ITEM 1. BUSINESS
General
First Investors Financial Services Group, Inc., organized in 1989, is a consumer finance company engaged in both the purchase of receivables originated by franchised automobile dealers and originating loans directly to consumers in connection with the sale or refinance of new and late-model used vehicles. The Company specializes in lending to consumers with impaired credit profiles. Additionally, the Company has purchased receivables in bulk portfolio acquisitions or from other third party originators. The Company does not utilize off-balance sheet securitization to finance its Receivables Held for Investment. As of April 30, 2003, the Company had Receivables Held for Investment in the aggregate principal amount of $226,362,218, having an effective yield of 15.0 percent and a net interest spread to the Company of 10.4 percent (net of cost of funds and other carrying costs).
During the fiscal year ended April 30, 2003, the Company started performing servicing and collection activities for third parties through First Investors Servicing Corporation ("FISC"), a wholly owned subsidiary located in Atlanta, Georgia. The total managed portfolio serviced by FISC was $659 million as of April 30, 2003.
History
The Company was organized in 1989 by Tommy A. Moore, Jr. and Walter A. Stockard to conduct an automobile finance business, with Mr. Moore providing the operating expertise and Mr. Stockard and members of his family furnishing the initial financial support. During the first three years of the Company's existence, its operations consisted primarily of purchasing and pooling receivables for resale to financial institutions and others. In March 1992, the Company obtained additional capital from a group of private investors and decided to expand its operations and reorient its business. Instead of acquiring receivables for resale, the Company adopted a strategy of purchasing receivables for retention.
On October 2, 1998, the Company completed the acquisition of First Investors Servicing Corporation ("FISC"), formally known as Auto Lenders Acceptance Corporation, from Fortis, Inc. Headquartered in Atlanta, Georgia, FISC was engaged in essentially the same business as the Company and additionally performs servicing and collection activities on a portfolio of receivables acquired for investment as well as on a portfolio of receivables acquired and sold pursuant to two asset securitizations. As a result of the acquisition, the Company increased the total dollar value on its balance sheet of receivables, acquired an interest in certain trust certificates related to the asset securitizations and acquired certain servicing rights along with furniture, fixtures, equipment and technology to perform the servicing and collection functions for the portfolio of receivables under management.
Industry
The automobile finance industry is the second largest consumer finance market in the United States. Most automobile financing is provided by captive finance subsidiaries of major automobile manufacturers, banks, thrifts, credit unions and independent finance companies such as the Company. The overall industry is generally segmented according to the type of vehicle sold (new vs. used), the nature of the dealership (franchised vs. independent) and the credit characteristics of the borrower (prime vs. non-prime). The non-prime market is comprised of individuals who are relatively high credit risks and who have limited access to traditional financing sources, generally due to unfavorable past credit experience, low income or limited financial resources and/or the absence or limited extent of prior credit history.
Originating Dealer Base
General. The Company primarily purchases receivables from the new and used car departments of dealers operating under franchises from the major automobile manufacturers. The Company does not generally do business with "independent" dealers who operate used car lots with no manufacturer affiliation. No dealer or group of dealers (who are affiliated with each other through common ownership) accounted for more than 5 percent of the receivables owned by the Company at April 30, 2003, and no dealer or group of related dealers originated more than 5 percent of the receivables held by the Company at that date. The volume and frequency of receivable purchases from particular dealers vary widely with the size of the dealerships as well as market and competitive factors in the various dealership locations.
Location of Dealers. Approximately 23 percent of the dealers with whom the Company has agreements are located in Texas, where the Company has operated since 1989. The Company's expansion beyond Texas began in 1992 and today the Company operates in 28 states.
The following table summarizes, with respect to each state in which the Company operates, the number of receivables (and percentage of total receivables) outstanding which were originated by the Company from dealers in such state or purchased through bulk portfolio acquisitions during the last two fiscal years:
(1)Includes dealers located in Connecticut, Delaware, Iowa, Idaho, Massachusetts, Maryland, Minnesota, Nebraska, Nevada, New Hampshire, New Jersey, New York, Oregon, Pennsylvania, South Carolina, South Dakota, Utah, Vermont, and Wisconsin.
Marketing Representatives. The Company utilizes a system of regional marketing representatives to recruit, enroll and to provide new dealers with the Company's underwriting guidelines and credit policies as well as to maintain relationships with the Company's existing dealers. The representatives are full-time employees who reside in the region for which they are responsible.
In addition to soliciting and enrolling new dealers, the regional representatives assist new dealers in assimilating the Company's system of credit application submission, review, acceptance and funding, as well as dealing with routine dealer relations on a daily basis. The role of the regional representatives is generally limited to marketing the Company's core finance programs and maintaining relationships with the Company's originating dealer base. The representatives do not enter into or modify dealer agreements on behalf of the Company, do not participate in credit evaluation or loan funding decisions and do not handle funds belonging to the Company or its dealers. Each representative reports to, and is supervised by, the Company's sales and marketing manager in Houston.
In 1997, the Company established a telemarketing department to supplement the efforts of its marketing representatives in the field. The telemarketing staff (dealer sales representatives) is located in Houston and is primarily responsible for new loan volume in rural areas or states in which the Company cannot justify a field marketing representative.
It has been the policy of the Company to avoid the establishment of branch offices because it believes that the expenses and administrative burden of such offices are generally unjustified. Moreover, in view of the availability of modern data transmission technology, the Company has concluded that the critical functions of credit evaluation and loan origination are best performed and controlled on a centralized basis from its Houston facility. Accordingly, as the marketing representative system has operated satisfactorily, the Company does not plan to create branch offices in the future.
Financing Programs
The Company originates loans from two sources: (i) dealer indirect (the "core program"), and (ii) consumer direct utilizing direct marketing. The core program generates approximately 81 percent of the Company's current origination volume and consists of loans purchased directly from dealerships in states in which the Company operates. Consumer direct originations contribute approximately 19 percent of originations and involve applications for credit obtained through direct marketing efforts from consumers who are seeking to acquire a vehicle or refinance an existing automobile loan.
Credit applications generated by each of the above sources are forwarded to the Company's centralized credit department in Houston with decisions made based on the Company's standard underwriting guidelines and credit scoring model. The internal credit decision and acceptance process is essentially the same regardless of the origination source. Third party originators have no credit approval authority and are subject to individual contracts that specify the obligations of the parties. Essentially all of the Company's receivables are acquired on a non-recourse basis.
In addition to purchasing receivables from dealers under the core program or making loans directly to consumers, the Company has also acquired seasoned receivables in bulk portfolio acquisitions or from other third party originators and may continue to do so from time to time.
The Company had active dealership agreements with 1,620 dealers at April 30, 2003. These are non-exclusive agreements terminable at any time by either party and they require no specific volume levels. The agreements with the core program dealers contain customary representations and warranties concerning title to the receivables sold, validity of the liens on the underlying vehicles, compliance with applicable laws and related matters. Although the dealers are obligated to repurchase receivables that do not conform to these warranties, the dealers do not guarantee collectibility or obligate themselves to repurchase receivables solely because of payment default. The receivables are purchased at par or at prices that may reflect a discount or premium depending on the annual percentage rates of particular
receivables and the Company's assessment of relative credit risk. The pricing and credit terms upon which the Company agrees to acquire receivables is governed by the Company's credit policy and a credit score generated by the Company's proprietary, empirical based scoring model.
Credit Evaluation
General. In connection with the origination of a receivable for purchase by the Company, the Company follows systematic procedures designed to eliminate unacceptable risks. This involves a three-step process whereby (i) the creditworthiness of the borrower and the terms of the proposed transaction are evaluated and either approved, declined or modified by the Company's credit verification department, (ii) the loan documentation and collateralization is reviewed by the Company's funding department, and (iii) additional collateral verification procedures and customer interviews are conducted by the Company. During the course of this process, the Company's credit verification and funding personnel coordinate closely with the finance and insurance departments of the dealers tendering receivables or with individuals to whom the Company lends directly. The Company has developed various financing programs under which it approves loans that vary in pricing and loan terms depending on the relative credit risk determined for each loan. Credit or default risk is evaluated by the Company's loan officers in conjunction with a proprietary, empirical based credit scoring model developed based on the Company's 15 year database of non-prime lending results.
Collateral Verification. As a condition to the purchase of each receivable originated by the Company, the Company performs an individual audit evaluation consisting of personal telephonic interviews with each vehicle purchaser to verify the details of the credit application and to confirm that the material terms of the sale conform to the purchaser's understanding of the transaction. The Company will purchase a receivable under its core program only after receipt and review of a satisfactory audit report.
Servicing
The Company believes that competent, attentive and efficient loan servicing is as important as sound credit evaluation for purposes of assuring the integrity of a receivable.
From its inception in 1989 until July 1999, the Company had a servicing relationship with General Electric Capital Corporation ("GECC") an affiliate of General Electric Corporation. The division of GECC which serviced the Company's receivables operates primarily as a servicer of automobile installment loans and is one of the largest such servicers in the United States. The Company's relationship with GECC was governed by a servicing agreement entered into in October 1992 although the Company had done business with GECC under previous agreements since 1989. Under the agreement, GECC was responsible for all aspects of loan servicing and collections with the exception of the disposition of repossessed vehicles, which was the responsibility of the Company. Servicing fees paid by the Company to GECC represented a variable cost that increased in proportion to the volume of receivables carried.
In July 1999, the Company elected to terminate the servicing agreement with GECC in connection with the transfer of the servicing and collection activities on the receivables to the Company's internal servicing and collection platform. In addition to servicing its owned portfolio, in December 2002, the Company began servicing and collection activities for third parties in exchange for servicing fees. The Company completed two transactions during the fiscal year ended April 30, 2003, both of which related to portfolio acquisitions from collateral previously originated by Union Acceptance Corporation. Under the first transaction, the Company invested $475,061 for a 40% ownership interest and $712,591 in junior mezzanine debt of First Auto Receivables Corporation ("FARC"). FARC purchased a $197.5 million automobile loan portfolio. In addition to the equity and debt investments, the Company collects a fee for servicing the portfolio. The second transaction is a $276 million auto loan portfolio
purchased by a third party and serviced by the Company. The Company will continue to seek opportunities to increase servicing income through investments in bulk portfolio acquisitions.
Portfolio Characteristics
General. In selecting receivables for inclusion in its portfolio, the Company seeks to identify potential borrowers whom it regards as creditworthy despite credit histories that limit their access to traditional sources of consumer credit. In addition to personal credit qualifications, the Company attempts to assure that the characteristics of the automobile sold and the terms of the sale are likely to result in a consistently performing receivable. These considerations include amount financed, monthly payments required, duration of the loan, age of the automobile, mileage on the automobile and other factors.
Customer Profile. The Company's primary goal in credit evaluation is to make loans to customers having stable personal situations, predictable incomes and the ability and inclination to perform their obligations in a timely manner. Many of the Company's customers are persons who have experienced credit difficulties in the past by reason of illness, divorce, job loss, reduction in pay or other adversities, but who appear to the Company to have the capability and commitment to meet their obligations. Through its credit evaluation process, the Company seeks to distinguish these persons from those applicants who are chronically poor credit risks. Certain information concerning the Company's obligors for the past two fiscal years (based on credit information compiled at the time of the loan origination) is set forth in the following table:
(1)Includes military personnel and persons residing with relatives. Portfolio Profile. In order to manage the risks associated with the relatively high yields available in the non- prime market, the Company endeavors to maintain a receivables portfolio having characteristics that, in its judgment, reflect an optimal balance between achievable yield and acceptable
risk. The following table sets forth certain information concerning the composition of the Company's portfolio as of the end of the past two fiscal years:
(1)Calculated on the basis of number of receivables outstanding as of the date indicated. (2)Because the actual life of many receivables will differ from the stated term by reason of prepayments and defaults, data reflecting the average stated term of receivables included in a portfolio will not correspond with actual average life. Financing Arrangements
General. The Company financing strategy is to utilize credit and commercial paper facilities with financial institutions to fund originations. When sufficient volume is originated, the Company will complete an on balance sheet securitization and issue term notes, thereby freeing up capacity in the warehouse and credit facilities. Additionally, the Company has a working capital term loan that was utilized for working capital and general corporate purposes. Lastly, the Company has an agreement with one of its shareholders who is a member of its Board of Directors to borrow up to $2.5 million. Proceeds of the borrowings are to be used to fund private and open market purchases of the Company's common stock pursuant to a Stock Repurchase Plan and for general corporate purposes. The following chart summarizes the borrowing status at April 30, 2003:
Please see Note 7 to the consolidated financial statements for further information regarding interest rates, expiration dates and other terms of the various facilities.
Risk Areas
Warehouse Credit Facilities. The Company's credit and commercial paper facilities with financial institutions, collectively referred to as warehouse credit facilities, are renewed periodically. On December 5, 2002, the maturity date of the FIRC facility was extended to December 4, 2003. Under the terms of the renewal, the facility was to revert back to $50 million on June 30, 2003 based on the anticipated issuance of additional asset-backed notes which would decrease the borrowings below the reduced facility limit. On June 30, 2003, the FIRC credit facility commitment of $75 million was extended to October 31, 2003 at which time it will convert to $50 million. There were no other material changes to the terms and conditions of the facility. Under the renewal mechanics of the facility, should the lenders elect not to renew the facility beyond October 31, 2003, the facility would convert to a term loan facility which would mature six months thereafter and amortize monthly in accordance with the borrowing base with any remaining balance due at maturity. The FIARC commercial paper facility expired on January 12, 2003 and was renewed until December 4, 2003. No other material changes were made. If the facility is not extended beyond the maturity date, receivables pledged as collateral would be allowed to amortize; however, no new receivables would be allowed to transfer from the credit facility. The Company presently intends to seek a renewal of the facility from its lenders prior to maturity. Management considers its relationship with its lenders to be satisfactory and has no reason to believe that this credit facility will not be renewed. If the facility is not renewed, however, or if material changes are made to its terms and conditions, it could have a material adverse effect on the Company.
Term Notes. The Company relies on its ability to pool and sell receivables in the asset-backed market in order to generate cash used to pay down the warehouse facilities. Adverse terms or unfavorable occurences in the auto asset-backed market could make securitizations more expensive or could impair the ability to complete securitizations which would have an adverse effect on the Company's liquidity and financial position.
Loan Covenants. The documentation governing each of the Company's financing arrangements contains numerous covenants relating to the Company's business, the maintenance of credit enhancement insurance covering the receivables (if applicable), the observance of certain financial covenants, the avoidance of certain levels of delinquency experience, and other matters. The breach of these covenants, if not cured within the time limits specified, could precipitate events of default that might result in the acceleration of the FIRC credit facility and working capital facility or the termination of the commercial paper facilities. Through the operation of the collateral agency arrangements, which are in the nature of a "lock-box" security device covering the collection of principal and interest on almost all of the Company's receivables, such a default could cause the immediate termination of the Company's primary sources of liquidity. The Company was not in default with respect to any covenants governing these financing arrangements at April 30, 2003.
Interest Rate Management. The Company's warehouse credit facilities bear interest at floating interest rates which are reset on a short-term basis while the secured Term Notes bear interest at a fixed rate of interest. The Company's receivables bear interest at fixed rates that do not generally vary with changes in market interest rates. Since a primary contributor to the Company's profitability is its ability to manage its net interest spread, the Company seeks to maximize the net interest spread while minimizing exposure to changes in interest rates. In connection with managing the net interest spread, the Company may periodically enter into interest rate swaps or caps to minimize the effects of market interest rate fluctuations on the net interest spread. To the extent that the Company has outstanding floating rate borrowings or has elected to convert a portion of its borrowings from fixed rates to floating rates, the Company will be exposed to fluctuations in short-term interest rates. Please see Market Risk under Item 7 for quantification.
The following is a summary of the financial instruments owned as of April 30, 2003:
(a)This interest rate represents the cap rate. In the event interest rates rise above the cap rate, the Company will receive the rate difference multiplied by the outstanding notional balance. Since the Company has offsetting positions on the interest rate swap transactions, the exposure is limited to the notional balance multiplied by 1.395% for the remaining term of the swaps. The pay fixed interest rate swap transaction was entered into as protection for interest rate movements in conjunction with floating rates on the warehouse credit facilities. Partially due to anticipation of the issuance of fixed rate Term Notes, the Company entered into the offsetting receive fixed swap.
The interest rate caps were purchased as a requirement of the FIARC commercial paper facility and expiration dates range from April 2006 to May 2009. The interest rate caps were purchased at a cost of $522,204 and have amortizing notional balances in accordance with expected paydowns on the corresponding FIARC debt.
As of May 1, 2001 the Company designated its interest rate swaps and an interest rate cap with an aggregate notional value of $130,165,759 as cash flow hedges as defined under SFAS No. 133. Accordingly, any changes in the fair value of these instruments resulting from the mark-to-market process were recorded as unrealized gains or losses and reflected as an increase or reduction in shareholders' equity through other comprehensive income (loss). In connection with the decision to enter into the $100 million floating rate swap on June 1, 2001, the Company elected to change the designation of the $100 million fixed rate swap and not account for the instrument as a hedge under SFAS No. 133. As a result, the change in fair value of the swaps is reflected in net earnings for the period subsequent to May 31, 2001. In conjunction with this designation and the adoption of SFAS 133 and SFAS 138, the Company recorded a transition adjustment in the aggregate amount of $(2,501,595), net of a tax benefit of $1,437,925, as a reduction to shareholders' equity and recorded a corresponding liability to reflect the fair market value of the derivatives as of May 1, 2001. The equity adjustment is classified as other comprehensive income (loss) and the derivative liability is classified in the interest rate derivative positions liability. Over a period ending April 2004, the maturity date of the final swap, the Company will reclassify into earnings substantially all of the transition adjustment originally recorded.
The interest rate caps are not designated as hedges and, accordingly, changes in the fair value are recorded as unrealized gains or losses and reflected in net earnings. Hedge accounting was not adopted for the interest rate cap positions due to mark-to-market movements being deemed ineffective since they relate to time value and would be required to flow through net earnings thus eliminating any benefits of hedge accounting.
Credit Enhancement-FIRC Credit Facility. In order to obtain a lower cost of funding, the Company has agreed under the FIRC credit facility to maintain credit enhancement insurance covering all of its receivables pledged as collateral under this facility. The facility lenders are named as additional insureds under these policies. The coverages are obtained on each receivable at the time it is purchased by the Company and the applicable premiums are prepaid for the life of the receivable. Each receivable is covered by three separate credit insurance policies, consisting of basic default insurance under a standard auto loan protection policy (known as "ALPI" insurance) together with certain supplemental coverages relating to physical damage and other risks. Solely at its expense, the Company carries these coverages and neither the vehicle purchasers nor the dealers are charged for the coverages and they are usually unaware of their existence. The Company's ALPI insurance policy is written by National Union Fire Insurance Company of Pittsburgh ("National Union"), which is a wholly-owned subsidiary of American International Group. As of April 30, 2003 National Union had been assigned a rating of A+ + by A.M. Best Company, Inc.
The premiums that the Company paid during its past fiscal year for its three credit enhancement insurance coverages, of which the largest component is the basic ALPI insurance, represented approximately 3.9 percent of the principal amount of the receivables acquired during the year. Aggregate premiums paid for ALPI coverage alone during the fiscal years ended April 30, 2001, 2002 and 2003 were $3,413,186, $2,382,031 and $4,141,328, respectively, and accounted for 3.0 percent, 3.1 percent and 3.8 percent of the aggregate principal balance of the receivables acquired during such respective periods.
Prior to establishing its relationship with National Union in March 1994, the Company's ALPI policy was provided by another third-party insurer. In April 1994, the Company organized First Investors Insurance Company (the "Insurance Subsidiary") under the captive insurance company laws of the State of Vermont. The Insurance Subsidiary is an indirect wholly-owned subsidiary of the Company and is a party to a reinsurance agreement whereby the Insurance Subsidiary reinsures 100 percent of the risk under the Company's ALPI insurance policy. At the time each receivable is insured by National Union, the risk is automatically reinsured to its full extent and approximately 96 percent of the premium paid by the Company to National Union with respect to such receivable is ceded to the Insurance Subsidiary. When a loss covered by the ALPI policy occurs, National Union pays it after the claim is processed, and National Union is then reimbursed in full by the Insurance Subsidiary. As of April 30, 2003, gross premiums had been ceded to the Insurance Subsidiary since its inception by National Union in the amount of $28,486,788 and the Insurance Subsidiary reimbursed National Union for aggregate reinsurance claims in the amount of $8,089,381. In addition to the monthly premiums and liquidity reserves of the Insurance Subsidiary, a trust account is maintained by National Union to secure the Insurance Subsidiary's obligations for losses it has reinsured.
The result of the foregoing reinsurance structure is that National Union, as the "fronting" insurer under the captive arrangement, is unconditionally obligated to the Company's credit facility lenders for all losses covered by the ALPI policy, and the Company, through its Insurance Subsidiary, is obligated to indemnify National Union for all such losses. As of April 30, 2003, the Insurance Subsidiary had capital and surplus of $1,753,375 and unencumbered cash reserves of $1,521,507 in addition to the $2,725,785 trust account.
The ALPI coverage as well as the Insurance Subsidiary's liability under the Reinsurance Agreement, remains in effect for each receivable that is pledged as collateral under the warehouse credit facility. Once receivables are transferred from FIRC to FIARC and financed under the commercial paper facility, ALPI coverage and the Insurance Subsidiary's liability under the Reinsurance Agreement is cancelled with respect to the transferred receivables. Any unearned premium associated with the transferred receivables is returned to the Company. The Company believes the losses its Insurance Subsidiary will be required to indemnify will be less than the premiums ceded to it. However,
there can be no assurance that losses will not exceed the premiums ceded and the capital and surplus of the Insurance Subsidiary.
