agreement set forth certain mutual commitments of the parties with respect to the Companys
consideration of a restructuring or spin-off of its ownership of FCMC (a Potential
Restructuring), as well as certain guaranties of Thomas J. Axon, the Chairman of the Company and
FCMC.
56
Under the terms of the Letter Agreement, FCMC paid the Bank (i) $1 million towards expenses of
the Loan Sale, (ii) $1million to pay off the outstanding debt under the Licensing Credit Agreement,
and (iii) $1million to reduce the revolving line of credit from $2 million, which resulted in a
release of $1 million in cash collateral that was used by FCMC to pay down debt of the Company
under the Legacy Credit Agreement. The Company expects that for FCMC these payments will result in a
pre-tax $1 million charge to earnings and a reduction of stockholders equity in the amount of $2
million, pre-tax, in the third quarter ending September 30, 2010.
In addition, in accordance with the Letter Agreement, FCMC agreed to an additional aggregate
payment of $3 million payable semi-annually (EBITDA Payment) over a three year period commencing
with the period July 1, 2010 if the Potential Restructuring is acceptable to the Bank and the
required lenders under the Legacy Credit Agreement, in each partys sole discretion, and the
Potential Restructuring does not result in material tax, legal, regulatory, or accounting
impediments or issues for Franklin or FCMC. In addition, Thomas J. Axons existing personal
guaranty to the Bank was extended to the EBITDA Payment, such that to the extent that the EBITDA
Payment in respect of any period is less than $500,000, Mr. Axon will pay such shortfall. Mr.
Axons obligations pursuant to the guaranty are secured by the collateral he had pledged to the
Bank on March 31, 2009. As a result, the aggregate $3 million to be paid over three years will be
charged to FCMCs earnings in the quarterly period in which the parties determine that a Potential
Restructuring is acceptable.
Any payments by FCMC or Mr. Axon in respect of the EBITDA Payment would go to reduce the
obligation of the other in respect of the obligations to make such payment, or the guaranty in
respect of such payment, as the case may be; and, any payments in respect of the EBITDA Payments,
and application of payments to the Bank in respect of distributions by FCMC to its stockholders (in
accordance with an amendment to the Licensing Credit Agreement with the Bank as described below and
the requirement under the Legacy Credit Agreement that all such distributions to stockholders be
accompanied by such application such that such applications are not less than 70% of the total
amounts of such applications and distributions for any semi-annual period), would each serve as a
credit against the other, which could have the effect of reducing the impact of the $3 million
maximum amount of the EBITDA Payments otherwise payable as described above.
57
A summary of FCMCs stand-alone financial results for the three and six months ended June 30,
2010 and 2009, and at June 30, 2010 and December 31, 2009 are as follows:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
Three Months Ended |
|
STATEMENT OF INCOME |
|
June 30, 2010 |
|
|
June 30, 2009 |
|
REVENUES: |
|
|
|
|
|
|
|
|
Servicing fees and other income |
|
$ |
5,704,392 |
|
|
$ |
7,206,007 |
|
Interest income |
|
|
8,535 |
|
|
|
21,973 |
|
|
|
|
|
|
|
|
Total revenues |
|
|
5,712,927 |
|
|
|
7,227,980 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
OPERATING EXPENSES: |
|
|
|
|
|
|
|
|
Interest expense |
|
|
22,412 |
|
|
|
25,121 |
|
Collection, general and administrative |
|
|
4,733,981 |
|
|
|
4,552,163 |
|
Depreciation |
|
|
141,518 |
|
|
|
156,736 |
|
|
|
|
|
|
|
|
Total operating expenses |
|
|
4,897,911 |
|
|
|
4,734,020 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
INCOME BEFORE PROVISION FOR INCOME TAXES |
|
$ |
815,016 |
|
|
$ |
2,493,960 |
|
Provision for income taxes |
|
|
327,000 |
|
|
|
274,030 |
|
|
|
|
|
|
|
|
NET INCOME |
|
$ |
488,016 |
|
|
$ |
2,219,930 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended |
|
|
Six Months Ended |
|
|
|
June 30, 2010 |
|
|
June 30, 2009 |
|
REVENUES: |
|
|
|
|
|
|
|
|
Servicing fees and other income |
|
$ |
11,380,257 |
|
|
$ |
15,087,327 |
|
Interest income |
|
|
17,781 |
|
|
|
72,586 |
|
|
|
|
|
|
|
|
Total revenues |
|
|
11,398,038 |
|
|
|
15,159,913 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
OPERATING EXPENSES: |
|
|
|
|
|
|
|
|
Interest expense |
|
|
44,270 |
|
|
|
29,784 |
|
Collection, general and administrative |
|
|
9,165,014 |
|
|
|
10,876,099 |
|
Depreciation |
|
|
285,874 |
|
|
|
313,384 |
|
|
|
|
|
|
|
|
Total operating expenses |
|
|
9,495,158 |
|
|
|
11,219,267 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
INCOME BEFORE PROVISION FOR INCOME TAXES |
|
$ |
1,902,880 |
|
|
$ |
3,940,646 |
|
Provision for income taxes |
|
|
761,550 |
|
|
|
433,165 |
|
|
|
|
|
|
|
|
NET INCOME |
|
$ |
1,141,330 |
|
|
$ |
3,507,481 |
|
|
|
|
|
|
|
|
58
|
|
|
|
|
|
|
|
|
BALANCE SHEET |
|
At June 30, 2010 |
|
|
At December 31, 2009 |
|
ASSETS: |
|
|
|
|
|
|
|
|
Cash and cash equivalents |
|
$ |
17,472,027 |
|
|
$ |
15,116,880 |
|
Restricted cash |
|
|
3,789,461 |
|
|
|
4,770,867 |
|
Receivables, fixed and other assets |
|
|
6,044,259 |
|
|
|
6,436,434 |
|
|
|
|
|
|
|
|
Total assets |
|
$ |
27,305,747 |
|
|
$ |
26,324,181 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES: |
|
|
|
|
|
|
|
|
Debt |
|
$ |
1,000,000 |
|
|
$ |
1,000,000 |
|
Servicing liabilities |
|
|
3,789,461 |
|
|
|
4,770,867 |
|
Other liabilities |
|
|
1,907,764 |
|
|
|
1,675,372 |
|
|
|
|
|
|
|
|
Total liabilities |
|
$ |
6,697,225 |
|
|
$ |
7,446,239 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
STOCKHOLDERS EQUITY |
|
$ |
20,608,522 |
|
|
$ |
18,877,942 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and stockholders equity |
|
$ |
27,305,747 |
|
|
$ |
26,324,181 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
SERVICING PORTFOLIO: |
|
|
|
|
|
|
|
|
Number of loans serviced |
|
|
34,100 |
|
|
|
36,700 |
|
Unpaid principal balance serviced |
|
$ |
1.83 |
billion |
|
$ |
1.80 |
billion |
Results of Operations Franklin Credit Holding Corporation
Although the transfer of the trust certificates, representing approximately 83% of the
Portfolio, to the REIT was structured in substance as a sale of financial assets, the transfer, for
accounting purposes, is treated as a secured financing in accordance with ASC Topic 860 because for
accounting purposes the requisite level of certainty that the transferred assets have been legally
isolated from the Company and put presumptively beyond the reach of the Company and its creditors,
including in a bankruptcy proceeding, was not achieved. Therefore, the mortgage loans and real
estate have remained on the Companys balance sheet classified as mortgage loans and real estate
held for sale securing a nonrecourse liability in an equal amount. The treatment as a financing on
the Companys balance sheet, however, did not affect the cash flows of the transfer, and does not
affect the Companys cash flows or its reported net income nor would it, necessarily, dictate the
treatment of the assets in a bankruptcy.
