ITEM 1. BUSINESS
General
First Investors Financial Services Group, Inc., together with its wholly-owned subsidiaries, (“Company”) is a consumer finance company engaged in originating and holding for investment retail installment sales contracts and promissory notes receivable secured by new and used automobiles and light trucks arising from the sale of the vehicle by factory authorized franchised dealers or refinanced by the vehicle owner (consumer). The Company specializes in lending to consumers with impaired credit profiles. Additionally, the Company has purchased receivables in 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, 2006, the Company had Receivables Held for Investment in the aggregate principal amount of approximately $369 million having an effective yield of 12.5% and a net interest spread of 7.8% (net of cost of funds and other carrying costs).
The Company performs 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 approximately $475 million as of April 30, 2006.
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 expanded its operations and reoriented its business towards originating receivables for retention. In October 1995, the Company completed the initial public offering of common stock which resulted in net proceeds of $18.5 million.
On October 2, 1998, the Company completed the acquisition of First Investors Servicing Corporation (“FISC”), formerly known as Auto Lenders Acceptance Corporation, from Fortis, Inc. Headquartered in Atlanta, Georgia. FISC engaged in essentially the same business as the Company and additionally performed servicing and collection activities on a portfolio of receivables originated for investment as well as on a portfolio of receivables originated 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 Base
General. The Company primarily originates receivables from refinancing existing loans originally financed from an outside third party and the new and used car departments of dealers that operate 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% of the receivables owned by the Company at April 30, 2006, and no dealer or group of related dealers originated more than 5% of the receivables held by the Company at that date. The volume and frequency of receivable originations 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 48% of the dealers with whom the Company has agreements are located in Texas, where the Company has operated since 1989, 22% in Georgia and 13% in Tennessee. The Company’s expansion beyond Texas began in 1992. Currently, the Company is licensed to conduct business in 21 states for direct to consumer loans and 23 states for indirect loans, and is actively originating loans in 17 states for both direct to consumer loans and indirect loans.
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 refinancing existing loans originally financed from an outside third party, dealers in such states or purchased through bulk portfolio acquisitions:
(1) Represents obligor’s current state of residence
(2) Includes loans located in Alabama, Arkansas, Connecticut, Delaware, Iowa, Idaho, Kansas, Kentucky, Massachusetts, Maryland, Michigan, Minnesota, Mississippi, Nebraska, Nevada, New Hampshire, New Jersey, New Mexico, New York, Oregon, Pennsylvania, South Dakota, Utah, Vermont, Virginia, West Virginia 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.
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 currently expect to create branch offices.
Financing Programs
The Company originates loans from two sources: (i) dealer indirect and (ii) consumer direct. The dealer indirect program generated 35% of the Company’s origination volume for the year ended April 30, 2006, and consisted of loans originated directly from dealerships in states in which the Company operates. Consumer direct originations contributed 65% of origination volume for the year ended April 30, 2006, and involved applications for credit obtained through direct marketing efforts from consumers who are primarily 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 dealer indirect receivables are originated on a non-recourse basis.
In addition to originating receivables from dealers under the core program or making loans directly to consumers, the Company has acquired seasoned receivables in 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 273 dealers at April 30, 2006 compared to 1,477 at April 30, 2005. The decrease in active dealership agreements is due to a large number of dealerships having little or no volume, whose agreements were deactivated. These are non-exclusive agreements terminable at any time by either party and they require no specific volume levels. The agreements with the 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 purchase receivables that do not conform to these warranties, the dealers do not guarantee collectibility or obligate themselves to purchase receivables solely because of payment default. The receivables are originated 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 originate receivables is governed by the Company’s credit policy and a credit score generated by the Company’s proprietary, empirical scoring model.
Credit Evaluation
In connection with the origination of a receivable by the Company, the Company follows systematic procedures designed to eliminate unacceptable risks. This involves a three-step process in which (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 or with individuals to whom
the Company lends directly. The Company has developed 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 credit scoring and loan pricing models developed from the Company’s 18 year database of non-prime lending results.
In addition to this credit underwriting process, and prior to the origination of a receivable by the Company, the Company performs additional procedures to validate the details of the credit application, including income and/or employment information, to verify that the collateral is insured, and to confirm that the material terms of the sale conform to the purchaser’s understanding of the transaction. The Company will originate a receivable 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.
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 40% of the common stock 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 was an agreement to service, for a third party, a $276 million auto loan portfolio. The Company will continue to seek opportunities to increase servicing income through investments in 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 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 dollar value 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 contractual term of receivables included in a portfolio will not correspond with actual average life.
Financing Arrangements
General. The Company’s 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 is utilized for working capital and general corporate purposes. Lastly, the Company has an agreement with a limited partnership that is affiliated with a current shareholder and member of the 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, 2006, under these facilities:
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 15, 2005, the maturity date of the FIRC facility was extended to February 14, 2007. No other material changes were made. The FIARC commercial paper facility expired on February 15, 2006, and after an extension through March 16, 2006 was renewed until February 14, 2007. In connection with the renewal, the Company obtained approval from the lender to eliminate the requirement that a surety bond be maintained to provide additional enhancement to the commercial paper investors. As a result, the 0.35% surety bond premium and the 0.25% unused surety bond premium were eliminated. In exchange, the Company agreed to increase the program fee paid to the lender from 0.30% to 0.55% and to increase the unused fee paid to the lender from 0.25% to 0.30%. 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 be funded under the credit facility. The Company intends to seek a renewal of the facilities from its lenders prior to maturity. Management considers its relationship with its lenders to be satisfactory and has no reason to believe that these credit facilities will not be renewed. If these facilities are 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 occurrences 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, 2006.
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 generally do not 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. Accordingly, 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 7A for quantification.
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 coverage is obtained on each receivable at the time it is originated 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.
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 1.9% of the
principal amount of the receivables originated during the year. Aggregate premiums paid for ALPI coverage alone during the fiscal years ended April 30, 2004, 2005 and 2006 were $3,066,131, $3,669,198, and $3,768,534, respectively, and accounted for 3.5%, 2.3% and 1.4% of the aggregate principal balance of the receivables originated during such respective periods.
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% 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, 2006, gross premiums had been ceded to the Insurance Subsidiary since its inception by National Union in the amount of $38,876,337 and the Insurance Subsidiary reimbursed National Union for aggregate reinsurance claims in the amount of $9,785,667. 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, 2006, the Insurance Subsidiary had capital and surplus of $2,766,495 and unencumbered cash reserves of $1,442,680 in addition to $3,430,734 in a 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 - Term Note. A surety bond issued by MBIA Insurance Corporation enhances the 2003-A Term Notes issued on November 20, 2003. The surety bond provides payment of principal and interest to the note holders in the event of payment default by the 2003-A Trust. MBIA is paid a surety premium equal to 0.35% per annum on the outstanding balance of the 2003-A Term Notes. The surety bond was issued for the term of the underlying notes, which mature on April 20, 2011. Termination of the surety bond would result in default under the governing documents.
A surety bond issued by MBIA Insurance Corporation enhances the 2005-A Term Notes issued on May 5, 2005. The surety bond provides payment of principal and interest to the note holders in the event of payment default by the 2005-A Trust. MBIA is paid a surety premium equal to 0.35% per annum on the outstanding balance of the 2005-A Term Notes. The surety bond was issued for the term of the underlying notes, which mature on July 16, 2012. Termination of the surety bond would result in default under the governing documents.
A surety bond issued by MBIA Insurance Corporation enhances the 2006-A Term Notes issued on January 26, 2006. The surety bond provides payment of principal and interest to the note holders in the event of payment default by the 2006-A Trust. MBIA is paid a surety premium equal to 0.28% per annum on the outstanding balance of the 2006-A Term Notes. The surety bond was issued for the term of the underlying notes, which mature on April 15, 2013. 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 been positively impacted by increasing wholesale prices of used vehicles which decreases losses to the Company upon repossession. 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 specified 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.
Employees
The Company had 193 employees as of April 30, 2006, including 100 located at its headquarters in Houston, 89 located at its loan servicing center in Atlanta and 4 regional marketing representatives. The Company’s employees are covered by group health insurance. 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 effective the first enrollment period after 90 days of 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% of the participant’s compensation. In fiscal years 2006, 2005, and 2004, the Company recorded matching contributions to the 401(k) plan of $42,168, $23,425, and $40,062, respectively. Effective April 28, 1998, the Company established a participant-directed Deferred Compensation Plan for certain executive officers of the Company. The Deferred Compensation Plan was terminated during the fourth quarter of the fiscal year 2005 in response to changes in the tax law associated with such plans. The assets in the plan were distributed to the particpants.
Information Systems
The Company utilizes advanced information management systems including a fully integrated software program designed to expedite each element in the receivables underwriting 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 an 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 origination 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 originates. 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 originating 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 their intended use.
The Company’s offices in suburban Houston consist of approximately 17,304 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 $311,384 and expiring on February 28, 2011, with an option to renew for five years at the market rate then prevailing.
The Company’s offices in suburban Atlanta consist of approximately 28,133 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 $519,000 and expiring on December 31, 2015, with an option to renew for an additional five years at the market rate then prevailing. The Company owns no real property.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Other than as discussed herin, 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 was traded on the NASDAQ National Market System, under the symbol “FIFS” from the completion of the Company’s initial public offering on October 4, 1995 through December 1, 2004. On December 2, 2004, the Company’s common stock started trading on the over-the-counter bulletin board market. High and low closing prices of the common stock are set forth below for the periods indicated.
As of May 31, 2006, there were approximately 20 shareholders of record of the Company’s common stock. The Company believes that the number of beneficial owners is significantly greater than the number of shareholders of record.
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. The Company has no plans to pay cash dividends on the common stock in the foreseeable future.
During the twelve months ended April 30, 2006 and 2005, the Company repurchased -0- and 588,576 shares of common stock, respectively. The quarterly detail of such repurchases appears below.
ITEM 6.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data of the Company for each of the five fiscal years ended April 30, 2006, 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 per share data). As reflected in the Company’s Form 10-K filed November 29, 2002, the Company restated its 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. Restricted cash, deferred expenses, receivables held for investment, and tax balances have been adjusted for the restatement for all applicable years.
Reclassifications. Certain reclassifications have been made to the 2002, 2003, 2004 and 2005 amounts to conform to the 2006 presentation.
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 used in the 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 Held for Investment. Receivables Held for Investment represents the aggregate outstanding balance of installment sales contracts and promissory notes originated by the Company through its automobile dealer relationships or directly with consumers. The Company accrues interest income monthly using the effective interest method. When a receivable becomes 90 days past due, the 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. Other Income consists of income received from servicing activities, late fees and other loan-related fees, income from investments, reinvestment revenue, GAP insurance and extended service contracts, and unrealized loss on interest rate derivative positions. Servicing revenue is accrued as services are rendered. Late fees and other loan-related fees are recognized when received. Income from investments and reinvestment revenue are accrued based on the respective interest rate of such investment. Revenue from the sale of GAP insurance and extended service contracts is recognized when sold as the Company has no further obligation after the sale. Unrealized loss on interest rate derivatives is recognized when incurred.
Advertising Costs. The Company expenses advertising costs as incurred.