Credit Enhancement-FIARC Commercial Paper Facility. Enhancement for the FIARC commercial paper facility is provided by a surety bond issued by MBIA Insurance Corporation. The surety bond provides payment of principal and interest to Variable Funding Capital Corporation ("VFCC") in the event of payment default by FIARC. MBIA is paid a surety premium equal to 0.35 percent per annum on the average outstanding borrowings under the facility. The surety bond is issued for a term to coincide with the facility. Termination of the surety bond would result in default under the FIARC commercial paper facility.
Credit Enhancement-Term Notes. A surety bond issued by MBIA Insurance Corporation enhances the 2002-A Term Notes issued in January 2002. The surety bond provides payment of principal and interest to the noteholders in the event of payment default by the 2002-A Trust. MBIA is paid a surety premium equal to 0.35 percent per annum on the outstanding balance of the 2002-A Term Notes. The surety bond was issued for the term of the underlying notes, which mature on December 15, 2008. Termination of the surety bond would result in default under the governing documents.
Economy. Periods of weakened economic condition and slow or negative growth will tend to have an unfavorable effect on delinquencies, defaults and losses, particularly with non prime borrowers. Recent periods have also been negatively impacted by declining prices of used vehicles which increases losses to the Company upon repossession. These decreasing prices are primarily due to heavy incentives being offered on new vehicles which has decreased the demand in the used market. Losses have adverse effects on the Company's liquidity and operating results.
Servicer Default. The Company performs servicing and collection activities for its owned portfolio as well as two pools of loans owned or partially owned by third parties. Each of the servicing agreements identifies areas of servicer default which are generally defined as the inability to protect the assets under agreement or failing trigger tests of the portfolios. Triggers are related to negative default and loss performance as compared to trigger levels. An event of servicer default would have adverse effects on liquidity and profitability and could result in having the portfolios transferred to another servicer.
Securitization
Many finance companies similar to the Company engage in "securitization" transactions whereby receivables are pooled and conveyed to a trust or other special purpose entity, with interests in the entity being sold to investors. As the pooled receivables amortize, finance charge collections are passed through to the investors at a specified rate for the life of the pool and an interest in collections exceeding the specified rate is retained by the sponsoring finance company. For accounting purposes, the sponsor often recognizes as revenue the discounted present value of this excess interest as estimated over the life of the pool. This revenue, or "gain on sale", is recognized for the period in which the transaction occurs.
The Company does not use off-balance sheet financing structures for receivables originated by the Company and therefore, recognizes interest income on the accrual method over the life of the receivables rather than recording gains when those receivables are sold. The Company does not currently intend to engage in off-balance sheet securitization transactions resulting in gains on sale of receivables.
In connection with the acquisition of FISC in October 1998, the Company obtained interests in two securitizations of automobile receivables. The outstanding balance of the receivables sold pursuant
to these two securitizations were repurchased by the Company in September 2000 and March 2001, respectively, and are now reflected in Receivables Acquired for Investment.
Employees
The Company had 166 employees as of April 30, 2003, including 49 located at its headquarters in Houston, 113 located at its loan servicing center in Atlanta and 4 regional marketing representatives. The Company's employees are covered by group health insurance, but the Company has no pension, profit-sharing or other material benefit programs. Effective May 1, 1994, the Company adopted a participant-directed 401(k) retirement plan for its employees. An employee becomes eligible to participate in the plan immediately upon employment. The Company pays the administrative expenses of the 401(k) plan. The Company also matches a percentage of each participant's voluntary contributions up to a maximum voluntary contribution of 3 percent of the participant's compensation. In fiscal years 2003 and 2002, the Company recorded matching contributions to the 401(k) plan of $32,548 and $30,265, respectively. Effective April 28, 1998, the Company established a participant-directed Deferred Compensation Plan for certain executive officers of the Company. Under the terms of the Deferred Compensation Plan, the participants may elect to make contributions to the plan that exceeds amounts allowed under the Company's 401(k) plan. The Company pays the administrative expenses of the Deferred Compensation Plan. As of April 30, 2003 and 2002, the amounts invested under the Deferred Compensation Plan totaled $236,378 and $256,876, respectively. The Company has no collective bargaining agreements and considers its employee relations to be satisfactory.
Information Systems
The Company utilizes advanced information management systems including a fully integrated software program designed to expedite each element in the receivables acquisition process, including the entry and verification of credit application data, credit analysis and the communication of credit decisions to originating dealers. The Company also utilizes a number of analytical tools in managing credit risk including an empirical scoring model, trend and discriminant analysis and pricing models which are designed to optimize yield given an expected default rate.
The servicing and collection platform is provided by a third party application service provider through which the Company accesses a mainframe system which is designed to provide support for all collections and servicing activities including billing, collection process management, account activity history, repossession management, loan accounting information and payment posting. The Company pays a monthly usage fee to the service provider based on the number of accounts serviced. The Company also utilizes auto dialer software that interfaces with the system and serves as an efficiency tool in the collection process.
Both the front-end and back-end platforms are highly compatible from an integration standpoint with all loans boarded electronically following funding from the origination system to the collection system.
In addition to its two primary operating systems, the Company also utilizes third-party software in its accounting, human resources, and data management functions, all of which are products well known in the marketplace.
The Company believes that its data processing and information management capacity is sufficient to accommodate significantly increased volumes of receivables without material additional capital expenditures for this purpose.
Competition
The business of direct and indirect lending for the purchase of new and used automobiles is intensely competitive in the United States. Such financing is provided by commercial banks, thrifts, credit unions, the large captive finance companies affiliated with automobile manufacturers, and many independent finance companies such as the Company. Many of these competitors and potential competitors have significantly greater financial resources than the Company and, particularly in the case of the captive finance companies, enjoy ready access to large numbers of dealers. The Company believes that a number of factors including historical market orientations, traditional risk-aversion preferences and in some cases regulatory constraints, have discouraged many of these entities from entering the non-prime sector of the market where the Company operates. However, as competition intensifies, these well-capitalized concerns could enter the market, and the Company could find itself at a competitive disadvantage.
The non-prime market in which the Company operates also consists of a number of both large and mid-sized independent finance companies doing business on a local, regional or national basis including some which are affiliated with captive finance companies or large insurance groups. Reliable data regarding the number of such companies and their market shares is unavailable; however, the market is highly fragmented and intensely competitive.
Regulation
The operations of the Company are subject to regulation, supervision and licensing under various federal and state laws and regulations. State consumer protection laws, motor vehicle installment sales acts and usury laws impose ceilings on permissible finance charges, require licensing of finance companies as consumer lenders, and prescribe many of the substantive provisions of the retail installment sales contracts that the Company purchases. Federal consumer credit statutes and regulations primarily require disclosure of credit terms in consumer finance transactions, although rules adopted by the Federal Trade Commission (including the so-called holder-in-due-course rule) also affect the substantive rights and remedies of finance companies purchasing automobile installment sales contracts.
The Company's business requires it to hold consumer lending licenses issued by individual states, under which the Company is subject to periodic examinations. State consumer credit regulatory authorities generally enjoy broad discretion in the revocation and renewal of such licenses and the loss of one or more of these in states in which the Company conducts material business could adversely affect the Company's operations.
In addition to specific licensing and consumer regulations applicable to the Company's business, the Company's ability to enforce and collect its receivables is limited by several laws of general application including the Fair Debt Collection Practices Act, Federal bankruptcy laws and the Uniform Commercial Codes of the various states. These and similar statutes govern the procedures, and in many instances limit the rights of creditors, in connection with asserting defaults, repossessing and selling collateral, realizing the proceeds thereof, and enforcing deficiencies.
The Company's insurance subsidiary is subject to regulation by the Department of Banking, Insurance and Securities of the State of Vermont. The plan of operation of the subsidiary, described above under "Financing Arrangements" and "Credit Enhancement", was approved by the Department and any material changes in those operations would likewise require the Department's approval. The subsidiary is subject to minimum capital and surplus requirements, restrictions on dividend payments, annual reporting, and periodic examination requirements.
The Company believes that its operations comply in all material respects with the requirements of laws and regulations applicable to its business. These requirements and the interpretations thereof,
change from time to time and are not uniform among the states in which the Company operates. The Company retains a specialized consumer credit legal counsel that engages and supervises local legal counsel in each state where the Company does business, to monitor compliance on an ongoing basis and to respond to changes in applicable requirements as they occur.
ITEM 2.
ITEM 2. PROPERTIES
The Company's principal physical properties are its data processing and communications equipment and furniture and fixtures, all of which the Company believes to be adequate for its intended use.
The Company's offices in suburban Houston consist of approximately 12,369 square feet on the seventh floor of an eight-story office building. This space is held under a lease requiring average annual rentals of approximately $220,000 and expiring on February 28, 2005, with an option to renew for five years at the market rate then prevailing.
The Company's offices in suburban Atlanta consist of approximately 27,467 square feet on the third and fourth floors of a four-story office building. This space is held under a lease requiring average annual rentals of approximately $571,000 and expiring on June 30, 2007, with an option to renew for two consecutive five-year periods at the market rate then prevailing.
The Company owns no real property.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to any material litigation and is currently not aware of any threatened litigation that could have a material adverse effect on the Company's business, results of operations or financial condition.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's securities holders during the fourth quarter of the past fiscal year.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANTS' COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
The Company's common stock has been traded on the NASDAQ National Market System, under the symbol "FIFS" since the completion of the Company's initial public offering on October 4, 1995. High and low bid prices of the common stock are set forth below for the periods indicated.
As of July 1, 2003, there were approximately 30 shareholders of record of the Company's common stock. The Company believes the number of beneficial owners to be approximately 232.
The Company has not declared or paid any cash dividends on its common stock since its inception. The payment of cash dividends in the future will depend on the Company's earnings, financial condition and capital needs and on other factors deemed pertinent by the Company's Board of Directors. It is currently the policy of the Board of Directors to retain earnings to finance the operation and expansion of the Company's business and the Company has no plans to pay any cash dividends on the common stock in the foreseeable future.
ITEM 6.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data of the Company for the four fiscal years ended April 30, 2003, has been derived from the audited consolidated financial statements of the Company and should be read in conjunction with such statements (dollars in thousands, except share data). The selected consolidated financial data for the year ending April 30, 1999 and the balance sheet data as of April 30, 2000 has been derived from the unaudited financial statements of the Company. As reflected in the Company's Form 10-K/A filed November 29, 2002, the Company restated the Consolidated Financial Statements as of April 30, 2002 and 2001, and for the three years ended April 30, 2002 to correct for certain prior period misstatements that were discovered by the Company as it was performing additional control procedures adopted during the first quarter 2003 period at the request of its new accounting firm, Grant Thornton LLP. The restatement related to overstated balances that should have been identified by the Company upon conversion from a third party servicer. The restatement impacted certain restricted cash, deferred expenses, receivables held for investment, and tax balances as reported, but it did not affect the Company's free liquidity position or debt position. The balance of retained earnings as of April 30, 1999 has been restated from amounts previously reported to reflect a retroactive charge of $1,248,918, after tax. Restricted cash, deferred expenses, receivables held for investment, and tax balances have been adjusted for the restatement for all
applicable years. Because of the restatement and due to the predecessor auditing firm no longer being in business, an updated opinion could not be obtained for 1999.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Critical Accounting Policies
Financial Reporting Release No. 60, which was issued by the Securities and Exchange Commission ("SEC"), requires all registrants to discuss critical accounting policies or methods used in the preparation of financial statements. Note 2 to the consolidated financial statements includes a summary of the significant accounting policies and methods in preparation of the Company's consolidated financial statements.
The preparation of financial statements includes the use of estimates and assumptions that affect the reported amounts of assets and liabilities and the reported amounts of net revenues and expenses during the reporting periods.
The following is a review of the more significant assumptions and estimates, as well as the accounting policies and methods used in the preparation of the consolidated financial statements.
Receivables Acquired for Investment. In connection with loans that were acquired in a portfolio purchase by the Partnership, the Company estimates the amount and timing of undiscounted expected future principal and interest cash flows. For certain purchased loans, the amount paid for a loan reflects the Company's determination that it is probable the Company will be unable to collect all amounts due according to the loan's contractual terms. Accordingly, at acquisition, the Company recognizes the excess of the loan's scheduled contractual principal and contractual interest payments over its expected cash flows as an amount that should not be accreted. The remaining amount, representing the excess of the loan's expected cash flows over the amount paid, is accreted into interest income over the remaining life of the loan. Assets are reported for the entire Partnership and the partner's share of income is reported as minority interest. See Note 7-Acquisition Facility.
Over the life of the loan, the Company continues to estimate expected cash flows on a pool by pool basis. The Company evaluates whether the present value of any decrease in the loan's actual or
expected cash flows should be recorded as a loss provision for the loan. For any material increases in estimated cash flows, the Company adjusts the amount of accretable yield by reclassification from nonaccretable difference. The Company then adjusts the amount of periodic accretion over the loan's remaining life. See Note 4.
Income Recognition. For Receivables Held for Investment, the Company accrues interest income monthly based upon contractual terms using the effective interest method. Interest income also includes additional amounts received upon early payoffs of certain receivables attributable to the difference between the principal balance of the receivables calculated using the Rule of 78's method and the principal balance of the receivables calculated using the effective interest method. When a receivable becomes 90 days past due, income accrual is suspended until the payments become current. When a loan is charged off or the collateral is repossessed, the remaining income accrual is written off. Other income includes late charge fees and is recognized as collected. Servicing income is accrued as it is earned and intercompany amounts are eliminated upon consolidation.
Allowance for Credit Losses. For receivables financed under the FIRC credit facility, the Company purchases credit enhancement insurance from third-party insurers which covers the risk of loss upon default and certain other risks. The Company established a captive insurance subsidiary to reinsure the credit enhancement insurance coverage. The credit enhancement insurance coverage for all receivables acquired in March 1994 and thereafter has been reinsured by FIIC. Beginning in October 1996, all receivables recorded by the Company were covered by credit enhancement insurance while pledged as collateral for the FIRC credit facility. Once receivables are transferred to the FIARC commercial paper facility, credit enhancement insurance is cancelled. In addition, no default insurance is purchased for core receivables originated and financed under the FIACC commercial paper facility. Accordingly, the Company is exposed to credit losses for all receivables either reinsured by FIIC or uninsured and provides an allowance for such losses.
Efforts to make customer contact generally begin when the customer is three days past due and become more aggressive as the loan becomes further past due. Management reviews past due loans and considers various factors including payment history, job status and any events that may have occurred that prevent the customer from making a payment. Through the evaluation, if it is determined that the loan is uncollectible, the collateral is repossessed. Generally this occurs at 90 to 120 days past due. Upon repossession, an impairment is recorded to write off Receivables Held for Investment and record the fair value as Assets Held for Sale. Fair value is determined by estimating the proceeds of the collateral which primarily are comprised of auction proceeds on the sale of the automobile less selling related expenses. After collection of all proceeds, the Company realizes an adjustment, positive or negative, based on the difference between the fair value estimate and the true proceeds received. In the event the collateral is unable to be located, the Company will write off the entire balance after exhausting all collection efforts.
The Company calculates the allowance for credit losses in accordance with SFAS 5, Accounting for Contingencies. SFAS 114, Accounting for Creditors for Impairment of a Loan does not apply to the Company since the Receivables Held for Investment are comprised of a large group of smaller balance homogenous loans that are evaluated collectively for impairment.
The Company applies a systematic methodology in order to determine the amount of the allowance for credit losses. The specific methodology utilized is a six-month migration analysis whereby the Company compares the aging status of each loan from six months prior to the aging loan status as of the reporting date. These factors are then applied to the aging status of each loan at the reporting date in order to calculate the number of loans that are expected to migrate to impaired status. The estimated number of impairments is then multiplied by estimated loss per loan, which is based on historical information. The computed reserve is then compared to the amount recorded for adequacy. The Company compares the six-month result to prior six-month periods to compare trends and
evaluate any other internal or external factors that may affect collectibility. The allowance for credit losses is based on estimates and qualitative evaluations and ultimate losses will vary from current estimates. These estimates are reviewed periodically and as adjustments, either positive or negative, become necessary, are reported in earnings in the period they become known.
Deferred Financing Costs. The Company defers financing costs and amortizes the costs related to the respective warehouse credit facilities and Term Notes over the estimated average life of the receivables financed under those respective facilities as the provisions of such facility generally provide that receivables assigned to such facility would be allowed to amortize should the facilities not be extended. Deferred financing costs are expensed proportionately if borrowing capacity is reduced.
Derivatives. In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133 establishes accounting and reporting standards requiring that every derivative instrument (including certain derivative instruments embedded in other contracts) be recorded in the balance sheet as either an asset or liability at its fair value. The Statement requires that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. In June 2000, the FASB issued SFAS No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities-an Amendment of FASB Statement No. 133.
As of May 1, 2001 the Company designated its interest rate swaps and an interest rate cap with an aggregate notional value of $130,165,759 as cash flow hedges as defined under SFAS No. 133. Accordingly, any changes in the fair value of these instruments resulting from the mark-to-market process are recorded as unrealized gains or losses and reflected as an increase or reduction in shareholders' equity through other accumulated comprehensive income (loss). In connection with the decision to enter into the $100 million floating rate swap on June 1, 2001, the Company elected to change the designation of the $100 million fixed rate swap and not account for the instrument as a hedge under SFAS No. 133. As a result, the change in fair value of the swaps is reflected in net earnings for the period subsequent to May 31, 2001. The interest rate caps entered into as a requirement of the FIARC commercial paper facility are not designated as hedges and, accordingly, changes in the fair value are recorded as unrealized gains or losses and reflected in net earnings. Hedge accounting was not adopted for these positions due to mark-to-market movements being deemed ineffective since they relate to time value and would be required to flow through net earnings thus eliminating any benefits of hedge accounting.
Treasury Stock. On December 14, 2001, the Board of Directors authorized the Company to repurchase up to 5% of the Company's outstanding common stock. During the year ended April 30, 2002, 170,000 shares were repurchased under this authorization at an average price of $3.03. During the year ended April 30, 2003, 370,400 shares were repurchased at an average price of $3.40.
Stock-Based Compensation. The Company has an employee stock option plan and a non employee director stock option plan, which are described more fully in Note 15. The Company applies APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations in accounting for its plans. The following table illustrates the effect on net income (loss) and earnings (loss) per share if the Company had applied the fair value recognition provisions of FASB Statement
No. 123, Accounting for Stock-Based Compensation (with assumptions described in Note 15), to its stock option plans.
General
Net income for the year ended April 30, 2003, was $332,618 or $0.07 per common share. Net loss for the year ended April 30, 2002, was $(309,012) or $(0.06) per common share. The increase in net income is primarily related to a $1,260,000 loss or $882,000, net of minority interest, in fiscal year 2002 on the Receivables Acquired for Investment due to an increase in the projected loss rates. Additionally, during 2002, the Company amortized deferred financing costs and warrants of $602,162 related to restructuring of debt facilities. In fiscal year 2003, the Company experienced lower net interest margin due to a lower average outstanding portfolio and lower rates and also experienced higher credit losses. These decreases were offset by higher fee income. See Results of Operations.
Overview
The Company is a consumer finance company engaged in both the purchase of receivables originated by franchised automobile dealers and originating loans directly to consumers in connection with the sale of new and late-model used vehicles. The Company specializes in lending to consumers with impaired credit profiles. At April 30, 2003, the Company had a network of 1,620 franchised dealers in 28 states from which it regularly purchases receivables at the time of origination. The Company also originates loans directly through consumers utilizing direct marketing programs targeting consumers who wish to refinance an existing loan. While the Company intends to continue efforts to geographically diversify its receivables portfolio, approximately 26 percent of Receivables Held for Investment at April 30, 2003 represent receivables acquired from dealers or originated to consumers located in Texas.
The primary source of the Company's revenues is interest income from receivables retained as investments and servicing income, while its primary cost has been interest expense arising from the financing of the Company's investment in such receivables. The profitability of the Company during this period has been determined by the growth of the receivables portfolio, inclusion of two new servicing transactions, and effective management of net interest income and fixed operating expenses. First Investors Servicing Corporation ("FISC") performs servicing and collection functions on a $659 million portfolio of loans.
The Company's managed receivables are (dollars in thousands):
The following table summarizes the Company's net interest income (dollars in thousands):
(1)Amounts shown are net of amortization of premium and deferred fees.
(2)Amounts shown for the year ended April 30, 2003 and April 30, 2002 reflect $171 and $709, respectively, in interest income related to minority interest.
(3)Includes facility fees and fees on the unused portion of the credit facilities. The following table sets forth information with regard to the Company's net interest spread, which represents the difference between the effective yield on Receivables Held for Investment and the
Company's average cost of debt utilized to fund these receivables, and its net interest margin (averages based on month-end balances):
(1)Represents interest income as a percentage of average Receivables Held for Investment outstanding.
(2)Represents interest expense as a percentage of average debt outstanding.
(3)Represents yield on Receivables Held for Investment less average cost of debt.
(4)Represents net interest income as a percentage of average Receivables Held for Investment outstanding. The Company intends to increase its acquisition of receivables by expanding its dealer base in existing states served, by expanding its dealer base into new states and by generating additional loan volume by increasing direct to consumer lending. To the extent that the Company's receivables acquisitions exceed the extinguishment of receivables through principal payments, payoffs or defaults, its receivables portfolio and interest income will continue to increase. The following table summarizes the activity in the Company's receivables portfolio (dollars in thousands):
Receivables may be paid earlier than their contractual term, primarily due to prepayments and liquidation of collateral after defaults. See discussion on delinquency and credit loss experience.
Analysis of Net Interest Income
Net interest income is the difference between interest earned from the receivables portfolio and interest expense incurred on the credit facilities used to acquire the receivables. Net interest income was $22.8 million in 2003, a decrease of 4 percent when compared to amounts reported in 2002 and a decrease of 6 percent when compared to amounts reported in 2001.