Because the loans transferred by the Company to the Trust continue to be included on the
Companys consolidated balance sheet, the revenues from such loans are reflected in the Companys
consolidated results, in accordance with accounting principles generally accepted in the United
States of America (GAAP), notwithstanding the fact that trust certificates representing an
undivided interest in approximately 83% of the Portfolio were transferred to Huntington in the
Restructuring. Accordingly, the fees received from Huntington subsequent to March 31, 2009 for
servicing their loans, and the third-party costs incurred by us in the servicing and collection of
their loans and reimbursed by Huntington, for purposes of these consolidated financial statements
are not recognized as servicing fees and reimbursement of third-party servicing costs, but instead
as additional interest and other income earned and additional, offsetting expenses as if the
Company owned and self serviced the loans.
59
Three Months Ended June 30, 2010 Compared to Three Months Ended June 30, 2009
Overview. As part of the Restructuring with the Bank on March 31, 2009, substantially all of
the Companys portfolio of subprime mortgage loans and owned real estate, was transferred to a
trust (with the loans and owned real estate transferred to the Trust collectively referred to
herein as the Portfolio) in exchange for trust certificates. In addition, at March 31, 2009, the
Company transferred trust certificates representing ownership of approximately 83%, or
approximately $760 million, of the Portfolio to Huntington and received preferred and common stock
in the amount of $477.3 million in Huntingtons REIT, which REIT has since merged into another
Huntington REIT. Effective March 31, 2009, the carrying value of the remaining approximately 17%,
or $151.2 million, of the Portfolio, which was also transferred to the Trust as part of the
Restructuring in exchange for trust certificates (investments in trust certificates at fair value)
that are held by the Company, was reclassified as an investment available for sale and,
therefore, recorded at fair value approximating $95.8 million on March 31, 2009. In addition, the
Company classified as an investment held for sale loans with a carrying value of approximately
$11.4 million representing the Companys remaining subprime mortgage loans not subject to the
Restructuring (notes receivable held for sale, net) that collateralizes the Unrestructured Debt,
which, on March 31, 2009, was recorded at fair value approximating $4.3 million.
The Company had a net loss attributed to common stockholders of $13.1 million for the second
quarter of 2010, compared with net income of $20.3 million for the second quarter of 2009.
Revenues decreased by $33.0 million to $12.1 million for the three months ended June 30, 2010, from
revenues of $45.2 million for the three months ended June 30, 2009. The Company had a loss per
common share for the three months ended June 30, 2010 of $1.63 both on a diluted and basic basis,
compared to earnings per common share of $2.53 on both a diluted and basic basis for the three
months ended June 30, 2009. Net income in the quarter ended June 30, 2009 included a nonrecurring
gain on recoveries from contractual loan purchase rights in the aggregate amount of $30.6 million,
which was received in the second quarter of 2009.
Our total debt outstanding increased slightly to $1.373 billion at June 30, 2010 from $1.370
billion at March 31, 2010 due to the addition of accrued and unpaid interest at a fixed interest
rate of 15% on Tranche C debt. Interest expense decreased by $328,000 or 2%, including the cost of
the interest-rate swaps, during the second quarter of 2010 compared with the same period in 2009,
as a result of both lower interest expense on borrowed funds and lower costs of interest rate swaps
during the quarter ended June 30, 2010. At June 30, 2010, the weighted average interest rate of
borrowed funds was 4.14%. Collection, general and administrative expenses increased by $1.2
million, or 18%, to $8.1 million during the three months ended June 30, 2010, from $6.9 million for
the same period in 2009 due principally to increased third-party servicing costs incurred for
servicing the Banks portfolio. Stockholders deficit increased to $821.3 million at June 30,
2010, or a deficit book value per common share at June 30, 2010 of approximately $102.28, from
stockholders deficit of $806.8 million at December 31, 2009.
Revenues. Revenues decreased by $33.0 million to $12.1 million during the second quarter of
2010, or 73%, from revenues of $45.2 million during the same period in 2009. Revenues include
interest income, dividend income, purchase discount earned, loss on mortgage loans and real estate
held for sale, loss on valuation of trust certificates and notes receivable held for sale, fair
valuation adjustments, gain on sale of OREO and servicing fees and other income.
Interest income decreased by $5.8 million, or 35%, to $10.9 million during the three months
ended June 30, 2010 from $16.7 million during the three months ended June 30, 2009. The decrease
in interest income principally reflected an approximate 28% decrease in the amount of interest
collected during the three months ended June 30, 2010 as compared to the same period last year due
to increased
serious delinquencies in the Companys loan portfolio. The Company changed its accrual policy
on March 31, 2009 to only accrue one month of interest on performing loans.
60
Dividend income from the investment in REIT securities, received in exchange for Trust
Certificated transferred to the Banks REIT on March 31, 2009, was $10.6 million during the three
months ended June 30, 2010 and 2009.
Gain on recovery of contractual loan purchase rights amounted to $30.6 million during the
three months ended June 30, 2009. The gain was the result of proceeds received from contractual
loan purchase rights during the three months ended June 30, 2009. There was no gain on recovery of
contractual loan purchase rights in the three months ended June 30, 2010.
Fair valuation adjustments (fair value adjustments of the investment in trust certificates and
the nonrecourse liability) amounted to a net loss of $10.9 million for the three months ended June
30, 2010, compared to a net loss of $14.4 million for the three months ended June 30, 2009.
Included in the fair valuation adjustments in the three months ended June 30, 2010 were a net
decrease of $36.1 million in the valuation of the nonrecourse liability, a gain on OREO sold in the
amount of $2.6 million, a valuation loss on trust certificates of $5.7 million and various other
net negative adjustments of approximately $7.8 million, which included expenses recognized on the
nonrecourse liability equal to the interest income and fees received of approximately $4.1 million
and fair value adjustments to the nonrecourse liability for offsets to OREO gains of approximately
a negative $3.5 million. Included in the fair valuation adjustments in the three months ended June
30, 2009 were a net increase of $16.4 million in the valuation on the nonrecourse liability, a loss
on OREO sold in the amount of $11.6 million, a valuation write-down on OREO and various other
negative adjustments to the fair value in the amount of approximately $2.8 million, net.
Servicing fees and other income (principally third-party subservicing fees, third-party
acquisition services fees and late charges, prepayment penalties and other miscellaneous servicing
revenues) decreased by $187,000, or 11%, to $1.5 million during the three months ended June 30,
2010 from $1.7 million during the corresponding period last year. This decrease was principally
the result of decreased recoveries of outside foreclosure attorney costs from delinquent borrowers,
reduced late charges collected from delinquent borrowers, no prepayment penalties due to the
absence of loan payoffs in the current quarter, the nonaccrual of administrative fees associated
with services provided to the Bosco entity by FCMC, and a reduction of $396,000 in the servicing
fees recognized on the portfolio of loans serviced for Bosco as a result of amendments to the
servicing contract with Bosco effective in February and October 2009. The decreases in servicing
fees and other income were partially offset by $219,000 of due diligence fees earned from third
parties during the three months ended June 30, 2010 and a nonrecurring reimbursement from a state
agency.
Operating Expenses. Operating expenses increased by $624,000, or 3%, to $25.1 million during
the second quarter of 2010 from $24.5 million during the same period in 2009. Total operating
expenses include interest expense, collection, general and administrative expenses, provisions for
loan losses, amortization of deferred financing costs and depreciation expense.
61
Interest expense decreased by $328,000, or 2%, to $16.8 million during the three months ended
June 30, 2010, from $17.1 million during the three months ended June 30, 2009. This decrease was
the result of both lower interest expense on borrowed funds and lower costs of interest rate swaps
during the quarter ended June 30, 2010 compared with the quarter ended June 30, 2009. Interest
expense on borrowed funds, excluding the cost of interest rate swaps, declined $177,000 during the
three months ended June 30, 2010 due to a reduced average balance of borrowed funds, and a somewhat
lower LIBOR rate. However, this reduction in interest expense was significantly negatively
affected, and almost offset,
by an increase in the interest expense of the Companys Tranche C debt, the principal amount
of which increased from $125 million at March 31, 2009 to $151.0 million at June 30, 2010 due to
the addition of accrued and unpaid interest at a fixed interest rate of 15%. The average cost of
funds, including interest rate swaps, during the three months ended June 30, 2010 was 4.89%,
compared to 4.71% during the three months ended June 30, 2009, principally reflecting the interest
cost of the Companys Tranche C debt. The Company has in place fixed-rate interest rate swaps in
order to limit the negative effect of a rise in short-term interest rates by effectively
stabilizing the future interest payments on a portion of its variable-rate debt. Because
short-term interest rates have actually declined in the months following the purchases of these
swaps, and have remained at extremely low levels, and due to the amortization of the AOCL balance,
which was offset somewhat by an increase in the fair value of the swaps, the interest rate swaps
actually increased the Companys interest cost in the quarter ended June 30, 2010 by $2.7 million.