Allowance for Credit Losses. The Company calculates the allowance for credit losses in accordance with SFAS No. 5, Accounting for Contingencies. SFAS No. 114, Accounting by Creditors for Impairment of a Loan, does not apply to loans currently held by the Company because they are comprised of a large group of smaller balance homogenous loans that are evaluated collectively for impairment.
The Company initiates efforts to make customer contact as early as when the customer is one day 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 typically repossessed. Generally this occurs at 60 to 90 days after the loan becomes past due. Upon repossession, the uncollectible portion of the loan and 100% of accrued interest is written off. The fair value of the collateral is recorded in Assets Held for Sale. Fair value is determined by estimating the proceeds from the sale 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 records an adjustment, positive or negative, based on the difference between the fair value estimate and the proceeds received. In the event the collateral cannot be located or if the customer refuses to pay and is not subject to bankruptcy court protection, the Company will write off the entire balance of the loan once it reaches 180 days past due. If the customer is subject to bankruptcy court protection, the loan generally remains in bankruptcy status as long as payments are being received from the trustee. If a payment is missed, the Company seeks to repossess the collateral with approval of the court. If the customer is dismissed from bankruptcy, the Company resumes collection efforts.
The Company applies a systematic methodology in order to determine the amount of the allowance for credit losses. The specific methodology 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 the estimated loss per loan, which is based on historical information. Effective for the quarter ended April 30, 2005, the Company elected to increase its allowance for loan losses against loans that were greater than 120 days past due and loans in which the collateral had been assigned for repossession but had not yet been repossessed as of the reporting date. The Company believes that this increase is warranted in light of the change in federal bankruptcy laws enacted during the period and the recognition that the migration trends of severely delinquent loans and loans subject to bankruptcy are expected to become more protracted. Based on this, the Company has assigned a specific allowance against these loans equal to the outstanding balance of loans in these categories less the estimated recovery amount based on current data regarding liquidation of the collateral and collection of any additional payments. The Company utilized its most recent recovery rates in order to assess fair value of these loans. For loans that are not classified into these categories, the historical migration pattern is utilized in order to establish the estimated impairment. Despite the increase in allowance associated with the higher delinquency loans and bankrupt accounts, the total allowance for loan losses decreased during the period as a percentage of Receivables Held for Investment due to improving overall delinquency trends and lower repossession and loss rates. The allowance for credit losses is based on estimates and qualitative evaluations. Ultimate losses may 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.
Stock-Based Compensation. The Company has an employee stock option plan and a non-employee director stock option plan. The Company has adopted the disclosure provisions of SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure, an amendment of FASB Statement No. 123. This pronouncement requires prominent disclosures in both annual and interim financial statements regarding the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company accounts for stock compensation awards under the intrinsic value method of Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees which requires compensation cost to be recognized based on the excess, if any, between the quoted market price of the stock at the date of grant and the amount an employee must pay to acquire the stock. All options awarded under the Company’s plan are granted with an exercise price equal to or greater than the fair market value on the date of the grant.
General
Net income for the year ended April 30, 2006, was $2,445,153 or $0.55 per common share. Net income for the years ended April 30, 2005, was $683,529 or $0.14 per common share. For the year ended April 30, 2006, the Company experienced a significant increase in loan origination volume, a resulting growth in the average portfolio of receivables outstanding, lower credit losses, an increase in other interest income, and lower collection-related expenses than for the year ended April 30, 2005. These were partially offset by lower servicing revenue, lower net interest margin due to lower effective yields, a higher cost of borrowing for the year ended April 30, 2006, and higher salary expense to support the increase in origination volume. Net income for the year ended April 30, 2004, was $33,563 or $0.01 per common share. See Results of Operations.
Overview
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 has been impacted by the growth of the receivables portfolio, inclusion of two new servicing transactions, and effective management of net interest income and fixed operating expenses. In fiscal 2006, First Investors Servicing Corporation (“FISC”) performed servicing and collection functions on an average portfolio balance of $475 million of loans.
The Company’s managed receivables are (dollars in thousands):
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 receivables by increasing the amount of originations obtained from its existing dealer base and by increasing the volume of originations in its direct lending business. 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 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 $24.3 million in 2006, an increase of 17.4% when compared to amounts reported in 2005 and an increase of 10.0% when compared to amounts reported in 2004.
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, 2006, Compared to Fiscal Year Ended April 30, 2005 (dollars in thousands)
Key Factors. The critical factors affecting the Company’s profitability during any period are (i) loan origination volume and the corresponding growth in receivables held for investment; (ii) the level of net interest spread, which is defined as the difference between the effective yield on receivables held for investment and the cost of funds under the Company’s credit facilities and securitizations utilized to finance these receivables; (iii) the level of provision for credit losses; (iv) the amount of income derived from other activities; and (v) the ability of the Company to control operating expenses relative to the total amount of the managed portfolio.
Executive Summary. Net income for the year ended April 30, 2006 was $2,445 compared to $684 for the year ended April 30, 2005. Basic earnings per common share were $0.55 and $0.14 and diluted earnings per common share were $0.53 and $0.14 for the years ended April 30, 2006, and April 30, 2005, respectively.
The 258% increase in net income for the year ended April 30, 2006 compared to April 30, 2005 is due primarily to an increase in net interest income and other interest income, and a decline in provision for credit losses during the
2006 period. The increase in net interest income was due to a 43% increase in the average portfolio of Receivables Held for Investment, partially offset by (i) a 46% increase in the average debt balance and (ii) an increase in the average cost of debt from 3.5% during 2005 to 4.7% during 2006 as a result of two securitizations and an increase in overall market interest rates as a result of the current economic environment and market rate increases adopted by the Federal Reserve Board. Provision for credit losses decreased 21% during the year as a result of lower repossessions and charge-offs and improving recovery rates. This improvement in overall credit quality is due to (i) improvements in general economic conditions including a lower unemployment rate, (ii) an increase in the percentage of loans originated under the Direct Program which exhibit much lower default rates than the Indirect Program and (iii) higher recovery rates on the sale of repossessed collateral due to improvements in the used car market. Other interest income increased 134% due to (i) an increase in average cash due to increased collections as a result of a 43% increase in the average portfolio of Receivables Held for Investment in 2006 and (ii) an increase in overall market interest rates as a result of the current economic environment and market rate increases adopted by the Federal Reserve Board.
These factors were partially offset by (i) a 45% decrease in servicing income, (ii) an 18% increase in salaries and benefits, and (iii) a 381% increase in legal fees. The decline in servicing revenue and income from investment is due to a decrease in the portfolio of receivables serviced for third parties and a decrease in the portfolio of receivables serviced on behalf of FARC. The increase in salaries and benefits is primarily due to a 61% increase in the average portfolio of Receivables Held for Investment, partially offset by a decrease in staff due to the decrease in the Company’s serviced portfolio. The increase in legal fees is primarily due to settlement costs and legal fees totaling $800 associated with defending and settling a lawsuit brought against a wholly-owned subsidiary of the Company.
Interest Income. Total interest income for the year ended April 30, 2006 increased to $39,300 compared to $28,272 for the year ended April 30, 2005.
The level of interest income, a primary driver of financial results, is impacted by the average outstanding balance of the portfolio of Receivables Held for Investment, the weighted average interest rate on receivables originated by the Company, the mix of direct and indirect lending activities and the level of prepayments and charge-offs. Interest income on Receivables Held for Investment increased 39% for the year ended April 30, 2006 compared to the year ended April 30, 2005. This is primarily due to a 43% increase in the average portfolio of Receivables Held for Investment, partially offset by a 35 basis point reduction in the average effective yield during the year ended April 30, 2006 due to (i) a lower weighted average interest rate on the performing portfolio which reflects the Company’s increased focus on receivables originated directly to consumers which typically carry lower interest rates and (ii) the overall competitive environment for receivables originated through dealerships.
Interest Expense. Interest expense for the year ended April 30, 2006 increased to $15,042 compared to $7,616 for the year ended April 30, 2005. Interest expense on Receivables Held for Investment increased 98% for the year ended April 30, 2006. The increase in interest expense is primarily due to (i) a 46% increase in the average debt outstanding during 2006 due to a 43% increase in the average portfolio of Receivables Held for Investment and (ii) an increase in the average cost of debt from 3.5% during 2005 to 4.7% during 2006 as a result of two securitizations and an increase in overall market interest rates as a result of the current economic environment and market rate increases adopted by the Federal Reserve Board.
Provision for Credit Losses. The provision for credit losses for the year ended April 30, 2006 decreased to $7,503 as compared to $9,520 for the year ended April 30, 2005. The decrease in provision for credit losses is primarily due to (i) improving economic trends, (ii) a change in portfolio mix to loans originated directly with the customer which typically have a lower loss frequency and (iii) the increase in recovery rates on repossessions and general defaults.
Net charge-offs for the year ended April 30, 2006 decreased to $7,420 compared to $9,470 for the year ended April 30, 2005. The decrease in net charge-offs for the year ended April 30, 2006 is primarily due to (i) a decrease in loss frequency and loss severity from repossessions and (ii) an increase in recoveries from defaulted loans.
The level of provision for credit losses is a key driver of overall financial performance and should be positively impacted by improvement in general economic conditions, improvements in wholesale used car prices and lower delinquency rates and net losses projected for the portfolio of Receivables Held for Investment. Any additional
economic deterioration or decline in wholesale used car prices will negatively impact provision expense to the extent that these events cause an increase in delinquency rates, bankruptcy rates or net charge-off rates in the portfolio of Receivables Held for Investment.
Servicing Revenue. On December 24, 2002, the Company entered into an agreement to provide loan servicing and collection activities on behalf of FARC. FARC, which is 40% owned by the Company, purchased a portfolio of approximately $200,000 of installment loan receivables. On March 19, 2003, the Company entered into an agreement to provide loan servicing and collection activities on $276,000 of installment loan receivables for unrelated third parties. Servicing revenue decreased to $1,884 for the year ended April 30, 2006 compared to $3,399 for year ended April 30, 2005. The decrease in servicing revenue for the year ended April 30, 2006 is due to the liquidation of serviced receivables during 2006. Revenue derived from servicing activities will increase or decrease in direct proportion to the average outstanding balance of serviced receivables.
Insurance Products. Insurance products revenue increased to $928 for year ended April 30, 2006, compared to $735 for the year ended April 30, 2005. The increase is due to an increase of 61% in loan originations for the year ended April 30, 2006. This is partially offset by lower gross margins due to the Company’s increased costs in purchasing the insurance products. Insurance products revenue is primarily driven by growth rates in the Company’s direct lending business which will affect the ability of the Company to generate fee income from marketing insurance and warranty products.
Income from Investment. Income from investment decreased to $413 for the year ended April 30, 2006 compared to $669 for the year ended April 30, 2005. The decrease in income from investment is due to the liquidation of serviced receivables during the year. Revenue derived from income from investment will increase or decrease in direct proportion to the average outstanding balance of serviced receivables.
Other Interest Income. Other interest income increased to $1,371 for the year ended April 30, 2006, compared to $427 for the year ended April 30, 2005. The increase in other interest income is due to (i) an increase in average cash due to increased collections as a result of a 43% increase in the average portfolio of Receivables Held for Investment in 2006, (ii) an increase in restricted cash due to prefunding accounts related to securitizations, and (iii) an increase in overall market interest rates as a result of the current economic environment and market rate increases adopted by the Federal Reserve Board.