The amount of net interest income is the result of the relationship between the average principal amount of receivables held and average rate earned thereon and the average principal amount of debt incurred to finance such receivables and the average rates paid thereon. Changes in the principal amount and rate components associated with the receivables and debt can be segregated to analyze the
periodic changes in net interest income. The following table analyzes the changes attributable to the principal amount and rate components of net interest income (dollars in thousands):
Results of Operations
Fiscal Year Ended April 30, 2003, Compared to Fiscal Year Ended April 30, 2002 (dollars in thousands)
Interest Income. Interest income for 2003 decreased $4,607, or 12 percent, over 2002, primarily as a result of a decrease in the average principal balance of Receivables Held for Investment of 4 percent from 2002 to 2003 and a decrease in the effective yield from 15.4% for 2002 to 15.0% in 2003. Additionally the interest income on Receivables Acquired for Investment decreased by 83 percent. The decrease in interest income on Receivables Acquired for Investment is attributable to a 74 percent decline in the average principal balances of the Receivables Acquired for Investment for 2003 as compared to 2002.
Interest Expense. Interest expense for 2003 decreased by $3,544, or 26 percent, over 2002. A decrease in the weighted average borrowings outstanding under credit and term facilities of 3 percent resulted in $394 of this difference. These facilities are used to fund Receivables Held for Investment. The weighted average cost of debt to fund Receivables Held for Investment decreased to 4.6 percent for the year ended April 30, 2003 compared to 5.8 percent for the year ended April 30, 2002 accounting for $2,619 of the difference. Lastly, the interest expense on the Receivables Acquired for Investment decreased $531 resulting from a decrease in the weighted average borrowings outstanding of 85 percent.
Net Interest Income. Net interest income decreased by $1,063 in 2003, a decrease of 4 percent over 2002. Decreases in interest income from the Receivables Held for Investment and Receivables Acquired for Investment were offset by savings in interest expense on the Receivables Acquired for Investment.
Provision for Credit Losses. The provision for credit losses for 2003 increased by $1,397, or 16 percent, over 2002. The provision is affected by a) the amount of net charge offs and b) changes in the portfolio size. Net charge offs increased from $9,291 in fiscal 2002 to $10,279 in fiscal 2003 due to an increase in the frequency of repossessions and lower recovery rates from the sales of repossessed vehicles. The higher frequency is directly related to the weakened economic conditions and the resulting inability of certain customers to maintain comparable employment. Lower recovery rates on repossessions are due to an increase in supply of used vehicles and increased incentives for new vehicles which decreased the demand and price for used vehicles. Contributing to the increase in charge offs was the provision impact of a growing portfolio. Based primarily on historical loss experience of various aging categories, the Company provides a reserve equal to 1.1% of the outstanding principal balance of Receivables Held for Investment. Since the average portfolio size decreased during fiscal 2002 and increased in 2003, a higher provision expense was incurred for 2003.
Loss on Receivables Acquired for Investment. During fiscal year 2002, a loss of $1,260 was recorded on the Receivables Acquired for Investment. These assets are comprised of loans previously originated by Auto Lenders Acceptance Corporation and include a portfolio of warehouse loans and a portfolio of loans that were previously securitized. The securitized loans were subsequently redeemed and funded through the FIACC credit facility. The 2002 loss is due to a 87 basis point increase in the cumulative loss rate from 2001 for these portfolios. The increase in the cumulative loss rate was due to the higher loss frequency and severity in these portfolios. These loans are secured by older vehicles which typically experience a larger drop in value in a weak auction market.
Late Fees and Other Income. Late fees and other income primarily represents late fees collected from customers on past due accounts, fees for telephone pay service, interest income earned on short-term marketable securities and money market instruments, and equity investment income from an ownership interest. Late fees and other income increased to $1,886 in 2003 from $1,810 in 2002 or a
4% increase. The increase is due to a 40% ownership interest in First Auto Receivables Corporation during fiscal 2003. See Note 9 to the consolidated financial statements for more information. As a result of the investment, $418 of investment income was recognized for the fiscal year 2003. This increase is offset by $398 lower reinvestment income earned on restricted cash balances due primarily to declining reinvestment interest rates.
Servicing Income. During the third and fourth quarter of fiscal 2003, FISC contracted with FARC and with an unrelated third party to perform servicing and collection activities for two separate, distinct pools. The gross servicing fee income of $1,080 relates to the income earned on these pools.
Unrealized Loss on Interest Rate Derivative Positions. In conjunction with the adoption of SFAS 133, the Company is required to report the fair value of interest rate derivative positions. Unrealized losses of $256 for fiscal year 2003 principally are due to negative mark to market movements due to the declining interest rate environment on interest rate caps required for the FIARC credit facility. For fiscal year 2002, the Company purchased both sides of the interest rate caps through separate subsidiaries and thus market movements offset. The remaining unrealized losses are due to movements in the $100 million 6.42% pay fixed swap versus movements in the $100 million 5.025% pay floating swap. These two derivatives will not directly offset over the remaining term due to interest rate fluctuations between periods.
Salaries and Benefit Expenses. Salaries and benefit costs decreased to $7,879 in 2003 from $8,041 in 2002. The decrease is primarily due to reduced headcount needs related to lower average portfolio and outsourcing a portion of collections to a third party service. Salaries and benefits did increase in the fourth quarter of fiscal 2003 due to the addition of two servicing portfolios.
Other Interest Expense. Other interest expense decreased $142, or 18 percent, for the year ended April 30, 2003 over the year ended April 30, 2002. The decrease is principally related to a decrease in the average borrowings outstanding under the working capital facility of 16 percent and a 7 percent reduction in the interest rate.
Other Expenses. Other expenses decreased $750 or 11 percent in fiscal 2003 primarily due to $666 decrease in amortization expense of which $555 related to a 2002 termination of a term loan working capital facility. Additionally, decreases in depreciation and telephone expense were partially offset by higher 2003 expenses related to a higher managed portfolio and the ramp up of the direct lending business.
Income Before Provision for Income Taxes and Minority Interest. During 2003, income before provision for income taxes and minority interest increased by $803, or 487 percent, from 2002 as a result of the factors discussed above.
Fiscal Year Ended April 30, 2002, Compared to Fiscal Year Ended April 30, 2001 (dollars in thousands)
Interest Income. Interest income for 2002 decreased $6,818, or 15 percent, over 2001, primarily as a result of a decrease in the average principal balance of Receivables Held for Investment of 8 percent from 2001 to 2002 and a decrease in the effective yield from 16.1% for 2001 to 15.4% in 2002. Additionally the interest income on Receivables Acquired for Investment and Investment in Trust Certificates decreased by 39 percent. The decrease in interest income on Receivables Acquired for Investment and Investment in Trust Certificates is attributable to a 60 percent decline in the average principal balances of the Receivables Acquired for Investment and Investment in Trust Certificates for 2002 as compared to 2001.
Interest Expense. Interest expense for 2002 decreased by $6,431, or 32 percent, over 2001. A decrease in the weighted average borrowings outstanding under credit and term facilities of 9 percent resulted in $1,802 of this difference. These facilities are used to fund Receivables Held for Investment.
The weighted average cost of debt to fund Receivables Held for Investment decreased to 5.8 percent for the year ended April 30, 2002 compared to 7.6 percent for the year ended April 30, 2001 accounting for $4,117 of the difference. Included in the decrease is the 2001 write off of $230 of deferred financing costs related to a reduction in the FIACC borrowing capacity. Lastly, the interest expense on the Receivables Acquired for Investment decreased $512 primarily resulting from a decrease in the weighted average borrowings outstanding of 42 percent.
Net Interest Income. Net interest income decreased by $387 in 2002, a decrease of 2 percent over 2001. Decreases in interest income from the Receivables Held for Investment and Receivables Acquired for Investment and Investment in Trust Certificates were offset by savings in interest expense on the Receivables Acquired for Investment and Investment in Trust Certificates.
Provision for Credit Losses. The provision for credit losses for 2002 increased by $589, or 7 percent, over 2001. The provision is affected by a) the amount of net charge offs, b) changes in the portfolio size, and c) changes in the target percentage of overall allowance to outstanding receivables. Net charge offs increased from $7,796 in fiscal 2001 to $9,291 in fiscal 2002 due to an increase in the frequency of repossessions and lower recovery rates from the sales of repossessed vehicles. The higher frequency is directly related to the weakened economic conditions and the resulting inability of certain customers to maintain comparable employment. Lower recovery rates on repossessions are due to an increase in supply of used vehicles and increased incentives for new vehicles which decreased the demand and price for used vehicles. Offsetting the increase in the charge offs was the provision impact of a declining portfolio. Based primarily on historical loss experience of various aging categories, the Company provides a reserve equal to 1.1% of the outstanding principal balance of Receivables Held for Investment. Since the average portfolio size has decreased during fiscal 2002, a lower provision expense was incurred. Lastly, in fiscal 2001, the provision expense increased from .9% to 1.1% of outstanding principal balance of Receivables Held for Investment or $430. The increase was made in light of the slowdown in economic growth and softness in the employment rate. This increased the provision expense in 2001 and also contributed an offsetting effect to the higher charge offs when comparing total 2002 expense to 2001.
Loss on Receivables Acquired for Investment and Trust Certificates. The loss in fiscal year 2002 increased to $1,260 from $400 for fiscal 2001. During the third quarter of fiscal 2002 a loss of $1,260 was recorded on the Receivables Acquired for Investment and Investment in Trust Certificates. These assets are comprised of loans previously originated by Auto Lenders Acceptance Corporation and include a portfolio of warehouse loans and a portfolio of loans that were previously securitized. The securitized loans were subsequently redeemed and funded through the FIACC credit facility. The 2002 loss is due to a .42%, or $334, and 1.44%, or $954, increase in the cumulative loss rate for the FIACC and warehouse portfolios, respectively. The increase in the cumulative loss rates was necessary due to the higher loss frequency and severity in these portfolios. These loans are secured by older vehicles which typically experience a larger drop in value in a weak auction market. The fiscal 2001 writedown of $400 was recorded on the ALAC Automobile Receivables Trust 1998-1 and was due to an increase in the cumulative loss rate of .81%. The increase in the loss rate was necessary due to estimated future losses exceeding losses that were previously projected due to softened economic conditions and lower recovery rates on the collateral. The loss to the Company, net of minority interest, is $882 and $280 for fiscal 2002 and 2001, respectively.
Servicing Income. Servicing income represents amounts received on loan receivables previously sold by FISC in connection with two asset securitization transactions. Under these transactions, FISC, as servicer, is entitled to receive a fee of 3 percent on the outstanding principal balance of the securitized receivables plus reimbursement for certain costs and expenses incurred as a result of its collection activities. One securitization was called September 15, 2000 and the other was called
March 15, 2001, when the underlying receivables were repurchased. Subsequent to the call date, no further servicing income is earned.
Late Fees and Other Income. Late fees and other income primarily represents late fees collected from customers on past due accounts, collections on certain FISC assets which had previously been charged off by the Company, and interest income earned on short-term marketable securities and money market instruments. Late fees and other income decreased to $1,810 in 2002 from $2,563 in 2001 or a 29% decrease. The decrease is primarily due to lower reinvestment rates earned on restricted cash balances. In addition to the declining reinvestment rates, the reinvestment income was also negatively impacted by the smaller portfolio.
Unrealized Loss on Interest Rate Derivative Positions. In conjunction with the adoption of SFAS 133, the Company is required to report the fair value of interest rate derivative positions. Unrealized losses are primarily related to mark to market movements in the $100 million 6.42% pay fixed swap versus movements in the $100 million 5.025% pay floating swap. These two derivatives will not directly offset over the remaining term due to interest rate fluctuations between periods.
Salaries and Benefit Expenses. Salaries and benefit costs decreased to $8,041 in 2002 from $9,389 in 2001. The decrease is primarily due to reduced headcount needs related to lower originations and a lower managed portfolio.
Other Interest Expense. Other interest expense decreased $526, or 40 percent, for the year ended April 30, 2002 over the year ended April 30, 2001. The decrease is principally related to a decrease in the average borrowings outstanding under the working capital facility of 9 percent and a 34 percent reduction in the interest rate.
Other Expenses. Other expenses decreased $232 or 3% percent in fiscal 2002 primarily due to decreases in telephone expense and lease expense of $388 and $180, respectively, offset by increases in depreciation and amortization of $160 and third party service bureau fees of $159. Telephone expense decreased from 2001 to 2002 due to lower long distance rates and a smaller portfolio. Lease expense decreased primarily due to the completion of an operating lease in 2002. Amortization increased due to amortization of deferred financing costs and stock warrants related to the term loan working capital facility restructured with Bank of America on December 22, 2001. Amortization of these fees and warrants were $686 higher in 2002 compared to 2001. Included in this increase is $555 of amortization related to the termination of the term loan working capital facility with Bank of America on December 6, 2001. A new term loan facility with First Union National Bank was entered into on December 6, 2001 in order to refinance the outstanding borrowings and increase the size of the facility. Depreciation decreased by $526 in 2002 compared to 2001 related to a write off of capitalized software in 2001 and the completion of a capital lease amortization in mid 2002. In December 2000 in order to increase the stability of operations, the Company migrated to a third party service bureau which became the primary system for collecting and servicing the managed loan portfolio. After conversion and testing, the Company abandoned the use of internal software and expensed $274 of unamortized amounts. Additionally, in November 2001, the Company completed the amortization of a capital lease used to acquire assets in conjunction with the purchase of FISC. Consequently, expenses for 2002 were $250 less than 2001 as related to the capital lease. Third party service bureau fees increased as the Company began using the third party provider in December 2000, thus only five months of expenses were incurred in 2001 compared to a full year for 2002.
Income Before Provision for Income Taxes and Minority Interest. During 2002, income before provision for income taxes and minority interest decreased by $1,061, or 118 percent from 2001 as a result of the factors discussed above.
Liquidity and Capital Resources
Sources and Uses of Cash Flows. The Company's business requires significant cash flow to support its operating activities. The principal cash requirements include (i) amounts necessary to acquire receivables from dealers and fund required reserve accounts, (ii) amounts necessary to fund premiums for credit enhancement insurance or other credit enhancement required by the Company's financing programs, and (iii) amounts necessary to fund costs to retain receivables, primarily interest expense. The Company also requires a significant amount of cash flow for working capital to fund fixed operating expenses, primarily salaries and benefits.
The Company's most significant cash flow requirement is the acquisition of receivables. The Company paid $114 million for receivables acquired to be held for investment for 2003 compared to $78 million in 2002.
The Company funds the purchase price of receivables through a combination of two warehouse facilities. The FIRC credit facility generally permits the Company to borrow up to the outstanding principal balance of qualified receivables, but not to exceed $75 million. Receivables that have accumulated in the FIRC credit facility may be transferred to the FIARC commercial paper facility at the option of the Company. The FIARC commercial paper facility provides an additional financing source up to $150 million. Additionally, the Company has transferred receivables from the warehouse credit facilities and issued Term Notes. Substantially all of the Company's receivables are pledged to collateralize these credit facilities and Term Notes.
The Company's most significant source of cash flow is the principal and interest payments received from the receivables portfolios. The Company received such payments in the amount of $113.4 million in 2003 and $126.2 million in 2002. Such cash flow funds repayment of amounts borrowed under the FIRC credit and commercial paper facilities and other holding costs, primarily interest expense and servicing and custodial fees. During the fiscal year 2003, the Company required net cash of $33.2 million as the receivable purchases exceeded the portfolio collections. During the fiscal year 2002, the Company's collections on Receivables Held for Investment exceeded cash required to purchase Receivables Held for Investment by $12.9 million. The Company has relied on borrowed funds to provide the source of cash flow in periods of growth. As of April 30, 2003, the Company has $83.1 million of available capacity in the warehouse credit facilities to fund future growth.
In addition to the excess cash flow generated from the principal and interest collections on the receivables portfolio, the Company collects servicing fees funded from each of the credit facilities. Servicing fees range from 1.4% to 2.5% of the outstanding principal balance of the loans. Excess cash flows and servicing fees are received after month end but relate to the prior month activity. Thus upon filing of the monthly servicing statements, a portion of the restricted cash is converted to cash available to fund operations. At April 30, 2003 and 2002, the Company's unencumbered cash was $2,617,680 and $585,727, respectively. Excess cash and servicing fees collected after month end but related to the prior month activity totaled $2,053,646 and $1,845,664 as of April 30, 2003 and 2002, respectively. The increase in available cash is primarily due to an increasing managed portfolio's effect on excess cash and servicing fees. Management believes the unencumbered cash and cash inflows are adequate to fund cash requirements for operations.
Capitalization. The Company has financed its acquisition of such receivables primarily through these types of credit facilities since 1992. The Company's equity was not a significant factor in its capitalization until the completion of the Company's initial public offering of common stock in October 1995, resulting in net proceeds of $18.5 million. However, the Company expects to continue to rely primarily on its credit facilities and the issuance of secured term notes to acquire and retain receivables. The Company believes its existing credit facilities have adequate capacity to fund the increase of the receivables portfolio expected in the foreseeable future. While the Company has no reason to believe that these facilities will not continue to be available, their termination could have a
material adverse effect on the Company's operations if substitute financing on comparable terms was not obtained.
Financing Arrangements The Company finances the acquisition of its receivables portfolio through two warehouse credit facilities. The Company's credit facilities provide for one-year terms and have been renewed annually. Management of the Company believes that the credit facilities will continue to be renewed or extended or that it would be able to secure alternate financing on satisfactory terms; however, there can be no assurance that it will be able to do so. In January 2000 and January 2002, the Company issued $168 million and $159 million, respectively, in asset-backed notes ("Term Notes") secured by discrete pools of receivables. Proceeds from the two note issuances were used to repay outstanding borrowings under the various revolving credit facilities. Substantially all receivables retained by the Company are pledged as collateral for the credit facilities and the Term Notes. The weighted average interest rate for the Company's secured borrowings including the effect of program fees, dealer fees, and other comprehensive income (loss) amortization was 4.6% and 5.8% for the fiscal years ending April 30, 2003 and 2002, respectively.
Warehouse Facilities as of April 30, 2003
(1)Inclusive of amortization of other comprehensive income. Warehouse Facilities-Credit Enhancement as of April 30, 2003
FIRC-In order to obtain a lower cost of funding, the Company has agreed under the FIRC credit facility to maintain credit enhancement insurance covering all of its receivables pledged as collateral under this facility. The facility lenders are named as additional insureds under these policies. The coverages are obtained on each receivable at the time it is purchased by the Company and the applicable premiums are prepaid for the life of the receivable. Each receivable is covered by three separate credit insurance policies, consisting of basic default insurance under a standard auto loan protection policy (known as "ALPI" insurance) together with certain supplemental coverages relating to physical damage and other risks. Solely at its expense, the Company carries these coverages and neither the vehicle purchasers nor the dealers are charged for the coverages and they are usually unaware of their existence. The Company's ALPI insurance policy is written by National Union Fire Insurance Company of Pittsburgh ("National Union"), which is a wholly-owned subsidiary of American
International Group. As of April 30, 2003 National Union had been assigned a rating of A+ + by A.M. Best Company, Inc.
The premiums that the Company paid during its past fiscal year for its three credit enhancement insurance coverages, of which the largest component is the basic ALPI insurance, represented approximately 3.9 percent of the principal amount of the receivables acquired during the year. Aggregate premiums paid for ALPI coverage alone during the fiscal years ended April 30, 2001, 2002 and 2003 were $3,413,186, $2,382,031 and $4,141,328, respectively, and accounted for 3.0 percent, 3.1 percent and 3.8 percent of the aggregate principal balance of the receivables acquired during such respective periods.
Prior to establishing its relationship with National Union in March 1994, the Company's ALPI policy was provided by another third-party insurer. In April 1994 the Company organized First Investors Insurance Company (the "Insurance Subsidiary") under the captive insurance company laws of the State of Vermont. The Insurance Subsidiary is an indirect wholly-owned subsidiary of the Company and is a party to a reinsurance agreement whereby the Insurance Subsidiary reinsures 100 percent of the risk under the Company's ALPI insurance policy. At the time each receivable is insured by National Union, the risk is automatically reinsured to its full extent and approximately 96 percent of the premium paid by the Company to National Union with respect to such receivable is ceded to the Insurance Subsidiary. When a loss covered by the ALPI policy occurs, National Union pays it after the claim is processed, and National Union is then reimbursed in full by the Insurance Subsidiary. As of April 30, 2003, gross premiums had been ceded to the Insurance Subsidiary since its inception by National Union in the amount of $28,486,788 andthe Insurance Subsidiary reimbursed National Union for aggregate reinsurance claims in the amount of $8,089,381. In addition to the monthly premiums and liquidity reserves of the Insurance Subsidiary, a trust account is maintained by National Union to secure the Insurance Subsidiary's obligations for losses it has reinsured.
The result of the foregoing reinsurance structure is that National Union, as the "fronting" insurer under the captive arrangement, is unconditionally obligated to the Company's credit facility lenders for all losses covered by the ALPI policy, and the Company, through its Insurance Subsidiary, is obligated to indemnify National Union for all such losses. As of April 30, 2003, the Insurance Subsidiary had capital and surplus of $1,753,375 and unencumbered cash reserves of $1,521,507 in addition to the $2,725,785 trust account.
The ALPI coverage as well as the Insurance Subsidiary's liability under the Reinsurance Agreement, remains in effect for each receivable that is pledged as collateral under the warehouse credit facility. Once receivables are transferred from FIRC to FIARC and financed under the commercial paper facility, ALPI coverage and the Insurance Subsidiary's liability under the Reinsurance Agreement is cancelled with respect to the transferred receivables. Any unearned premium associated with the transferred receivables is returned to the Company. The Company believes the losses its Insurance Subsidiary will be required to indemnify will be less than the premiums ceded to it. However, there can be no assurance that losses will not exceed the premiums ceded and the capital and surplus of the Insurance Subsidiary.