However, compared with the same quarter of 2009, the cost of the interest-rate swaps decreased by
$151,000. At June 30, 2010, the weighted average interest rate of our borrowed funds, exclusive of
the effect of the interest-rate swaps, was 4.14%, compared with 3.92% at June 30, 2009.
Collection, general and administrative expenses increased by $1.2 million, or 18%, to $8.1
million during the three months ended June 30, 2010, from $6.9 million during the corresponding
period in 2009. For the purpose of the discussion below comparing collection, general and
administrative expenses incurred by the Company on a recurring basis, the following costs are
excluded from the quarter-to-quarter change analysis: (i) third-party servicing expenses, which
since the March 31, 2009 Restructuring are reimbursed by the Bank, in the aggregate amount of $2.7
million and $1.8 million, respectively, during the quarter ended June 30, 2010 and 2009. These
third-party servicing expenses are, however, included in the consolidated statements of operations
due to the treatment for accounting purposes of the transfer of the trust certificates,
representing ownership in approximately 83% of the Portfolio transferred to the REIT, as a
financing in accordance with GAAP and, as a result the mortgage loans and real estate have remained
on the Companys balance sheet. Therefore, the third-party costs incurred by us in the servicing
and collection of the Banks loans and reimbursed by the Bank, for purposes of these consolidated
financial statements, are not treated as reimbursed third-party servicing costs but as additional
collection, general and administrative expenses as if the Company owned and self serviced the
loans, with an offsetting amount included in fair valuation adjustments, which had no impact on the
Companys consolidated net loss. The third-party servicing costs increased in the three months
ended June 30, 2010 from the period ended June 30, 2009 due to increased legal fees, REO expenses
and various other third-party collection costs due to more aggressive servicing work rules
applicable under our servicing agreement with the Bank during the three months ended June 30, 2010
as compared to the same quarter last year.
Exclusive of these items described above, collection, general and administrative expenses
increased by $384,000, or 8%, in the three months ended June 30, 2010, from $5.1 million during the
corresponding period in 2009. Salaries and employee benefits expenses decreased by $308,000, or
9%, to $3.1 million during the three months ended June 30, 2010, from $3.4 million during the three
months ended June 30, 2009, due to reductions in staff throughout the Company. The number of
servicing employees decreased to 97 at June 30, 2010, from 129 employees at June 30, 2009. The
Company ended the three months ended June 30, 2010 with 134 employees, compared with 178 employees
at June 30, 2009. Included in the reduced number of employees at June 30, 2010 were employees laid
off in June 2010. The cost reduction associated with the June 2010 reduction in force will be
realized, however, beginning in July 2010. Salaries and employee benefits expenses were reduced in
the three months ended June 30, 2009 due to across the board salary reductions that were effective
April 1, 2009. Effective September 1, 2009 (and effective for senior officers on January 1, 2010
other than the President and the Chief Financial Officer) salaries and employee benefits were
increased to the levels that had been applicable before the reductions. The Company experienced an
increase in corporate legal expenditures of $113,000, or 87%, to $243,000 from $130,000 as compared
to the same three-month period last year,
62
with the increase principally due to additional costs related to our Restructuring Agreements
and litigation matters that were not incurred in the prior year quarter. Professional fees
increased by $249,000, or 58%, to $680,000 from $431,000, principally due to outside tax consulting
associated with the early preparation of our 2009 tax return, as requested by the Bank, SAS 70 fees
related to our servicing operations and the timing of audit expense payments, as compared to the
same period last year, which were partially offset by a reduction in our outside audit engagement
fee. The reduction in outside audit fees was due to (i) the Companys changed business model where
the complex accounting for possible loan losses and purchase discount on acquired subprime
portfolios of mortgage loans is no longer necessary and (ii) managements evaluation of the costs
of outside audit services, including a competitive bid process, resulted in securing outside audit
services at a reduced cost. Various other general and administrative expenses increased by
$330,000 primarily due to increased promotional, travel, computer license and property and
franchise tax expenses during the three months ended June 30, 2010.
Amortization of deferred financing costs decreased by $260,000, or 90%, to $29,000 during the
second quarter of 2010 from $289,000 during the second quarter of 2009. This decrease resulted
primarily from a reduction in portfolio collections that culminated in a decrease in the pay down
of our borrowed funds made in accordance with the terms of the Restructuring Agreements.
Depreciation expenses decreased by $16,000, or 10%, to $142,000 in the second quarter of 2010.
This decrease during the three months ended June 30, 2010 was principally due to fully depreciated
assets during the past twelve months and a reduction in assets purchased compared with the same
quarterly period in 2009.
Our pre-tax income decreased by $33.7 million to a pre-tax loss of $13.0 million during the
three months ended June 30, 2010, from pre-tax income of $20.7 million during the three months
ended June 30, 2009 for the reasons set forth above.
The Company recorded a state income tax expense of $74,000 on income from one of its
subsidiaries during the three months ended June 30, 2010, compared to a state income tax expense of
$433,000 during the three months ended June 30, 2009.
Six Months Ended June 30, 2010 Compared to Six Months Ended June 30, 2009
Overview. The Company had a net loss attributed to common stockholders of $19.8 million for
the first half of 2010, compared with a net loss of $342.1 million for the first half of 2009.
Revenues increased by $312.0 million to $31.6 million for the six months ended June 30, 2010, from
a loss of $280.3 million for the six months ended June 30, 2009. The Company had a loss per common
share for the six months ended June 30, 2010 of $2.47 both on a diluted and basic basis, compared
to a loss per share of $42.78 on both a diluted and basic basis for the six months ended June 30,
2009. The net loss in the first half of 2009 resulted principally from the loss recognized by the
Company on 83% of the Portfolio contributed to the Trust as a result of the transfer of trust
certificates representing that percentage of ownership of the Trust to the Bank in exchange for the
preferred and common stock of the Banks REIT. The REIT Securities, common and preferred shares,
had an aggregate value of $477.3 million intended to approximate the fair market value of the trust
certificates transferred to the Bank as of March 31, 2009. The Company incurred a loss of $282.6
million on the transfer of assets. In addition, the Company recognized a loss of $62.7 million on
the valuation of the remaining investments on the Companys balance sheet, approximately 17% of the
Portfolio transferred to the Trust in exchange for trust certificates and the remaining loans not
subject to the Restructuring.
63
Our total debt outstanding increased slightly to $1.373 billion at June 30, 2010 from $1.368
billion at December 31, 2009. As a result of the March 31, 2009 Restructuring of our debt and the
effect
of an interest rate of 15% on $125 million of Tranche C debt, interest expense increased by
$1.0 million, or 3%, including the cost of the interest-rate swaps, during the first half of 2010
compared with the same period in 2009. Interest expense on borrowed funds increased $3.7 million
during the six months ended June 30, 2010, while the cost of the interest-rate swaps decreased by
$2.7 million. Our average cost of funds, excluding the cost of interest-rate swaps, during the six
months ended June 30, 2010 increased to 4.03% from 3.31% during the six months ended June 30, 2009.
