Docoh
Loading...

Shepherd's Finance

Filed: 5 Nov 20, 2:46pm

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q

 

[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the Quarterly Period Ended September 30, 2020

 

or

 

[  ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the Transition Period From to

 

Commission File Number 333-224557

 

SHEPHERD’S FINANCE, LLC

(Exact name of registrant as specified on its charter)

 

Delaware 36-4608739
(State or other jurisdiction of (I.R.S. Employer
Incorporation or organization) Identification No.)

 

13241 Bartram Park Blvd., Suite 2401, Jacksonville, Florida 32258

(Address of principal executive offices)

 

(302) 752-2688

(Registrant’s telephone number including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Each Class Trading Symbol(s) Name of Each Exchange on Which Registered
None None None

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [  ]

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes [X] No [  ]

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

 Large accelerated filer[  ]Accelerated filer[  ]
 Non-accelerated filer[X]Smaller reporting company[X]
 Emerging growth company[X]  

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [X]

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [  ] No [X]

 

 

 

   
 

 

FORM 10-Q

SHEPHERD’S FINANCE, LLC

TABLE OF CONTENTS

 

 Page
  
Cautionary Note Regarding Forward-Looking Statements3
  
PART I. FINANCIAL INFORMATION4
  
Item 1. Financial Statements4
  
Interim Condensed Consolidated Balance Sheets as of September 30, 2020 (Unaudited) and December 31, 20194
  
Interim Condensed Consolidated Statements of Operations (Unaudited) for the Three and Nine Months Ended September 30, 2020 and 20195
  
Interim Condensed Consolidated Statements of Changes in Members’ Capital (Unaudited) for the Nine Months Ended September 30, 2020 and 2019 and for the Three Months Ended September 30, 2020 and 20196
  
Interim Condensed Consolidated Statements of Cash Flows (Unaudited) for the Nine Months Ended September 30, 2020 and 20197
  
Notes to Interim Condensed Consolidated Financial Statements (Unaudited)8
  
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations19
  
Item 3. Quantitative and Qualitative Disclosure About Market Risk38
  
Item 4. Controls and Procedures38
  
PART II. OTHER INFORMATION38
  
Item 1. Legal Proceedings38
  
Item 1A. Risk Factors38
  
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds39
  
Item 3. Defaults upon Senior Securities39
  
Item 4. Mine Safety Disclosures39
  
Item 5. Other Information40
  
Item 6. Exhibits40

 

 2 
 

 

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

Certain statements contained in this Form 10-Q of Shepherd’s Finance, LLC, other than historical facts, may be considered forward-looking statements within the meaning of the federal securities laws. Words such as “may,” “will,” “expect,” “anticipate,” “believe,” “estimate,” “continue,” “predict,” or other similar words identify forward-looking statements. Forward-looking statements appear in a number of places in this report, including without limitation, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and include statements regarding our intent, belief or current expectation about, among other things, trends affecting the markets in which we operate, our business, financial condition and growth strategies. Although we believe that the expectations reflected in these forward-looking statements are based on reasonable assumptions, forward-looking statements are not guarantees of future performance and involve risks and uncertainties. These risks and uncertainties include, but are not limited to: uncertainties relating to the effects of COVID-19; the length of the COVID-19 pandemic and severity of such outbreak nationally and across the globe; the pace of recovery following the COVID-19 pandemic; general economic uncertainty in key global markets and a worsening of global economic conditions or low levels of economic growth; the rate and the pace of economic recovery following economic downturns; and those other risks described in other risk factors as outlined in our Registration Statement on Form S-1, as amended, and our Annual Report on Form 10-K. If any of the events described in “Risk Factors” occur, they could have an adverse effect on our business, consolidated financial condition, results of operations, and cash flows. For further information regarding risks and uncertainties associated with our business, and important factors that could cause our actual results to vary materially from those expressed or implied in such forward-looking statements, please refer to the factors set forth in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors” sections of the documents we file from time to time with the U.S. Securities and Exchange Commission, including, but not limited to, our Annual Report on Form 10-K for the year ended December 31, 2019 and subsequent Quarterly Reports on Form 10-Q. When considering forward-looking statements, you should keep these risk factors, as well as the other cautionary statements in this report and in our Annual Report on Form 10-K for the year ended December 31, 2019 in mind. You should not place undue reliance on any forward-looking statement. We are not obligated to update forward-looking statements.

 

 3 
 

 

PART I – FINANCIAL INFORMATION

 

ITEM 1.FINANCIAL STATEMENTS

 

Shepherd’s Finance, LLC

Interim Condensed Consolidated Balance Sheets

 

(in thousands of dollars) September 30, 2020  December 31, 2019 
  (Unaudited)    
Assets        
Cash and cash equivalents $3,150  $1,883 
Accrued interest receivable  748   1,031 
Loans receivable, net  47,984   55,369 
Real estate investments  1,154   - 
Foreclosed assets  3,690   4,916 
Premises and equipment  911   936 
Other assets  462   202 
Total assets $58,099  $64,337 
Liabilities and Members’ Capital        
Customer interest escrow $447  $643 
Accounts payable and accrued expenses  234   466 
Accrued interest payable  3,047   2,533 
Notes payable secured, net of deferred financing costs  22,753   26,991 
Notes payable unsecured, net of deferred financing costs  26,484   26,520 
PPP Loan and EIDL Advance  371   - 
Due to preferred equity member  10   37 
Total liabilities $53,346  $57,190 
         
Commitments and Contingencies (Note 10)        
         
Redeemable Preferred Equity        
Series C preferred equity $3,197  $2,959 
         
Members’ Capital        
Series B preferred equity  1,550   1,470 
Class A common equity  6   2,718 
Members’ capital $1,556  $4,188 
         
Total liabilities, redeemable preferred equity and members’ capital $58,099  $64,337 

 

The accompanying notes are an integral part of these interim condensed consolidated financial statements.