Realized and 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. The net losses of $175 for the year ended April 30, 2006 and $373 for the year ended April 30, 2005 are principally due to the termination and mark to market of these positions. The realized loss recognized during 2006 and 2005 was the result of the termination of certain interest rate cap agreements which are required by the credit enhancement provider under the FIARC Credit Facility. The agreements were terminated in connection with the issuance of the 2005-A term notes on May 5, 2005 and the issuance of the 2006-A term notes issued on January 26, 2006.
Salaries and Benefit Expenses. Salaries and benefit expense increased to $10,505 for the year ended April 30, 2006, compared to $8,917 for the year ended April 30, 2005. The increase is primarily due to an increase in staff due to a 61% increase in loan originations for the year ended April 30, 2006. This is partially offset by a decrease in staff associated with a decrease in the Company’s serviced portfolio. The overall number of employees of the Company is primarily correlated to (i) the total number of receivables managed, since the majority of the Company’s employees are involved in loan collection activities and (ii) origination growth rates which require additional marketing and credit underwriting personnel.
Operating Expenses. Operating expenses decreased to $3,965 for the year ended April 30, 2006, compared to $4,801 for the year ended April 30, 2005. The decrease in operating expenses for the fiscal year 2006 period is due to the decreased servicing costs associated with improvements in delinquency and repossession rates and a decline in total managed receivables. Overall operating expenses are generally correlated to the total number of receivables managed by the Company, delinquency and repossession rates and the composition of loans originated between indirect and direct consumer loans. The decrease for the year ended April 30, 2006 was primarily due to an increase in the dollar amount of expenses which the Company was able to capitalize as deferred acquisition costs. Although expenses increased during the year, the Company was able to capitalize a higher level of these expenses due to the significant increase in origination volume and increased efficiency in its loan origination functions. The decline in
operating expenses was also positively impacted by lower collection-related costs as a result of improving credit quality.
General and Administrative. General and administrative expenses increased to $4,655 for the year ended April 30, 2006, compared to $3,732 for the year ended April 30, 2005. The year ended April 30, 2006 experienced an increase in professional fees due to the Company’s defense of a class action lawsuit. General and administrative costs tend to be more fixed in nature and not as dependent on the overall level of managed receivables.
For the year ended April 30, 2006, the Company incurred legal expenses of $350 and settlement costs of $450 in connection with its defense and settlement of a class action lawsuit filed against a wholly-owned subsidiary alleging violations of the Fair Credit Reporting Act. The Company’s decision to settle the lawsuit was prompted by the trial court’s granting the plaintiff’s motion for summary judgment on January 20, 2006. The Company and its counsel believe that the court’s ruling is contrary to the statute and the facts in the case, and believe that an appeal would be successful. However, given the trial court’s ruling, the Company concluded that settlement is preferable to continuing to incur the costs associated with the appeal and defense of the lawsuit.
Other Interest Expense. Other interest expense increased to $1,323 for year ended April 30, 2006, compared to $565 for the year ended April 30, 2005. The increase was primarily due to (i) a 40% increase for the year ended April 30, 2006 in the average outstanding borrowings on the Company’s working capital line and (ii) the related party note having an outstanding balance of $2,500 for the entire year ended April 30, 2006, as compared to an outstanding balance of $2,500 for one month for the year ended April 30, 2005.
Fiscal Year Ended April 30, 2005, Compared to Fiscal Year Ended April 30, 2004 (dollars in thousands)
Interest Income. Total interest income for the year ended April 30, 2005 decreased to $28,272 compared to $30,498 for the year ended April 30, 2004.
The level of interest income, a primary driver of financial results, is impacted by the average outstanding balance of the portfolio of Receivables Held for Investment, the weighted average interest rate on receivables originated by the Company, the mix of direct and indirect lending activities and the level of early prepayments and charge-offs. Interest income on Receivables Held for Investment decreased 7% for the year ended April 30, 2005 compared to the year ended April 30, 2004. This is a reduction of 97 basis points, or a 7% decrease, in the yield on Receivables Held for Investment for the year ended April 30, 2005 compared the year ended April 30, 2004. The reduction in yield for the year ended April 30, 2005 is due to (i) a lower weighted average interest rate on the performing portfolio which reflects the Company’s increased focus on receivables originated directly to consumers which typically carry lower interest rates and (ii) the overall competitive environment for receivables originated through dealerships.
Interest Expense. Interest expense for the year ended April 30, 2005 decreased to $7,616 compared to $8,438 for the year ended April 30, 2004. Interest expense on Receivables Held for Investment decreased 10% for the year ended April 30, 2005. The reduction in interest expense is primarily due to the expiration of certain interest rate swaps in April 2004 which was offset by increasing short term interest rates during 2005 and a decline in the average debt outstanding during 2005. The average cost of debt decreased 23 basis points, or 6%, on the outstanding borrowings for the year ended April 30, 2005, compared to the year ended April 30, 2004, while the average outstanding debt declined by 4% as a result of a slightly lower average portfolio of Receivables Held for Investment.
Provision for Credit Losses. The provision for credit losses for the year ended April 30, 2005 decreased to $9,520 as compared to $12,428 for the year ended April 30, 2004. The decrease in provision for credit losses is primarily due to (i) improving economic trends, (ii) a change in portfolio mix to loans originated directly with the customer which typically have a lower loss frequency and (iii) the increase in recovery rates on repossessions and general defaults.
Net charge-offs for the year ended April 30, 2005 decreased to $9,470 compared to $12,626 for the year ended April 30, 2004. The decrease in net charge-offs for the year ended April 30, 2005 is primarily due to (i) a decrease in loss frequency and loss severity from repossessions and (ii) an increase in recoveries from defaulted loans.
The level of provision for credit losses is a key driver of overall financial performance and should be positively impacted by improvement in general economic conditions, improvements in wholesale used car prices and lower delinquency rates and net losses projected for the portfolio of Receivables Held for Investment. Any additional economic deterioration or decline in wholesale used car prices will negatively impact provision expense to the extent that these events cause an increase in delinquency rates, bankruptcy rates or net charge-off rates in the portfolio of Receivables Held for Investment.
Servicing Revenue. On December 24, 2002, the Company entered into an agreement to provide loan servicing and collection activities on behalf of FARC. FARC, which is 40% owned by the Company, purchased a portfolio of approximately $200,000 of installment loan receivables. On March 19, 2003, the Company entered into an agreement to provide loan servicing and collection activities on $276,000 of installment loan receivables for unrelated third parties. Servicing revenue decreased to $3,399 for the year ended April 30, 2005 compared to $4,889 for year ended April 30, 2004. The decrease in servicing revenue for the year ended April 30, 2005 is due to the liquidation of serviced receivables during 2005. Revenue derived from servicing activities will increase or decrease in direct proportion to the average outstanding balance of serviced receivables.
Other Finance Charges and Fees. Other finance charges and fees increased to $2,439 for the year ended April 30, 2005, compared to $1,666 for the year ended April 30, 2004. The increase is attributable to (i) increased collections and payments allocated to late fees and other income as a result of changes made to the methodology under which the Company allocated cash received to interest, uncollected fees and principal and (ii) an increase in loans originated for a third party. Income derived from late fees and collection activities are recognized when received, and therefore can be potentially volatile from period to period based on overall cash collection, seasonality, delinquency rates and other factors.
Other finance charges and fees are driven by a number of factors including overall delinquency rates, the percentage of customers utilizing electronic payment methods and growth rates in the Company’s direct lending business which will affect the ability of the Company to generate fee income from marketing insurance and warranty products.
Insurance Products. Insurance products revenue increased to $735 for the year ended April 30, 2005 from $107 for the year ended April 30, 2004. The increase is due to the Company selling insurance products for the entire year ended April 30, 2005 as opposed to the Company only selling insurance products for part of the year for the year ended April 30, 2004.
Income from Investment. Income from investment reflects 40% of total servicing revenue earned from servicing activities performed by the Company for FARC and 40% of interest income earned on junior mezzanine debt. Income from investment decreased to $669 for the year ended April 30, 2005 compared to $1,009 for the year ended April 30, 2004. The decrease in income from investment for fiscal year 2005 is due to the liquidation of the FARC portfolio during 2005. Income from investments is impacted by the outstanding balance of investments held, general market interest rates and the profitability of FARC. The Company anticipates that contributions from the FARC investment will continue to decline as the portfolio of receivables owned by FARC amortizes.
Other Interest Income. Other interest income decreased to $427 for the year ended April 30, 2005, compared to $460 for the year ended April 30, 2004. Other interest income is impacted by and comprised of the outstanding balance of the junior mezzanine debt owned by FARC, interest earned on overnight deposits, and general market interest rates.
Realized and 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. The net losses of $373 for the year ended April 30, 2005 and $34 for the year ended April 30, 2004 are principally due to the termination and mark to market of these positions. The realized loss recognized during 2005 was the result of the termination of certain interest rate cap agreements which are required by the credit enhancement provider under the FIARC Credit Facility. The agreements were terminated in connection with the issuance of the 2005-A term notes on May 5, 2005.
Salaries and Benefit Expenses. Salaries and benefit expense increased to $8,917 for the year ended April 30, 2005, compared to $8,538 for the year ended April 30, 2004. The increase is primarily due to (i) higher benefits costs and higher staffing levels required to accommodate the increase in direct lending activities, and (ii) an increase
in temporary labor to support increased origination volume. This is partially offset by a decrease in salaries and benefits due to the consolidation and restructuring of certain management positions and a decline in loan collections and customer service personnel as a result of the decline in total managed receivables. The overall number of employees of the Company is primarily correlated to (i) the total number of receivables managed, since the majority of the Company’s employees are involved in loan collection activities and (ii) origination growth rates which require additional marketing and credit underwriting personnel.
Operating Expenses. Operating expenses decreased to $4,801 for the year ended April 30, 2005, compared to $5,098 for the year ended April 30, 2004. The decrease in operating expenses for the fiscal year 2005 period is due to the decreased servicing costs associated with improvements in delinquency and repossession rates and a decline in total managed receivables. Overall operating expenses are generally correlated to the total number of receivables managed by the Company, delinquency and repossession rates and the composition of loans originated between indirect and direct consumer loans.
General and Administrative. General and administrative expenses increased to $3,732 for the year ended April 30, 2005, compared to $3,723 for the year ended April 30, 2004. General and administrative costs tend to be more fixed in nature and not as dependent on the overall level of managed receivables.
Other Interest Expense. Other interest expense increased to $565 for year ended April 30, 2005, compared to $468 for the year ended April 30, 2004. The increase was primarily due to (i) a 23% increase in the average outstanding borrowings on the Company’s working capital line and (ii) an increase in the average interest rate of 6.8% for the year ended April 30, 2005, compared to 2004.
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 enhancements 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 for the origination of receivables. The Company originated $254 million of Receivables Held for Investment for 2006 compared to $158 million in 2005.
The Company funds loan originations through a combination of two warehouse credit facilities. The FIRC credit facility generally permits the Company to borrow up to the outstanding principal balance of qualified receivables, not to exceed $50 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 of 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 is obligated to meet certain financial covenants. Noncompliance may significantly affect cash flow.