Warehouse Facilities-Agents and Expirations
Management considers its relationship with its lenders to be satisfactory and has no reason to believe that the FIRC and FIARC facilities will not be renewed.
The following table contains pertinent information on the Term Notes as of April 30, 2003.
Term Notes-On January 29, 2002, the Company, through its indirect, wholly-owned subsidiary First Investors Auto Owner Trust 2002-A ("2002 Auto Trust") completed the issuance of $159,036,000 of 3.46% percent Class A asset-backed notes ("2002-A Term Notes"). The initial pool of automobile receivables transferred to the 2002 Auto Trust totaled $135,643,109, which were previously owned by FIRC and FIARC, secure the 2002-A Term Notes. In addition to the issuance of the Class A Notes, the 2002 Auto Trust also issued $4,819,000 in Class B Notes which were retained by the Company and pledged to secure the Working Capital Facility as further described below. Proceeds from the issuance, which totaled $159,033,471 were used to (i) fund a $25,000,000 pre-funding account to be used for future loan originations; (ii) repay all outstanding borrowings under the FIARC commercial paper facility, (iii) reduce the outstanding borrowings under the FIRC credit facility, (iv) pay transaction fees related to the 2002-A Term Note issuance, and (v) fund a cash reserve account of 2 percent or $2,712,862 of the initial receivables pledged which will serve as a portion of the credit enhancement for the transaction. The Class A Term Notes bear interest at 3.46 percent and require monthly principal reductions sufficient to reduce the balance of the Class A Term Notes to 97 percent of the outstanding balance of the underlying receivables pool. The final maturity of the 2002-A Term Notes is December 15, 2008. The Class B Notes do not bear interest but require principal reductions sufficient to reduce the balance of the Class B Notes to 3 percent of the outstanding balance of the underlying receivables pool. A surety bond issued by MBIA Insurance Corporation provides credit enhancement for the Class A Notes. Additional credit support is provided by the cash reserve account, which equals 2 percent of the original balance of the receivables pool plus 2 percent of the original balance of receivables transferred under the pre-funding provision. Further enhancement is provided through an initial 1 percent overcollateralization which is required to be increased to 3 percent through excess monthly principal and interest collections. In the event that certain asset quality covenants are not met, the reserve account target level will increase to 6 percent of the then current principal balance of the receivables pool. As of April 30, 2002 and 2003, the outstanding principal balances on the 2002-A Term Notes were $143,096,983 and $87,358,847, respectively.
On January 24, 2000, the Company, through its indirect, wholly-owned subsidiary, First Investors Auto Owner Trust 2000-A ("Auto Trust"), completed the issuance of $167,969,000 of 7.174 percent asset-backed notes ("2000-A Term Notes"). A pool of automobile receivables totaling $174,968,641, which were previously owned by FIRC, FIARC and FIACC, secures the 2000-A Term Notes. Proceeds from the issuance, which totaled $167,967,690, were used to repay all outstanding borrowings under the FIARC and FIACC commercial paper facilities, to reduce the outstanding borrowings under the FIRC credit facility, to pay transaction fees related to the 2000-A Term Note issuance and to fund a cash reserve account of 2 percent or $3,499,373 which will serve as a portion of the credit enhancement for the transaction. The 2000-A Term Notes bear interest at 7.174 percent and require monthly principal reductions sufficient to reduce the balance of the 2000-A Term Notes to 96 percent of the outstanding balance of the underlying receivables pool. A surety bond issued by MBIA Insurance Corporation provides credit enhancement for the Term Note holders. Additional credit support is provided by the cash reserve account, which equals 2 percent of the original balance of the receivables pool and a 4 percent over-collateralization requirement. In the event that certain asset quality covenants are not met, the reserve account target level will increase to 6 percent of the then current principal balance of the receivables pool. As of April 30, 2002, the outstanding principal balance on the 2000-A Term Notes was $40,162,801. On November 15, 2002, the Company exercised its right to prepay the outstanding debt thus there were no outstanding borrowings on the 2000-A Term Notes as of April 30, 2003. The collateral was financed through borrowings under the FIARC commercial paper facility.
The following table summarizes borrowings under the warehouse credit facility, the FIARC commercial paper facility, and the 2000-A and 2002-A Term Notes (dollars in thousands):
(1)Based on interest rates, facility fees, surety bond fees and hedge instruments applied to borrowings outstanding at period-end. (2)Based on month-end balances.
Acquisition Facility. On October 2, 1998, the Company, through its indirect, wholly-owned subsidiary, FIFS Acquisition Funding Company LLC (FIFS Acquisition), entered into a $75 million non-recourse bridge financing facility with VFCC, an affiliate of Wachovia Securities, to finance the Company's acquisition of FISC. Contemporaneously with the Company's purchase of FISC, FISC transferred certain assets to FIFS Acquisition, consisting primarily of (i) all receivables owned by FISC as of the acquisition date, (ii) FISC's ownership interest in certain Trust Certificates and subordinated spread or cash reserve accounts related to two asset securitizations previously conducted by FISC, and (iii) certain other financial assets, including charged-off accounts owned by FISC as of the acquisition date. These assets, along with a $1 million cash reserve account funded at closing, served as the collateral for the bridge facility. The facility bore interest at VFCC's commercial paper rate plus 2.35 percent and expired on August 14, 2000. Under the terms of the facility, all cash collections from the receivables or cash distributions to the certificate holder under the securitizations were first applied to pay FISC a servicing fee in the amount of 3 percent on the outstanding balance of all owned or managed receivables and then to pay interest on the facility. Excess cash flow available after servicing fees and interest payments was utilized to reduce the outstanding principal balance on the indebtedness. In addition, one-third of the servicing fee paid to FISC was also utilized to reduce principal outstanding on the indebtedness.
On August 8, 2000, the Company entered into an agreement with Wachovia Securities to refinance the acquisition facility. Under the agreement, a partnership was created in which FIFS Acquisition serves as the general partner and contributed its assets for a 70 percent interest in the partnership and First Union Investors, Inc., an affiliate of Wachovia Securities, serves as the limited partner with a 30 percent interest in the partnership (the "Partnership"). Pursuant to the refinancing, the Partnership issued Class A Notes in the amount of $19,204,362 and Class B Notes in the amount of $979,453 to VFCC, the proceeds of which were used to retire the acquisition debt. The Class A Notes bear interest at VFCC's commercial paper rate plus 0.95 percent per annum and amortize on a monthly basis by an amount necessary to reduce the Class A Note balance as of the payment date to 75 percent of the outstanding principal balance of Receivables Acquired for Investment, excluding Receivables Acquired for Investment that are applicable to FIACC, as of the previous month end. The Class B Notes bear interest at VFCC's commercial paper rate plus 5.38 percent per annum and amortize on a monthly basis by an amount which varied based on excess cash flows received from Receivables Acquired for Investment after payment of servicing fees, trustee and back-up servicer fees, Class A Note interest and Class A Note principal, plus collections received on the Trust Certificates. The outstanding balance of the Class A Notes was $3,670,765 at April 30, 2002. The Class B Notes were paid in full on September 15, 2000. After the Class B Notes were paid in full, all cash flows received after payment of Class A Note principal and interest, servicing fees and other costs, are distributed to the Partnership for subsequent distribution to the partners based upon the respective partnership interests. During the nine months ended January 31, 2002, $866,583 was distributed to the limited partner. Beginning in November 2001, the partnership used excess cash flow to retire additional Class A Note principal thus no further partnership distributions were paid until the Class A Notes were retired. On February 20, 2003, the Class A Notes were fully paid and all excess cash flows are paid to the partners. The amount of the partners' cash flow will vary depending on the timing and amount of cash flows from the assets. For the year ended April 30, 2003, $318,281 was distributed to the limited partner. The Company is accounting for Wachovia Securities' limited partnership interest in the Partnership as a minority interest.
Working Capital Facility. On December 6, 2001, the Company entered into an agreement with Wachovia Securities to refinance the $11,175,000 outstanding balance of the working capital term loan previously provided by Bank of America and Wachovia and increase the size of the facility to $13.5 million. The renewal facility was provided to a special-purpose, wholly-owned subsidiary of the Company, First Investors Residual Funding LP. The facility originally consisted of a $9 million revolving tranche and a $4.5 million term loan tranche which amortizes monthly. The term loan tranche of this
working capital facility will be evidenced by the Class B Notes issued in conjunction with the 2002 Auto Trust financing. The remaining $9 million of the $13.5 million working capital facility revolves monthly in accordance with a borrowing base consisting of the overcollateralization amount and reserve accounts for each of the Company's other credit facilities. The facility is secured solely by the residual cash flow and cash reserve accounts related to the Company's warehouse credit facilities, the acquisition facility and the existing and future term note facilities. Pricing under the facility is based on the LIBOR rate plus 1.5% plus another 1.5% on the facility limit. On December 5, 2002, the maturity of the facility was extended to December 4, 2003. Under the terms of the renewal, the interest rate was increased to LIBOR plus 2.25%. In addition, the monthly principal amortization under the term loan tranche was increased to the greater of $250,000 or the principal distributions made under the Class B Notes issued under the 2002 Auto Trust financing. This amortization schedule will continue until the term loan tranche is repaid, leaving the remaining facility consisting of the $9 million revolving tranche. In the event that the facility is not renewed at maturity, residual cash flows from the various receivables financing transactions will be applied to amortize the debt over the remaining life of the underlying receivables. At April 30, 2002 and 2003, there was $11,798,520 and $8,714,518, respectively, outstanding under this facility.
The Company presently intends to seek a renewal of the working capital facility from its lender prior to maturity. Should the facility not be renewed, the outstanding balance of the receivables would be amortized in accordance with the borrowing base. Management considers its relationship with its lenders to be satisfactory and has no reason to believe that this credit facility will not be renewed. If the facility is not renewed, however, or if material changes are made to its terms and conditions, it could have a material adverse effect on the Company.
Shareholder Loans-On December 3, 2001 the Company entered into an agreement with one of its shareholders who is a member of its Board of Directors under which the Company may, from time to time, borrow up to $2.5 million. The proceeds of the borrowings will be utilized to fund certain private and open market purchases of the Company's common stock pursuant to a Stock Repurchase Plan authorized by the Board of Directors and for general corporate purposes. Borrowings under the facility bear interest at a fixed rate of 10 percent per annum paid monthly. The facility is unsecured and expressly subordinated to the Company's senior credit facilities. The facility matures on December 3, 2008 but may be repaid at any time unless the Company is in default on one of its other credit facilities. At April 30, 2002 and 2003, there was $525,000 and $746,280, respectively, outstanding under this facility.
Interest Rate Management. The Company's warehouse credit facilities bear interest at floating interest rates which are reset on a short-term basis while the secured Term Notes bear interest at a fixed rate of interest. The Company's receivables bear interest at fixed rates that do not generally vary with a change in market interest rates. Since a primary contributor to the Company's profitability is its ability to manage its net interest spread, the Company seeks to maximize the net interest spread while minimizing exposure to changes in interest rates. In connection with managing the net interest spread, the Company may periodically enter into interest rate swaps or caps to minimize the effects of market interest rate fluctuations on the net interest spread. To the extent that the Company has outstanding floating rate borrowings or has elected to convert a portion of its borrowings from fixed rates to floating rates, the Company will be exposed to fluctuations in short-term interest rates.
In connection with the issuance of the 2000-A Term Notes, the Company entered into a swap agreement with Bank of America pursuant to which the Company pays a floating rate equal to the prevailing one month LIBOR rate plus 0.505 percent and receives a fixed rate of 7.174 percent from the counterparty. The initial notional amount of the swap was $167,969,000, which amortized in accordance with the expected amortization of the Term Notes. Final maturity of the swap was August 15, 2002.
On September 27, 2000, the Company elected to terminate the aforementioned swap at no material gain or loss and enter into a new swap under which the Company would pay a fixed rate of 6.30 percent and receive the prevailing one month LIBOR rate plus 0.505 percent on a notional amount of $100 million. Under the terms of the swap, the counterparty had the option of extending the swap for an additional three years to mature on April 15, 2004 at a fixed rate of 6.42 percent. On April 15, 2001, the counterparty exercised its extension option.
On June 1, 2001, the Company entered into interest rate swaps with an aggregate notional amount of $100 million and a maturity date of April 15, 2004. Under the terms of these swaps, the Company will pay a floating rate based on one month LIBOR and receive a fixed rate of 5.025 percent. Management elected to enter into these swap agreements to offset the uneconomical position of the existing pay fixed swap created by rapidly declining market interest rates.
During the year ended April 30, 2003 and as a requirement of the FIARC commercial paper facility, the Company entered into nine interest rate cap transactions at cap rates ranging from 6.5% to 7.5% with an amortizing notional balance that is expected to coincide with the outstanding balance of the FIARC commercial paper facility. The interest rate caps were not designated as hedges and, accordingly, changes in the fair value of the interest rate caps are recorded as unrealized gains or losses and reflected in net earnings. Hedge accounting was not adopted for these positions due to mark-to-market movements being deemed ineffective since they relate to time value and would be required to flow through net earnings thus eliminating any benefits of hedge accounting.
In connection with the repurchase of the ALAC 97-1 Securitization and the financing of that repurchase through the FIACC subsidiary on September 15, 2000, FIACC entered into an interest rate swap agreement with Wachovia Securities under which FIACC paid a fixed rate of 6.76 percent as compared to the one month commercial paper index rate. The initial notional amount of the swap was $6,408,150, which amortized monthly in accordance with the expected amortization of the FIACC borrowings. The final maturity of the swap was December 15, 2001. On March 15, 2001, in connection with the repurchase of the ALAC 1998-1 Securitization and the financing of that purchase through the FIACC subsidiary, the Company and the counterparty modified the existing interest rate swap increasing the notional amount initially to $11,238,710 and reducing the fixed rate from 6.76 percent to 5.12 percent. The new notional amount amortized monthly in accordance with the expected principal amortization of the underlying borrowings. The expiration date of the swap was changed from December 15, 2001 to September 1, 2002.
On October 2, 1998, in connection with the $75 million acquisition facility, the Company, through FIFS Acquisition, entered into a series of hedging instruments with Wachovia Securities designed to hedge floating rate borrowings under the acquisition facility against changes in market rates. Accordingly, the Company entered into two interest rate swap agreements, the first in the initial notional amount of $50.1 million ("Class A swap") pursuant to which the Company's interest rate is fixed at 4.81 percent; and, the second in the initial notional amount of $24.9 million ("Class B swap") pursuant to which the Company's interest rate was fixed at 5.50 percent. The notional amount outstanding under each swap agreement amortized based on an implied amortization of the hedged indebtedness. The Class A swap had a final maturity of December 20, 2002, while the Class B swap matured on February 20, 2000. The Company also purchased two interest rate caps, which protect the Company and the lender against any material increases in interest rates that may adversely affect any outstanding indebtedness that is not fully covered by the aggregate notional amount outstanding under the swaps. The first cap agreement ("Class A cap") enabled the Company to receive payments from the counterparty in the event that the one-month commercial paper rate exceeded 4.81 percent on a notional amount that increased initially and then amortized based on the expected difference between the outstanding notional amount under Class A swap and the underlying indebtedness. The interest rate cap expired December 20, 2002 and the cost of the cap was amortized in interest expense for the period. The second cap agreement ("Class B cap") enabled the Company to receive payments from the
counterparty in the event that the one-month commercial paper rate exceeded 6 percent on a notional amount that increased initially and then amortized based on the expected difference between the outstanding notional amount under Class B swap and the underlying indebtedness. The interest rate cap expired December 20, 2002 and the cost of the cap was imbedded in the fixed rate applicable to Class B swap. Pursuant to the refinance of the acquisition facility on August 8, 2000, the Class B cap was terminated and the notional amounts of the Class A swap and Class A cap were adjusted downward to reflect the lower outstanding balance of the Class A Notes. The amendment or cancellation of these instruments resulted in a gain of $418,609. This derivative net gain was amortized over the life of the initial derivative instrument. In addition, the two remaining hedge instruments were assigned by FIFS Acquisition to the Partnership.
As of May 1, 2001 the Company designated its interest rate swaps and an interest rate cap with an aggregate notional value of $130,165,759 as cash flow hedges as defined under SFAS No. 133. Accordingly, any changes in the fair value of these instruments resulting from the mark-to-market process are recorded as unrealized gains or losses and reflected as an increase or reduction in shareholders' equity through other accumulated comprehensive income (loss). In connection with the decision to enter into the $100 million floating rate swap on June 1, 2001, the Company elected to change the designation of the $100 million fixed rate swap and not account for the instrument as a hedge under SFAS No. 133. As a result, the change in fair value of the swaps is reflected in net earnings for the period subsequent to May 31, 2001. The interest rate caps entered into as a requirement of the FIARC commercial paper facility are not designated as hedges and, accordingly, changes in the fair value are recorded as unrealized gains or losses and reflected in net earnings. Hedge accounting was not adopted for these positions due to mark-to-market movements being deemed ineffective since they relate to time value and would be required to flow through net earnings thus eliminating any benefits of hedge accounting.
Delinquency and Credit Loss Experience
The Company's results of operations, financial condition and liquidity may be adversely affected by nonperforming receivables. The Company seeks to manage its risk of credit loss through (i) prudent credit evaluations, (ii) risk management activities, (iii) effective collection procedures, and (iv) by maximizing recoveries on defaulted loans. The allowance for credit losses of $2,397,216 as of April 30, 2003 and $2,338,625 as of April 30, 2002 as a percentage of Receivables Held for Investment of $226,362,218 as of April 30, 2003 and $212,926,747 as of April 30, 2002 was 1.1 percent.
With respect to Receivables Acquired for Investment, the Company has established a nonaccretable difference which represents the excess of the loan's scheduled contractual principal and interest payments over its expected cash flows. As of April 30, 2003 and April 30, 2002, the nonaccretable difference as a percentage of Receivables Acquired for Investment was 7.2% and 14.6%, respectively. The decrease as of April 30, 2003 is primarily related to the liquidating nature of the portfolio and that the loans are well seasoned. For the April 30, 2002 period, an additional reserve was provided by the third quarter write down of $1.3 million related to increasing the cumulative loss rate in the cash flow projections. This write down occurred due to higher severity and frequency of losses realized to date and to reserve for higher expected potential losses. The Company also reclassifies accretable yield and nonaccretable difference as assumptions are updated. For the year ending April 30, 2003, the decrease in accretable yield is due to a slightly higher cumulative loss assumption. For the year ended April 30, 2002, the increase in accretable yield is primarily due to increasing the expected term of the remaining cash flow in order to allow for collections on charged off receivables. By extending the cash flow projection model life, accretable yield must be increased to provide for future income.
The Company considers a loan to be delinquent when the borrower fails to make a scheduled payment of principal and interest. Accrual of interest is suspended when the payment from the
borrower is over 90 days past due. Generally, repossession procedures are initiated 90 to 120 days after the payment default.
The Company retains the credit risk associated with the receivables acquired. The Company purchases credit enhancement insurance from third party insurers which covers the risk of loss upon default and certain other risks. Until March 1994, such insurance absorbed substantially all credit losses. In April 1994, the Company established a captive insurance subsidiary to reinsure certain risks under the credit enhancement insurance coverage for all receivables acquired in March 1994 and thereafter. In addition, receivables financed under the Auto Trust, FIARC and FIACC commercial paper facilities do not carry default insurance. Provisions for credit losses of $10,337,718 and $8,940,601 have been recorded for the twelve months ended April 30, 2003 and April 30, 2002, respectively.
The Company calculates the allowance for credit losses in accordance with SFAS 5, Accounting for Contingencies. SFAS 114, Accounting for Creditors for Impairment of a Loan, does not apply to the Company since the Receivables Held for Investment are comprised of a large group of smaller balance homogenous loans that are evaluated collectively for impairment.
The Company applies a systematic methodology in order to determine the amount of the allowance for credit losses. The specific methodology utilized is a six-month migration analysis whereby the Company compares the aging status of each loan from six months prior to the aging loan status as of the reporting date. These factors are then applied to the aging status of each loan at the reporting date in order to calculate the number of loans that are expected to migrate to impaired status. The estimated number of impairments is then multiplied by estimated loss per loan, which is based on historical information. The computed reserve is then compared to the amount recorded for adequacy. The Company compares the six-month result to prior six-month periods to compare trends and evaluate any other internal or external factors that may affect collectibility. The allowance for credit losses is based on estimates and qualitative evaluations and ultimate losses will vary from current estimates. These estimates are reviewed periodically and as adjustments, either positive or negative, become necessary, are reported in earnings in the period they become known.
For Receivables Acquired for Investment, nonaccretable difference represents the excess of the loan's scheduled contractual principal and interest payments over its expected cash flows. The Company analyzes the composition of these liquidating portfolios in order to estimate a future loss rate. Criteria evaluated include delinquencies, historical charge offs, recovery rates, portfolio seasoning and economic conditions. A cash flow model that considers term, interest rate, loss rate, prepayment rate and recovery rate is consistently applied to project expected cash flows. The difference between expected cash flows and total contractual principal and interest payments is the nonaccretable difference. For the year ended April 30, 2003, the Company increased the cumulative loss rate by 22 basis points from 2002 which was partially offset by higher expected recovery collections. During the third quarter of the year ended April 30, 2002, the Company increased the cumulative loss rate on the portfolio by 87 basis points from 2001. The total increase to nonaccretable difference of $1,288,885 relates to the recessionary environment and the impact it has on customers' ability to maintain comparable paying employment. Additionally, the effective decrease in prices of new automobiles through incentive programs offered by captives contributed to decreasing prices and demands for used vehicles. This results in lower recovery rates realized through repossessions. The collateral comprising the Receivables Acquired for Investment is at higher risk as it is primarily older model used cars with higher mileage. The increase in accretable yield results from increasing the expected term of the remaining cash flow in order to allow for collections on charged off receivables. By extending the cash flow projection model life, accretable yield must be increased to provide for future income.