 

 4 
 

 

Shepherd’s Finance, LLC

Interim Condensed Consolidated Statements of Operations - Unaudited

For the Three and Nine Months Ended September 30, 2020 and 2019

 

  Three Months Ended  Nine Months Ended 
  September 30,  September 30, 
(in thousands of dollars) 2020  2019  2020  2019 
Interest Income                
Interest and fee income on loans $1,909  $2,600  $5,841  $7,486 
Interest expense:                
Interest related to secured borrowings  727   746   2,354   2,196 
Interest related to unsecured borrowings  793   736   2,335   2,077 
Interest expense  1,520   1,482   4,689   4,273 
                 
Net interest income  389   1,118   1,152   3,213 
Less: Loan loss provision  70   3   1,665   201 
                 
Net interest income after loan loss provision  319   1,115   (513)  3,012 
                 
Non-Interest Income                
Gain on sale of foreclosed assets  135   -   138   - 
Gain on foreclosure of assets  -   86   -   181 
Impairment gain on foreclosed assets  95   -   95   - 
                 
Total non-interest income  230   86   233   181 
                 
Income  549   1,201   (280)  3,193 
                 
Non-Interest Expense                
Selling, general and administrative  367   703   1,536   1,947 
Depreciation and amortization  21   21   64   66 
Loss on sale of foreclosed assets  51   274   86   274 
Loss on foreclosure of assets  2   -   2   169 
Impairment loss on foreclosed assets  4   -   205   107 
                 
Total non-interest expense  445   998   1,893   2,563 
                 
Net Income $104  $203  $(2,173) $630 
                 
Earned distribution to preferred equity holders  104   118   322   333 
                 
Net income attributable to common equity holders $-  $85  $(2,495) $297 

 

The accompanying notes are an integral part of these interim condensed consolidated financial statements.

 

 5 
 

 

Shepherd’s Finance, LLC

Interim Condensed Consolidated Statements of Changes in Members’ Capital - Unaudited

For the Nine and Three Months Ended September 30, 2020 and 2019

 

For the Nine Months Ended September 30, 2020 and 2019

 

(in thousands of dollars) 2020  2019 
       
Members’ capital, beginning balance, December 31 $4,188  $3,697 
Net income less distributions to Series C preferred equity holders of $275 and $229  (2,448)  401 
Contributions from Series B preferred equity holders  80   130 
Earned distributions to Series B preferred equity holders  (47)  (104)
Distributions to common equity holders  (217)  (166)
Members’ capital, ending balance September 30 $1,556  $3,958 

 

For the Three Months Ended September 30, 2020 and 2019

 

(in thousands of dollars) 2020  2019 
       
Members’ capital, beginning balance, June 30 $1,526  $3,844 
Net income less distributions to Series C preferred equity holders of $94 and $85  10   118 
Contributions from Series B preferred equity holders  30   30 
Earned distributions to Series B preferred equity holders  (10)  (34)
Distributions to common equity holders  -   - 
Members’ capital, ending balance September 30 $1,556  $3,958 

 

The accompanying notes are an integral part of the interim condensed consolidated financial statements.

 

 6 
 

 

Shepherd’s Finance, LLC

Interim Condensed Consolidated Statements of Cash Flows - Unaudited

For the Nine Months Ended September 30, 2020 and 2019

 

  Nine Months Ended September 30, 
(in thousands of dollars) 2020  2019 
       
Cash flows from operations        
Net (loss) income $(2,173) $630 
Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities        
Amortization of deferred financing costs  112   197 
Provision for loan losses  1,665   201 
Change in loan origination fees, net  89   440 
Depreciation and amortization  64   66 
Impairment of foreclosed assets, net  110   107 
Gain on sale of foreclosed assets, net  (138)  (181)
Loss on foreclosed assets  2   169 
Loss on sale of foreclosed assets  86   274 
Net change in operating assets and liabilities:        
Other assets  (313)  (107)
Accrued interest receivable  283   (116)
Customer interest escrow  (270)  (125)
Accrued interest payable  514   244 
Accounts payable and accrued expenses  (232)  (312)
         
Net cash (used in) provided by operating activities  (201)  1,487 
         
Cash flows from investing activities        
Loan originations and principal collections, net  4,212   (8,491)
Investment in foreclosed assets  (801)  (608)
Proceeds from sale of foreclosed assets  2,246   4,543 
Premises and equipment additions  -   (4)
         
Net cash provided by (used in) investing activities  5,657   (4,560)
         
Cash flows from financing activities        
Contributions from preferred equity holders  80   330 
Distributions to redeemable preferred equity holders  (37)  (30)
Distributions to common equity holders  (217)  (166)
Proceeds from secured note payable  9,739   13,954 
Repayments of secured note payable  (14,010)  (13,137)
Proceeds from unsecured notes payable  7,391   9,570 
Redemptions/repayments of unsecured notes payable  (7,369)  (6,356)
Proceeds from PPP Loan and EIDL Advance  371   - 
Deferred financing costs paid  (137)  (5)
         
Net cash (used in) provided by financing activities  (4,189)  4,160 
         
Net change in cash and cash equivalents  1,267   1,087 
         
Cash and cash equivalents        
Beginning of period  1,883   1,401 
End of period $3,150  $2,488 
         
Supplemental disclosure of cash flow information        
Cash paid for interest $4,175  $4,029 
         
Non-cash investing and financing activities        
Earned by Series B preferred equity holders but not distributed to customer interest escrow $10  $36 
Earned by Series B preferred equity holders and distributed to customer interest escrow $74  $100 
Foreclosure of assets transferred from loans receivable, net $279  $2,006 
Earned but not paid distributions of Series C preferred equity holders $275  $229 
Unsecured transferred to secured notes payable $38  $1,014 
Construction loans repaid through the reduction of Secured LOC Principal Balance $-  $410 
Reclassification of deferred financing costs from other assets $-  $330 
Transfer of loan receivables to real estate investments $1,140  $- 

 

The accompanying notes are an integral part of these interim condensed consolidated financial statements.