The Company’s most significant source of cash flow is the principal and interest payments received from its receivable portfolios. The Company received such payments in the amount of $146 million in 2006 and $129 million in 2005. These funds are used to repay the amounts borrowed under the Company’s credit facilities and other holding costs, primarily interest expense and servicing and custodial fees. During the years ended April 30, 2006 and 2005, the Company required net cash of $108 million and $29 million, respectively, as the receivables originated exceeded portfolio collections. The Company relies on borrowed funds to provide cash flow in periods of growth. As of April 30, 2006, the Company had $153 million of available capacity in the FIRC and FIARC credit facilities to fund future growth.
In addition to the cash flow generated from the principal and interest collections on its receivables portfolio, the Company collects servicing fees. Servicing fees range from 1.4% to 2.5% of the outstanding principal balance of the loans in the portfolio. Cash flow 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, 2006 and 2005 the Company’s unencumbered cash was $3,380,367 and $2,413,738 respectively. Cash and servicing fees collected after year-end, but related to the prior year’s activity totaled $153,661 and $271,127 as of April 30, 2006 and 2005, respectively. The decrease in cash and servicing fees collected after year-end is primarily due to the decrease in the amount of third party loans serviced as of April 30, 2006. Management believes the unencumbered cash and cash inflows and amounts available under the working capital facility are adequate to fund cash requirements for operations.
Contractual Obligations. The following table summarizes the expected scheduled payments, excluding interest, where applicable, under the Company’s contractual obligations:
(1) Yearly contractual obligations may vary as principal payments are determined by cash received on the underlying asset, and may differ from the expected scheduled payments.
Capitalization. The Company expects 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 its loan originations 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, 2002 the Company issued $159 million in asset-backed notes (“Term Notes”) secured by discrete pools of receivables. These notes were subsequently called and redeemed in March, 2005. In November, 2003, the Company issued $140 million in Term Notes secured by a discrete pool of receivables. In May, 2005, the Company issued $175 million in Term Notes secured by a discrete pool of receivables. In January, 2006, the Company issued $189 million in Term Notes secured by a discrete pool of receivables. 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 and dealer fees was 4.5% and 3.5% for the fiscal years ending April 30, 2006 and 2005, respectively.
Warehouse Facilities as of April 30, 2006
Warehouse Facilities - Credit Enhancement as of April 30, 2006
FIRC - In order to obtain a lower cost of funding, the Company has agreed to maintain credit enhancement insurance covering the receivables pledged as collateral under the FIRC credit facility. The facility lenders are named as additional insureds under these policies. The coverages are obtained on each receivable at the time it is originated by the Company and the applicable premiums are prepaid for the life of the receivable. Generaly, 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. The Company carries these coverages at its sole expense, and neither the vehicle purchasers nor the dealers are charged for the coverages nor are they usually aware 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.
The premiums that the Company paid during fiscal year 2006 for its three credit enhancement insurance coverages, of which the largest component is basic ALPI insurance, represented approximately 1.9% of the principal amount of the receivables originated during the year. Aggregate premiums paid for ALPI coverage alone during the fiscal years ended April 30, 2004, 2005 and 2006 were $3,066,131, $3,669,198, and $3,768,534, respectively, and accounted for 3.5%, 2.3% and 1.4% of the aggregate principal balance of the receivables originated during such respective periods.
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% 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% 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. 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, 2006, the Insurance Subsidiary had capital and surplus of $2,766,495 and unencumbered cash reserves of $1,442,680 in addition to $3,430,734 in a 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.
FIARC - Credit Enhancement for the FIARC warehouse facility is provided to the commercial paper investors by a 6% overcollaterization level and a cash reserve account equal to 1% of the receivables held by FIARC. The Company is not a guarantor of, or otherwise a party to, such commercial paper.
Warehouse Facilities - Agents and Expirations
On December 4, 2003, the FIRC facility was renewed, under similar terms and conditions, at the $50 million commitment level until December 2, 2004, and was subsequently extended until February 14, 2007. On June 15, 2004, the FIRC facility was extended to $65 million, and reverted back to $50 million on September 13, 2004. As of April 30, 2005 and 2006, there was $43.6 and $47.1 million, respectively, outstanding.
On January 29, 2004, following a short-term extension of the original maturity date, the FIARC facility was renewed, under similar terms and conditions, to December 2, 2004, and was subsequently extended until February 14, 2007. In connection with the renewal, the Company obtained approval from the lender to eliminate the requirement that a surety bond be maintained to provide additional enhancement to the commercial paper investors. As a result, the 0.35% surety bond premium and the 0.25% unused surety bond premium were eliminated. In exchange, the Company agreed to increase the program fee paid to the lender from 0.30% to 0.55% and to increase the unused fee paid to the lender from 0.25% to 0.30%. As of April 30, 2005 and 2006, there was $127.9 and $-0- million, respectively, outstanding.
Management presently intends to seek further extensions to these warehouse facilities prior to the current expiration dates. 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 at each of their respective expiration dates.
The following table contains pertinent information on the Term Notes as of April 30, 2006.
Credit enhancement on the Term Note is as follows:
Term Notes - On November 20, 2003, the Company, through its indirect, wholly-owned subsidiary First Investors Auto Owner Trust 2003-A (“2003 Auto Trust”) completed the issuance of $139,661,000 of 2.58% Class A asset-backed notes (“2003-A Term Notes”). The initial pool of automobile receivables transferred to the 2003 Auto Trust totaled $114,726,891, which was previously owned by FIRC and FIARC, secure the 2003-A Term Notes. In addition to the issuance of the Class A Notes, the 2003 Auto Trust also issued a $5,065,891 Class B Note that was retained by the Company and pledged to secure the Working Capital Facility as further described below. Proceeds from the issuance, which totaled $139,656,629 were used to (i) fund a $30,000,000 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 2003-A term note issuance, and (v) fund an initial cash reserve account of 0.5% or $573,635 of the initial receivables pledged. The Class A Term Notes bear interest at 2.58% and requires monthly principal reductions sufficient to reduce the balance of the Class A Term Notes to 96.1% of the outstanding balance of the underlying receivables pool. The final maturity of the 2003-A Term Notes is April 20, 2011. The Class B Note does not bear interest but requires principal reductions sufficient to reduce the balance of the Class B Note to 3.9% 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. In the event that certain asset quality covenants are not met, the reserve account target level will increase to 6% of the then current principal balance of the receivables pool. As of April 30, 2005 and 2006, the outstanding principal balances on the 2003-A term notes were $70,050,511 and $37,714,745, respectively.
On May 5, 2005, the Company, through its indirect, wholly-owned subsidiary First Investors Auto Owner Trust 2005-A (“2005 Auto Trust”) completed the issuance of $69,000,000 of 3.57% Class A-1 asset-backed notes and $106,493,000 of 4.23% Class A-2 asset-backed notes (collectively “2005-A Term Notes”), for a total of $175,493,000 of asset backed notes. The initial pool of automobile receivables transferred to the 2005 Auto Trust totaled $150,920,721, which was previously owned by FIRC and FIARC, and secures the 2005-A Term Notes. In addition to the issuance of the Class A-1 and Class A-2 Notes, the 2005 Auto Trust also issued a $5,427,619 Class B Note that was retained by the Company and pledged to secure the Working Capital Facility as further described below. Proceeds from the issuance, which totaled $175,487,827 were used to (i) fund a $29,999,898 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 2005-A Term Note issuance, and (v) fund an initial cash reserve account of 1% or $1,509,207 of the initial receivables pledged. The Class A-1 and Class A-2 Term Notes bear interest at 3.57% and 4.23%, respectively, and requires monthly principal reductions sufficient to reduce the balance of the Class A Term Notes to 95.75% of the outstanding balance of the underlying receivables pool. The final maturity of the Class A-1 and Class A-2 Term Notes is December 17, 2007 and July 16, 2012, respectively. The Class B Note does not bear interest but requires principal reductions sufficient to reduce the balance of the Class B Note to 4.25% 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. In the event that certain asset quality covenants are not met, the reserve account target level will increase to 2% of the then current principal balance of the receivables pool. As of April 30, 2006, the outstanding principal balances on the 2005-A Class A-1 and Class A-2 term notes were $-0- and $106,161,988, respectively.
On January 26, 2006, the Company, through its indirect, wholly-owned subsidiary First Investors Auto Owner Trust 2006-A (“2006 Auto Trust”) completed the issuance of $32,000,000 of 4.57% Class A-1 asset-backed notes, $47,000,000 of 4.87% Class A-2 asset-backed notes, $74,000,000 of 4.93% Class A-3 asset-backed notes, and $36,060,000 of 5.00% Class A-4 asset-backed notes (collectively “2006-A Term Notes”), for a total of $189,060,000 of asset backed notes. The initial pool of automobile receivables transferred to the 2006 Auto Trust totaled $151,939,112, was previously owned by FIRC and FIARC, and secures the 2006-A Term Notes. In addition to the issuance of the Class A-1, Class A-2, Class A-3, and Class A-4 notes, the 2006 Auto Trust also issued a $2,879,112 Class B Note that was retained by the Company and pledged to secure the Working Capital Facility as further described below. Proceeds from the issuance, which totaled $188,445,709 were used to (i) fund a $40,000,000 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 2006-A Term Note issuance, and (v) fund an initial cash reserve account of 1% or $1,519,391 of the initial receivables pledged. The 2006-A Term Notes require monthly principal reductions sufficient to reduce the balance of the notes to 96.75% of the outstanding balance of the underlying receivables pool. The final maturity of the Class A-1, Class A-2, Class A-3, and Class A-4 Term Notes is January 16, 2007, March 16, 2009, February 15, 2011, and April 15, 2013, respectively. The Class B Note does not bear interest but requires principal reductions sufficient to reduce the balance of the Class B Note to 3.25% 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. In the event that certain asset quality covenants are not met, the reserve account target level will increase to the greater of 2% of the initial pool balance or 6% of the then current principal balance of the receivables pool. As of April 30, 2006, the outstanding principal balances on the 2006-A Class A-1, Class A-2, Class A-3, and Class A-4 term notes were $15,647,831, $47,000,000, $74,000,000 and $36,060,000, respectively.
Working Capital Facility. The facility is provided to a special-purpose, wholly-owned subsidiary of the Company, First Investors Residual Funding LP. This facility revolves monthly in accordance with a borrowing base consisting of the overcollateralization amount and reserve account 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 and the existing and future term note facilities. The outstanding borrowings under the facility bear interest at one-month LIBOR plus 2.25%. In addition, a commitment fee of 1.5% is paid on the total amount of this facility. On October 26, 2004, the Working Capital Facility was extended until October 10, 2005, increasing the commitment amount from $9 million to $13.5 million. The interest rate remained at LIBOR plus 2.25% and the commitment fee paid on the total available amount of the facility was maintained at 1.5%. On August 15, 2005, the Working Capital Facility was extended until February 15, 2006, increasing the commitment amount to $23.5 million, and was subsequently extended on February 15, 2006 until February 14, 2007. The interest rate remained at LIBOR plus 2.25% and the commitment fee paid on the total available amount of the facility was maintained at 1.5%. As of April 30, 2005 and 2006, there was $10,500,000 and $16,454,329, 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.