The following table sets forth certain information regarding the Company's delinquency and charge-off experience over its last two fiscal years (dollars in thousands):
The higher annualized charge-off rate results from a higher number of repossessions coupled with lower recovery rates on the repossessed collateral which is due to continued economic weakness and a poor market for used vehicles.
As of April 30, 2003, there were 621 accounts totaling $6,106,924 that were in bankruptcy status and were more than 30 days past due. As of April 30, 2002, there were 562 accounts totaling $6,379,156 that were in bankruptcy status and were more than 30 days past due. As of April 30, 2002 and 2003, 87% and 82%, respectively, of the bankruptcy delinquencies filed for protection under Chapter 13.
The total number of delinquent accounts (30 days or more) as a percentage of the number of outstanding receivables for the Company's portfolio of Receivables Acquired for Investment and Securitized Receivables was 11.3 percent, or 274 accounts, and 41.5 percent, or 194 accounts, as of April 30, 2002, and 2003, respectively. These are liquidating pools and delinquencies are more volatile due to the smaller number of loans in the portfolio.
New Accounting Pronouncements
The FASB has issued SFAS No. 143, Accounting for Asset Retirement Obligations ("SFAS 143"), addressing accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. SFAS 143 will be effective May 1, 2003 for the Company and early adoption is encouraged. SFAS 143 requires that the fair value of a liability for an asset's retirement obligation be recorded in the period in which it is incurred and the corresponding cost capitalized by increasing the carrying amount of the related long-lived asset. The liability is accreted to its then present value each period, and the capitalized cost is depreciated over the useful life of the related asset. If the liability is settled for an amount other than the recorded amount, a gain or loss is recognized. The Company does not anticipate that the adoption of the new standard will have a significant effect on its consolidated financial statements.
In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of SFAS No. 13, and Technical Corrections ("SFAS 145"). This statement rescinds the requirement in SFAS No. 4, Reporting Gains and Losses from Extinguishment of Debt, that material gains and losses on the extinguishment of debt be treated as extraordinary items. The statement also amends SFAS No. 13, Accounting for Leases, to eliminate an inconsistency between the accounting for sale-leaseback transactions and the accounting for certain lease modifications that have economic
effects that are similar to sale-leaseback transactions. Finally the standard makes a number of consequential and other technical corrections to other standards. The provisions of the statement relating to the rescission of SFAS 4 are effective for fiscal years beginning after May 15, 2002. Provisions of the statement relating to the amendment of SFAS 13 are effective for transactions occurring after May 15, 2002 and the other provisions of the statement are effective for financial statements issued on or after May 15, 2002. The Company has reviewed SFAS 145 and its adoption is not expected to have a material effect on its consolidated financial statements.
In July 2002, the FASB issued SFAS No. 146, Accounting for Exit or Disposal Activities ("SFAS 146"). SFAS 146 applies to costs associated with an exit activity (including restructuring) or with a disposal of long-lived assets. Those activities can include eliminating or reducing product lines, terminating employees and contracts, and relocating plant facilities or personnel. SFAS 146 will require a Company to disclose information about its exit and disposal activities, the related costs, and changes in those costs in the notes to the interim and annual financial statements that include the period in which an exit activity is initiated and in any subsequent period until the activity is completed. SFAS 146 is effective prospectively for exit or disposal activities initiated after December 31, 2002, with earlier adoption encouraged. SFAS 146 supersedes Emerging Issues Task Force Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring), and requires liabilities associated with exit and disposal activities to be expensed as incurred and can be measured at fair value. SFAS 146 is effective for exit or disposal activities that are initiated after December 31, 2002.
In November 2002, FASB Interpretation 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others ("FIN 45"), was issued. FIN 45 requires a guarantor entity, at the inception of a guarantee covered by the measurement provisions of the interpretation, to record a liability for the fair value of the obligation undertaken in issuing the guarantee. The Company previously did not record a liability when guaranteeing obligations. Interpretation 45 applies prospectively to guarantees the Company issues or modifies subsequent to December 31, 2002. FIN 45 did not have a material effect on the Company's financial statements. The Company has historically issued guarantees only on a limited basis and does not anticipate FIN 45 will have a material effect on its financial statements in the future.
In December 2002, the FASB issued Statement 148, Accounting for Stock-Based Compensation Transition and Disclosure-an Amendment of FASB Statement No. 123 ("SFAS 148"), to provide alternative transition methods for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS 148 amends the disclosure requirements of SFAS 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the pro-forma effect on reported results of applying the fair value based method for entities which use the intrinsic value method of accounting. This statement is effective for financial statements for fiscal years ending after December 15, 2002 and is effective for financial reports containing condensed financial statements for interim periods beginning after December 15, 2002 with earlier application permitted. The Company does not plan a change to the fair-value based method of accounting for stock-based employee compensation.
In January 2003, the FASB issued FASB Interpretation No. 46, Consolidation of Variable Interest Entities ("FIN 46"). FIN 46 clarifies the application of Accounting Research Bulletin No. 51, Consolidated Financial Statements, for certain entities which do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties or in which equity investors do not have the characteristics of a controlling financial interest ("variable interest entities"). Variable interest entities will be required to be consolidated by their primary beneficiary. The primary beneficiary of a variable interest entity is determined to be the party that absorbs a majority of the entity's expected losses, receives a majority of its expected returns, or both, as
a result of holding variable interests, which are ownership, contractual, or other pecuniary interests in an entity. FIN 46 applies immediately to variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. It applies in the first fiscal year or interim period beginning after June 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. FIN 46 applies to the Company as of the beginning of the applicable interim or annual period. The Company does not anticipate FIN 46 will have a material effect on its financial statements.
In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities ("SFAS 149"). SFAS No. 149 amends and clarifies the accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. In addition, the statement clarifies when a contract is a derivative and when a derivative contains a financing component that warrants special reporting in the statement of cash flows. SFAS No. 149 is generally effective prospectively for contracts entered into or modified, and hedging relationships designated, after June 30, 2003. Management does not expect adoption to have a material effect on the Company's financial statements.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity ("SFAS 150"). SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity, and imposes certain additional disclosure requirements. The provisions of SFAS No. 150 are generally effective for financial instruments entered into or modified after May 31, 2003. Management does not expect adoption to have a material effect on the Company's financial statements.
Market Risk
The market risk discussion and the estimated amounts generated from the analysis that follows are forward-looking statements of market risk assuming certain adverse market conditions occur. Actual results in the future may differ materially due to changes in the Company's product and debt mix, developments in the financial markets, and further utilization by the company of risk-mitigating strategies such as hedging.
The Company's operating revenues are derived almost entirely from the collection of interest on the receivables it retains and its primary expense is the interest that it pays on borrowings incurred to purchase and retain such receivables. The Company's credit facilities bear interest at floating rates which are reset on a short-term basis, whereas its receivables bear interest at fixed rates which do not generally vary with changes in interest rates. The Company is therefore exposed primarily to market risks associated with movements in interest rates on its credit facilities. The Company believes that it takes the necessary steps to appropriately reduce the potential impact of interest rate increases on the Company's financial position and operating performance.
The Company relies almost exclusively on revolving credit facilities to fund its origination of receivables. Periodically, the Company will transfer receivables from a revolving to a term credit facility. Currently all of the Company's credit facilities in combination with various swaps bear interest at floating rates tied to either a commercial paper index or LIBOR.
As of April 30, 2003, the Company had $150.6 million of floating rate secured debt outstanding. The Company is exposed to interest rate movements until interest rates equal 6.5%. The Company has interest rate cap agreements as protection for rate movements beyond 6.5% on $90.0 million of notional balance. For every 1 percent increase in commercial paper rates or LIBOR up to 6.5%, annual after-tax earnings would decrease by approximately $957,000 assuming the Company maintains a level amount of floating rate debt and assuming an immediate increase in rates. For every 1 percent increase in commercial paper rates or LIBOR over 6.5%, annual after-tax earnings would decrease by approximately $385,000 assuming the Company maintains a level amount of floating rate debt and
assuming an immediate increase in rates. As of April 30, 2002, the Company had $38 million of floating rate secured debt outstanding net of swap and cap agreements. For every 1 percent increase in commercial paper rates or LIBOR, annual after-tax earnings would decrease by approximately $244,000 assuming the Company maintains a level amount of floating rate debt and assuming an immediate increase in rates.
Forward Looking Information
Statements and financial discussion and analysis included in this report that are not historical are considered to be forward-looking in nature. Forward-looking statements involve a number of risks and uncertainties that may cause actual results to differ materially from anticipated results. Specific factors that could cause such differences include unexpected fluctuations in market interest rates, changes in economic conditions, changes in the competition for loans, or the inability to renew or obtain financing. Further information concerning risks and uncertainties is included throughout Item 1.
The Company believes the factors discussed are important factors that could cause actual results to differ materially from those expressed in any forward looking statement made herein or elsewhere by the Company or on its behalf. The factors listed are not necessarily all of the important factors. Unpredictable or unknown factors not discussed herein could also have material adverse effects on actual results of matters that are the subject of forward looking statements. The Company does not intend to update its description of important factors each time a potential important factor arises. The Company advises its stockholders that they should: (1) be aware that important factors no described herein could affect the accuracy of our forward looking statements, and (2) use caution and common sense when analyzing our forward looking statements in this document or elsewhere. All of such forward looking statements are qualified in their entirety by this cautionary statement.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Consolidated Financial Statements of the Company included in this Form 10-K are listed under Item 14(a). The Company is not required to file any supplementary financial data under this item.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
Part III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS
Information responsive to this item appears under the caption "Election of Directors" in the Company's Proxy Statement for the 2003 Annual Meeting of Shareholders expected to be held on September 10, 2003, which is to be filed with the Securities and Exchange Commission, and is incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Information responsive to this item appears under the caption "Summary Compensation Table" in the Company's Proxy Statement for the 2003 Annual Meeting of Shareholders expected to be held on September 10, 2003, which is to be filed with the Securities and Exchange Commission, and is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information responsive to this item appears under the caption "Security Ownership of Management and Certain Beneficial Owners" in the Company's Proxy Statement for the 2003 Annual Meeting of Shareholders expected to be held on September 10, 2003, which is to be filed with the Securities and Exchange Commission, and is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information responsive to this item appears under the caption "Certain Transactions" in the Company's Proxy Statement for the 2003 Annual Meeting of Shareholders expected to be held on September 10, 2003, which is to be filed with the Securities and Exchange Commission, and is incorporated herein by reference.
ITEM 14.
ITEM 14. CONTROLS AND PROCEDURES
(a)Evaluation of Disclosure Controls and Procedures. As of a date within 90 days prior to the filing of this report, an evaluation of the effectiveness of the Company's disclosure controls and procedures was carried out under the supervision and with the participation of Tommy A. Moore, Jr., the Company's Chief Executive Officer, and Bennie H. Duck, the Company's Chief Financial Officer. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective.
(b)Changes to Internal Controls. There were no significant changes to the Company's internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Part IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1)(2) Financial Statements and Financial Statement Schedules See Index to Consolidated Financial Statements on Page.
(3)Exhibits
2.1(j)
-
Stock Purchase Agreement, dated as of September 9, 1998, between First Investors Financial Services Group, Inc. and Fortis, Inc. to purchase Auto Lenders Acceptance Corporation, a wholly-owned subsidiary of Fortis, Inc.
3.1(a)
-
Articles of Incorporation, as amended
3.2(a)
-
Bylaws, as amended
4.1(a)
-
Excerpts from the Articles of Incorporation, as amended (included in Exhibit 3.1).
4.3(a)
-
Specimen Stock Certificate
10.5(a)
-
Credit Agreement dated as of October 16, 1992 among F.I.R.C., Inc. ("FIRC") and NationsBank of Texas, N.A., individually and as agent for the banks party thereto, as amended by First Amendment to Credit Agreement and Loan Documents dated as of November 5, 1993, Second Amendment to Credit Agreement and Loan Documents dated as of March 3, 1994, Third Amendment to Credit Agreement and Loan Documents dated as of March 17, 1995 and Fourth Amendment to Credit Agreement and Loan Documents dated as of July 7, 1995.
10.6(a)
-
Intentionally omitted.
10.7(a)
-
Intentionally omitted.
10.8(a)
-
Intentionally omitted.
10.9(a)
-
Intentionally omitted.
10.10(a)
-
Intentionally omitted.
10.11(a)
-
Intentionally omitted.
10.12(a)
-
Intentionally omitted.
10.13(a)
-
Facultative Reinsurance Agreement between National Fire Insurance Company of Pittsburgh and First Investors Insurance Company, as reinsurer, dated as of May 26, 1995.
10.14(a)
-
Blanket Collateral Protection Insurance Policy dated October 5, 1992 issued by Agricultural Excess & Surplus Insurance Company to FIRC as insured.
10.15(a)
-
Intentionally omitted.
10.16(a)
-
Intentionally omitted.
10.17(a)
-
Lease Agreement between A.I.G. Realty, Inc. and First Investors dated as of June 1, 1992, as amended by Amendment One dated October 29, 1993 and Amendment Two dated October 26, 1994.
10.18(a)
-
Redemption Agreement dated as of June 8, 1995 among the Registrant and all holders of its class of 1993 Preferred Stock.
10.21(a)
-
1995 Employee Stock Option Plan of the Registrant.
10.22(a)
-
Form of Stock Option Agreement between the Registrant and Robert L. Clarke dated August 25, 1995.
10.23(b)
-
Intentionally omitted.
10.24(b)
-
Intentionally omitted.
10.25(b)
-
Amendment Three dated October 10, 1995 to the Lease Agreement between A.I.G. Realty, Inc. and the Registrant, filed as Exhibit 10.17.
10.26(b)
-
Intentionally omitted.
10.27(b)
-
Intentionally omitted.
10.28(c)
-
Intentionally omitted.
10.29(d)
-
Security Agreement dated as of October 22, 1996 among First Investors Auto Receivables Corporation, Enterprise Funding Corporation, Texas Commerce Bank National Association, MBIA Insurance Corporation, NationsBank N.A., and First Investors Financial Services, Inc.
10.30(d)
-
Note Purchase Agreement dated as of October 22, 1996 between First Investors Auto Receivables Corporation and Enterprise Funding Corporation.
10.31(d)
-
Purchase Agreement dated as of October 22, 1996 between First Investors Financial Services, Inc. and First Investors Auto Receivables Corporation.
10.32(d)
-
Insurance Agreement dated as of October 1, 1996 among First Investors Auto Receivables Corporation, MBIA Insurance Corporation, First Investors Financial Services, Inc., Texas Commerce Bank National Association, and NationsBank N.A.
10.33(d)
-
Intentionally omitted.
10.34(d)
-
Amended and Restated Credit Agreement dated as of October 30, 1996 among F.I.R.C., Inc. and NationsBank of Texas, N.A., individually and as Agent for the financial institutions party thereto.
10.35(d)
-
Amended and Restated Collateral Security Agreement dated as of October 30, 1996 between F.I.R.C., Inc. and Texas Commerce Bank National Association as collateral agent for the ratable benefit of NationsBank of Texas, N.A. individually and as agent for the financial institutions party to the Amended and Restated Credit Agreement filed as Exhibit 10.34.
10.36(d)
-
Amended and Restated Purchase Agreement dated as of October 30, 1996 between First Investors Financial Services, Inc. and F.I.R.C., Inc.
10.37(d)
-
Amended and Restated Servicing Agreement between F.I.R.C., Inc. and General Electric Capital Corporation.
10.38(e)
-
Intentionally omitted.
10.39(f)
-
First Amendment to the Amended and Restated Credit Agreement dated January 31, 1997 by and among F.I.R.C., Inc. and NationsBank of Texas, N.A., individually and as agent for the banks party thereto.
10.40(f)
-
Second Amendment to the Amended and Restated Credit Agreement dated May 15, 1997 by and among F.I.R.C., Inc. and NationsBank of Texas, N.A., individually and as agent for the banks party thereto.
10.41(f)
-
Intentionally omitted.
10.42(f)
-
Intentionally omitted.
10.43(f)
-
Intentionally omitted.
10.44(f)
-
Intentionally omitted.
10.45(g)
-
Intentionally omitted.
10.46(g)
-
Intentionally omitted.
10.47(g)
-
Intentionally omitted.
10.48(g)
-
Intentionally omitted.
10.49(h)
-
Intentionally omitted.
10.50(h)
-
Intentionally omitted.
10.51(i)
-
Intentionally omitted.
10.52(i)
-
Intentionally omitted.
10.53(i)
-
Intentionally omitted.
10.54(i)
-
Intentionally omitted.
10.55(k)
-
Third Amendment to the Amended and Restated Credit Agreement dated January 25, 1999 by and among F.I.R.C., Inc. and NationsBank of Texas, N.A., individually and as agent for the banks party thereto.
10.56(k)
-
Intentionally omitted.
10.57(l)
-
Amendment Number 2 to Security Agreement dated March 31, 1999 among First Investors Auto Receivables Corporation, Enterprise Funding Corporation, Chase Bank of Texas, National Association, Norwest Bank Minnesota, National Association, MBIA Insurance Corporation, NationsBank N.A., and First Investors Financial Services, Inc.
10.58(l)
-
Amendment Number 1 to Note Purchase Agreement dated as of March 31, 1999 among First Investors Auto Receivables Corporation and Enterprise Funding Corporation.
10.59(l)
-
Amendment Number 1 to Insurance Agreement dated March 31, 1999 among First Investors Auto Receivables Corporation, MBIA Insurance Corporation, First Investors Financial Services, Inc., Auto Lenders Acceptance Corporation, Norwest Bank Minnesota, National Association and NationsBank, N.A.
10.60(l)
-
Servicing Agreement dated March 31, 1999 among First Investors Auto Receivables Corporation, Norwest Bank Minnesota, National Association and Auto Lenders Acceptance Corporation.
10.61(l)
-
Guaranty dated March 31, 1999 by First Investors Financial Services, Inc., First Investors Auto Receivables Corporation, Auto Lenders Acceptance Corporation and Norwest Bank Minnesota, National Association.
10.62(m)
-
Intentionally omitted.
10.63(m)
-
Intentionally omitted.
10.64(m)
-
Intentionally omitted.
10.65(m)
-
Intentionally omitted.
10.66(m)
-
Intentionally omitted.
10.67(m)
-
Intentionally omitted.
10.68(n)
-
Administrative Services Agreement dated as of August 8, 2000 between Project Brave Limited Partnership and First Union Securities, Inc.
10.69(n)
-
Project Brave Limited Partnership Agreement of Limited Partnership dated as of July 1, 2000.
10.70(n)
-
Amended and Restated NIM Collateral Purchase Agreement dated as of August 8, 2000.
10.71(n)
-
Amended and Restated Contract Purchase Agreement dated as of August 8, 2000.
10.72(n)
-
First Amendment to Amended and Restated NIM Collateral Purchase Agreement dated as of September 15, 2000.
10.73(n)
-
First Amendment to Servicing Agreement dated as of September 13, 2000.
10.74(n)
-
First Amendment to Transfer and Servicing Agreement dated as of September 15, 2000.
10.75(n)
-
Project Brave Limited Partnership Asset-Backed Notes Indenture dated as of August 8, 2000.
10.76(n)
-
Note Purchase Agreement between Project Brave Limited Partnership as Issuer, First Union Securities, Inc., as Deal Agent, the Note Investors named herein, First Union National Bank as Liquidity Agent and Variable Funding Capital Corporation, as an Initial Note Investor, dated as of August 8, 2000.
10.77(n)
-
Supplemental Indenture No. 1 (Project Brave Limited Partnership) dated as of September 15, 2000.
10.78(n)
-
Third Amendment to Security Agreement dated as of September 13, 2000.
10.79(n)
-
Transfer and Servicing Agreement among Project Brave Limited Partnership, Issuer, FIFS Acquisition Funding Company, L.L.C., as Transferor, First Investors Servicing Corporation as Servicer and a Transferor Party, ALAC Receivables Corp., as a Transferor Party, First Union Securities, Inc., as Deal Agent and Collateral Agent and Wells Fargo Bank Minnesota, National Association as Backup Servicer, Collateral Custodian and Indenture Trustee dated as of August 8, 2000.
10.80(o)
-
Second Amended and Restated Credit Agreement dated as of November 15, 2000 Among F.I.R.C., Inc. as Borrower and the Financial Institutions Now or Hereafter Parties Hereto as Banks and Bank of America, N. A. as Agent.
10.81(o)
-
Third Amended and Restated Collateral Security Agreement dated as of November 15, 2000.
10.82(o)
-
Fourth Amendment to Amended and Restated Purchase Agreement dated as of November 15, 2000.
10.83(o)
-
First Amendment to Servicing Agreement dated as of November 15, 2000.
10.84(o)
-
Intentionally omitted.
10.85(o)
-
Intentionally omitted.
10.86(o)
-
Intentionally omitted.
10.87(o)
-
Intentionally omitted.
10.88(o)
-
Intentionally omitted.
10.89(o)
-
Intentionally omitted.
10.90(o)
-
Intentionally omitted.
10.91(o)
-
Intentionally omitted.
10.92(o)
-
Amendment No. 2 To Insurance Agreement for First Investors Auto Receivables Corporation Revolving Automobile Receivables Financing Facility dated as of November 29, 2000.
10.93(o)
-
Amendment Number 3 To Security Agreement dated as of November 29, 2000.