 

 7 
 

 

Shepherd’s Finance, LLC

Notes to Interim Condensed Consolidated Financial Statements (unaudited)

 

Information presented throughout these notes to the interim condensed consolidated financial statements (unaudited) is in thousands of dollars.

 

1. Description of Business and Basis of Presentation

 

Description of Business

 

Shepherd’s Finance, LLC and subsidiary (the “Company”) was originally formed as a Pennsylvania limited liability company on May 10, 2007. The Company is the sole member of a consolidating subsidiary, 84 REPA, LLC. The Company operates pursuant to its Second Amended and Restated Operating Agreement, as amended, by and among Daniel M. Wallach and the other members of the Company effective as of March 16, 2017.

 

As of September 30, 2020, the Company extends commercial loans to residential homebuilders (in 21 states) to:

 

 construct single family homes,
 develop undeveloped land into residential building lots, and
 purchase and improve for sale older homes.

 

Basis of Presentation

 

The accompanying (a) interim condensed consolidated balance sheet as of September 30, 2020, which has been derived from audited consolidated financial statements, and (b) unaudited interim condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information, the instructions to Form 10-Q and Article 8 of Regulation S-X. While certain information and disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”), management believes that the disclosures herein are adequate to make the unaudited interim condensed consolidated information presented not misleading. In the opinion of management, the unaudited interim condensed consolidated financial statements reflect all adjustments necessary for a fair presentation of the consolidated financial position, results of operations, and cash flows for the periods presented. Such adjustments are of a normal, recurring nature. The consolidated results of operations for any interim period are not necessarily indicative of results expected for the fiscal year ending December 31, 2020. These unaudited interim condensed consolidated financial statements should be read in conjunction with the 2019 consolidated financial statements and notes thereto (the “2019 Financial Statements”) included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019 (the “2019 Form 10-K”). The accounting policies followed by the Company are set forth in Note 2 – Summary of Significant Accounting Policies in the 2019 Financial Statements.

 

Accounting Standards to be Adopted

 

Financial Accounting Standards Board (“FASB”) Accounting Standards Update (“ASU”) 2016-13, “Financial Instruments-Credit Losses: Measurement of Credit Losses on Financial Instruments”. The amendments in ASU 2016-13 introduce a new current expected credit loss (“CECL”) model for certain financial assets, including mortgage loans and reinsurance receivables. The new model will not apply to debt securities classified as available-for-sale. For assets within the scope of the new model, an entity will recognize as an allowance against earnings its estimate of the contractual cash flows not expected to be collected on day one of the asset’s acquisition. The allowance may be reversed through earnings if a security recovers in value. This differs from the current impairment model, which requires recognition of credit losses when they have been incurred and recognizes a security’s subsequent recovery in value in other comprehensive income. ASU 2016-13 also makes targeted changes to the current impairment model for available-for-sale debt securities, which comprise the majority of the Company’s invested assets. Similar to the CECL model, credit loss impairments will be recorded in an allowance against earnings that may be reversed for subsequent recoveries in value. The amendments in ASU 2016-13, along with related amendments in ASU No. 2018-19, “Codification Improvements to Topic 326, Financial Instruments—Credit Losses,” are effective for annual and interim periods beginning after December 15, 2019 on a modified retrospective basis. For smaller reporting companies, the effective date for annual and interim periods is January 1, 2023. The Company is reviewing its policies and processes to ensure compliance with the requirements in ASU 2016-13.

 

 8 
 

 

2. Fair Value

 

The Company had no financial instruments measured at fair value on a recurring basis as of September 30, 2020 or December 31, 2019.

 

The following tables present the balances of non-financial instruments measured at fair value on a non-recurring basis as of September 30, 2020 and December 31, 2019.

 

  September 30, 2020  

Quoted

Prices in Active

Markets for Identical

  

Significant

Other Observable

  Significant Unobservable 
  Carrying  Estimated  Assets  Inputs  Inputs 
  Amount  Fair Value  Level 1  Level 2  Level 3 
                
Foreclosed assets $3,690  $3,690  $       -  $          -  $3,690 
Impaired loans due to COVID-19, net  9,107   9,107   -   -   9,107 
Other impaired loans, net  1,625   1,625   -   -   1,625 
Total $14,422  $14,422  $-  $-  $14,422 

 

  December 31, 2019  

Quoted Prices in Active

Markets for Identical

  

Significant

Other Observable

  Significant Unobservable 
  Carrying  Estimated  Assets  Inputs  Inputs 
  Amount  Fair Value  Level 1  Level 2  Level 3 
                
Foreclosed assets $4,916  $4,916  $              -  $              -  $4,916 
Impaired assets, net  1,487   1,487   -   -   1,487 
Total $6,403  $6,403  $-  $-  $6,403 

 

The table below is a summary of fair value estimates for financial instruments:

 

  September 30, 2020  December 31, 2019 
  Carrying  Estimated  Carrying  Estimated 
  Amount  Fair Value  Amount  Fair Value 
Financial Assets                
Cash and cash equivalents $3,150  $3,150  $1,883  $1,883 
Loans receivable, net  47,984   47,984   55,369   55,369 
Accrued interest on loans  748   748   1,031   1,031 
Financial Liabilities                
Customer interest escrow  447   447   643   643 
Notes payable secured, net  22,753   22,753   26,991   26,991 
Notes payable unsecured, net  26,484   26,484   26,520   26,520 
PPP Loan and EIDL Advance  371   371   -   - 
Accrued interest payable  3,047   3,047   2,533   2,533 

 

 9 
 

 

3. Financing Receivables

 

Financing receivables are comprised of the following as of September 30, 2020 and December 31, 2019:

 

  September 30, 2020  December 31, 2019 
       
Loans receivable, gross $51,521  $57,608 
Less: Deferred loan fees  (1,116)  (856)
Less: Deposits  (1,400)  (1,352)
Plus: Deferred origination costs  375   204 
Less: Allowance for loan losses  (1,396)  (235)
         
Loans receivable, net $47,984  $55,369 

 

The allowance for loan losses at September 30, 2020 was $1,396, of which $163 is related to loans without specific reserves. The Company recorded specific reserves for loans impaired due to impacts from COVID-19 of $1,041, special mention loans of $120 and impaired loans not due to impacts from COVID-19 of $72. As of December 31, 2019, the allowance was $235, of which $230 related to loans without specific reserves. During the nine months ended September 30, 2020, we incurred $504 in direct charge-offs compared to $173 for the year ended December 31, 2019.