At June 30, 2010, the weighted average interest rate of borrowed funds was 4.14%. Collection,
general and administrative expenses decreased by $10.6 million, or 41%, to $15.0 million during the
six months ended June 30, 2010, from $25.6 million for the same period in 2009 due principally to
costs incurred in the first quarter of 2009 for the March 2009 Restructuring, reduced third-party
servicing costs incurred for servicing the Portfolio and generally reduced costs throughout the
Company. Stockholders deficit increased to $821.3 million at June 30, 2010, or a deficit book
value per common share at June 30, 2010 of approximately $102.28, from stockholders deficit of
$806.8 million at December 31, 2009.
Revenues. Revenues increased by $312.0 million to $31.6 million during the first half of
2010, from a loss of $280.3 million during the same period in 2009. Revenues include interest
income, dividend income, purchase discount earned, loss on mortgage loans and real estate held for
sale, loss on valuation of trust certificates and notes receivable held for sale, fair valuation
adjustments, gain on sale of OREO and servicing fees and other income.
Interest income decreased by $10.8 million, or 33%, to $22.4 million during the six months
ended June 30, 2010 from $33.1 million during the six months ended June 30, 2009. The decrease in
interest income reflected an approximate 33% decrease in the amount of interest collected during
the six months ended June 30, 2010 as compared to the same period last year due to increased
serious delinquencies in the Companys loan portfolio. The Company changed its accrual policy on
March 31, 2009 to only accrue one month of interest on performing loans.
Dividend income from the investment in REIT securities, received in exchange for Trust
Certificated transferred to the Banks REIT on March 31, 2009, was $21.3 million during the six
months ended June 30, 2010, compared to $10.6 million during the same period last year. The
increase in dividend income was the result of dividends on the REIT securities being effective
after the March 2009 Restructuring and, therefore, only a single quarter of income earned during
the six months ended June 30, 2009.
There was no purchase discount earned during the first half of 2010 as purchase discount on
loans acquired in past years was eliminated effective March 31, 2009 with the Restructuring.
During the first half of 2009, purchase discount earned amounted to $392,000.
Gain on recovery of contractual loan purchase rights amounted to $30.6 million during the six
months ended June 30, 2009. The gain was the result of proceeds received from contractual loan
purchase rights during the three months ended June 30, 2009. There was no gain on recovery of
contractual loan purchase rights in the six months ended June 30, 2010.
Loss on mortgage loans and real estate held for sale, which was the result of the
Restructuring at March 31, 2009, was $282.6 million during the six months ended June 30, 2009.
There was no such loss during the first half of 2010 as subsequent changes in fair value are
reflected as Fair valuation adjustments. On March 31, 2009, the Company transferred trust
certificates in the Trust having a carrying value approximating $759.9 million, representing
approximately 83% of the trust certificates representing the Portfolio previously transferred to
the Trust, in exchange for preferred and common stock in Huntingtons REIT (REIT Securities) with a
fair market value approximating $477.3 million. The loss represented the application of fair
market value accounting that resulted in a write-down to fair
market value. Included in the realized loss from the March 31, 2009 exchange was a charge-off
of accrued interest on the loans exchanged in the amount of $8.6 million that was not collected as
part of the Restructuring.
64
Loss on valuation of investment in trust certificates, mortgage loans and real estate held for
sale, which was the result of the Restructuring at March 31, 2009, was $62.7 million during the six
months ended June 30, 2009. There was no such loss during the first quarter of 2010 as subsequent
changes in fair value are reflected as Fair valuation adjustments. At March 31, 2009, effective
with the Restructuring, the retained trust certificates in the Trust had a book value of
approximately $151.2 million, representing approximately the remaining 17% of the Companys
economic interest in the Portfolio, exclusive of the assets collateralizing the Unrestructured
Debt, were classified as available for sale and fair market value accounting was applied that
resulted in a write-down to fair market value approximating $95.8 million. The loans
collateralizing the Unrestructured Debt with a carrying value of $11.4 million were classified as
held for sale and adjusted to approximate the fair market value of $4.1 million, which resulted
in a realized a loss of $7.3 million.
Fair valuation adjustments (fair value adjustments of the investment in trust certificates and
the nonrecourse liability) amounted to a net loss of $14.7 million for the six months ended June
30, 2010. Included in the fair valuation adjustments in the six months ended June 30, 2010 were a
net decrease of $34.1 million in the valuation of the nonrecourse liability, a gain on OREO sold in
the amount of $4.3 million, a valuation loss on trust certificates of $3.7 million and various
other net negative adjustments of approximately $15.3 million, which included expenses recognized
on the nonrecourse liability equal to the interest income and fees received of approximately $9.3
million and fair value adjustments to the nonrecourse liability for offsets to OREO gains of
approximately a negative $5.9 million. Included in the fair valuation adjustments in the six
months ended June 30, 2009 were a net increase of $14.4 million in the valuation on the nonrecourse
liability, a loss on OREO sold in the amount of $11.6 million, a valuation write-down on OREO and
various other adjustments to the fair value in the amount of
approximately $2.8 million, net.
During the six months ended June 30, 2010, gains and losses on sales of OREO were reflected as
fair valuation adjustments. During the six months ended June 30, 2009, we realized a net gain of
$374,000 from the sales of 198 OREO properties with an aggregate carrying value of $18.9 million.
Servicing fees and other income (principally third-party subservicing fees, third-party
acquisition services fees and late charges, prepayment penalties and other miscellaneous servicing
revenues) decreased by $1.5 million, or 36%, to $2.7 million during the six months ended June 30,
2010 from $4.2 million during the corresponding period last year. This decrease was principally
the result of decreased recoveries of outside foreclosure attorney costs from delinquent borrowers,
reduced late charges collected from delinquent borrowers, significantly reduced prepayment
penalties due to a continuing slower rate of loan payoffs, the nonaccrual of administrative fees
associated with services provided to the Bosco entity by FCMC, and a reduction of $878,000 in the
servicing fees recognized on the portfolio of loans serviced for Bosco as a result of amendments to
the servicing contract with Bosco effective in February and October 2009. The decreases in income
were partially offset by $337,000 of due diligence fees earned from third parties during the six
months ended June 30, 2010 and a nonrecurring reimbursement received from a state agency in the
second quarter of 2010.
Operating Expenses. Operating expenses decreased by $10.2 million, or 17%, to $51.2 million during
the first half of 2010 from $61.3 million during the same period in 2009. Total operating expenses
include interest expense, collection, general and administrative expenses, provisions for loan
losses, amortization of deferred financing costs and depreciation expense.
65
Interest expense increased by $1.0 million, or 3%, to $35.8 million during the six months
ended June 30, 2010, from $34.8 million during the six months ended June 30, 2009. This increase
was the result of a higher average cost of borrowed funds during the six months ended June 30, 2010
of 5.23%, compared to 4.83% during the six months ended June 30, 2009, principally reflecting the
interest cost of the Companys Tranche C debt, the principal amount of which increased from $125
million at March 31, 2009 to $151.0 million at June 30, 2010 due to the addition of accrued and
unpaid interest at a fixed interest rate of 15%. Interest expense on borrowed funds, excluding the
cost of interest rate swaps, increased $3.7 million during the six months ended June 30, 2010 due
principally to the 15% interest rate on $125 million of Tranche C debt effective as of the March
31, 2009 Restructuring and an increased balance of Tranche C debt to $151.0 million at June 30,
2010 due to the addition of accrued and unpaid interest at a fixed interest rate of 15%, offset
somewhat by a reduced average balance of borrowed funds during the six months ended June 30, 2010.
The Company has in place fixed-rate interest rate swaps in order to limit the negative effect of a
rise in short-term interest rates by effectively stabilizing the future interest payments on a
portion of its variable-rate debt. Because short-term interest rates have actually declined in the
months following the purchases of these swaps and due to the amortization of the AOCL balance,
which was offset somewhat by an increase in the fair value of the swaps, the interest rate swaps
actually increased the Companys interest cost in the six months ended June 30, 2010 by $8.2
million. However, compared with the same six months of 2009, the cost of the interest-rate swaps
decreased by $2.7 million. At June 30, 2010, the weighted average interest rate of our borrowed
funds, exclusive of the effect of the interest-rate swaps, was 4.14%, compared with 3.92% at June
30, 2009.