10.94(o)
-
Warrant No. 1 to Purchase 111,334 Shares of Common Stock, $.01 par value.
10.95(o)
-
Warrant No. 2 to Purchase 55,667 Shares of Common Stock, $.01 par value.
10.96(o)
-
Amendment Number 3 To Purchase Agreement dated as of November 29, 2000.
10.97(o)
-
Amendment Number 1 To Servicing Agreement dated as of November 29, 2000.
10.98(p)
-
First Omnibus Amendment to the Transaction Documents dated December 6, 2001 between F.I.R.C., Inc., First Investors Financial Services, Inc., First Investors Servicing Corporation, Bank of America, N.A., First Union Securities, Inc. and Wells Fargo Bank Minnesota, National Association
10.99(p)
-
Security Agreement dated December 6, 2001 between First Investors Residual Funding L.P. and First Union Securities, Inc.
10.100(p)
-
Sale and Servicing Agreement dated December 6, 2001 between First Investors Residual Funding L.P., First Investors Financial Services, Inc. and First Union Securities, Inc.
10.101(p)
-
Note Purchase Agreement dated December 6, 2001 between First Investors Residual Funding L.P, First Union Securities, Inc., First Union National Bank and Variable Funding Capital Corporation
10.102(p)
-
Asset Purchase Agreement dated December 6, 2001 between First Investors Residual Funding L.P., FIFS Acquisition Funding Company LLC, First Investors Auto Investment Corp. and First Investors Auto Receivables Corporation
10.103(p)
-
Indenture dated January 1, 2002 between First Investors Auto Owner Trust 2002-A, First Investors Financial Services, Inc. and Wells Fargo Bank Minnesota, National Association
10.104(p)
-
Sale and Allocation Agreement dated January 1, 2002 between First Investors Auto Owner Trust 2002-A, First Investors Financial Services, Inc., First Investors Servicing Corporation, First Investors Auto Funding Corporation and Wells Fargo Bank Minnesota, National Association
10.105(p)
-
Amended and Restated Trust Agreement dated January 1, 2002 between First Investors Auto Funding Corporation and Bankers Trust (Delaware)
10.106(p)
-
First Omnibus Amendment to Transaction Documents dated January 14, 2002 between First Investors Auto Receivables Corporation, First Investors Financial Services, Inc., First Investors Servicing Corporation, Enterprise Funding Corporation, Bank of America, N.A., Variable Funding Capital Corporation, First Union Securities, Inc., MBIA Insurance Corporation, and Wells Fargo Bank Minnesota, National Association
10.107(p)
-
Amendment No. 3 to Note Purchase Agreement dated January 14, 2002 between First Investors Auto Receivables Corporation and Variable Funding Capital Corporation
10.108(p)
-
Amendment No. 4 to Security Agreement dated January 14, 2002 between First Investors Auto Receivables Corporation, First Investors Financial Services, Inc., First Investors Servicing Corporation, Variable Funding Capital Corporation, First Union Securities, Inc., MBIA Insurance Corporation and Wells Fargo Bank Minnesota, National Association
10.109(q)
-
2002 Non-Employee Director Stock Option Plan dated July 18, 2002
21.1(j)
-
Subsidiaries of the Registrant.
99.1
-
Certification by Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.2
-
Certification by Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(a)
-
Exhibit previously filed with the Company's Registration Statement on Form S-1, Registration No. 33-94336 and incorporated herein by reference.
(b)
-
Exhibit previously filed on 1996 Form 10-K and incorporated herein by reference.
(c)
-
Exhibit previously filed on July 31, 1996 First Quarter Form 10-Q and incorporated herein by reference.
(d)
-
Exhibit previously filed on October 31, 1996 Second Quarter Form 10-Q and incorporated herein by reference.
(e)
-
Exhibit previously filed on January 31, 1997 Third Quarter Form 10-Q and incorporated herein by reference.
(f)
-
Exhibit previously filed on July 31, 1997 First Quarter Form 10-Q and incorporated herein by reference.
(g)
-
Exhibit previously filed on January 31, 1998 Third Quarter Form 10-Q and incorporated herein by reference.
(h)
-
Exhibit previously filed on 1998 Form 10-K and incorporated herein by reference.
(i)
-
Exhibit previously filed on October 31, 1998 Second Quarter Form 10-Q and incorporated herein by reference.
(j)
-
Exhibit previously filed on October 2, 1998 Form 8-K and incorporated herein by reference.
(k)
-
Exhibit previously filed on January 31, 1999 Third Quarter Form 10-Q and incorporated herein by reference.
(l)
-
Exhibit previously filed on 1999 Form 10-K and incorporated herein by reference.
(m)
-
Exhibit previously filed on March 21, 2000 Third Quarter Form 10-Q/A and incorporated herein by reference.
(n)
-
Exhibit previously filed on October 31, 2000 Second Quarter Form 10-Q and incorporated herein by reference.
(o)
-
Exhibit previously filed on January 31, 2001 Third Quarter Form 10-Q and incorporated herein by reference.
(p)
-
Exhibit previously filed on January 31, 2002 Third Quarter Form 10-Q and incorporated herein by reference.
(q)
-
Exhibit previously filed on July 31, 2002 First Quarter Form 10-Q/A and incorporated herein by reference.
(b)Reports On Form 8-K
None.
SIGNATURES
Pursuant to the requirements of the Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Annual Report on Form 10-K to be signed on its behalf by the undersigned thereunto duly authorized.
First Investors Financial Services Group, Inc.
(Registrant)
Date: July 18, 2003
By:
/s/ TOMMY A. MOORE, JR. Tommy A. Moore, Jr.
President and Chief Executive Officer
(Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of First Investors Financial Services Group, Inc. and in the capacities and on the date indicated.
Signature
Title
/s/ TOMMY A. MOORE, JR. Tommy A. Moore, Jr.
President and Chief Executive Officer, Director
(Principal Executive Officer)
/s/ BENNIE H. DUCK Bennie H. Duck
Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
/s/ JOHN H. BUCK John H. Buck
Director
/s/ ROBERT L. CLARKE Robert L. Clarke
Director
/s/ SEYMOUR M. JACOBS Seymour M. Jacobs
Director
/s/ ROBERTO MARCHESINI Roberto Marchesini
Director
/s/ WALTER A. STOCKARD Walter A. Stockard
Director
/s/ WALTER A. STOCKARD, JR. Walter A. Stockard, Jr.
Director
/s/ DANIEL M. THERIAULT Daniel M. Theriault
Director
Date: July 18, 2003
Certification Required
by Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934
I, Tommy A. Moore, Jr., certify that:
1.I have reviewed this annual report on Form 10-K of First Investors Financial Services Group, Inc. (the "Company");
2.Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3.Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the Company as of, and for, the periods presented in this annual report;
4.The Company's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the Company and we have:
a)designed such disclosure controls and procedures to ensure that material information relating to the Company, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b)evaluated the effectiveness of the Company's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
c)presented in this annual report our conclusions and about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5.The Company's other certifying officers and I have disclosed, based on our most recent evaluation, to the Company's auditors and the audit committee of Company's board of directors (or persons performing the equivalent function):
a)all significant deficiencies in the design or operation of internal controls, which could adversely affect the Company's ability to record, process, summarize and report financial data and have identified for the Company's auditors any material weaknesses in internal controls; and
b)any fraud, whether or not material, that involves management or other employees who have a significant role in the Company's internal controls; and 6.The Company's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: July 18, 2003
By:
/s/ TOMMY A. MOORE, JR. Tommy A. Moore, Jr.
Chief Executive Officer
I, Bennie H. Duck, certify that:
1.I have reviewed this annual report on Form 10-K of First Investors Financial Services Group, Inc. (the "Company");
2.Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;
3.Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the Company as of, and for, the periods presented in this annual report;
4.The Company's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the Company and we have:
a)designed such disclosure controls and procedures to ensure that material information relating to the Company, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;
b)evaluated the effectiveness of the Company's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and
c)presented in this annual report our conclusions and about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5.The Company's other certifying officers and I have disclosed, based on our most recent evaluation, to the Company's auditors and the audit committee of Company's board of directors (or persons performing the equivalent function):
a)all significant deficiencies in the design or operation of internal controls, which could adversely affect the Company's ability to record, process, summarize and report financial data and have identified for the Company's auditors any material weaknesses in internal controls; and
b)any fraud, whether or not material, that involves management or other employees who have a significant role in the Company's internal controls; and 6.The Company's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: July 18, 2003
By:
/s/ BENNIE H. DUCK Bennie H. Duck
Chief Financial Officer
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT CERTIFIED
PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders of First Investors Financial Services Group, Inc.:
We have audited the accompanying consolidated balance sheets of First Investors Financial Services Group, Inc. (a Texas corporation) and subsidiaries as of April 30, 2003 and 2002, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended April 30, 2003. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of First Investors Financial Services Group, Inc. and subsidiaries as of April 30, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended April 30, 2003, in conformity with accounting principles generally accepted in the United States of America.
/s/ GRANT THORNTON LLP
Houston, Texas
July 11, 2003
FIRST INVESTORS FINANCIAL SERVICES GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS-APRIL 30, 2002 and 2003
The accompanying notes are an integral part of these consolidated financial statements.
FIRST INVESTORS FINANCIAL SERVICES GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Years Ended April 30, 2001, 2002 and 2003
The accompanying notes are an integral part of these consolidated financial statements.
FIRST INVESTORS FINANCIAL SERVICES GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
For the Years Ended April 30, 2001, 2002 and 2003
The accompanying notes are an integral part of this consolidated financial statement.
FIRST INVESTORS FINANCIAL SERVICES GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended April 30, 2001, 2002 and 2003
FIRST INVESTORS FINANCIAL SERVICES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
April 30, 2001, 2002 and 2003
1. The Company
Organization. First Investors Financial Services Group, Inc. (First Investors or the Company) was established to serve as a holding company for First Investors Financial Services, Inc. (FIFS) and FIFS's wholly-owned subsidiaries, First Investors Insurance Company (FIIC), First Investors Auto Receivables Corporation (FIARC), F.I.R.C., Inc. (FIRC), First Investors Auto Capital Corporation (FIACC), First Investors Servicing Corporation (FISC), formerly known as Auto Lenders Acceptance Corporation (ALAC), First Investors Auto Investment Corporation, FIFS Acquisition Funding Corp. LLC, Farragut Financial Corporation, and First Investors Auto Funding Corporation. First Investors, together with its wholly- and majority-owned subsidiaries, is hereinafter referred to as the Company.
FIFS began operations in May 1989 and is principally involved in the business of acquiring and holding for investment retail installment contracts and promissory notes secured by new and used automobiles (receivables) originated by factory authorized franchised dealers or directly through consumers. As of April 30, 2003, approximately 26 percent of receivables held for investment had been originated in Texas. The Company currently operates in 28 states.
FIIC was organized under the captive insurance company laws of the state of Vermont for the purpose of reinsuring certain credit enhancement insurance policies that have been written by unrelated third party insurance companies.
On October 2, 1998, the Company completed the acquisition of FISC and the operations of FISC are included in the consolidated results of the Company since the date of acquisition. Headquartered in Atlanta, Georgia, FISC was engaged in essentially the same business as the Company and additionally performs servicing and collection activities on a portfolio of receivables acquired for investment as well as on a portfolio of receivables acquired and sold pursuant to two asset securitizations. As a result of the acquisition, the Company increased the total dollar value on its balance sheet of receivables, acquired an interest in certain trust certificates related to the asset securitizations and acquired certain servicing rights along with furniture, fixtures, equipment and technology to perform the servicing and collection functions for the portfolio of receivables under management.
On August 8, 2000, the Company entered into a partnership agreement whereby a subsidiary of the Company is the general partner owning 70 percent of the partnership assets and First Union Investors, Inc. serves as the limited partner and owns 30 percent of the partnership assets (the "Partnership"). The Partnership consists primarily of a portfolio of loans previously owned or securitized by FISC and certain other financial assets including charged-off accounts owned by FISC. The consolidated financial statements of the Company include the accounts of the Partnership. Intercompany transactions and balances have been eliminated upon consolidation.
On December 24, 2002, the Company purchased a 40% ownership interest and an investment in the junior mezzanine debt of First Auto Receivables Corporation ("FARC"). FARC purchased an approximately $197.5 million portfolio of installment loan receivables from a subsidiary of Union Acceptance Corporation. FISC performs ongoing servicing and collection activities on the portfolio.
On March 19, 2003, FISC entered into a servicing agreement with an unrelated third party to service an approximately $300 million portfolio of installment loan receivables purchased from a subsidiary of Union Acceptance Corporation.
In total, at April 30, 2003, FISC performs servicing and collection functions on a managed receivables portfolio of $659 million.
2. Significant Accounting Policies
Basis of Presentation. The consolidated financial statements include the accounts of First Investors and its wholly- and majority-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. Investments in unconsolidated subsidiaries representing ownership of at least 20% but less than 50% or where the Company otherwise exercises significant influence are accounted for under the equity method.
Use of Estimates. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The most significant estimates used by the Company relate to the allowance for credit losses and nonaccretable difference. See Notes 3 and 4. Actual results could differ from those estimates.
Receivables Held for Investment. The Company acquires automobile loans from dealers and originates loans directly to consumers. Fees and expenses of originating loans are capitalized and amortized in accordance with Statement of Financial Accounting Standards ("SFAS") No. 91, Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases.
Receivables are generally acquired from dealers at a premium or discount from the principal amounts financed by the borrower. The Company and the dealers negotiate this premium or discount, and such premium or discount is included in the carrying amount of the receivable. The basis in the receivables includes the costs to acquire the receivables from the dealer, plus or minus any fees paid or received related to the purchase of the receivables.
Also included in the carrying amount of receivables is the insurance premium paid to third-party insurers, net of any premiums ceded to FIIC for reinsurance. The Company amortizes the difference between the principal balance of the receivables and its carrying amount over the expected remaining life of the receivables using the interest method.
Receivables Acquired for Investment. In connection with loans that were acquired in a portfolio purchase by the Partnership, the Company estimates the amount and timing of undiscounted expected future principal and interest cash flows. For certain purchased loans, the amount paid for a loan reflects the Company's determination that it is probable the Company will be unable to collect all amounts due according to the loan's contractual terms. Accordingly, at acquisition, the Company recognizes the excess of the loan's scheduled contractual principal and contractual interest payments over its expected cash flows as an amount that should not be accreted. The remaining amount, representing the excess of the loan's expected cash flows over the amount paid, is accreted into interest income over the remaining life of the loan. Assets are reported for the entire Partnership and the partner's share of income is reported as minority interest. See Note 7-Acquisition Facility.
Over the life of the loan, the Company continues to estimate expected cash flows on a pool by pool basis. The Company evaluates whether the present value of any decrease in the loan's actual or expected cash flows should be recorded as a loss provision for the loan. For any material increases in estimated cash flows, the Company adjusts the amount of accretable yield by reclassification from nonaccretable difference. The Company then adjusts the amount of periodic accretion over the loan's remaining life. See Note 4.
Income Recognition. For Receivables Held for Investment, the Company accrues interest income monthly based upon contractual terms using the effective interest method. Interest income also includes
additional amounts received upon early payoffs of certain receivables attributable to the difference between the principal balance of the receivables calculated using the Rule of 78's method and the principal balance of the receivables calculated using the effective interest method. When a receivable becomes 90 days past due, income accrual is suspended until the payments become current. When a loan is charged off or the collateral is repossessed, the remaining income accrual is written off. Other income includes late charge fees and is recognized as collected. Servicing income is accrued as it is earned and intercompany amounts are eliminated upon consolidation.
Allowance for Credit Losses. For receivables financed under the FIRC credit facility, the Company purchases credit enhancement insurance from third-party insurers which covers the risk of loss upon default and certain other risks. The Company established a captive insurance subsidiary to reinsure the credit enhancement insurance coverage. The credit enhancement insurance coverage for all receivables acquired in March 1994 and thereafter has been reinsured by FIIC. Beginning in October 1996, all receivables recorded by the Company were covered by credit enhancement insurance while pledged as collateral for the FIRC credit facility. Once receivables are transferred to the FIARC commercial paper facility, credit enhancement insurance is cancelled. In addition, no default insurance is purchased for core receivables originated and financed under the FIACC commercial paper facility. Accordingly, the Company is exposed to credit losses for all receivables either reinsured by FIIC or uninsured and provides an allowance for such losses.
Efforts to make customer contact generally begin when the customer is three days past due and become more aggressive as the loan becomes further past due. Management reviews past due loans and considers various factors including payment history, job status and any events that may have occurred that prevent the customer from making a payment. Through the evaluation, if it is determined that the loan is uncollectible, the collateral is repossessed. Generally this occurs at 90 to 120 days past due. Upon repossession, an impairment is recorded to write off Receivables Held for Investment and record the fair value as Assets Held for Sale. Fair value is determined by estimating the proceeds of the collateral which primarily are comprised of auction proceeds on the sale of the automobile less selling related expenses. After collection of all proceeds, the Company realizes an adjustment, positive or negative, based on the difference between the fair value estimate and the true proceeds received. In the event the collateral is unable to be located, the Company will write off the entire balance after exhausting all collection efforts.
The Company calculates the allowance for credit losses in accordance with SFAS 5, Accounting for Contingencies. SFAS 114, Accounting for Creditors for Impairment of a Loan, does not apply to the Company since the Receivables Held for Investment are comprised of a large group of smaller balance homogenous loans that are evaluated collectively for impairment.
The Company applies a systematic methodology in order to determine the amount of the allowance for credit losses. The specific methodology utilized is a six-month migration analysis whereby the Company compares the aging status of each loan from six months prior to the aging loan status as of the reporting date. These factors are then applied to the aging status of each loan at the reporting date in order to calculate the number of loans that are expected to migrate to impaired status. The estimated number of impairments is then multiplied by estimated loss per loan, which is based on historical information. The computed reserve is then compared to the amount recorded for adequacy. The Company compares the six-month result to prior six-month periods to compare trends and evaluate any other internal or external factors that may affect collectibility. The allowance for credit losses is based on estimates and qualitative evaluations and ultimate losses will vary from current estimates. These estimates are reviewed periodically and as adjustments, either positive or negative, become necessary, are reported in earnings in the period they become known.
Funds Held Under Reinsurance Agreement. The Company provides financial assurance for the third party insurance company it reinsures by maintaining premiums ceded to it in a restricted trust account for the benefit of the third party insurance company. The reinsurance agreement provides, among other things, that the funds held can be withdrawn by the third party insurance company due to an insolvency of the Company or to reimburse the third party insurance company for the Company's share of losses paid by the third party insurance company pursuant to the reinsurance agreement.
Assets Held for Sale. The Company commences repossession procedures against the underlying collateral when the Company determines that collection efforts are likely to be unsuccessful. Upon repossession, the receivable is written down to the estimated fair value of the collateral, less the cost of disposition and plus the expected recoveries from third-party insurers, through a charge to the allowance for credit losses. Additionally, the repossessed collateral is reclassified to assets held for sale.
Deferred Financing Costs. The Company defers financing costs and amortizes the costs related to the respective warehouse credit facilities and Term Notes over the estimated average life of the receivables financed under those respective facilities as the provisions of such facility generally provide that receivables assigned to such facility would be allowed to amortize should the facilities not be extended. Deferred financing costs are expensed proportionately if borrowing capacity is reduced.
Other Operating Expenses. Other operating expenses include primarily depreciation expense, professional fees, service bureau fees, telephone, repossession related expenses, and rent.
Income Taxes. The Company follows SFAS No. 109, which prescribes that deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates applied to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under SFAS No. 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period that includes the enactment date.
Derivatives. In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133 establishes accounting and reporting standards requiring that every derivative instrument (including certain derivative instruments embedded in other contracts) be recorded in the balance sheet as either an asset or liability at its fair value. The Statement requires that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. In June 2000, the FASB issued SFAS No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities-an Amendment of FASB Statement No. 133.
As of May 1, 2001 the Company designated its interest rate swaps and an interest rate cap with an aggregate notional value of $130,165,759 as cash flow hedges as defined under SFAS No. 133. Accordingly, any changes in the fair value of these instruments resulting from the mark-to-market process are recorded as unrealized gains or losses and reflected as an increase or reduction in shareholders' equity through other accumulated comprehensive income (loss). In connection with the decision to enter into the $100 million floating rate swap on June 1, 2001, the Company elected to change the designation of the $100 million fixed rate swap and not account for the instrument as a hedge under SFAS No. 133. As a result, the change in fair value of the swaps is reflected in net earnings for the period subsequent to May 31, 2001. The interest rate caps entered into as a requirement of the FIARC commercial paper facility are not designated as hedges and, accordingly, changes in the fair value are recorded as unrealized gains or losses and reflected in net earnings. Hedge accounting was not adopted for these positions due to mark-to-market movements being
deemed ineffective since they relate to time value and would be required to flow through net earnings thus eliminating any benefits of hedge accounting.
Earnings Per Share. Earnings per share amounts are calculated based on net income available to common shareholders divided by the weighted average number of shares of common stock outstanding (see Note 15 and Note 17).
Furniture and Equipment. Furniture and equipment are carried at cost, less accumulated depreciation. Depreciable assets are amortized using the straight-line method over the estimated useful lives (two to five years) of the respective assets.
Cash and Short-Term Investments. The Company considers all investments with a maturity of three months or less when purchased to be short-term investments and treated as cash equivalents. See Note 5 for components of restricted cash.
Treasury Stock. On December 14, 2001, the Board of Directors authorized the Company to repurchase up to 5% of the Company's outstanding common stock. During the year ended April 30, 2002, 170,000 shares were repurchased under this authorization at an average price of $3.03. During the year ended April 30, 2003, 370,400 shares were repurchased at an average price of $3.40.