 

Commercial Construction and Development Loans

 

Commercial Loans – Construction Loan Portfolio Summary

 

The following is a summary of the loan portfolio to builders for home construction loans as of September 30, 2020 and December 31, 2019:

 

Year  

Number

of

States

  

Number
of

Borrowers

  

Number
of

Loans

  Value of
Collateral(1)
  Commitment Amount  

Gross

Amount

Outstanding

  

Loan to Value

Ratio(2)

  Loan Fee 
2020   21   67   235  $88,860  $63,928  $42,368   72%(3)  5%
2019   21   70   241   93,211   65,273   48,611   70%(3)  5%

 

(1)The value is determined by the appraised value.
  
(2)The loan to value ratio is calculated by taking the commitment amount and dividing by the appraised value.
  
(3)Represents the weighted average loan to value ratio of the loans.

 

Commercial Loans – Real Estate Development Loan Portfolio Summary

 

The following is a summary of our loan portfolio to builders for land development as of September 30, 2020 and December 31, 2019:

 

Year  

Number

of

States

  

Number of

Borrowers

  

Number of

Loans

  

Gross

Value of

Collateral(1)

  Commitment Amount(2)  

Gross Amount

Outstanding

  

Loan to Value

Ratio(3)

  Interest Spread 
2020    4   5   8  $  10,748  $10,608  $9,153   86%  7%
2019   4   5   9   13,007   9,866   8,997   69%  7

 

(1)The value is determined by the appraised value adjusted for remaining costs to be paid. A portion of this collateral is $1,550 and $1,470 as of September 30, 2020 and December 31, 2019, respectively, of preferred equity in our Company. In the event of a foreclosure on the property securing these loans, the portion of our collateral that is preferred equity might be difficult to sell, which may impact our ability to recover the loan balance. In addition, a portion of the collateral value is estimated based on the selling prices anticipated for the homes.

 

 10 
 

 

(2)The commitment amount does not include letters of credit and cash bonds.
  
(3)The loan to value ratio is calculated by taking the outstanding amount and dividing by the appraised value calculated as described above.

 

Credit Quality Information

 

The following tables present credit-related information at the “class” level in accordance with FASB ASC 310-10-50, “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.” See our 2019 Form 10-K, as filed with the SEC, for more information.

 

Finance receivables – By risk rating:

 

  September 30, 2020  December 31, 2019 
       
Pass $37,314  $53,542 
Special mention  2,353   2,571 
Classified – accruing  -   - 
Classified – nonaccrual  11,854   1,495 
         
Total $51,521  $57,608 

 

Finance receivables – Method of impairment calculation:

 

  September 30, 2020  December 31, 2019 
       
Performing loans evaluated individually $16,954  $26,233 
Performing loans evaluated collectively  22,713   29,880 
Non-performing loans without a specific reserve  4,120   1,467 
Non-performing loans with a specific reserve to COVID-19  7,015   - 
Non-performing loans with a specific reserve  719   28 
         
Total evaluated collectively for loan losses $51,521  $57,608 

 

As September 30, 2020 and December 31, 2019, there were no loans acquired with deteriorated credit quality.

 

Impaired Loans

 

The following is a summary of our impaired nonaccrual commercial construction loans as of September 30, 2020 and December 31, 2019.

 

  September 30, 2020  December 31, 2019 
       
Unpaid principal balance (contractual obligation from customer) $11,875  $1,495 
Charge-offs and payments applied  (21  - 
Gross value before related allowance  11,854   1,495 
Related allowance  (1,122)  (8)
Value after allowance $10,732  $1,487 

 

 11 
 

 

Concentrations

 

Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of loans receivable. Our concentration risks for our top three customers listed by geographic real estate market are summarized in the table below:

 

  September 30, 2020 December 31, 2019
    Percent of    Percent of 
  Borrower Loan  Borrower Loan 
  City Commitments  City Commitments 
           
Highest concentration risk Pittsburgh, PA  26% Pittsburgh, PA  25%
Second highest concentration risk Orlando, FL  13% Orlando, FL  15%
Third highest concentration risk Cape Coral, FL  7% Cape Coral, FL  3%

 

4. Real Estate Investment Assets

 

During June 2020, the Company acquired two lots from a borrower in exchange for the transfer of loans secured by those lots. The Company extinguished the principal balance for the loans on the lots in the amount of $640 and in addition, paid a $500 management fee for the development of homes on certain of the Company’s lots that were previously carried as loan receivables. The management fee was paid through reducing the principal balance on a current loan receivable with the borrower.