Related Party 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. On December 6, 2004, the original $2.5 million shareholder loan was replaced with a $2.5 million loan containing identical terms and conditions between the Company and a limited partnership that is affiliated with a current shareholder and member of the Board of Directors The proceeds of the borrowings have been 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% 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. There was $2.5 million outstanding under these facilities as of April 30, 2005 and 2006. For the fiscal years ended April 30, 2004, 2005, 2006, the Company recorded interest expense under these facilities of $67,676, $17,808 and $250,000, respectively.
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 financial and non-financial covenants governing these financing arrangements at April 30, 2006.
Interest Rate Management. The Company’s warehouse credit facilities and working capital 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.
During fiscal year 2006, as a requirement of the FIARC commercial paper facility, the Company entered into seven interest rate cap transactions, with a strike rate of 6%. The aggregate initial notional amount of the caps was $131,710,159 which amortizes over six years. The Company paid $449,746 in premium to purchase these caps. The interest rate caps were not designated as hedges, and accordingly, changes in the fair value of the interest rate caps are recorded as realized gains or losses and reflected in net income On January 26, 2006, the Company terminated all interest rate caps outstanding in exchange for proceeds of $275,000. The caps were terminated following the repayment of all balances outstanding under the FIARC facility prior to the issuance of the 2006-A Term Notes. As a result, a realized loss of $174,746 was incurred relative to the aggregate market value of the interest rate caps.
During fiscal year 2005, as a requirement of the FIARC commercial paper facility, the Company entered into nine interest rate cap transactions, with strike rates between 5% and 6%. The aggregate initial notional amount of the caps was $126,086,843 which amortized over six years. The Company paid an aggregate of $1,213,097 in premiums to purchase these caps. 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 income. On April 28, 2005, the Company terminated all interest rate caps outstanding in exchange for proceeds of $840,000. The caps were terminated following the repayment of all amounts outstanding under the FIARC facility prior to the issuance of the 2005-A term notes. As a result, a realized loss of $373,097 was incurred relative to the aggregate market value of the interest rate caps.
During fiscal year 2004, as a requirement of the FIARC commercial paper facility, the Company entered into various 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 were recorded as unrealized gains or losses and reflected in net income. On December 2, 2003, the Company terminated all interest rate caps outstanding in exchange for proceeds of $356,000. The caps were terminated following the repayment of all outstandings under the FIARC facility following the issuance of the 2003-A term notes. As a result, a realized loss of $14,000 was incurred relative to the aggregate market value of the interest rate caps.
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 $2,332,342 as of April 30, 2006 and $2,248,599 as of April 30, 2005 as a percentage of Receivables Held for Investment of $368,878,300 as of April 30, 2006 and $245,581,749 as of April 30, 2005 was 0.6% and 0.9%, respectively.
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 60 to 90 days after the payment default.
The Company retains the credit risk associated with the receivables originated. The Company purchases credit enhancement insurance from third party insurers which cover the risk of loss upon default and certain other risks. The Company established a captive insurance subsidiary to reinsure certain risks under the credit enhancement insurance coverage for all receivables. In addition, receivables financed under the Auto Trust, FIARC and FIACC commercial paper facilities do not carry default insurance. Provisions for credit losses of $7,503,245, $9,519,607, and $10,337,718 have been recorded for the years ended April 30, 2006, April 30, 2005, and April 30, 2004, respectively.
The Company calculates the allowance for credit losses in accordance with SFAS No. 5, Accounting for Contingencies. SFAS No. 114, Accounting by Creditors for Impairment of a Loan, does not apply to loans currently held by the Company because they 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 is a six-month migration analysis whereby the Company compares the aging status of each loan from six months prior to the aging 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 the estimated loss per loan, which is based on historical information. Effective the quarter ended April 30, 2005, the Company elected to increase its allowance for loan losses against loans that were greater than 120 days past due and loans in which the collateral had been assigned for repossession but had not yet been repossessed as of the reporting date. The Company believes that this increase is warranted in light of the change in federal bankruptcy laws enacted during the period and the recognition that the migration trends of severely delinquent loans and loans subject to bankruptcy are expected to become more protracted. Based on this, the Company has assigned a specific allowance against these loans equal to the outstanding balance of loans in these categories less the estimated recovery amount based on current data regarding liquidation of the collateral and collection of any additional payments. The Company utilized its most recent recovery rates in order to assess fair value of these loans. For loans that are not classified into these categories, the historical migration pattern is utilized in order to establish the estimated impairment. Despite the increase in allowance associated with the higher delinquency loans and bankrupt accounts, the total allowance for loan losses decreased during the period as a percentage of Receivables Held for Investment due to improving overall delinquency trends and lower repossession and loss rates. The allowance for credit losses is based on estimates and qualitative evaluations. Ultimate losses may vary from current estimates. These estimates are reviewed periodically and as adjustments, either positive or negative, become necessary, they are reported in earnings in the period they become known.
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):
(1) Delinquent amounts outstanding do not include loans in bankruptcy status since collection activity is limited and highly regulated for bankrupt accounts.
The lower annualized charge-off rate results from a lower number of repossessions coupled with higher recovery rates on the repossessed collateral.
As of April 30, 2006, there were 239 accounts totaling $2,462,970 that were in bankruptcy status and were more than 30 days past due. As of April 30, 2005, there were 483 accounts totaling $4,627,082 that were in bankruptcy status and were more than 30 days past due. As of April 30, 2006 and 2005, 92% and 90%, respectively, of the bankruptcy delinquencies filed for protection under Chapter 13.
New Accounting Pronouncements
In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments-an amendment of FASB Statements No. 133 and 140 (“SFAS 155”). This statement amends SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (“SFAS 133”), and SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities and resolves issues addressed in SFAS 133 Implementation Issue No. D1, “Application of Statement 133 to Beneficial Interest in Securitized Financial Assets”. This Statement: (a) permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation; (b) clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS 133; (c) establishes a requirement to evaluate beneficial interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation; (d) clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives; and, (e) eliminates restrictions on a qualifying special-purpose entity’s ability to hold passive derivative financial instruments that pertain to beneficial interests that are or contain a derivative financial instrument. The standard also requires presentation within the financial statements that identifies those hybrid financial instruments for which the fair value election has been applied and information on the income statement impact of the changes in fair value of those instruments. The Company is required to apply SFAS 155 to all financial instruments acquired, issued or subject to a remeasurement event beginning January 1, 2007 although early adoption is permitted as of the beginning of an entity’s fiscal year. The provisions of SFAS 155 are not expected to have a financial statement impact at adoption; however, the standard could affect the future income recognition for securitized financial assets because there may be more embedded derivatives identified with changes in fair value recognized in net income.
In May 2005, SFAS No. 154, Accounting Changes and Error Corrections, was issued. This statement applies to all voluntary changes in accounting principles and requires retrospective application to prior periods’ financial statements of changes in accounting principles, unless this would be impracticable. This statement also makes a distinction between “retrospective application” of an accounting principle and the “restatement” of financial
statements to reflect the correction of an error. This statement is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company does not expect the adoption of this interpretation to have a material impact on its financial position, cash flows and results of operations.
In December 2004, the FASB issued SFAS No. 123(R), Share-Based Payment -a revision to SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123(R)”) that addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. SFAS No. 123(R) eliminates the ability to account for share-based compensation transactions using APB Opinion No. 25, Accounting for Stock Issued to Employees, and generally requires instead that such transactions be accounted for using a fair-value-based method.
SFAS No. 123(R) is effective as of the beginning of the fiscal year that begins after June 15, 2005. SFAS 123(R) applies to all awards granted after the required effective date and to such awards modified, repurchased, or cancelled after that date. The cumulative effect of initially applying SFAS No. 123(R), if any, is recognized as of the required effective date. As of the required effective date, all public entities that used the fair-value-based method for either recognition or disclosure under SFAS No. 123 will apply SFAS No. 123(R) using a modified version of prospective application. Under that transition method, compensation cost is recognized on or after the required effective date for the portion of outstanding awards for which the requisite service has not yet been rendered, based on the grant-date fair value of those awards calculated under SFAS No. 123 for either recognition or pro forma disclosures. For periods before the required effective date, those entities may elect to apply a modified version of retrospective application under which financial statements for prior periods are adjusted on a basis consistent with the pro forma disclosures required for those periods by SFAS No. 123. The Company expects compensation expense related to SFAS No. 123(R) to be approximately $169,000 for the fiscal year ending April 30, 2007.
ITEM 7A.
ITEM 7A. QUANTATATIVE AND QUALITATIVE DISCLOSURES ABOUT 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 bear interest at floating rates tied to either a commercial paper index or LIBOR.
As of April 30, 2006, the Company had $63.5 million of floating rate secured debt outstanding. For every 1% increase in the commercial paper rate or LIBOR annual after-tax earnings would decrease by approximately $416,148 assuming the Company maintains a level amount of floating rate debt and assuming an immediate increase in rates. As of April 30, 2005, the Company had $182.1 million of floating rate secured debt outstanding. For every 1% increase in commercial paper rates or LIBOR, annual after-tax earnings would decrease by approximately $1,192,507 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 not 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.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
In accordance with Exchange Act Rules 13a-15 and 15d-15, the Company carried out an evaluation, under the supervision and with the participation of management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of April 30, 2006 to provide reasonable assurance that information required to be disclosed in the Company’s reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.
There has been no change in the Company’s internal controls over financial reporting that occurred during the year ended April 30, 2006 that has materially affected, or is reasonably likely to materially affect, the Company’s internal controls over financial reporting, other than increased controls surrounding the Company’s reporting for income taxes. Historically, the Company has utilized third parties to prepare federal and state tax returns, and to provide accounting entries to record differences between the current and deferred tax accounts on the Company’s balance sheet. In an effort to provide adequate assurances that federal and state tax returns continue to be filed in a timely and accurate manner, and specifically to ensure that entries made to record current and deferred tax assets and liabilities are fully documented, the Company has instituted additional reconciliation and testing procedures which will enhance internal controls and provide additional information to management on the nature of these assets and liabilities. The Company has also elected to engage a national accounting firm to provide advisory and compliance services with respect to the Company’s federal and state tax obligations.
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 2006 Annual Meeting of Shareholders expected to be held on September 6, 2006, which is to be filed with the Securities and Exchange Commission, and is incorporated herein by reference.
Information related to the nomination of directors appears under the caption “Corporate Governance” in the Company’s Proxy Statement for the 2006 Annual Meeting of Shareholders expected to be held on September 6, 2006, which is to be filed with the Securities and Exchange Commission, and is incorporated herein by reference.
Information related to the Company’s Code of Business Conduct and Ethics, adopted April 28, 2004, appears under the caption “Corporate Governance” in the Company’s Proxy Statement for the 2006 Annual Meeting of Shareholders expected to be held on September 6, 2006, which is to be filed with the Securities and Exchange Commission, and is incorporated herein by reference. The Code of Business Conduct and Ethics has also been filed under Item 15 as an exhibit to this Form 10-K.