Collection, general and administrative expenses decreased by $10.6 million, or 41%, to $15.0
million during the six months ended June 30, 2010, from $25.6 million during the corresponding
period in 2009. For the purpose of the discussion below of comparing collection, general and
administrative expenses incurred by the Company on a recurring basis, the following costs are
excluded from the six months-to-six months change analysis: (i) Restructuring costs incurred in the
first quarter of 2009 in the aggregate amount of $5.5 million and not incurred in the current year;
and, (ii) third-party servicing expenses, which since the March 31, 2009 Restructuring are
reimbursed by the Bank, in the aggregate amount of $4.5 million and $7.2 million, respectively,
during the six months ended June 30, 2010 and 2009. These third-party servicing expenses are,
however, included in the consolidated statements of operations due to the treatment for accounting
purposes of the transfer of the trust certificates, representing ownership in approximately 83% of
the Portfolio transferred to the REIT, as a financing in accordance with GAAP and, as a result the
mortgage loans and real estate have remained on the Companys balance sheet. Therefore, the
third-party costs incurred by us in the servicing and collection of the Banks loans and reimbursed
by the Bank, for purposes of these consolidated financial statements, are not treated as reimbursed
third-party servicing costs but as additional collection, general and administrative expenses as if
the Company owned and self serviced the loans, with an offsetting amount included in fair valuation
adjustments, which had no impact on the Companys consolidated net loss. The third-party servicing
costs were substantially decreased in the six months ended June 30, 2010 from the same period ended
June 30, 2009 as the Bank modified the work rules applicable under our servicing agreement for the
Company as servicer of the Portfolio, particularly for collection, loss mitigation, deficiency
foreclosure, bankruptcy and judgment activities for delinquent loans, and OREO, and there were
substantially fewer OREO properties and OREO additions and dispositions during the first six months
of 2010.
66
Exclusive of these items described above, collection, general and administrative expenses
decreased by $2.3 million, or 18%, in the six months ended June 30, 2010, from $12.9 million during
the corresponding period in 2009. Salaries and employee benefits expenses decreased by $2.2
million, or 27%, to $6.1 million during the six months ended June 30, 2010, from $8.3 million
during the six months ended June 30, 2009, due to reductions in staff throughout the Company.
These reductions in salaries and employee benefits expenses, effective April 1, 2009 were somewhat
offset by increases in salaries and employee benefits, effective September 1, 2009 for most of the
staff and effective January 1, 2010 for senior officers other than the President and the Chief
Financial Officer, to the levels that had been applicable before the reductions. The number of
servicing employees decreased to 97 at June 30, 2010, from 129 employees at June 30, 2009 and 159
employees at December 31, 2008. The Company ended the six months ended June 30, 2010 with 134
employees, compared with 178 employees at June 30, 2009 and 220 employees at December 31, 2008.
The Company also experienced a decrease in corporate legal expenditures of $222,000, or 25%, to
$665,000 from $887,000 as compared to the same six-month period last year, with the decrease
principally related to legal costs that were incurred for a nonrecurring matter in the six months
ended June 30, 2009. Professional fees increased by $92,000, or 10%, to $1.1 from $1.0 million,
principally due to outside tax consulting associated with the early preparation of our tax return,
as requested by the Bank, SAS 70 fees related to our servicing operations and the timing of audit
expense payments, as compared to the same period last year, which were partially offset by a
reduction in our outside audit engagement fee. The reduction in outside audit fees was due to (i)
the Companys changed business model where the complex accounting for possible loan losses and
purchase discount on acquired subprime portfolios of mortgage loans is no longer necessary and (ii)
managements evaluation of the costs of outside audit services, including a competitive bid
process, resulted in securing outside audit services at a reduced cost. Various other general and
administrative expenses increased slightly by $6,000 during the six months ended June 30, 2010.
There was no provision for loan losses during the six months ended June 30, 2010, compared
with a provision of $169,000 during the six months ended June 30, 2009. The absence of a provision
for loan losses during the six months ended June 30, 2010 and the virtual absence of a provision
for loan losses since the first quarter of 2009 are reflective of the transfer of a significant
portion of our portfolio of notes receivable, loans held for sale and OREO properties to the Bank
on March 31, 2009 and the exchange and retention, principally in the form of trust certificates, of
the remaining portion of our portfolio of notes receivable, loans held for sale and OREO properties
as part of the Restructuring. As a result of the Restructuring and the exchange of the Companys
loans and OREO assets for investments carried at either fair market value or lower of cost or
market value, an allowance for loan losses is no longer necessary.
Amortization of deferred financing costs decreased by $392,000, or 86%, to $64,000 during the
first half of 2010 from $455,000 during the first half of 2009. This decrease resulted primarily
from a reduction in portfolio collections that culminated in a decrease in the pay down of our
borrowed funds made in accordance with the terms of the Restructuring Agreements.
Depreciation expenses decreased by $27,000, or 9%, to $288,000 in the first six months of
2010. This decrease during the six months ended June 30, 2010 was principally due to fully
depreciated assets during the past twelve months and a reduction in assets purchased compared with
the same quarterly period in 2009.
Our pre-tax loss decreased by $322.2 million to a loss of $19.6 million during the six months
ended June 30, 2010, from a loss of $341.7 million during the six months ended June 30, 2009 for
the reasons set forth above.
The Company recorded a state income tax expense of $172,000 on income from one of its
subsidiaries during the six months ended June 30, 2010, compared to a state income tax expense of
$433,000 during the six months ended June 30, 2009.
67
Liquidity and Capital Resources
General
We ceased to acquire and originate loans in November 2007, and under the terms of the
Restructuring Agreements, the Company cannot originate or acquire mortgage loans or other assets
without the prior consent of the Bank.
As of June 30, 2010, we had one limited source of external funding to meet our liquidity
requirements, in addition to the cash flow provided from servicing loans and performing due
diligence services for third parties, dividends from preferred stock in a REIT owned by a
Huntington subsidiary, and borrower payments of interest and principal from the notes receivable
held for sale and the mortgage loans collateralizing the owned trust certificates. As a direct
result of the Banks REIT not declaring dividends throughout the remainder of 2010, which the
Company was verbally advised of on July 23, 2010, the Company will be unable to pay monthly
interest due on Tranche A debt under the Legacy Credit Agreement with the Bank. Accordingly, the
Company, under the terms of the Legacy Credit Agreement, anticipates that it will elect to accrue
interest on Tranche A debt, to the extent not paid (due to the temporary deferral of preferred
dividends by the REIT), through distributions made on the Companys investment in Trust
Certificates of the Trust, by adding the amount unpaid to the outstanding principal balance of the
Tranche A debt.
See Note 1 Business Going Concern Uncertainty Franklin Holding, Note 7 Notes
Payable and Financing Agreements March 2009 Restructuring, and Note 11 Subsequent Events.
We are required to submit all payments we receive from our preferred stock investments, the
trust certificates that we own and the notes receivable held for sale to a lockbox, which is
controlled by the Bank. Substantially all amounts submitted to the lockbox are used to pay down
amounts outstanding under our Legacy Credit Agreement with the Bank. If the cash flow received
from servicing loans and performing due diligence services for third parties is insufficient to
sustain the cost of operating our business, and we have fully utilized our licensing credit
facilities, there is no guarantee that we can continue in business. The Bank can terminate without
cause the Servicing Agreement with the Company without penalty on 90 days prior written notice, or
30 days prior written notice in connection with a sale of some or all of the assets serviced for
the Trust.
Short-term Investments. The Companys investment policy is structured to provide an adequate
level of liquidity in order to meet normal working capital needs, while taking minimal credit risk.
As of June 30, 2010, all of the Companys unrestricted cash was invested in money market accounts
and certificates of deposits held at the Bank.
Cash Flow from Operating, Investing and Financing Activities
Liquidity represents our ability to obtain adequate funding to meet our financial obligations.