 

The following table is a roll forward of real estate investment assets:

 

  

Nine Months

Ended

September 30, 2020

  

Year

Ended

December 31, 2019

  

Nine Months

Ended

September 30, 2019

 
          
Beginning balance $  $            –  $              – 
Transfers from loans  1,140       
Additions for construction/development  14       
Ending balance $1,154  $  $ 

 

5. Foreclosed Assets

 

The following table is a roll forward of foreclosed assets:

 

  

Nine Months

Ended

September 30,

2020

  

Year

Ended

December 31,

2019

  

Nine Months

Ended

September 30,

2019

 
          
Beginning balance $4,916  $5,973  $5,973 
Additions from loans  279   3,352   2,006 
Additions for construction/development  801   763   608 
Sale proceeds  (2,246)  (4,543)  (4,543)
Loss on sale  (86)  (274)  (274)
Gain on foreclosure  -   203   181 
Gain on sale of foreclosed assets  138   -   - 
Impairment gain on foreclosed assets  68   -   - 
Impairment gain on foreclosed assets due to COVID-19  27   -   - 
Loss on foreclosure  (2)  -   (169)
Impairment loss on foreclosed assets  (114)  -   (107)
Impairment loss on foreclosed assets due to COVID-19  (91)  (558)  - 
Ending balance $3,690  $4,916  $3,675 

 

 12 
 

 

6. Borrowings

 

The following table displays our borrowings and a ranking of priority:

 

  Priority Rank September 30, 2020  December 31, 2019 
Borrowing Source          
Purchase and sale agreements and other secured borrowings 1 $22,762  $26,806 
Secured lines of credit from affiliates 2  1   189 
Unsecured line of credit (senior) 3  -   500 
PPP Loan and EIDL Advance 3  371   - 
Other unsecured debt (senior subordinated) 4  1,377   1,407 
Unsecured Notes through our public offering, gross 5  21,319   20,308 
Other unsecured debt (subordinated) 5  3,633   4,131 
Other unsecured debt (junior subordinated) 6  590   590 
           
Total   $50,053  $53,931 

 

The following table shows the maturity of outstanding debt as of September 30, 2020:

 

Year Maturing 

Total Amount

Maturing

  

Public

Offering

 

Other

Unsecured(1)

  

Secured

Borrowings

 
2020 $25,431  $974  $2,676  $21,781 
2021  13,257   12,073   1,168   16 
2022  5,541   3,706   1,819   16 
2023  1,119   824   189   106 
2024 and thereafter  4,705   3,742   120   843 
Total $50,053  $21,319  $5,972  $22,762 

 

 (1)Other Unsecured includes our PPP Loan of $361 and EIDL Advance of $10 (each described below) of which $21, $247, and $103, collectively, matures during 2020, 2021 and 2022, respectively. All or a portion of the PPP Loan may be forgiven.

 

Secured Borrowings

 

New Lines of Credit

 

During September 2020, we entered into an amended line of credit agreement (the “Eppinger LOC Agreement”) with Jeffrey Eppinger. The original line of credit from Mr. Eppinger was one of the New LOC Agreements described in the 2019 Form 10-K. Pursuant to the Eppinger LOC Agreement, Mr. Eppinger will provide us with a revolving line of credit of $1,500, an increase of $500. Principal for the New LOC Agreements, as amended, will not exceed $5,500. All other terms were unchanged.

 

 13 
 

 

Lines of Credit from Affiliates

 

As of September 30, 2020, the Company had borrowed $1 on its lines of credit from affiliates, which have a total limit of $2,500.

 

Secured Deferred Financing Costs

 

The Company had secured deferred financing costs of $9 and $5 as of September 30, 2020 and December 31, 2019, respectively.

 

Summary

 

Borrowings secured by loan assets are summarized below:

 

  September 30, 2020  December 31, 2019 
  

Book Value of

Loans which Served as

Collateral

  

Due from Shepherd’s

Finance to Loan Purchaser or

Lender

  Book Value of Loans which Served as Collateral  Due from Shepherd’s Finance to Loan Purchaser or Lender 
Loan Purchaser                
Builder Finance, Inc. $8,860  $6,202  $13,711  $9,375 
S.K. Funding, LLC  7,063   4,791   10,394   6,771 
                 
Lender                
Stephen K. Shuman  1,722   1,325   1,785   1,325 
Jeffrey Eppinger  3,170   1,500   1,821   1,000 
Hardy Enterprises, Inc.  1,726   1,000   1,684   1,000 
Gary Zentner  389   250   472   250 
R. Scott Summers  1,416   847   841   628 
Paul Swanson  8,304   5,862   8,377   5,824 
Total $32,650  $21,777  $39,085  $26,173 

 

Unsecured Borrowings

 

Unsecured Notes through the Public Offering (“Notes Program”)

 

On March 22, 2019, the Company terminated its second public offering and commenced its third public offering of fixed rate subordinated notes (the “Notes”). The effective interest rate on borrowings through our Notes Program at September 30, 2020 and December 31, 2019 was 10.31% and 10.56%, respectively, not including the amortization of deferred financing costs. We generally offer four durations at any given time, ranging from 12 to 48 months from the date of issuance. There are limited rights of early redemption. Our 36-month Note has a mandatory early redemption option, subject to certain conditions. The following table shows the roll forward of our Notes Program:

 

  

Nine Months

Ended

September 30,

2020

  

Year Ended

December 31,

2019

  

Nine Months

Ended

September 30,

2019

 
          
Gross Notes outstanding, beginning of period $20,308  $17,348  $17,348 
Notes issued  6,454   11,127   9,201 
Note repayments / redemptions  (5,443)  (8,167)  (5,793)
             
Gross Notes outstanding, end of period $21,319  $20,308  $20,756 
             
Less deferred financing costs, net  435   416   425 
             
Notes outstanding, net $20,884  $19,892  $20,331 

 

 14 
 

 

The following is a roll forward of deferred financing costs:

 

  

Nine Months

Ended

September 30,

2020

  

Year

Ended

December 31,

2019

  

Nine Months

Ended

September 30,

2019

 
          
Deferred financing costs, beginning balance $786  $1,212  $1,212 
Additions  131   365   336 
Disposals  -   (791)  - 
Deferred financing costs, ending balance  917   786   1,548 
Less accumulated amortization  (482)  (370)  (1,123)
Deferred financing costs, net $435  $416  $425 

 