The Audit Committee of the Board of Directors has designated one or more persons as financial experts. Information related to the financial expert designation and the Audit Committee appears under the caption “Other Information Concerning the Board of Directors” in the Company’s Proxy Statement for the 2006 Annual Meeting of Shareholders expected to be held on September 6, 2006, 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 “Executive Compensation” in the Company’s Proxy Statement for the 2006 Annual Meeting of Shareholders expected to be held on September 6, 2006, 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 2006 Annual Meeting of Shareholders expected to be held on September 6, 2006, 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 “Related Party Transactions” in the Company’s Proxy Statement for the 2006 Annual Meeting of Shareholders expected to be held on September 6, 2006, which is to be filed with the Securities and Exchange Commission, and is incorporated herein by reference.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information related to this item appears under the caption “Proposal 2: Ratification of appointment of Independent Auditors” in the Company’s proxy statement for the 2006 annual meeting of shareholders expected to be held on September 6, 2006, which is to be filed with the Securities and Exchange Commission, and is incorporated herein by reference.
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)
-
Intentionally omitted.
10.21(a)
-
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
10.110(r)
-
Amended and Restated Trust Agreement dated November 20, 2003 between First Investors Auto Funding Corporation and Deutsche Bank Trust Company Delaware.
10.111(r)
-
Indenture dated November 20, 2003 between First Investors Auto Owner Trust 2003-A and Wells Fargo Bank Minnesota, National Association.
10.112(r)
-
Sale and Allocation Agreement dated November 20, 2003 between First Investors Auto Owner Trust 2003-A, First Investors Auto Funding Corporation, First Investors Servicing Corporation and Wells Fargo Bank Minnesota, National Association.
10.113(r)
-
Insurance Agreement dated November 20, 2003 between MBIA Insurance Corporation, First Investors Servicing Corporation, First Investors Financial Services, Inc., First Investors Auto Funding Corporation, First Investors Auto Owner Trust 2003-A, Deutsche Bank Trust Company Delaware and Wells Fargo Bank Minnesota, National Association.
10.114(s)
-
Amended and Restated Trust Agreement dated May 5, 2005 between First Investors Auto Funding Corporation and Deutsche Bank Trust Company Delaware.
10.115(s)
-
Indenture dated May 5, 2005 between First Investors Auto Owner Trust 2005-A and Wells Fargo Bank Minnesota, National Association.
10.116(s)
-
Sale and Allocation Agreement dated May 5, 2005 between First Investors Auto Owner Trust 2005-A, First Investors Auto Funding Corporation, First Investors Servicing Corporation and Wells Fargo Bank Minnesota, National Association.
10.117(s)
-
Insurance Agreement dated May 5, 2005 between MBIA Insurance Corporation, First Investors Servicing Corporation, First Investors Financial Services, Inc., First Investors Auto Funding Corporation, First Investors Auto Owner Trust 2005-A, Deutsche Bank Trust Company Delaware and Wells Fargo Bank Minnesota, National Association.
10.118(s)
-
Servicing Agreement dated May 5, 2005 between Wells Fargo Bank Minnesota, National Association and First Investors Auto Owner Trust 2005-A.
10.119(s)
-
Administration Agreement dated May 5, 2005 between Wells Fargo Bank Minnesota, National Association, First Investors Financial Services, Inc. and First Investors Auto Owner Trust 2005-A.
10.120(s)
-
Contribution Agreement dated May 5, 2005 between First Investors Financial Services, Inc. and First Investors Auto Funding Corporation.
10.121(t)
-
2005 Employee Stock Option Plan of the Registrant.
10.122(t)
-
Amendment No. 5 to Note Purchase Agreement dated August 15, 2005, between First Investors Residual Funding LP, Variable Funding Capital Corporation, Wachovia Bank, NA, and Wachovia Capital Markets, LLC.
10.123(t)
-
Amendment No. 7 to Security Agreement dated August 15, 2005, between First Investors Residual Funding LP, First Investors Financial Services, Inc., and Wachovia Capital Markets, LLC.
10.124(u)
-
Amended and Restated Trust Agreement dated January 26, 2006 between First Investors Auto Funding Corporation and Wells Fargo Delaware Trust Company.
10.125(u)
-
Indenture dated January 26, 2006 between First Investors Auto Owner Trust 2006-A and Wells Fargo Bank, National Association.
10.126(u)
-
Sale and Allocation Agreement dated January 26, 2006 between First Investors Auto Owner Trust
(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.
(r)
-
Exhibit previously filed on January 31, 2004 Third Quarter Form 10-Q and incorporated herein by reference.
(s)
-
Exhibit previously filed on 2004 Form 10-K and incorporated herein by reference.
(t)
-
Exhibit previously filed on 2005 Form 10-K and incorporated herein by reference.
(u)
-
Exhibit previously filed on October 31, 2005 Second Quarter Form 10-Q and incorporated herein by reference.
(v)
-
Exhibit previously filed on January 31, 2006 Third Quarter Form 10-Q and incorporated herein by reference.
(b) Reports on Form 8-K
Form 8-K filed March 9, 2006 reporting third quarter financial results.
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.
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.
FIRST INVESTORS FINANCIAL SERVICES GROUP, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of April 30, 2005 and 2006
Consolidated Statements of Earnings for the Years Ended April 30, 2004, 2005 and 2006
Consolidated Statement of Shareholders’ Equity for the Years Ended April 30, 2004, 2005 and 2006
Consolidated Statements of Cash Flows for the Years Ended April 30, 2004, 2005 and 2006
Notes to Consolidated Restated Financial Statements
REPORT OF INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM
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, 2006 and 2005, and the related consolidated statements of earnings, shareholders’ equity and cash flows for each of the three years in the period ended April 30, 2006. 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 the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, 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, 2006 and 2005, and the results of their operations and their cash flows for each of the three years in the period ended April 30, 2006, in conformity with accounting principles generally accepted in the United States of America.
FIRST INVESTORS FINANCIAL SERVICES GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS - APRIL 30, 2005 and 2006
The accompanying notes are an integral part of these consolidated financial statements.
FIRST INVESTORS FINANCIAL SERVICES GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
For the Years Ended April 30, 2004, 2005 and 2006
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, 2004, 2005 and 2006
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, 2004, 2005 and 2006
The accompanying notes are an integral part of these consolidated financial statements.
FIRST INVESTORS FINANCIAL SERVICES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
April 30, 2004, 2005 and 2006
1. The Company
Organization. First Investors Financial Services Group, Inc. (First Investors) 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 Servicing Corporation (FISC), 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 originating and holding for investment retail installment contracts and promissory notes secured by new and used automobiles originated by factory authorized franchised dealers or directly through consumers. As of April 30, 2006, approximately 30% and 16% of Receivables Held for Investment had been originated in Texas and Georgia, respectively. 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 performed servicing and collection activities on a portfolio of receivables originated for investment as well as on a portfolio of receivables originated 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 was the general partner owning 70% of the partnership interests and First Union Investors, Inc. served as the limited partner and owned 30% of the partnership interests. On September 19, 2003, First Investors Financial Services, Inc. purchased the limited partnership interests previously held by First Union Investors, Inc. 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.
On December 24, 2002, the Company purchased 40% of the common stock 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, 2006, FISC performs servicing and collection functions on a managed receivables portfolio of approximately $475 million.
2. Significant Accounting Policies
Basis of Presentation. The consolidated financial statements include the accounts of First Investors and its wholly-owned and majority-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. Investments in which the Company exercises significant influence, but which it does not control (generally a 20% to 50% ownership interest), are accounted for under the equity method of accounting, except for variable interest entities for which the Company is considered the primary beneficiary under Financial Accounting Standards Board (“FASB”) Interpretation No. 46, Consolidation of Variable Interest Entities, an interpretation of ARB No. 51, as amended in December 2003 by Interpretation 46R. As of April 30, 2006, the Company does not have any entities under which FIN 46 as amended by Interpretation 46R would apply.
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. See Note 3. Actual results could differ from those estimates.
Receivables Held for Investment. Receivables Held for Investment represents the aggregate outstanding balance of installment sales contracts and promissory notes originated by the Company through its automobile dealer relationships or directly with consumers. The Company accrues interest income monthly using the effective interest method. When a receivable becomes 90 days past due, the 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. The Company defers and capitalizes certain expenses related to the origination of receivables held for investment, and amortizes these expenses in proportion to their underlying receivable.
Other Income. Other Income consists of income received from servicing activities, other finance charges and fees, income from investments, reinvestment revenue, income earned from the sale of GAP insurance and extended service contracts, and realized and unrealized loss on interest rate derivative positions. Servicing revenue is accrued as services are rendered. Other finance charges and fees are recognized when received. Income from investments and reinvestment revenue are accrued based on the respective interest rate of such investment. Income from the sale of GAP insurance and extended service contracts is recognized when sold as the Company has no further obligation after the sale. Unrealized loss on interest rate derivatives is recognized when incurred.
Allowance for Credit Losses. The Company calculates the allowance for credit losses in accordance with SFAS No. 5, Accounting for Contingencies. SFAS No. 114, Accounting by Creditors for Impairment of a Loan, does not apply to loans currently held by the Company because they comprise a large group of smaller balance homogenous loans that are evaluated collectively for impairment.
The Company initiates efforts to make customer contact as early as when the customer is one day 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 typically repossessed. Generally this occurs at 60 to 90 days after the loan becomes past due. Upon repossession, the uncollectible portion of the loan and 100% of accrued interest is written off. The fair value of the collateral is recorded in Assets Held for Sale. Fair value is determined by estimating the proceeds from the sale 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 records an adjustment, positive or negative, based on the difference between the fair value estimate and the proceeds received. In the event the collateral cannot be located or if the customer refuses to pay and is not subject to bankruptcy court protection, the Company will write off the entire balance of the loan once it reaches 180 days past due. If the customer is subject to bankruptcy court protection, the loan generally remains in bankruptcy status as long as payments are being received from the trustee. If a payment is missed, the Company seeks to repossess the collateral with approval of the court. If the customer is dismissed from bankruptcy, the Company resumes collection efforts.
The Company applies a systematic methodology in order to determine the amount of the allowance for credit losses. The specific methodology is a six-month migration analysis whereby the Company compares the aging status of each loan from six months prior to the aging 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 the estimated loss per loan, which is based on historical information. Effective the quarter ended April 30, 2005, the Company elected to increase its allowance for loan losses against loans that were greater than 120 days past due and loans in which the collateral had been assigned for repossession but had not yet been repossessed as of the reporting date. The Company believes that this increase is warranted in light of the change in federal bankruptcy laws enacted during the period and the recognition that the migration trends of severely delinquent loans and loans subject to bankruptcy are expected to become more protracted. Based on this, the Company has assigned a specific allowance against these loans equal to the outstanding balance of loans in these categories less the estimated recovery amount based on current data regarding liquidation of the collateral and collection of any additional payments. The Company utilized its most recent recovery rates in order to assess fair value of these loans. For loans that are not classified into these categories, the historical migration pattern is utilized in order to establish the estimated impairment. Despite the increase in allowance associated with the higher delinquency loans and bankrupt accounts, the total allowance for loan losses decreased during the period as a percentage of Receivables Held for Investment due to improving overall delinquency trends and lower repossession and loss rates. The allowance for credit losses is based on estimates and qualitative evaluations. Ultimate losses may 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. 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 records an adjustment, positive or negative, based on the difference between the fair value estimate and the proceeds received.
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 facilities generally provide that receivables assigned to each facility would be allowed to amortize should the facility 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, mail cost associated with the direct business and rent.