As of June 30, 2010 and since March 31, 2009, our liquidity position is, and has been, affected
principally by the collections from servicing the Portfolio and distributions from the trust
certificates and the dividends received from the preferred stock investment in the Huntington
subsidiary REIT.
At June 30, 2010, we had cash and cash equivalents of $17.9 million compared with $16.0
million at December 31, 2009. Restricted cash of $2.6 million at both June 30, 2010 and December
31, 2009, was restricted under our credit agreements and lockbox facility with the Bank.
68
Changes in several of the cash flows noted in the explanations that follow were the result of
the March 31, 2009 Restructuring and the resultant changed asset classifications form notes
receivable and originated loans held for investment to investment in trust certificates at fair
value and mortgage loans and real estate held for sale.
Net cash provided by operating activities was $36.1 million as of June 30, 2010, compared with
net cash provided of $63.7 million during the six months ended June 30, 2009. The decrease in cash
provided by operating activities was primarily due to the decreases in principal collections on
mortgage loans held for sale and proceeds from the sale of real estate held for sale during the
period as a result of a declining portfolio, coupled with increased delinquencies, that were only
partially offset by an increase in paid in kind interest and significant changes in other assets
and liabilities.
Net cash provided by investing activities was $457,000 in the six months ended June 30, 2010,
compared to $62.5 million of cash provided in the six months ended June 30, 2009. The decrease in
cash provided by investing activities during the six months ended June 30, 2010 was due primarily
to reductions in principal collections on both notes receivable and loans held for investment,
decreased proceeds from the sale of OREO properties and a reduction in restricted cash, which was
significantly higher at December 31, 2008.
Net cash used in financing activities decreased to approximately $34.6 million during the six
months ended June 30, 2010, compared to $134.3 million used during the six months ended June 30,
2009. The decrease in cash used in financing activities during the six months ended June 30, 2010
was due to a reduction in principal payments of notes receivable for the reasons set forth above.
Borrowings
As of June 30, 2010, the Company had total borrowings of $1.37 billion under the
Restructuring Agreements, of which $1.33 billion was subject to the Legacy Credit Agreement and
$39.1 million remained under a credit facility excluded from the Restructuring Agreements (the
Unrestructured Debt). During the six months ended June 30, 2010, while the Company made principal
payments on the senior portion (Tranche A) of the notes payable in the amount of $13.2 million,
total notes payable outstanding increased by $5.3 million. While the balance of the Tranche A debt
was reduced by $13.2 million during the six months ended June 30, 2010, the balance of the
subordinate portions (Tranches B and C) of notes payable actually increased during this six-month
period as interest due and unpaid was accrued and added to the outstanding debt balance as per the
terms of Restructuring Agreements, which require all available cash to be applied to interest and
principal on Tranche A until paid in full before payments can be applied to Tranches B and C.
Substantially all of the debt under these facilities was incurred in connection with the
Companys purchase and origination of residential 1-4 family mortgage loans prior to December 2007.
These borrowings are shown in the Companys financial statements as Notes payable (referred to
as term loans or term debt herein).We ceased to acquire and originate loans in November 2007,
and under the terms of the Restructuring Agreements, the Company cannot originate or acquire
mortgage loans or other assets without the prior consent of the Bank. In 2008, the Company changed
its business model to seek to become a provider to third parties of loan servicing and recovery
collection services, due diligence and certain other services for residential mortgage loans and
assets.
At June 30, 2010 and December 31, 2009, FCMC owed $1 million under the revolving line of its
Licensing Credit Agreement with the Bank, which is shown in the Companys financial statements as
Financing agreement.
69
See Note 7 Notes Payable and Financing Agreements and Note 11 Subsequent Events.
Interest Rate Swaps
At June 30, 2010, the Company had $390 million, notional amount, of interest rate swaps
outstanding.
During 2008, the Company entered into a series of fixed-rate interest rate swaps with the Bank
in order to effectively stabilize the future interest payments on a portion of its
interest-sensitive borrowings. The fixed-rate swaps are for periods ranging from one to four
years, and are non-amortizing. These swaps effectively fixed the Companys interest costs on a
portion of its borrowings regardless of increases or decreases in the one-month LIBOR. On March 5,
2009, $220 million of one-year interest rate swaps matured and have not been replaced.
Under these swap agreements, the Company makes interest payments to the Bank at fixed rates
and receives interest payments from the Bank on the same notional amounts at variable rates based
on LIBOR. Effective December 28, 2007, the Company pays interest on its interest-sensitive
borrowings, principally based on one-month LIBOR plus applicable margins.
In conjunction with the Restructuring, and at the request of the Bank, effective March 31,
2009, the Company exercised its right to terminate two non-amortizing fixed-rate interest rate
swaps with the Bank, one with a notional amount of $150 million and the other with a notional
amount of $240 million. The total termination fee for cancellation of the swaps was $8.2 million,
which is payable only to the extent cash is available under the waterfall provisions of the Legacy
Credit Agreement, and only after $759.1 million remaining at June 30, 2010 of Tranche A debt owed
to the Bank has been paid in full. See Note 7 Notes Payable and Financing Agreements.
The unamortized balance of derivative losses in the amount of $24.0 million at December 31,
2008, as a result of the Company electing to cease hedge accounting is amortized to interest
expense over time. The amount amortized during the six months ended June 30, 2010 was $5.2
million, which increased our interest expense. The balance of unamortized derivative losses at
June 30, 2010 was $7.1 million.
The following table presents the notional and fair value amounts of the interest rate swaps
outstanding at June 30, 2010.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Notional Amount |
|
|
Term |
|
Maturity Date |
|
Fixed Rate |
|
|
Estimated Fair Value* |
|
$ |
275,000,000 |
|
|
3 years |
|
March 5, 2011 |
|
|
3.47% |
|
|
$ |
(6,751,931 |
) |
|
70,000,000 |
|
|
3 years |
|
March 5, 2011 |
|
|
3.11% |
|
|
|
(1,244,467 |
) |
|
45,000,000 |
|
|
4 years |
|
March 5, 2012 |
|
|
3.43% |
|
|
|
(1,962,247 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
390,000,000 |
|
|
|
|
|
|
|
|
|
|
$ |
(9,958,645 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
* |
|
Determined in accordance with Topic 820, Fair Value Measurements and Disclosures, based
upon a Level 2 valuation methodology. |
70
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to various types of market risk in the normal course of business, including the
impact of interest rate changes, real estate, delinquency and default risks of the loans that we
service for third parties, the loans in the Portfolio (although transferred to the Bank, for
accounting purposes the portfolio is treated as a financing under GAAP and remains on the balance
sheet), and changes in corporate tax rates. A material change in these rates or risks could
adversely affect our operating results and cash flows.
Impact of Inflation
The Company measures its financial condition and operating results in historical dollars
without considering changes in the purchasing power of money over time due to inflation, although
the impact of inflation is reflected in increases in the costs of our operations. Substantially
all of the Companys assets and liabilities are monetary in nature, and therefore, interest rates
have a greater impact on our performance than the general effects of inflation. Because a
substantial portion of the Companys borrowings are sensitive to changes in short-term interest
rates, any increase in inflation, which often gives rise to increases in interest rates, could
materially impact the Companys financial performance.
Interest Rate Risk
Interest rate fluctuations can adversely affect our operating results and present a variety of
risks, including the risk of a mismatch between the repricing of interest-earning assets and
borrowings, and variances in the yield curve.
Interest rates are highly sensitive to many factors, including governmental monetary policies
and domestic and international economic and political conditions. Conditions such as inflation,
recession, unemployment, money supply and other factors beyond our control may also affect interest
rates. Fluctuations in market interest rates are neither predictable nor controllable and may have
a material adverse effect on our business, financial condition and results of operations.