The following is a roll forward of the accumulated amortization of deferred financing costs:

 

  

Nine Months

Ended

September 30,

2020

  

Year

Ended

December 31,

2019

  

Nine Months

Ended

September 30,

2019

 
          
Accumulated amortization, beginning balance $370  $1,000  $1,000 
Additions  112   161   123 
Disposals  -   (791)  - 
Accumulated amortization, ending balance $482  $370  $1,123 

 

Other Unsecured Debts

 

Our other unsecured debts are detailed below:

 

       Principal Amount Outstanding as of 
Loan 

Maturity

Date

 

Interest

Rate(1)

  

September 30,

2020

  December 31, 2019 
Unsecured Note with Seven Kings Holdings, Inc. Demand(2)  9.5% $500  $500 
Unsecured Line of Credit from Paul Swanson October 2020(6)  10.0%  1,138   1,176 
Subordinated Promissory Note October 2020  9.5%  563   563 
Subordinated Promissory Note December 2021  10.5%  146   146 
Subordinated Promissory Note April 2024  10.0%  100   100 
Subordinated Promissory Note April 2021  10.0%  174   174 
Subordinated Promissory Note August 2022  11.0%  200   200 
Subordinated Promissory Note March 2023  11.0%  169   169 
Subordinated Promissory Note April 2020  6.5%  -   500 
Subordinated Promissory Note February 2021  11.0%  600   600 
Subordinated Promissory Note Demand  5.0%  -   500 
Subordinated Promissory Note December 2020  5.0%  3   3 
Subordinated Promissory Note December 2023  11.0%  20   - 
Subordinated Promissory Note February 2024  11.0%  20   - 
Senior Subordinated Promissory Note March 2022(3)  10.0%  370   400 
Senior Subordinated Promissory Note March 2022(4)  1.0%  728   728 
Junior Subordinated Promissory Note March 2022(4)  22.5%  417   417 
Senior Subordinated Promissory Note October 2020(5)  1.0%  279   279 
Junior Subordinated Promissory Note October 2020(5)  20.0%  173   173 
        $5,600  $6,628 

 

 15 
 

 

(1) Interest rate per annum, based upon actual days outstanding and a 365/366-day year.

 

(2) Due six months after lender gives notice.

 

(3) Lender may require us to repay $20 of principal and all unpaid interest with 10 days’ notice.

 

(4) These notes were issued to the same holder and, when calculated together, yield a blended rate of 11% per annum.

 

(5) These notes were issued to the same holder and, when calculated together, yield a blended rate of 10% per annum.

 

(6) Amount due in October 2020 is $1,000 with the remainder due in November 2020.

 

In May 2020, the Company entered into a loan agreement (the “PPP Loan”) with LCA Bank Corporation to borrow $361 pursuant to the Paycheck Protection Program (“PPP”), created under the Coronavirus Aid, Relief, and Economic Security Act, or CARES Act. All or a portion of the loan may be forgivable, as provided by the terms of the PPP. During April 2020, the Company received a grant under the Economic Injury Disaster Loan Emergency Advance (the “EIDL Advance”) which may be used for payroll and other certain operating expenses. The EIDL Advance will reduce the forgiveness of the PPP Loan depending on certain parameters required by the CARES Act.

 

7. Redeemable Preferred Equity

 

The following is a roll forward of our Series C cumulative preferred equity (“Series C Preferred Units”):

 

  

Nine Months

Ended

September 30,

2020

  

Year

Ended

December 31,

2019

  

Nine Months

Ended

September 30,

2019

 
          
Beginning balance $2,959  $2,385  $2,385 
Additions from new investment  -   300   200 
Redemptions  (37)  (42)  (30)
Additions from reinvestment  275   316   229 
             
Ending balance $3,197  $2,959  $2,784 

 

The following table shows the earliest redemption options for investors in our Series C Preferred Units as of September 30, 2020:

 

Year of Available Redemption  

Total Amount

Redeemable

 
     
2024  $2,963 
2025   234 
Total  $3,197 

 

8. Members’ Capital

 

There are currently two classes of equity units outstanding that the Company classifies as Members’ Capital: Class A common units (“Class A Common Units”) and Series B cumulative preferred units (“Series B Preferred Units”). As of September 30, 2020, the Class A Common Units are held by eight members, all of whom have no personal liability. All Class A common members have voting rights in proportion to their capital account. There were 2,629 Class A Common Units outstanding at both September 30, 2020 and December 31, 2019.

 

 16 
 

 

Series B Preferred Units were initially issued to the Hoskins Group (consisting of Benjamin Marcus Homes, LLC, Investor’s Mark Acquisitions, LLC, and Mark L. Hoskins) through a reduction in a loan issued by the Hoskins Group to the Company. In December 2015, the Hoskins Group agreed to purchase 0.1 Series B Preferred Units for $10 at each closing of a lot to a third party in the Hamlets and Tuscany subdivisions. As of September 30, 2020, the Hoskins Group owns a total of 15.5 Series B Preferred Units, which were issued for a total of $1,550.

 

Earned but unpaid distributions on the Series B cumulative preferred units for the second and third quarters of 2020 total approximately $37 and $28, respectively, and have been rolled forward to be paid in a subsequent quarter.

 

9. Related Party Transactions

 

As of September 30, 2020, the Company had $1,249, $250, and $1,000 available to borrow against the line of credit from Daniel M. Wallach (our Chief Executive Officer and chairman of the board of managers) and his wife, the line of credit from the 2007 Daniel M. Wallach Legacy Trust, and the line of credit from William Myrick (our Executive Vice President of Sales), respectively. A more detailed description is included in Note 6 of our 2019 Financial Statements. These borrowings are in notes payable secured, net of deferred financing costs on the interim condensed consolidated balance sheet.

 

In July 2020, the Company purchased two loans at cost from Daniel M. Wallach (the Company’s CEO and Chairman of the board of managers) for approximately $198. Those loans had previously been purchased from the Company by Mr. Wallach.