Income Taxes. The Company follows SFAS No. 109, “Accounting for Income Taxes”, 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. Significant judgement is required in determining income tax provisions and in evaluating tax positions. The Company has established additional provisions for income taxes, despite its belief that the Company’s tax positions are fully supportable, when there remain certain positions that are subject to challenge and that may not be sustained on
review by tax authorities. Upon the closure of future audits and the expiration of certain statutes of limitations, significant income tax accrual reversals could occur starting the year ending April 30, 2007.
Derivatives. SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended, 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. The Company has determined that it does not meet the criteria for hedge accounting treatment, and accordingly changes in the fair value are recorded as unrealized gains or losses and reflected in the statement of earnings.
Income Per Share. Income 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.
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 4 for components of restricted cash.
Advertising Costs. The Company expenses advertising costs as incurred. As of April 30, 2006, 2005, and 2004, advertising expense was $1,777,873, $1,427,481, and $957,255, respectively.
Treasury Stock. In September, 2004, the Board of Directors authorized the Company to repurchase up to $1.5 million of the Company’s outstanding common stock. This plan was subsequently amended in December, 2004, authorizing the repurchase of an additional $1 million of the Company’s outstanding common stock, resulting in the total authorization of $2.5 million to repurchase the Company’s stock. During the years ended April 30, 2006 and 2005, the Company engaged in the following transactions:
As a result of the 588,576 shares repurchased during the year ended April 30, 2005, the Company completed the $2.5 million authorized share repurchase plan and, as a result, announced the conclusion of its share repurchase plan originally adopted in December 2001. Since the inception of the plan, a total of 1,171,976 shares were repurchased at a weighted average price of $3.81 per share.
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 14. The Company has adopted the disclosure provisions of SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure, an amendment of FASB Statement No. 123. This pronouncement requires prominent disclosures in both annual and interim financial statements regarding the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company accounts for stock compensation awards under the intrinsic value method of Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, which requires compensation cost to be recognized based on the excess, if any, between the quoted market price of the stock at the date of grant and the amount the grantee must pay to acquire the stock. All options awarded under the Company’s plan are granted with an exercise price equal to or greater than the fair market value on the date of the grant.
The following table presents the Company’s pro-forma net income and net income per share had the Company adopted the fair value method of accounting for stock-based compensation under SFAS No. 123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148.
Reclassifications. Certain reclassifications have been made to the 2004 and 2005 amounts to conform to the 2006 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, 2005 and 2006:
(1) Includes premium and discounts paid to dealer plus deferred acquisition cost.
At April 30, 2006, the weighted average remaining term of the receivable portfolio is 46 months and the weighted average contractual interest rate is 13.8%. 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, 2004, 2005, and 2006 was as follows:
4. Restricted Cash
The components of restricted cash at April 30, 2005 and 2006 are as follows:
5. Deferred Financing Costs and Other Assets
The components of deferred financing costs and other assets at April 30, 2005 and 2006 are as follows:
6. Accounts Payable and Accrued Liabilities
The components of accounts payable and accrued liabilities as of April 30, 2005 and 2006 are as follows:
7. Debt
The Company finances its loan originations 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, 2002 the Company
issued $159 million in asset-backed notes (“Term Notes”) secured by discrete pools of receivables. These notes were subsequently called and redeemed in March, 2005. In November, 2003, the Company issued $140 million in Term Notes secured by a discrete pool of receivables. In May, 2005, the Company issued $175 million in Term Notes secured by a discrete pool of receivables. In January, 2006, the Company issued $189 million in Term Notes secured by a discrete pool of receivables. 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 and dealer fees was 4.5% and 3.5% for the fiscal years ending April 30, 2006 and 2005, respectively.
Warehouse Facilities as of April 30, 2006
Warehouse Facilities - Credit Enhancement as of April 30, 2006
FIRC - In order to obtain a lower cost of funding, the Company has agreed to maintain credit enhancement insurance covering the receivables pledged as collateral under the FIRC credit facility. The facility lenders are named as additional insureds under these policies. The coverages are obtained on each receivable at the time it is originated by the Company and the applicable premiums are prepaid for the life of the receivable. Generaly, 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. The Company carries these coverages at its sole expense, and neither the vehicle purchasers nor the dealers are charged for the coverages nor are they usually aware 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.
The premiums that the Company paid during fiscal year 2006 for its three credit enhancement insurance coverages, of which the largest component is basic ALPI insurance, represented approximately 1.9% of the principal amount of the receivables originated during the year. Aggregate premiums paid for ALPI coverage alone during the fiscal years ended April 30, 2004, 2005 and 2006 were $3,066,131, $3,669,198, and $3,768,534, respectively, and accounted for 3.5%, 2.3% and 1.4% of the aggregate principal balance of the receivables originated during such respective periods.
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% 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% 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. 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, 2006, the Insurance Subsidiary had capital and surplus of $2,766,495 and unencumbered cash reserves of $1,442,680 in addition to $3,430,734 in a 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.
FIARC - Credit Enhancement for the FIARC warehouse facility is provided to the commercial paper investors by a 6% overcollaterization level and a cash reserve account equal to 1% of the receivables held by FIARC. The Company is not a guarantor of, or otherwise a party to, such commercial paper.
Warehouse Facilities - Agents and Expirations
On December 4, 2003, the FIRC facility was renewed, under similar terms and conditions, at the $50 million commitment level until December 2, 2004, and was subsequently extended until February 14, 2007. On June 15, 2004, the FIRC facility was extended to $65 million, and reverted back to $50 million on September 13, 2004. As of April 30, 2005 and 2006, there was $43.6 and $47.1 million, respectively, outstanding.
On January 29, 2004, following a short-term extension of the original maturity date, the FIARC facility was renewed, under similar terms and conditions, to December 2, 2004, and was subsequently extended until February 14, 2007. In connection with the renewal, the Company obtained approval from the lender to eliminate the requirement that a surety bond be maintained to provide additional enhancement to the commercial paper investors. As a result, the 0.35% surety bond premium and the 0.25% unused surety bond premium were eliminated. In exchange, the Company agreed to increase the program fee paid to the lender from 0.30% to 0.55% and to increase the unused fee paid to the lender from 0.25% to 0.30%. As of April 30, 2005 and 2006, there was $127.9 and $-0- million, respectively, outstanding.
Management presently intends to seek further extensions to these warehouse facilities prior to the current expiration dates. 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 at each of their respective expiration dates.
The following table contains pertinent information on the Term Notes as of April 30, 2006.
Credit enhancement on the Term Note is as follows:
Term Notes - On November 20, 2003, the Company, through its indirect, wholly-owned subsidiary First Investors Auto Owner Trust 2003-A (“2003 Auto Trust”) completed the issuance of $139,661,000 of 2.58% Class A asset-backed notes (“2003-A Term Notes”). The initial pool of automobile receivables transferred to the 2003 Auto Trust totaled $114,726,891, which was previously owned by FIRC and FIARC, secure the 2003-A Term Notes. In addition to the issuance of the Class A Notes, the 2003 Auto Trust also issued a $5,065,891 Class B Note that was retained by the Company and pledged to secure the Working Capital Facility as further described below. Proceeds from the issuance, which totaled $139,656,629 were used to (i) fund a $30,000,000 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 2003-A term note issuance, and (v) fund an initial cash reserve account of 0.5% or $573,635 of the initial receivables pledged. The Class A Term Notes bear interest at 2.58% and requires monthly principal reductions sufficient to reduce the balance of the Class A Term Notes to 96.1% of the outstanding balance of the underlying receivables pool. The final maturity of the 2003-A Term Notes is April 20, 2011. The Class B Note does not bear interest but requires principal reductions sufficient to reduce the balance of the Class B Note to 3.9% 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. In the event that certain asset quality covenants are not met, the reserve account target level will increase to 6% of the then current principal balance of the receivables pool. As of April 30, 2005 and 2006, the outstanding principal balances on the 2003-A term notes were $70,050,511 and $37,714,745, respectively.
On May 5, 2005, the Company, through its indirect, wholly-owned subsidiary First Investors Auto Owner Trust 2005-A (“2005 Auto Trust”) completed the issuance of $69,000,000 of 3.57% Class A-1 asset-backed notes and $106,493,000 of 4.23% Class A-2 asset-backed notes (collectively “2005-A Term Notes”), for a total of
$175,493,000 of asset backed notes. The initial pool of automobile receivables transferred to the 2005 Auto Trust totaled $150,920,721, which was previously owned by FIRC and FIARC, and secures the 2005-A Term Notes. In addition to the issuance of the Class A-1 and Class A-2 Notes, the 2005 Auto Trust also issued a $5,427,619 Class B Note that was retained by the Company and pledged to secure the Working Capital Facility as further described below. Proceeds from the issuance, which totaled $175,487,827 were used to (i) fund a $29,999,898 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 2005-A Term Note issuance, and (v) fund an initial cash reserve account of 1% or $1,509,207 of the initial receivables pledged. The Class A-1 and Class A-2 Term Notes bear interest at 3.57% and 4.23%, respectively, and requires monthly principal reductions sufficient to reduce the balance of the Class A Term Notes to 95.75% of the outstanding balance of the underlying receivables pool. The final maturity of the Class A-1 and Class A-2 Term Notes is December 17, 2007 and July 16, 2012, respectively. The Class B Note does not bear interest but requires principal reductions sufficient to reduce the balance of the Class B Note to 4.25% 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. In the event that certain asset quality covenants are not met, the reserve account target level will increase to 2% of the then current principal balance of the receivables pool. As of April 30, 2006, the outstanding principal balances on the 2005-A Class A-1 and Class A-2 term notes were $-0- and $106,161,988, respectively.
On January 26, 2006, the Company, through its indirect, wholly-owned subsidiary First Investors Auto Owner Trust 2006-A (“2006 Auto Trust”) completed the issuance of $32,000,000 of 4.57% Class A-1 asset-backed notes, $47,000,000 of 4.87% Class A-2 asset-backed notes, $74,000,000 of 4.93% Class A-3 asset-backed notes, and $36,060,000 of 5.00% Class A-4 asset-backed notes (collectively “2006-A Term Notes”), for a total of $189,060,000 of asset backed notes. The initial pool of automobile receivables transferred to the 2006 Auto Trust totaled $151,939,112, was previously owned by FIRC and FIARC, and secures the 2006-A Term Notes. In addition to the issuance of the Class A-1, Class A-2, Class A-3, and Class A-4 notes, the 2006 Auto Trust also issued a $2,879,112 Class B Note that was retained by the Company and pledged to secure the Working Capital Facility as further described below. Proceeds from the issuance, which totaled $188,445,709 were used to (i) fund a $40,000,000 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 2006-A Term Note issuance, and (v) fund an initial cash reserve account of 1% or $1,519,391 of the initial receivables pledged. The 2006-A Term Notes require monthly principal reductions sufficient to reduce the balance of the notes to 96.75% of the outstanding balance of the underlying receivables pool. The final maturity of the Class A-1, Class A-2, Class A-3, and Class A-4 Term Notes is January 16, 2007, March 16, 2009, February 15, 2011, and April 15, 2013, respectively. The Class B Note does not bear interest but requires principal reductions sufficient to reduce the balance of the Class B Note to 3.25% 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. In the event that certain asset quality covenants are not met, the reserve account target level will increase to the greater of 2% of the initial pool balance or 6% of the then current principal balance of the receivables pool. As of April 30, 2006, the outstanding principal balances on the 2006-A Class A-1, Class A-2, Class A-3, and Class A-4 term notes were $15,647,831, $47,000,000, $74,000,000 and $36,060,000, respectively.