Stock-Based Compensation. The Company has an employee stock option plan and a non employee director stock option plan, which are described more fully in Note 15. The Company applies APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations in accounting for its plans. The following table illustrates the effect on net income (loss) and earnings (loss) per share if the Company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation (with assumptions described in Note 15), to its stock option plans.
Reclassifications. Certain reclassifications have been made to the 2001 and 2002 amounts to conform to the 2003 presentation.
3. Receivables Held for Investment
The receivables generally have terms between 48 and 72 months and are collateralized by the underlying vehicles. Net receivable balances consisted of the following at April 30, 2002 and 2003:
At April 30, 2003, the weighted average remaining term of the receivable portfolio is 38 months and the weighted average contractual interest rate is 16.2 percent. Principal payments expected to be received on the receivable portfolio, assuming no defaults and that payments are received in accordance with contractual terms are summarized in the following table. Receivables may pay off prior to contractual due dates, primarily due to defaults and early payoffs.
Activity in the allowance for credit losses for the years ended April 30, 2002 and 2003 was as follows:
4. Receivables Acquired for Investment
Loans purchased at a discount relating to credit quality were included in the balance sheet amounts of Receivables Acquired for Investment as follows as of April 30, 2002 and 2003:
The carrying amount of Receivables Acquired for Investment is net of accretable yield and nonaccretable difference. Nonaccretable difference represents contractual principal and interest payments that the Company has estimated that it would be unable to collect.
Additions to nonaccretable difference for the year ended April 30, 2002 were due to a $1,260,000 loss recorded on the Receivables Acquired for Investment. Receivables Acquired for Investment are comprised of loans previously originated by Auto Lenders Acceptance Corporation and include a portfolio of warehouse loans and a portfolio of loans that were previously securitized. The securitized loans were subsequently redeemed and funded through the FIACC credit facility. The loss reduced the book value by increasing the nonaccretable difference. The loss relates to a 87 basis point increase in the cumulative loss rate from 2001 for the portfolios. The increase in the cumulative loss rates relates to the recessionary environment and the impact it has on customers' ability to maintain comparable paying employment. Additionally, the effective decrease in prices of new automobiles through incentive programs offered by captives contributed to decreasing prices and demands for used vehicles. This results in lower recovery rates realized through repossessions. The collateral comprising the Receivables Acquired for Investment is at higher risk as it is primarily older model used cars with higher mileage.
Nonaccretable difference eliminations represent contractual principal and interest amounts on loans charged-off for the period. For the year ending April 30, 2002, the increase in accretable yield through reclassifications results from increasing the expected term of the remaining cash flow in order to allow for collections on charged off receivables. By extending the cash flow projection model life, accretable yield must be increased to provide for future income. For the year ended April 30, 2003, the decrease in accretable yield is primarily due to a 22 basis point increase in the cumulative loss rate from 2002 of the portfolios due to slightly lower anticipated collections.
Principal payments expected to be received on the receivable portfolio, assuming no defaults and that payments are received in accordance with contractual terms are summarized in the following table. Receivables may pay off prior to contractual due dates, primarily due to defaults and early payoffs.
5. Restricted Cash
The components of restricted cash at April 30, 2002 and 2003 are as follows:
6. Deferred Financing Costs and Other Assets
The components of deferred financing costs and other assets at April 30, 2002 and 2003 are as follows:
For the year ended April 30, 2002 and in conjunction with the refinancing of the working capital facility, the Company expensed approximately $555,000 of deferred financing costs and warrants related to the old facility.
7. Debt
The Company finances the acquisition of its receivables portfolio through two warehouse credit facilities. The Company's credit facilities provide for one-year terms and have been renewed annually. Management of the Company believes that the credit facilities will continue to be renewed or extended or that it would be able to secure alternate financing on satisfactory terms; however, there can be no assurance that it will be able to do so. In January 2000 and January 2002, the Company issued $168 million and $159 million, respectively, in asset-backed notes ("Term Notes") secured by discrete pools of receivables. Proceeds from the two note issuances were used to repay outstanding borrowings under the various revolving credit facilities. Substantially all receivables retained by the Company are pledged as collateral for the credit facilities and the Term Notes. The weighted average interest rate for the Company's secured borrowings including the effect of program fees, dealer fees, and other comprehensive income (loss) amortization was 4.6% and 5.8% for the fiscal years ending April 30, 2003 and 2002, respectively.
Warehouse Facilities as of April 30, 2003
(1)Inclusive of amortization of other comprehensive income. Warehouse Facilities-Credit Enhancement as of April 30, 2003
FIRC-In order to obtain a lower cost of funding, the Company has agreed under the FIRC credit facility to maintain credit enhancement insurance covering all of its receivables pledged as collateral under this facility. The facility lenders are named as additional insureds under these policies. The coverages are obtained on each receivable at the time it is purchased by the Company and the applicable premiums are prepaid for the life of the receivable. Each receivable is covered by three separate credit insurance policies, consisting of basic default insurance under a standard auto loan protection policy (known as "ALPI" insurance) together with certain supplemental coverages relating to physical damage and other risks. Solely at its expense, the Company carries these coverages and neither the vehicle purchasers nor the dealers are charged for the coverages and they are usually unaware of their existence. The Company's ALPI insurance policy is written by National Union Fire Insurance Company of Pittsburgh ("National Union"), which is a wholly-owned subsidiary of American International Group. As of April 30, 2003, National Union had been assigned a rating of A+ + by A.M. Best Company, Inc.
The premiums that the Company paid during its past fiscal year for its three credit enhancement insurance coverages, of which the largest component is basic ALPI insurance, represented approximately 3.9 percent of the principal amount of the receivables acquired during the year. Aggregate premiums paid for ALPI coverage alone during the fiscal years ended April 30, 2001, 2002 and 2003 were $3,413,186, $2,382,031 and $4,141,328, respectively, and accounted for 3.0 percent, 3.1 percent and 3.8 percent of the aggregate principal balance of the receivables acquired during such respective periods.
Prior to establishing its relationship with National Union in March 1994, the Company's ALPI policy was provided by another third-party insurer. In April 1994, the Company organized First Investors Insurance Company (the "Insurance Subsidiary") under the captive insurance company laws of the State of Vermont. The Insurance Subsidiary is an indirect wholly-owned subsidiary of the
Company and is a party to a reinsurance agreement whereby the Insurance Subsidiary reinsures 100 percent of the risk under the Company's ALPI insurance policy. At the time each receivable is insured by National Union, the risk is automatically reinsured to its full extent and approximately 96 percent of the premium paid by the Company to National Union with respect to such receivable is ceded to the Insurance Subsidiary. When a loss covered by the ALPI policy occurs, National Union pays it after the claim is processed, and National Union is then reimbursed in full by the Insurance Subsidiary. As of April 30, 2003, gross premiums had been ceded to the Insurance Subsidiary since its inception by National Union in the amount of $28,486,788 and the Insurance Subsidiary reimbursed National Union for aggregate reinsurance claims in the amount of $8,089,381. In addition to the monthly premiums and liquidity reserves of the Insurance Subsidiary, a trust account is maintained by National Union to secure the Insurance Subsidiary's obligations for losses it has reinsured.
The result of the foregoing reinsurance structure is that National Union, as the "fronting" insurer under the captive arrangement, is unconditionally obligated to the Company's credit facility lenders for all losses covered by the ALPI policy, and the Company, through its Insurance Subsidiary, is obligated to indemnify National Union for all such losses. As of April 30, 2003, the Insurance Subsidiary had capital and surplus of $1,753,375 and unencumbered cash reserves of $1,521,507 in addition to the $2,725,785 trust account.
The ALPI coverage as well as the Insurance Subsidiary's liability under the Reinsurance Agreement, remains in effect for each receivable that is pledged as collateral under the warehouse credit facility. Once receivables are transferred from FIRC to FIARC and financed under the commercial paper facility, ALPI coverage and the Insurance Subsidiary's liability under the Reinsurance Agreement is cancelled with respect to the transferred receivables. Any unearned premium associated with the transferred receivables is returned to the Company. The Company believes the losses its Insurance Subsidiary will be required to indemnify will be less than the premiums ceded to it. However, there can be no assurance that losses will not exceed the premiums ceded and the capital and surplus of the Insurance Subsidiary.
Warehouse Facilities-Agents and Expirations
Management considers its relationship with its lenders to be satisfactory and has no reason to believe that the FIRC and FIARC facilities will not be renewed.
The following table contains pertinent information on the Term Notes as of April 30, 2003.
Term Notes-On January 29, 2002, the Company, through its indirect, wholly-owned subsidiary First Investors Auto Owner Trust 2002-A ("2002 Auto Trust") completed the issuance of $159,036,000 of 3.46% percent Class A asset-backed notes ("2002-A Term Notes"). The initial pool of automobile receivables transferred to the 2002 Auto Trust totaled $135,643,109, which were previously owned by FIRC and FIARC, secure the 2002-A Term Notes. In addition to the issuance of the Class A Notes, the 2002 Auto Trust also issued $4,819,000 in Class B Notes which were retained by the Company and pledged to secure the Working Capital Facility as further described below. Proceeds from the issuance, which totaled $159,033,471 were used to (i) fund a $25,000,000 pre-funding account to be used for future loan originations; (ii) repay all outstanding borrowings under the FIARC commercial paper facility, (iii) reduce the outstanding borrowings under the FIRC credit facility, (iv) pay transaction fees related to the 2002-A Term Note issuance, and (v) fund a cash reserve account of 2 percent or $2,712,862 of the initial receivables pledged which will serve as a portion of the credit enhancement for the transaction. The Class A Term Notes bear interest at 3.46 percent and require monthly principal reductions sufficient to reduce the balance of the Class A Term Notes to 97 percent of the outstanding balance of the underlying receivables pool. The final maturity of the 2002-A Term Notes is December 15, 2008. The Class B Notes do not bear interest but require principal reductions sufficient to reduce the balance of the Class B Notes to 3 percent of the outstanding balance of the underlying receivables pool. A surety bond issued by MBIA Insurance Corporation provides credit enhancement for the Class A Notes. Additional credit support is provided by the cash reserve account, which equals 2 percent of the original balance of the receivables pool plus 2 percent of the original balance of receivables transferred under the pre-funding provision. Further enhancement is provided through an initial 1 percent overcollateralization which is required to be increased to 3 percent through excess monthly principal and interest collections. In the event that certain asset quality covenants are not met, the reserve account target level will increase to 6 percent of the then current principal balance of the receivables pool. As of April 30, 2002 and 2003, the outstanding principal balances on the 2002-A Term Notes were $143,096,983 and $87,358,847, respectively.
On January 24, 2000, the Company, through its indirect, wholly-owned subsidiary, First Investors Auto Owner Trust 2000-A ("Auto Trust"), completed the issuance of $167,969,000 of 7.174 percent asset-backed notes ("2000-A Term Notes"). A pool of automobile receivables totaling $174,968,641, which were previously owned by FIRC, FIARC and FIACC, secures the 2000-A Term Notes. Proceeds from the issuance, which totaled $167,967,690, were used to repay all outstanding borrowings under the FIARC and FIACC commercial paper facilities, to reduce the outstanding borrowings under the FIRC credit facility, to pay transaction fees related to the 2000-A Term Note issuance and to fund a cash reserve account of 2 percent or $3,499,373 which will serve as a portion of the credit enhancement for the transaction. The 2000-A Term Notes bear interest at 7.174 percent and require monthly principal reductions sufficient to reduce the balance of the 2000-A Term Notes to 96 percent of the outstanding balance of the underlying receivables pool. A surety bond issued by MBIA Insurance Corporation provides credit enhancement for the Term Note holders. Additional credit support is provided by the cash reserve account, which equals 2 percent of the original balance of the receivables pool and a 4 percent over-collateralization requirement. In the event that certain asset quality covenants are not met, the reserve account target level will increase to 6 percent of the then current principal balance of the receivables pool. As of April 30, 2002, the outstanding principal balance on the 2000-A Term Notes was $40,162,801. On November 15, 2002, the Company exercised its right to prepay the outstanding
debt thus there were no outstanding borrowings on the 2000-A Term Notes as of April 30, 2003. The collateral was financed through borrowings under the FIARC commercial paper facility.
Acquisition Facility. On October 2, 1998, the Company, through its indirect, wholly-owned subsidiary, FIFS Acquisition Funding Company LLC (FIFS Acquisition), entered into a $75 million non-recourse bridge financing facility with VFCC, an affiliate of Wachovia Securities, to finance the Company's acquisition of FISC. Contemporaneously with the Company's purchase of FISC, FISC transferred certain assets to FIFS Acquisition, consisting primarily of (i) all receivables owned by FISC as of the acquisition date, (ii) FISC's ownership interest in certain Trust Certificates and subordinated spread or cash reserve accounts related to two asset securitizations previously conducted by FISC, and (iii) certain other financial assets, including charged-off accounts owned by FISC as of the acquisition date. These assets, along with a $1 million cash reserve account funded at closing, served as the collateral for the bridge facility. The facility bore interest at VFCC's commercial paper rate plus 2.35 percent and expired on August 14, 2000. Under the terms of the facility, all cash collections from the receivables or cash distributions to the certificate holder under the securitizations were first applied to pay FISC a servicing fee in the amount of 3 percent on the outstanding balance of all owned or managed receivables and then to pay interest on the facility. Excess cash flow available after servicing fees and interest payments was utilized to reduce the outstanding principal balance on the indebtedness. In addition, one-third of the servicing fee paid to FISC was also utilized to reduce principal outstanding on the indebtedness.
On August 8, 2000, the Company entered into an agreement with Wachovia Securities to refinance the acquisition facility. Under the agreement, a partnership was created in which FIFS Acquisition serves as the general partner and contributed its assets for a 70 percent interest in the partnership and First Union Investors, Inc., an affiliate of Wachovia Securities, serves as the limited partner with a 30 percent interest in the partnership (the "Partnership"). Pursuant to the refinancing, the Partnership issued Class A Notes in the amount of $19,204,362 and Class B Notes in the amount of $979,453 to VFCC, the proceeds of which were used to retire the acquisition debt. The Class A Notes bear interest at VFCC's commercial paper rate plus 0.95 percent per annum and amortize on a monthly basis by an amount necessary to reduce the Class A Note balance as of the payment date to 75 percent of the outstanding principal balance of Receivables Acquired for Investment, excluding Receivables Acquired for Investment that are applicable to FIACC, as of the previous month end. The Class B Notes bear interest at VFCC's commercial paper rate plus 5.38 percent per annum and amortize on a monthly basis by an amount which varied based on excess cash flows received from Receivables Acquired for Investment after payment of servicing fees, trustee and back-up servicer fees, Class A Note interest and Class A Note principal, plus collections received on the Trust Certificates. The outstanding balance of the Class A Notes was $3,670,765 at April 30, 2002. The Class B Notes were paid in full on September 15, 2000. After the Class B Notes were paid in full, all cash flows received after payment of Class A Note principal and interest, servicing fees and other costs, are distributed to the Partnership for subsequent distribution to the partners based upon the respective partnership interests. During the nine months ended January 31, 2002, $866,583 was distributed to the limited partner. Beginning in November 2001, the partnership used excess cash flow to retire additional Class A Note principal thus no further partnership distributions were paid until the Class A Notes were retired. On February 20, 2003, the Class A Notes were fully paid and all excess cash flows are paid to the partners. The amount of the partners' cash flow will vary depending on the timing and amount of cash flows from the assets. For the year ended April 30, 2003, $318,281 was distributed to the limited partner. The Company is accounting for Wachovia Securities' limited partnership interest in the Partnership as a minority interest.
Working Capital Facility. On December 6, 2001, the Company entered into an agreement with Wachovia Securities to refinance the $11,175,000 outstanding balance of the working capital term loan previously provided by Bank of America and Wachovia and increase the size of the facility to $13.5 million. The renewal facility was provided to a special-purpose, wholly-owned subsidiary of the Company, First Investors Residual Funding LP. The facility originally consisted of a $9 million revolving tranche and a $4.5 million term loan tranche which amortizes monthly. The term loan tranche of this working capital facility will be evidenced by the Class B Notes issued in conjunction with the 2002 Auto Trust financing. The remaining $9 million of the $13.5 million working capital facility revolves monthly in accordance with a borrowing base consisting of the overcollateralization amount and reserve accounts for each of the Company's other credit facilities. The facility is secured solely by the residual cash flow and cash reserve accounts related to the Company's warehouse credit facilities, the acquisition facility and the existing and future term note facilities. Pricing under the facility is based on the LIBOR rate plus 1.5% plus another 1.5% on the facility limit. On December 5, 2002, the maturity of the facility was extended to December 4, 2003. Under the terms of the renewal, the interest rate was increased to LIBOR plus 2.25%. In addition, the monthly principal amortization under the term loan tranche was increased to the greater of $250,000 or the principal distributions made under the Class B Notes issued under the 2002 Auto Trust financing. This amortization schedule will continue until the term loan tranche is repaid, leaving the remaining facility consisting of the $9 million revolving tranche. In the event that the facility is not renewed at maturity, residual cash flows from the various receivables financing transactions will be applied to amortize the debt over the remaining life of the underlying receivables. At April 30, 2002 and 2003, there was $11,798,520 and $8,714,518, respectively, outstanding under this facility.
The Company presently intends to seek a renewal of the working capital facility from its lender prior to maturity. Should the facility not be renewed, the outstanding balance of the receivables would be amortized in accordance with the borrowing base. Management considers its relationship with its lenders to be satisfactory and has no reason to believe that this credit facility will not be renewed. If the facility is not renewed, however, or if material changes are made to its terms and conditions, it could have a material adverse effect on the Company.
Shareholder Loans-On December 3, 2001 the Company entered into an agreement with one of its shareholders who is a member of its Board of Directors under which the Company may, from time to time, borrow up to $2.5 million. The proceeds of the borrowings will be utilized to fund certain private and open market purchases of the Company's common stock pursuant to a Stock Repurchase Plan authorized by the Board of Directors and for general corporate purposes. Borrowings under the facility bear interest at a fixed rate of 10 percent per annum. The facility is unsecured and expressly subordinated to the Company's senior credit facilities. The facility matures on December 3, 2008 but may be repaid at any time unless the Company is in default on one of its other credit facilities. At April 30, 2002 and 2003, there was $525,000 and $746,280, respectively, outstanding under this facility.
Loan Covenants. The documentation governing these credit facilities and Term Notes contains numerous covenants relating to the Company's business, the maintenance of credit enhancement insurance covering the receivables (if applicable), the observance of certain financial covenants, the avoidance of certain levels of delinquency experience and other matters. The breach of these covenants, if not cured within the time limits specified, could precipitate events of default that might result in the acceleration of the FIRC credit facility, the Term Notes and the working capital facility or the termination of the commercial paper facilities. The Company was not in default with respect to any covenants governing these financing arrangements at April 30, 2003.
Interest Rate Management. The Company's warehouse credit facilities bear interest at floating interest rates which are reset on a short-term basis while the secured Term Notes bear interest at a fixed rate of interest. The Company's receivables bear interest at fixed rates that do not generally vary with a change in market interest rates. Since a primary contributor to the Company's profitability is its ability to manage its net interest spread, the Company seeks to maximize the net interest spread while minimizing exposure to changes in interest rates. In connection with managing the net interest spread, the Company may periodically enter into interest rate swaps or caps to minimize the effects of market interest rate fluctuations on the net interest spread. To the extent that the Company has outstanding floating rate borrowings or has elected to convert a portion of its borrowings from fixed rates to floating rates, the Company will be exposed to fluctuations in short-term interest rates.
In connection with the issuance of the 2000-A Term Notes, the Company entered into a swap agreement with Bank of America pursuant to which the Company pays a floating rate equal to the prevailing one month LIBOR rate plus 0.505 percent and receives a fixed rate of 7.174 percent from the counterparty. The initial notional amount of the swap was $167,969,000, which amortized in accordance with the expected amortization of the Term Notes. Final maturity of the swap was August 15, 2002.
On September 27, 2000, the Company elected to terminate the aforementioned swap at no material gain or loss and enter into a new swap under which the Company would pay a fixed rate of 6.30 percent and receive the prevailing one month LIBOR rate plus 0.505 percent on a notional amount of $100 million. Under the terms of the swap, the counterparty had the option of extending the swap for an additional three years to mature on April 15, 2004 at a fixed rate of 6.42 percent. On April 15, 2001, the counterparty exercised its extension option.
On June 1, 2001, the Company entered into interest rate swaps with an aggregate notional amount of $100 million and a maturity date of April 15, 2004. Under the terms of these swaps, the Company will pay a floating rate based on one month LIBOR and receive a fixed rate of 5.025 percent. Management elected to enter into these swap agreements to offset the uneconomical position of the existing pay fixed swap created by rapidly declining market interest rates.
During the year ended April 30, 2003 and as a requirement of the FIARC commercial paper facility, the Company entered into nine interest rate cap transactions at cap rates ranging from 6.5% to 7.5% with an amortizing notional balance that is expected to coincide with the outstanding balance of the FIARC commercial paper facility. The interest rate caps were not designated as hedges and, accordingly, changes in the fair value of the interest rate caps are recorded as unrealized gains or losses and reflected in net earnings. Hedge accounting was not adopted for these positions due to mark-to-market movements being deemed ineffective since they relate to time value and would be required to flow through net earnings thus eliminating any benefits of hedge accounting.