 

10. Commitments and Contingencies

 

Unfunded commitments to extend credit, which have similar collateral, credit risk, and market risk to our outstanding loans, were $21,560 and $16,662 at September 30, 2020 and December 31, 2019, respectively.

 

11. Selected Quarterly Condensed Consolidated Financial Data (Unaudited)

 

Summarized unaudited quarterly condensed consolidated financial data for the quarters of 2020 and 2019 are as follows:

 

  Quarter 3  Quarter 2  Quarter 1  Quarter 4  Quarter 3  Quarter 2  Quarter 1 
  2020  2020(1)  2020  2019  2019  2019  2019 
                      
Net Interest Income (loss) $389  $(228) $990  $1,138  $1,118  $969  $1,126 
Loan loss provision  70   1,560   35   21   3   151   47 
Net (Loss) Interest Income after Loan Loss Provision  319   (1,788)  955   1,117   1,115   818   1,079 
Gain on sale of foreclosed assets  135   3                
Gain on foreclosure of assets           22   86   95    
Impairment gain on foreclosed assets  95                    
SG&A Expense  367   462   708   447   703   620   624 
Depreciation and Amortization  21   21   21   26   21   22   23 
Loss on Sale of Foreclosed Assets  51      35      274       
Loss on Foreclosure of Assets  2               169    
Impairment Loss on Foreclosed Assets  4   91   109   282      27   80 
Net (Loss) Income $104  $(2,359) $82  $384  $203  $75  $352 

 

 (1)During the quarter ended June 30, 2020, net interest income after loan loss provision was reduced due to COVID-19 by $1,492. In addition, the Company wrote off $469 of interest income directly related to COVID-19. During the quarter ended June 30, 2020, impairment loss on foreclosed assets of $91 was due to the impact of COVID-19.

 

 17 
 

 

12. Non-Interest Expense Detail

 

The following table displays our selling, general and administrative (“SG&A”) expenses:

 

  

For the Nine Months Ended

September 30,

 
  2020  2019 
Selling, general and administrative expenses        
Legal and accounting $202  $211 
Salaries and related expenses  684   1,143 
Board related expenses  74   66 
Advertising  54   102 
Rent and utilities  36   36 
Loan and foreclosed asset expenses  303   179 
Travel  105   101 
Other  78   109 
Total SG&A $1,536  $1,947 

 

13. Subsequent Events

 

Management of the Company has evaluated subsequent events through November 5, 2020, the date these interim condensed consolidated financial statements were issued.

 

 18 
 

 

ITEM 2.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

(All dollar [$] amounts shown in thousands.)

 

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our interim condensed consolidated financial statements and the notes thereto contained elsewhere in this report. The following Management’s Discussion and Analysis of Financial Condition and Results of Operations should also be read in conjunction with our audited annual consolidated financial statements and related notes and other consolidated financial data (the “2019 Financial Statements”) included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019 (the “2019 Form 10-K”). See also “Cautionary Note Regarding Forward-Looking Statements” preceding Part I.

 

Overview

 

The Company has been impacted by and continues to face risks related to COVID-19, which has caused disruptions to the economy and in all of the markets in which the Company lends. The Company’s operating results depend significantly on the homebuilding industry.

 

As of June 30, 2020, the Company had 46 loans at a gross loans receivable balance of $12,993 of impaired loans primarily due to COVID-19. In addition, we recognized $1,492 in loan loss expense and $91 in impairment loss of foreclosed assets during the quarter ended June 30, 2020.

 

As of September 30, 2020, the Company had 37 loans at a gross loans receivable balance of $11,854 of impaired loans primarily due to COVID-19. In addition, we reversed $170 in loan loss expense and $27 in impairment loss of foreclosed assets during the quarter ended September 30, 2020 related to the write offs from the quarter ended June 30, 2020.

 

The Company continues to lose interest income on assets that do not accrue interest. During the quarter ended June 30 and September 30, 2020 the estimated loss on interest income related to impaired and foreclosed assets was $578 and 484, respectively. Looking ahead, we expect this to decrease by year end and again by the end of the first quarter of 2021. We anticipate the lack of interest income will primarily be resolved by the end of the first quarter of 2021.

 

Finally, the impact of COVID-19 and prior to COVID-19 is the lack of loan originations which impacts our earnings through the loss of fee income. Loan originations and fee income for the first six months of 2020 and 2019 was $18,504 and $796 and $32,860 and $1,325, respectively. For the quarter ended September 30, 2020, loan originations increased to $21,374 compared to $13,111 for the same period of 2019 and we anticipate this rate of increase to continue through the fourth quarter of 2020 and first quarter of 2021.

 

Response to COVID-19

 

During March 2020, the Company made the decision due to the potential impact of COVID-19 to inform its borrowers that the Company would fund all loans where the underlying asset was currently under construction. Borrowers with loans in which the underlying asset was at a non-start position were informed to not start construction until told to do so by the Company.

 

During April 2020, as the Company continued to monitor market conditions overall and in the specific markets in which the Company lends, the Company observed that some markets had little to no impact from a housing perspective as a result of COVID-19; however, the Company’s borrowers in Pennsylvania and Michigan were significantly impacted due to the government shutting down home construction completely, and customers in Florida were significantly impacted by the changes in lending rules for end users and the high levels of unemployment caused by COVID-19. The Company made the decision to fund new loans to borrowers in stronger markets for the purpose of developing presold homes, which loans have reduced loan-to-value ratios. In addition, the Company continued to monitor funding spec loans in some markets on a case-by-case basis for loans with reduced loan-to-value ratios. In addition, the Company stopped recognizing interest on loans issued to customers impacted by COVID-19 which continued through September and is expected to continue until those loans are paid off. Through the quarter ended September 30 2020, the amount of estimated unearned interest income due to COVID-19 that was not recognized was $355.