Working Capital Facility. The facility is provided to a special-purpose, wholly-owned subsidiary of the Company, First Investors Residual Funding LP. This facility revolves monthly in accordance with a borrowing base consisting of the overcollateralization amount and reserve account 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 and the existing and future term note facilities. The outstanding borrowings under the facility bear interest at one-month LIBOR plus 2.25%. In addition, a commitment fee of 1.5% is paid on the total amount of this facility. On October 26, 2004, the Working Capital Facility was extended until October 10, 2005, increasing the commitment amount from $9 million to $13.5 million. The interest rate remained at LIBOR plus 2.25% and the commitment fee paid on the total available amount of the facility was maintained at 1.5%. On August 15, 2005, the Working Capital Facility was extended until February 15, 2006, increasing the commitment amount to $23.5 million, and was subsequently extended on February 15, 2006 until February 14, 2007. The interest rate remained at LIBOR plus 2.25% and the commitment fee paid on the total available amount of the facility was maintained at 1.5%. As of April 30, 2005 and 2006, there was $10,500,000 and $16,454,329, 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.
Related Party 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. On December 6, 2004, the original $2.5 million shareholder loan was replaced with a $2.5 million loan containing identical terms and conditions between the Company and a limited partnership that is affiliated with a current shareholder and member of the Board of Directors The proceeds of the borrowings have been 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% 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. There was $2.5 million outstanding under these facilities as of April 30, 2005 and 2006. For the fiscal years ended April 30, 2004, 2005, 2006, the Company recorded interest expense under these facilities of $67,676, $17,808 and $250,000, respectively.
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 financial and non-financial covenants governing these financing arrangements at April 30, 2006.
Interest Rate Management. The Company’s warehouse credit facilities and working capital 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.
During fiscal year 2006, as a requirement of the FIARC commercial paper facility, the Company entered into seven interest rate cap transactions, with a strike rate of 6%. The aggregate initial notional amount of the caps was $131,710,159 which amortizes over six years. The Company paid $449,746 in premium to purchase these caps. The interest rate caps were not designated as hedges, and accordingly, changes in the fair value of the interest rate caps are recorded as realized gains or losses and reflected in net income On January 26, 2006, the Company terminated all interest rate caps outstanding in exchange for proceeds of $275,000. The caps were terminated following the repayment of all balances outstanding under the FIARC facility prior to the issuance of the 2006-A Term Notes. As a result, a realized loss of $174,746 was incurred relative to the aggregate market value of the interest rate caps.
During fiscal year 2005, as a requirement of the FIARC commercial paper facility, the Company entered into nine interest rate cap transactions, with strike rates between 5% and 6%. The aggregate initial notional amount of the caps was $126,086,843 which amortized over six years. The Company paid an aggregate of $1,213,097 in premiums to purchase these caps. 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 income. On April 28, 2005, the Company terminated all interest rate caps outstanding in exchange for proceeds of $840,000. The caps were terminated following the repayment of all amounts outstanding under the FIARC facility prior to the
issuance of the 2005-A term notes. As a result, a realized loss of $373,097 was incurred relative to the aggregate market value of the interest rate caps.
During fiscal year 2004, as a requirement of the FIARC commercial paper facility, the Company entered into various 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 were recorded as unrealized gains or losses and reflected in net income. On December 2, 2003, the Company terminated all interest rate caps outstanding in exchange for proceeds of $356,000. The caps were terminated following the repayment of all outstandings under the FIARC facility following the issuance of the 2003-A term notes. As a result, a realized loss of $14,000 was incurred relative to the aggregate market value of the interest rate caps.
8. Income Taxes
The temporary differences which give rise to deferred tax assets (liabilities) are as follows at April 30, 2005 and 2006, respectively:
The provision (benefit) for income taxes on income before income taxes and minority interest for the years ended April 30, 2004, 2005 and 2006, 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, 2004, 2005 and 2006.
9. Investment in First Auto Receivables Corporation
On December 24, 2002, the Company invested $475,061 for a 40% ownership in common stock in First Auto Receivables Corporation (“FARC”) and $712,591 for junior mezzanine debt 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 performs loan servicing and collection activities on the portfolio. For the years ended April 30, 2004, 2005, and 2006, the Company recognized $1,352,234, $894,262, and $532,186 of servicing revenue, $161,750, $108,994, and $87,597 of interest income and $1,009,322, $668,774, and $413,354 of equity in the income from investment in FARC. As of April 30, 2005 and 2006, the equity investment in FARC of $968,327 and $734,014 and junior mezzanine debt of $832,696 and $192,093, respectively are included in Deferred Financing Costs and Other Assets on the balance sheet.
10. New Accounting Pronouncements
In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments-an amendment of FASB Statements No. 133 and 140 (“SFAS 155”). This statement amends SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (“SFAS 133”), and SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities and resolves issues addressed in SFAS 133 Implementation Issue No. D1, “Application of Statement 133 to Beneficial Interest in Securitized Financial Assets”. This Statement: (a) permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation; (b) clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS 133; (c) establishes a requirement to evaluate beneficial interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation; (d) clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives; and, (e) eliminates restrictions on a qualifying special-purpose entity’s ability to hold passive derivative financial instruments that pertain to beneficial interests that are or contain a derivative financial instrument. The standard also requires presentation within the financial statements that identifies those hybrid financial instruments for which the fair value election has been applied and information on the income statement impact of the changes in fair value of those instruments. The Company is required to apply SFAS 155 to all financial instruments acquired, issued or subject to a remeasurement event beginning January 1, 2007 although early adoption is permitted as of the beginning of an entity’s fiscal year. The provisions of SFAS 155 are not expected to have a financial statement impact at adoption; however, the standard could affect the future income recognition for securitized financial assets because there may be more embedded derivatives identified with changes in fair value recognized in net income.
In May 2005, SFAS No. 154, Accounting Changes and Error Corrections, was issued. This statement applies to all voluntary changes in accounting principles and requires retrospective application to prior periods’ financial statements of changes in accounting principles, unless this would be impracticable. This statement also makes a distinction between “retrospective application” of an accounting principle and the “restatement” of financial statements to reflect the correction of an error. This statement is effective for accounting changes and corrections of
errors made in fiscal years beginning after December 15, 2005. The Company does not expect the adoption of this interpretation to have a material impact on its financial position, cash flows and results of operations.
In December 2004, the FASB issued SFAS No. 123(R), Share-Based Payment -a revision to SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123(R)”) that addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. SFAS No. 123(R) eliminates the ability to account for share-based compensation transactions using APB Opinion No. 25, Accounting for Stock Issued to Employees, and generally requires instead that such transactions be accounted for using a fair-value-based method.
SFAS No. 123(R) is effective as of the beginning of the fiscal year that begins after June 15, 2005. SFAS 123(R) applies to all awards granted after the required effective date and to such awards modified, repurchased, or cancelled after that date. The cumulative effect of initially applying SFAS No. 123(R), if any, is recognized as of the required effective date. As of the required effective date, all public entities that used the fair-value-based method for either recognition or disclosure under SFAS No. 123 will apply SFAS No. 123(R) using a modified version of prospective application. Under that transition method, compensation cost is recognized on or after the required effective date for the portion of outstanding awards for which the requisite service has not yet been rendered, based on the grant-date fair value of those awards calculated under SFAS No. 123 for either recognition or pro forma disclosures. For periods before the required effective date, those entities may elect to apply a modified version of retrospective application under which financial statements for prior periods are adjusted on a basis consistent with the pro forma disclosures required for those periods by SFAS No. 123. The Company expects compensation expense related to SFAS No. 123(R) to be approximately $169,000 for the fiscal year ending April 30, 2007.
11. Credit Risks
Approximately 30% and 16% of the Company’s Receivables Held for Investment by principal balance at April 30, 2006, represents receivables originated in Texas and Georgia. 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.
12. 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.
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.
13. 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 effective the first enrollment period after 90 days of 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 2004, 2005, and 2006, the Company made matching contributions to the 401(k) plan in the amounts of $40,062, $23,425, and $42,168, respectively. Effective April 28, 1998, the Company established a participant-directed Deferred Compensation Plan for certain executive officers of the Company. The Deferred Compensation Plan was terminated during the fourth quarter of fiscal year 2005 in response to changes in the tax law associated with such plans. The assets in the plan were distributed to the participants.
14. Shareholders’ Equity
Preferred Stock. The Company has authorized 1,000,000 shares of preferred stock with a $1.00 par value. As of April 30, 2006, 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% 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% 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. As of April 30, 2005 and 2006, a total of 360,500 options had been issued, with 360,500 and 294,500, respectively, options outstanding under the plan. This plan expired on June 27, 2005.
On September 8, 2005, the shareholders approved the Company’s 2005 Employee Stock Option Plan (the 2005 Plan). The 2005 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 200,000 shares of common stock, subject to adjustment in the event of certain changes in capitalization. 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. The exercise price may not be less than 100% of the fair market value per share of common stock on the date of grant, and 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. As of
April 30, 2006, 102,500 options were issued and outstanding under the 2005 Plan, leaving 97,500 options remaining and available for issuance.
The exercise price of the option is payable in cash upon exercise. 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 grants will be both 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. As of April 30, 2005 and 2006, a total of 390,000 and 490,000, respectively, options had been issued under the plan, leaving a remaining 110,000 and 10,000, respectively, available for issuance. In addition to the options granted above, there were an additional 20,000 options granted to a director in 1995, before the adoption of the Non-Employee Stock Option Plan. All options issued under this plan were issued with an exercise price equal to the fair market value of the underlying common stock on the date of the grant
A summary of the status of the Company’s stock option plans for the years ended April 30, 2004, 2005 and 2006 is presented below:
Following is a summary of the status of options outstanding at April 30, 2006:
(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.
15. Commitments and Contingencies
Employment Agreement. As of April 30, 2006, 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, 2006, management believes there are no such legal proceedings that will 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, 2011. The Company is party to a lease agreement for office space in Atlanta which expires on December 31, 2015. Rent expense for office space and other operating leases for the years ended April 30, 2004, 2005 and 2006, was $764,283, $1,052,765 and $1,135,099, respectively. Required minimum lease payments for the remaining terms of the above leases are:
16. Income Per Share
Income 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, 2004, 2005, and 2006 are as follows:
At April 30, 2004, 2005, and 2006, the Company had 621,631, 218,000, and 10,000 employee stock options and warrants, respectively, and 70,000, 190,000, and 20,000 director options, respectively, which were not included in the computation of diluted earnings per share because to do so would have been antidilutive for the period presented.
17. Quarterly Financial Data (Unaudited)
The table below sets forth the unaudited consolidated operating results by quarter for the year ended April 30, 2006.
The table below sets forth the unaudited consolidated operating results by quarter for the year ended April 30, 2005.
The table below sets forth the unaudited consolidated operating results by quarter for the year ended April 30, 2004.