The Companys operating results depend in large part on differences between the interest
earned on its assets and the interest paid on its borrowings. Most of the Companys assets,
consisting primarily of REIT Securities (principally preferred REIT stock) and Trust Certificates
(collateralized by mortgage loans and real estate owned properties) generate fixed returns and have
remaining contractual maturities in excess of five years. Our borrowings are based on one-month
LIBOR. In most cases, the interest income from our assets will respond more slowly to interest
rate fluctuations than the cost of our borrowings, creating a mismatch between interest earned on
our interest-yielding assets and the interest paid on our borrowings. Consequently, changes in
interest rates, particularly short-term interest rates, will significantly impact our net interest
income and, therefore, net income. Our borrowings bear interest at rates that fluctuate with the
one-month LIBOR rate. We use from time to time interest-rate derivatives, essentially
interest-rate swaps, to hedge our interest rate exposure by converting a portion of our highly
interest-sensitive borrowings from variable-rate payments to fixed-rate payments. Based on
approximately $832.7 million of unhedged interest-rate sensitive borrowings outstanding at June 30,
2010, a 1% instantaneous and sustained increase in one-month LIBOR could increase quarterly
interest expense by as much as approximately $2.1 million, pre-tax, during the remaining terms of
the swap agreements, which would negatively impact our quarterly after-tax net income or loss. Due
to our liability-sensitive balance sheet, increases in these rates will decrease both net income,
or increase net loss, and the market value of our net assets. If the Companys existing swap
contracts expire, and are not renewed, a 1% instantaneous and sustained increase in one-month LIBOR
would have the effect of
increasing quarterly interest expense by approximately $3.1 million, pre-tax. See
Managements Discussion and Analysis Borrowings.
71
Real Estate Risk
Residential property values are subject to volatility and may be affected adversely by a
number of factors, including, but not limited to, national, regional and local economic conditions,
which may be adversely affected by industry slowdowns and other factors; local real estate
conditions (such as the supply of housing or the rapid increase in home values). Decreases in
property values reduce the value of the collateral and the potential proceeds available to
borrowers to repay their mortgage loans, which could cause the value of our investments not carried
at cost to decrease.
ITEM 4T. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
The Companys management, with the participation of the Companys Principal Executive Officer
and Chief Financial Officer, has evaluated the effectiveness of the Companys disclosure controls
and procedures (such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act as of
the end of the period covered by this Quarterly Report on Form 10-Q. Based upon that evaluation,
the Companys Principal Executive Officer and Chief Financial Officer concluded that the Companys
disclosure controls and procedures were effective as of the end of the period covered by this
report.
Changes in Internal Controls over Financial Reporting
There have been no changes in the Companys internal control over financial reporting during
the quarter ended June 30, 2010 that have materially affected, or are reasonably likely to
materially affect, such internal control over financial reporting.
72
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are involved in routine litigation matters generally incidental to our business, which
primarily consist of legal actions related to the enforcement of our rights under mortgage loans we
hold, held, service or collect for others, none of which is individually or in the aggregate
material. In addition, because we originated, acquired, service and collect on mortgage loans
throughout the country, we must comply and were required to comply with various state and federal
lending, servicing and debt collection laws, rules and regulations and we are routinely subject to
investigation and inquiry by regulatory agencies, some of which arise from complaints filed by
borrowers, none of which is individually or in the aggregate material.
ITEM 1A. RISK FACTORS
Risk factors applicable to the Company, including, but not limited to, those factors discussed
under the captions Impact of Inflation, Interest Rate Risk and Real Estate Risk are contained
in the Companys Annual Report on Form 10-K for the year ended December 31, 2009, filed with the
SEC on March 31, 2010.
The risk factors discussed in detail in the Companys Form 10-K filed on March 31, 2010
include the following:
Risks Related to Our Business
|
|
A prolonged economic slowdown or a lengthy or severe recession could harm our operations,
particularly if it results in a decline in the real estate market. |
|
|
The Company may not be able to continue as a going concern. |
|
|
Our credit facilities and servicing agreement with the Bank require us to observe certain
covenants, and our failure to satisfy such covenants could render us insolvent. |
|
|
Based on our current rate of collections on the assets we transferred to the Trust under
the Restructuring Agreement, without a significant special transaction, we may not be able to
achieve the minimum amount of net remittances necessary to reduce the pledge of FCMC stock to
the Bank from 70% to a minimum of 20% (which due to a failure to achieve the first collection
target by March 31, 2010, the minimum is currently 25%) or at all. |
|
|
If our lenders fail to renew our loans under the Licensing Credit Agreement for additional
terms or provide us with refinancing opportunities, our indebtedness under the $2 million
revolving line (which effective June 20, 2010, was reduced to $1 million) will become due and
payable in 2011; and, the draw line for working capital needs of FCMC will expire on May 31,
2010 (and which expired unrenewed). |
73
|
|
If our lenders fail to renew our loans under the Legacy Credit Agreement for additional
terms or provide us with refinancing opportunities, our legacy indebtedness will become due
and payable in 2012. |
|
|
If our lenders fail to extend the Forbearance Agreement covering the Unrestructured Deb
(which has been extended to September 30, 2010), the Unrestructured Debt will become due and
payable and the Bank would be able to foreclose on the portion of the stock of FCMC pledged to
it. |
|
|
The Bank may transfer our rights as servicer to the assets we transferred to the Trust
under the Restructuring Agreement to a third party (including, but not limited to, any of the
loans affecting our ability to meet net worth requirements in New York). |
|
|
The Bank may transfer our rights as servicer to any of the assets retained by the Trust and
serviced under the New Trust Servicing Agreement after the Loan Sale, including, but not
limited to, any of the loans affecting our ability to meet net worth requirements in New York
or any of the assets retained by the Trust following the Loan Sale. |
|
|
Our ability to fund operating expenses depends on the cash flow received from servicing
loans for third parties. |
|
|
Our business is sensitive to, and can be materially affected by, changes in interest rates. |
|
|
The Bank may prevent our pursuing future business opportunities. |
|
|
We may not be successful in entering into or implementing our planned business of providing
servicing and other mortgage related services for other entities on a fee-paying basis. |
|
|
If we do not obtain and maintain the appropriate state licenses, we will not be allowed to
service mortgage loans in some states, which would adversely affect our operations. |
|
|
A significant amount of the mortgage loans that we originated prior to the Restructuring
and transferred to the Trust as part of the Restructuring are secured by property in New York
and New Jersey, and our operations could be harmed by economic downturns or other adverse
events in these states. |
|
|
We may not be adequately protected against the risks inherent in servicing subprime
residential mortgage loans. |
|
|
A number of the second-lien mortgage loans that we service are subordinated to ARM or
interest-only mortgages that may be subject to monthly payment increases, which may result in
delinquencies and a decrease in servicing and collection revenues. |
|
|
We are subject to losses from the mortgage loans we acquired and originated prior to the
Restructuring due to fraudulent and negligent acts on the part of loan applicants, mortgage
brokers, sellers of loans we acquired, vendors and our employees. |
|
|
Legal proceedings could be brought which could adversely affect our financial results. |
|
|
Given the nature of the industry in which we operate, our businesses is, and in the future
may become, involved in various legal proceedings the ultimate resolution of which is
inherently
unpredictable and could have a material adverse effect on our business, financial position,
results of operations or cash flows. |
74
|
|
We are exposed to counter-party risk and there can be no assurances that we will manage or
mitigate this risk effectively. |
|
|
The success and growth of our servicing business will depend on our ability to adapt to and
implement technological changes, and any failure to do so could result in a material adverse
effect on our business. |
|
|
If we do not manage the changes in our businesses effectively, our financial performance
could be harmed. |
|
|
The inability to attract and retain qualified employees could significantly harm our
business. |
|
|
An interruption in or breach of our information systems may result in lost business and
increased expenses. |
|
|
We are exposed to the risk of environmental liabilities with respect to properties to which
we take title. |
|
|
A loss of our Chairman and President may adversely affect our operations. |
Risks Related to Our Financial Statements
|
|
Our financial condition and financial results can be materially affected by Federal
Reserves Board policies and the capital markets. |
|
|
We may become subject to liability and incur increased expenditures as a result of the
restatement of our financial statements. |
|
|
We may become subject to liability and incur increased expenditures as a result of our
having reassessed our allowance for loan losses and our transfer of substantially all our
mortgage portfolio related assets to the Bank. |
|
|
Failures in our internal controls and disclosure controls and procedures could lead to
material errors in our financial statements and cause us to fail to meet our reporting
obligations. |
Risks Related to the Regulation of Our Industry
|
|
New legislation and regulations directed at curbing predatory lending practices could
restrict our ability to service non-prime residential mortgage loans, which could adversely
impact our earnings. |
|
|
The broad scope of our operations exposes us to risks of noncompliance with an increasing
and inconsistent body of complex laws and regulations at the federal, state and local levels. |
|
|
We may be subject to fines or other penalties based upon the conduct of our independent
brokers. |
|
|
We are subject to reputation risks from negative publicity concerning the subprime mortgage
industry. |
75
|
|
We are subject to significant legal and reputation risks and expenses under federal and
state laws concerning privacy, use and security of customer information. |
|
|
If many of the borrowers of the loans we service become subject to the Servicemembers Civil
Relief Act of 2003, our cash flows and service fee income may be adversely affected. |
|
|
Legislative action to provide mortgage relief may negatively impact our business. |
Risks Related to Our Securities
|
|
Thomas J. Axon effectively controls our company, substantially reducing the influence of
our other stockholders. |
|
|
Our common stock is quoted only on the OTC Bulletin Board, which may adversely impact the
price and liquidity of the common stock, and our ability to raise capital. |
|
|
Our organizational documents, Delaware law and our Restructuring Agreements may make it
harder for us to be acquired without the consent and cooperation of our board of directors,
management and our Bank. |
|
|
Our quarterly operating results may fluctuate and cause our stock price to decline. |
|
|
Compliance with the rules of the market in which our common stock trades, and proposed and
recently enacted changes in securities laws and regulations are likely to increase our costs. |
There have been no material changes from the risk factors previously disclosed in Item 1A of
our Annual Report on Form 10-K for the year ended December 31, 2009, other than as set forth below,
which risk factors should be read in conjunction with the other risk factors disclosed in our Form
10-K.