In connection with the repurchase of the ALAC 97-1 Securitization and the financing of that repurchase through the FIACC subsidiary on September 15, 2000, FIACC entered into an interest rate swap agreement with Wachovia Securities under which FIACC paid a fixed rate of 6.76 percent as compared to the one month commercial paper index rate. The initial notional amount of the swap was $6,408,150, which amortized monthly in accordance with the expected amortization of the FIACC borrowings. The final maturity of the swap was December 15, 2001. On March 15, 2001, in connection with the repurchase of the ALAC 1998-1 Securitization and the financing of that purchase through the FIACC subsidiary, the Company and the counterparty modified the existing interest rate swap increasing the notional amount initially to $11,238,710 and reducing the fixed rate from 6.76 percent to 5.12 percent. The new notional amount amortized monthly in accordance with the expected principal
amortization of the underlying borrowings. The expiration date of the swap was changed from December 15, 2001 to September 1, 2002.
On October 2, 1998, in connection with the $75 million acquisition facility, the Company, through FIFS Acquisition, entered into a series of hedging instruments with Wachovia Securities designed to hedge floating rate borrowings under the acquisition facility against changes in market rates. Accordingly, the Company entered into two interest rate swap agreements, the first in the initial notional amount of $50.1 million ("Class A swap") pursuant to which the Company's interest rate is fixed at 4.81 percent; and, the second in the initial notional amount of $24.9 million ("Class B swap") pursuant to which the Company's interest rate was fixed at 5.50 percent. The notional amount outstanding under each swap agreement amortized based on an implied amortization of the hedged indebtedness. The Class A swap had a final maturity of December 20, 2002, while the Class B swap matured on February 20, 2000. The Company also purchased two interest rate caps, which protect the Company and the lender against any material increases in interest rates that may adversely affect any outstanding indebtedness that is not fully covered by the aggregate notional amount outstanding under the swaps. The first cap agreement ("Class A cap") enabled the Company to receive payments from the counterparty in the event that the one-month commercial paper rate exceeded 4.81 percent on a notional amount that increased initially and then amortized based on the expected difference between the outstanding notional amount under Class A swap and the underlying indebtedness. The interest rate cap expired December 20, 2002 and the cost of the cap was amortized in interest expense for the period. The second cap agreement ("Class B cap") enabled the Company to receive payments from the counterparty in the event that the one-month commercial paper rate exceeded 6 percent on a notional amount that increased initially and then amortized based on the expected difference between the outstanding notional amount under Class B swap and the underlying indebtedness. The interest rate cap expired December 20, 2002 and the cost of the cap was imbedded in the fixed rate applicable to Class B swap. Pursuant to the refinance of the acquisition facility on August 8, 2000, the Class B cap was terminated and the notional amounts of the Class A swap and Class A cap were adjusted downward to reflect the lower outstanding balance of the Class A Notes. The amendment or cancellation of these instruments resulted in a gain of $418,609. This derivative net gain was amortized over the life of the initial derivative instrument. In addition, the two remaining hedge instruments were assigned by FIFS Acquisition to the Partnership.
As of May 1, 2001 the Company designated its interest rate swaps and an interest rate cap with an aggregate notional value of $130,165,759 as cash flow hedges as defined under SFAS No. 133. Accordingly, any changes in the fair value of these instruments resulting from the mark-to-market process are recorded as unrealized gains or losses and reflected as an increase or reduction in shareholders' equity through other accumulated comprehensive income (loss). In connection with the decision to enter into the $100 million floating rate swap on June 1, 2001, the Company elected to change the designation of the $100 million fixed rate swap and not account for the instrument as a hedge under SFAS No. 133. As a result, the change in fair value of the swaps is reflected in net earnings for the period subsequent to May 31, 2001. The interest rate caps entered into as a requirement of the FIARC commercial paper facility are not designated as hedges and, accordingly, changes in the fair value are recorded as unrealized gains or losses and reflected in net earnings. Hedge accounting was not adopted for these positions due to mark-to-market movements being deemed ineffective since they relate to time value and would be required to flow through net earnings thus eliminating any benefits of hedge accounting.
8. Income Taxes
The temporary differences which give rise to deferred tax assets (liabilities) are as follows at April 30, 2002 and 2003, respectively:
Net operating loss carryforwards of $273,226 expire in 2021 and $247,492 expire in 2022.
The provision (benefit) for income taxes on income before income taxes and minority interest for the years ended April 30, 2001, 2002 and 2003, consists of the following:
The following is a reconciliation between the effective income tax rate and the applicable statutory federal income tax rate for the years ended April 30, 2001, 2002 and 2003.
9. Investment in First Auto Receivables Corporation
On December 24, 2002, the Company invested $475,061 for a 40% ownership interest in First Auto Receivables Corporation ("FARC") and $712,591 for junior mezzanine investments of FARC. FARC purchased a $197.5 million automobile loan portfolio from UAFC-2 Corporation, a subsidiary of Union Acceptance Corporation, with proceeds from $186 million in senior bridge debt, $8.9 million of senior
mezzanine debt, $1.8 million of junior mezzanine debt and $1.2 million of equity. The bridge debt interest rate is LIBOR plus 1%, the senior mezzanine interest rate is 22.5% and the junior mezzanine interest rate is 25%.
The Company accounts for its ownership investment in FARC using the equity method in accordance with APB Opinion 18. In addition to the equity and debt investments, the Company will also perform loan servicing and collection activities on the portfolio. For the year ended April 30, 2003, the Company recognized $631,750 of servicing income and $418,098 of other income related to the FARC investments. Other income is included in Late Fees and Other Income on the income statement and is primarily comprised of servicing income from FARC that is reclassified as income from the equity investment. This reclassification is necessary due to the Company owning 40% of the equity in FARC. The equity investment and junior mezzanine investment are included in Deferred Financing Costs and Other Assets on the balance sheet.
10. New Accounting Pronouncements
The FASB has issued SFAS No. 143, Accounting for Asset Retirement Obligations ("SFAS 143"), addressing accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. SFAS 143 will be effective May 1, 2003 for the Company and early adoption is encouraged. SFAS 143 requires that the fair value of a liability for an asset's retirement obligation be recorded in the period in which it is incurred and the corresponding cost capitalized by increasing the carrying amount of the related long-lived asset. The liability is accreted to its then present value each period, and the capitalized cost is depreciated over the useful life of the related asset. If the liability is settled for an amount other than the recorded amount, a gain or loss is recognized. The Company does not anticipate that the adoption of the new standard will have a significant effect on its consolidated financial statements.
In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of SFAS No. 13, and Technical Corrections ("SFAS 145"). This statement rescinds the requirement in SFAS No. 4, Reporting Gains and Losses from Extinguishment of Debt, that material gains and losses on the extinguishment of debt be treated as extraordinary items. The statement also amends SFAS No. 13, Accounting for Leases, to eliminate an inconsistency between the accounting for sale-leaseback transactions and the accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. Finally the standard makes a number of consequential and other technical corrections to other standards. The provisions of the statement relating to the rescission of SFAS 4 are effective for fiscal years beginning after May 15, 2002. Provisions of the statement relating to the amendment of SFAS 13 are effective for transactions occurring after May 15, 2002 and the other provisions of the statement are effective for financial statements issued on or after May 15, 2002. The Company has reviewed SFAS 145 and its adoption is not expected to have a material effect on its consolidated financial statements.
In July 2002, the FASB issued SFAS No. 146, Accounting for Exit or Disposal Activities ("SFAS 146"). SFAS 146 applies to costs associated with an exit activity (including restructuring) or with a disposal of long-lived assets. Those activities can include eliminating or reducing product lines, terminating employees and contracts, and relocating plant facilities or personnel. SFAS 146 will require a Company to disclose information about its exit and disposal activities, the related costs, and changes in those costs in the notes to the interim and annual financial statements that include the period in which an exit activity is initiated and in any subsequent period until the activity is completed. SFAS 146 is effective prospectively for exit or disposal activities initiated after December 31, 2002, with earlier adoption encouraged. SFAS 146 supersedes Emerging Issues Task Force Issue No. 94-3, Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring), and requires liabilities associated with exit and disposal activities to be expensed as incurred and can be measured at fair value. SFAS 146 is effective for exit or disposal activities that are initiated after December 31, 2002.
In November 2002, FASB Interpretation 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others ("FIN 45"), was issued. FIN 45 requires a guarantor entity, at the inception of a guarantee covered by the measurement provisions of the interpretation, to record a liability for the fair value of the obligation undertaken in issuing the guarantee. The Company previously did not record a liability when guaranteeing obligations. Interpretation 45 applies prospectively to guarantees the Company issues or modifies subsequent to December 31, 2002. FIN 45 did not have a material effect on the Company's financial statements. The Company has historically issued guarantees only on a limited basis and does not anticipate FIN 45 will have a material effect on its financial statements in the future.
In December 2002, the FASB issued Statement 148, Accounting for Stock-Based Compensation Transition and Disclosure-an Amendment of FASB Statement No. 123 ("SFAS 148"), to provide alternative transition methods for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS 148 amends the disclosure requirements of SFAS 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the pro-forma effect on reported results of applying the fair value based method for entities which use the intrinsic value method of accounting. This statement is effective for financial statements for fiscal years ending after December 15, 2002 and is effective for financial reports containing condensed financial statements for interim periods beginning after December 15, 2002 with earlier application permitted. The Company does not plan a change to the fair-value based method of accounting for stock-based employee compensation.
In January 2003, the FASB issued FASB Interpretation No. 46, Consolidation of Variable Interest Entities ("FIN 46"). FIN 46 clarifies the application of Accounting Research Bulletin No. 51, Consolidated Financial Statements, for certain entities which do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties or in which equity investors do not have the characteristics of a controlling financial interest ("variable interest entities"). Variable interest entities will be required to be consolidated by their primary beneficiary. The primary beneficiary of a variable interest entity is determined to be the party that absorbs a majority of the entity's expected losses, receives a majority of its expected returns, or both, as a result of holding variable interests, which are ownership, contractual, or other pecuniary interests in an entity. FIN 46 applies immediately to variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. It applies in the first fiscal year or interim period beginning after June 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. FIN 46 applies to the Company as of the beginning of the applicable interim or annual period. The Company does not anticipate FIN 46 will have a material effect on its financial statements.
In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities ("SFAS 149"). SFAS 149 amends and clarifies the accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. In addition, the statement clarifies when a contract is a derivative and when a derivative contains a financing component that warrants special reporting in the statement of cash flows. SFAS 149 is generally effective prospectively for contracts entered into or modified, and hedging
relationships designated, after June 30, 2003. Management does not expect adoption to have a material effect on the Company's financial statements.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity ("SFAS 150"). SFAS 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity, and imposes certain additional disclosure requirements. The provisions of SFAS 150 are generally effective for financial instruments entered into or modified after May 31, 2003. Management does not expect adoption to have a material effect on the Company's financial statements.
11. Credit Risks
Approximately 26 percent of the Company's Receivables Held for Investment by principal balance at April 30, 2003 represent receivables acquired from dealers located in Texas. The economy of Texas is primarily dependent on petroleum and natural gas production and sales of related supplies and services, petrochemical operations, light and medium manufacturing operations, computer and computer service businesses, agribusiness and tourism. Job losses in any or all of these primary economic segments of the Texas economy may result in a significant increase in delinquencies or defaults in the Company's receivable portfolio. While vehicles secure the receivables, it is not expected that the value of the vehicles if repossessed and sold by the Company would be sufficient to recover the principal outstanding under any defaulted loans.
The Company is also exposed to credit loss in the event that the counterparties to the swap agreements described in Note 7 do not perform their obligations. The terms of the Company's interest rate agreements provide for settlement on a monthly basis and accordingly, any credit loss due to non-performance of the counterparty would be limited to the amount due from the counterparty for the month non-performance occurred. The Company would be exposed to adverse interest rate fluctuations following any such non-performance. While management believes that it could enter into interest rate swap agreements with other counterparties to effectively manage such rate exposure, there is no assurance that it would be able to enter interest rate agreements on comparable terms as those of its present agreements.
12. Market Risks
The market risk discussion and the estimated amounts generated from the analysis that follows are forward-looking statements of market risk assuming certain adverse market conditions occur. Actual results in the future may differ materially due to changes in the Company's product and debt mix, developments in the financial markets, and further utilization by the Company of risk-mitigating strategies such as hedging.
The Company's operating revenues are derived almost entirely from the collection of interest on the receivables it retains and its primary expense is the interest that it pays on borrowings incurred to purchase and retain such receivables. The Company's credit facilities bear interest at floating rates which are reset on a short-term basis, whereas its receivables bear interest at fixed rates which do not generally vary with changes in interest rates. The Company is therefore exposed primarily to market risks associated with movements in interest rates on its credit facilities. The Company believes that it takes the necessary steps to appropriately reduce the potential impact of interest rate increases on the Company's financial position and operating performance.
The Company relies almost exclusively on revolving credit facilities to fund its origination of receivables. Periodically, the Company will transfer receivables from a revolving to a term credit facility.
Currently, all of the Company's credit facilities in combination with various swaps bear interest at floating rates tied to either a commercial paper index or LIBOR.
As of April 30, 2003, the Company had $150.7 million of floating rate secured debt outstanding. The Company is exposed to interest rate movements until interest rates equal 6.5%. The Company has interest rate cap agreements as protection for rate movements beyond 6.5% on $90.0 million of notional balance. For every 1 percent increase in commercial paper rates or LIBOR up to 6.5%, annual after-tax earnings would decrease by approximately $957,000 assuming the Company maintains a level amount of floating rate debt and assuming an immediate increase in rates. For every 1 percent increase in commercial paper rates or LIBOR over 6.5%, annual after-tax earnings would decrease by approximately $388,000 assuming the Company maintains a level amount of floating rate debt and assuming an immediate increase in rates. As of April 30, 2002, the Company had $38 million of floating rate secured debt outstanding net of swap and cap agreements. For every 1 percent increase in commercial paper rates or LIBOR, annual after-tax earnings would decrease by approximately $244,000 assuming the Company maintains a level amount of floating rate debt and assuming an immediate increase in rates.
13. Fair Value of Financial Instruments
The following table summarizes the carrying amounts and estimated fair values of the Company's financial instruments for those financial instruments whose carrying amounts differ from their estimated fair values. SFAS No. 107, Disclosures About Fair Value of Financial Instruments, defines the fair value of a financial instrument as the amount at which the instrument could be exchanged in a current transaction between willing parties. The carrying amounts shown in the table are included in the balance sheet under the indicated captions.
The following methods and assumptions were used to estimate the fair value of each category of financial instruments:
Cash and Short-Term Investments, Other Receivables, Accounts Payable and Accrued Liabilities. The carrying amounts approximate fair value because of the short maturity and market interest rates of those instruments.
Receivables Held for Investment. The fair values were estimated by discounting expected cash flows at a risk-adjusted rate of return deemed to be appropriate for investors in such receivables. Expected cash flows take into consideration management's estimates of prepayments, defaults and recoveries.
Receivables Acquired for Investment. The carrying value approximates fair value. The fair values were estimated by discounting expected cash flows at a risk-adjusted rate of return deemed to be appropriate for investors in such receivables. Expected cash flows take into consideration management's estimates of prepayments, defaults and recoveries.
Term Notes. The fair value was estimated by discounting cash payments using current rates and comparative maturities. Expected cash payments take into consideration prepayments, defaults and recoveries on the underlying collateral.
Credit Facilities. The carrying amount approximates fair value because of the floating interest rates on the credit facilities.
Swap Agreements. The fair value was estimated based on the payment the Company would have to make to or receive from the swap counterparty to terminate the swap agreements.
Cap Agreements. The fair value was estimated based on the payment the Company would receive from the cap counterparty to terminate the cap agreements.
14. Defined Contribution Plan
Effective May 1, 1994, the Company adopted a participant-directed 401(k) retirement plan for its employees. An employee becomes eligible to participate in the plan immediately upon employment. The Company pays the administrative expenses of the 401(k) plan. The Company also matches a percentage of each participant's voluntary contributions up to a maximum voluntary contribution of 3 percent of the participant's compensation. In fiscal year 2002 and 2003, the Company made matching contributions to the 401(k) plan in the amounts of $30,265 and $32,548, respectively. Effective April 28, 1998, the Company established a participant-directed Deferred Compensation Plan for certain executive officers of the Company. Under the terms of the Deferred Compensation Plan, the participants may elect to make contributions to the plan that exceeds amounts allowed under the Company's 401(k) plan. The Company pays the administrative expenses of the Deferred Compensation Plan. As of April 30, 2002 and April 30, 2003, the amounts invested under the Deferred Compensation Plan totaled $256,876 and $236,378, respectively.
15. Shareholders' Equity
Preferred Stock. In June 1995, the shareholders approved a new series of preferred stock (New Preferred Stock) with a $1.00 par value, and authorized 1,000,000 shares. As of April 30, 2003, no shares have been issued.
Employee Stock Option Plan. In June 1995, the Board of Directors adopted the Company's 1995 Employee Stock Option Plan (the Plan). The Plan is administered by the Compensation Committee of the Board of Directors and provides that options may be granted to officers and other key employees for the purchase of up to 300,000 shares of Common Stock, subject to adjustment in the event of certain changes in capitalization. On September 10, 2002, the number of shares of common stock available for issuance was increased to 500,000. Options may be granted either as incentive stock options (which are intended to qualify for certain favorable tax treatment) or as non-qualified stock options.
The Compensation Committee selects the persons to receive options and determines the exercise price, the duration, any conditions on exercise and other terms of the options. In the case of options intended to be incentive stock options, the exercise price may not be less than 100 percent of the fair market value per share of Common Stock on the date of grant. With respect to non-qualified stock
options, the exercise price may be fixed as low as 50 percent of the fair market value per share at the time of grant. In no event may the duration of an option exceed 10 years and no option may be granted after the expiration of 10 years from the adoption of the Plan.
The exercise price of the option is payable in full upon exercise and payment may be in cash, by delivery of shares of Common Stock (valued at their fair market value at the time of exercise), or by a combination of cash and shares. At the discretion of the Compensation Committee, options may be issued in tandem with stock appreciation rights entitling the option holder to receive an amount in cash or in shares of Common Stock, or a combination thereof, equal in value to any increase since the date of grant in the fair market value of the Common Stock covered by the option.
Non-Employee Director Stock Option Plan-In September 2002, the Non-Employee Stock Option Plan was established to further align the interests of the Company's directors with the interests of the shareholders, as well as attracting and retaining qualified directors. The Board of Directors administers the plan and the options will not be qualified as incentive stock options. A total of 500,000 shares of common stock are available for issuance. Option types will be automatic and discretionary. Automatic grants of 20,000 shares for each non-employee director, or 100,000 shares total, were approved in September 2002. Subsequent automatic grants of an option to purchase 20,000 shares shall be made to each non-employee director on July 15th each year, beginning July 15, 2003. The plan also gives the Board of Directors discretionary authority to provide for additional option grants if the Company's annual financial performance exceeds parameters established by the Board. No discretionary grants have been awarded.
A summary of the status of the Company's stock option plans for the years ended April 30, 2001, 2002 and 2003 is presented below:
Following is a summary of the status of options outstanding at April 30, 2003:
(1)The option will terminate one year after the Director ceases to be a member of the Board of Directors, except that in the event of the Director's death while serving as a Director the option would be exercisable by his heirs or representatives of his estate for a period of two years after date of death. The fair value of each option is estimated on the date of grant using the Black-Scholes option pricing model. The following weighted-average assumptions were used:
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.
16. Commitments and Contingencies
Employment Agreement. As of April 30, 2003, the Company was not a party to any employment agreements.
Litigation. The Company from time to time becomes involved in various routine legal proceedings which are incidental to the business. Management of the Company vigorously defends such matters. As of April 30, 2003, management believes there are no such legal proceedings that would have a material adverse impact on the Company's financial position or results of operations.
Leases. The Company is a party to a lease agreement for office space in Houston that expires on February 28, 2005. The Company is party to a lease agreement for office space in Atlanta which expires on June 30, 2007. Rent expense for office space and other operating leases for the years ended
April 30, 2001, 2002 and 2003, was $1,192,466, $910,816 and $813,504, respectively. Required minimum lease payments for the remaining terms of the above leases are:
17. Earnings Per Share
Earnings per share amounts are based on the weighted average number of shares of common stock and potential dilutive common shares outstanding during the period. The weighted average number of shares used to compute basic and diluted earnings per share for the years ended April 30, 2001, 2002 and 2003 are as follows:
At April 30, 2003, the Company had 464,487 employee stock options and warrants and 70,000 director options which were not included in the computation of diluted earnings per share because to do so would have been antidilutive for the period presented.
18. Quarterly Financial Data (Unaudited)
The table below sets forth the unaudited consolidated operating results by quarter for the year ended April 30, 2003.
The table below sets forth the unaudited consolidated operating results by quarter for the year ended April 30, 2002.
DOCUMENTS INCORPORATED BY REFERENCE
FIRST INVESTORS FINANCIAL SERVICES GROUP, INC. AND SUBSIDIARIES FORM 10-K APRIL 30, 2003
PART I
ITEM 1. BUSINESS
ITEM 2. PROPERTIES
ITEM 3. LEGAL PROCEEDINGS
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
PART II
ITEM 5. MARKET FOR REGISTRANTS' COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Part III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS
ITEM 11. EXECUTIVE COMPENSATION
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
ITEM 14. CONTROLS AND PROCEDURES
Part IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
SIGNATURES
Certification Required by Rules 13a-14 and 15d-14 under the Securities Exchange Act of 1934
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
FIRST INVESTORS FINANCIAL SERVICES GROUP, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS-APRIL 30, 2002 and 2003
FIRST INVESTORS FINANCIAL SERVICES GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS For the Years Ended April 30, 2001, 2002 and 2003
FIRST INVESTORS FINANCIAL SERVICES GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY For the Years Ended April 30, 2001, 2002 and 2003
FIRST INVESTORS FINANCIAL SERVICES GROUP, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS For the Years Ended April 30, 2001, 2002 and 2003
FIRST INVESTORS FINANCIAL SERVICES GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS April 30, 2001, 2002 and 2003