Additional Risks Related to Our Business
|
|
Under the Servicing Agreement entered into on March 31, 2009 as part of the Restructuring
with the Bank, which was amended and restated as of August 1, 2010, the Bank with notice could
terminate the Servicing Agreement if FCMC fails to maintain all material licenses and
approvals required and necessary in each state where any mortgaged property, other real estate
property serviced under the Servicing Agreement, or borrowers are located and such failure
continues unremedied for five (5) business days. |
|
|
There is no assurance that the New York State Banking Department will find the written
capital plan of FCMC acceptable and not request modifications to the capital plan or deny
FCMCs application for registration as a mortgage servicer or that FCMC will be able to regain
compliance with regulatory net worth requirements in New York State. |
|
|
A denial of our application to be a registered mortgage servicer in the State of New York
by the New York State Banking Department would entitle the Bank (with notice) to terminate the
Servicing Agreement. In addition, such a failure to obtain or maintain our license to service
mortgages loans as a registered mortgage servicer in New York would be a default under the
Licensing Credit Agreement and Legacy Credit Agreement and, with notice, the Bank could also
call an event of default under those agreements entered into in connection with the
Restructuring, which, among other remedies, would entitle the Bank to foreclose on the assets
of the Company
pledged to the Bank, including on Franklin Holdings pledge of 70% of the common stock of
FCMC. |
76
|
|
The Bank may transfer our rights as servicer to any of the assets retained by the Trust and
serviced under the New Trust Servicing Agreement after the Loan Sale, including, but not
limited to, any of the loans affecting our ability to meet net worth requirements in New York
or any of the assets retained by the Trust following the Loan Sale. |
|
|
The Purchaser of substantially all of the first mortgage liens owned by the Trust may
transfer our rights as servicer to a third party. |
On July 20, 2010, but effective as of July 1, 2010, FCMC entered into the Loan Sale Servicing
Agreement with the Purchaser, pursuant to which FCMC will continue to provide servicing for the
loans acquired by the Purchaser in the Loan Sale. However, the servicing of 25% of the loans
acquired (based on unpaid principal balance) are to be transferred by FCMC to an affiliate of the
Purchaser, which is expected to occur on or about September 1, 2010. With respect to the remaining
75% of the loans acquired (based on unpaid principal balance), the Purchaser, which is now the
second largest servicing client of FCMC, has the right to terminate the servicing of any of such
loans without cause upon ninety (90) calendar days prior written notice, subject to the payment of
a termination fee for each such loan terminated. If the Purchaser terminated us as servicer of all
of the assets acquired from the Trust, which would represent a significant loss of servicing
revenue, our operations and financial condition would be adversely affected.
|
|
Due to the expected significant reduction in revenue for FCMC and early termination
provisions under its only significant servicing contracts with independent third parties
(i.e., the New Trust Servicing Agreement with the Trust and the Loan Sale Servicing Agreement
with the Purchaser of loans from the Trust), compared to what had been earned previously for
the servicing of the same assets, FCMC may be unable to add business or take appropriate cost
saving measures to replace the reduced revenues. |
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. (REMOVED AND RESERVED)
ITEM 5. OTHER INFORMATION
None.
77
ITEM 6. EXHIBITS
|
|
|
Exhibit |
|
|
Number |
|
|
3.1
|
|
First Amended and Restated Certificate of Incorporation.
Incorporated by reference to Exhibit 3.1 to the
Registrants Current Report on Form 8-K, filed with the
Securities and Exchange Commission (the Commission) on
December 24, 2008. |
|
|
|
3.2
|
|
Amended and Restated By-laws. Incorporated by reference to
Exhibit 3.2 to the Registrants Current Report on Form 8-K,
filed with the Commission on December 24, 2008. |
|
|
|
10.3*
|
|
Amendment No.1 to Amended and Restated Credit Agreement and
Replacement of Schedule to Amended and Restated Security
Agreement by and among Franklin Credit Asset Corporation,
Tribeca Lending Corp., Franklin Asset, LLC and the Other
Borrowers Party thereto as Borrowers, the Financial
Institutions Party thereto as Lenders, and the Huntington
National Bank, as Administrative Agent, dated June 11,
2010.
|
|
|
|
10.4
|
|
Amendment No. 5 to First Amended and Restated Forbearance
Agreement and Amendment to Credit Agreements, effective as
of June 28, 2010, by and among the Registrant, Franklin
Credit Asset Corporation, Flow 2006 F Corp., FCMC 2006 M
Corp., FCMC 2006 K Corp. and The Huntington National Bank.
Incorporated by reference to Exhibit 10.1 to the
Registrants Current Report on Form 8-K, filed with the
Commission on June 28, 2010.
|
|
|
|
31.1*
|
|
Rule 13a-14(a) Certification of Chief Executive Officer of
the Registrant in accordance with Section 302 of the
Sarbanes-Oxley Act of 2002. |
|
|
|
31.2*
|
|
Rule 13a-14(a) Certification of Chief Financial Officer of
the Registrant in accordance with Section 302 of the
Sarbanes-Oxley Act of 2002. |
|
|
|
32.1*
|
|
Section 1350 Certification of Chief Executive Officer of
the Registrant in accordance with Section 906 of the
Sarbanes-Oxley Act of 2002. |
|
|
|
32.2*
|
|
Section 1350 Certification of Chief Financial Officer of
the Registrant in accordance with Section 906 of the
Sarbanes-Oxley Act of 2002. |
78
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
FRANKLIN CREDIT HOLDING CORPORATION
August 16, 2010
|
|
|
|
|
|
|
|
|
By: |
/s/ THOMAS J. AXON
|
|
|
|
Thomas J. Axon |
|
|
|
President
(Principal Executive Officer) |
|
|
August 16, 2010
|
|
|
|
|
|
|
|
|
By: |
/s/ PAUL D. COLASONO
|
|
|
|
Paul D. Colasono |
|
|
|
Executive Vice President and Chief Financial Officer
(Principal Financial Officer) |
|
|