 

 19 
 

 

On May 7, 2020, the Company made the decision to reopen lending under normal, pre-COVID-19 terms for a limited group of certain of its customers. In addition, the decision was made to allow rehab loans to builders at terms that are less conservative than those established in April 2020 but more conservative than terms prior to the arrival of COVID-19. Currently, the Company is offering normal terms to approximately 40% of its customers, and restricted terms to approximately 60% of its customers. The Company averaged $2,251 in new loan originations in the first five months of 2020, but under these terms the Company averaged $7,155 of loan originations in June through September 2020. The fees from these originations are typically recognized over 12 months. New loan fees from these four months before deferred loan origination costs were $746, which we will recognize over 12 months. The Company attributes this increase in volume to many of its larger nonbank competitors going out of business or leaving the lending business.

 

Overview of Financial Results

 

Net income for the quarter and nine months ended September 30, 2020 decreased $99 and $2,803, respectively, when compared to the same periods of 2019. The decrease in net income was primarily due to the economic effects stemming from the COVID-19 pandemic, which included the following:

 

 Interest income decreased $451 to $1,476 and $876 to $4,612 for the quarter and nine months ended September 30, 2020, respectively, compared to the same periods of 2019. The decrease was due primarily to direct write offs of interest income of $469 for the nine months ended September 30, 2020. In addition, the Company estimated $355 and $757 in reduced interest income for the quarter and nine months ended September 30, 2020 due to non-performing loans not accruing interest due to COVID-19.
   
 Fee income decreased $239 to $433 and $769 to $1,229 for the quarter and nine months ended September 30, 2020, respectively, compared to the same periods of 2019. Originations for the quarter and nine months ended September 30, 2020 were $21,374 and $39,878, respectively, compared to $13,111 and $58,771 for the same periods of 2019. The increase for the quarter ended September 30, 2020 was primarily due to stronger demand and less competition. The decrease in originations for the nine months ended September 30, 2020 was primarily due to the impact of the COVID-19 pandemic.
   
 Loan loss provision increased $67 to $70 and $1,464 to $1,665 for the quarter and nine months ended September 30, 2020, respectively, compared to the same periods of 2019. The increase was due primarily to impairment on loans related to COVID-19.
   
 Gain on sale of foreclosed assets increased $135 and $138 for the quarter and nine months ended September 30, 2020, respectively, compared to the same periods of 2019. During the quarter ended September 30, 2020, the Company sold four foreclosed assets with a gain on sale of $135 compared to none for the same period of 2019. During the nine months ended September 30, 2020, the Company sold five foreclosed assets with a gain on sale of $138 compared to the same period of 2019.
   
 Impairment gain on foreclosed assets increased $95 during both the quarter and nine months ended September 30, 2020 compared to the same periods of 2019. The increase was due primarily to percentage of completion increasing while costs remained low. In addition, during the third quarter of 2020 the Company reversed $27 in losses recognized during the second quarter of 2020.
   
 Loss on sale of foreclosed assets decreased $223 to $51 and $188 to $86 for the quarter and nine months ended September 30, 2020, respectively, compared to the same periods of 2019. The decreases related primarily to the sale of four and five foreclosed assets during the quarter and nine months ended September 30, 2020 for a loss of $51 and $86, respectively. During both the quarter and nine months ended September 30, 2019, the Company sold one foreclosed asset for a loss of $274.
   
 Impairment loss on foreclosed assets increased $4 and $98 for both the quarter and nine months ended September 30, 2020, compared to the same periods of 2019. During the nine months ended September 30, 2020, the Company recognized $91 in impairment loss on foreclosed assets due to COVID-19.

 

The Company anticipates an increase in profit in the fourth quarter of 2020 compared to the third quarter of 2020. To achieve these increases in profits, the Company is focused on the following three things:

 

 1.First, the Company is focused on reducing the number of assets currently not paying interest. Due primarily to the impact of COVID-19, the Company transferred the loan receivables balance of $9,728 for one of our largest borrowers into a non-performing asset. The Company’s reduction of non-performing assets is expected to be achieved by a combination of the selling of foreclosed assets and the payoff of nonperforming loans;
   
 2.Second, the Company is focused on continuing the higher level of new loan originations that the Company did not realize during the first six months of 2020. Average originations during the six months ended June 30, 2020 and three months ended September 30, 2020 was $3,084 and $7,125, respectively; and
   
 3.Third, the Company seeks to have the cash to fund new originations through new financing and the potential reduction of nonperforming assets.

 

 20 
 

 

We anticipate that the housing market in most of the areas in which we do business will be strong despite the impact of COVID-19, and that doing business with our best customers in those markets will provide good performing loans for our balance sheet. We also anticipate that the losses we incurred in principal related to COVID-19 will not continue, and that the lack of interest due to nonperforming assets from COVID-19 will decrease significantly over the course of the rest of 2020.

 

During the nine months ended September 30, 2020, the Company purchased $10,000 of life insurance covering Daniel M. Wallach for the benefit of the Company as a beneficiary, which renews annually.

 

We had $47,984 and $55,369 in loan assets as of September 30, 2020 and December 31, 2019, respectively. In addition, as of September 30, 2020, we had 235 construction loans in 21 states with 67 borrowers and eight development loans in four states with five borrowers.

 

Net cash (used in) provided by operations decreased $1,688 for the nine months ended September 30, 2020 as compared to the same period of 2019. Our decrease in operating cash flow was due primarily to impairment loss related to impacts of the COVID-19 pandemic.

 

Critical Accounting Estimates

 

To assist in evaluating our interim condensed consolidated financial statements, we describe below the critical accounting estimates that we use. We consider an accounting estimate to be critical if: (1) the accounting estimate requires us to make assumptions about matters that were highly uncertain at the time the accounting estimate was made, and (2) changes in the estimate that are reasonably likely to occur from period to period, or use of different estimates that we reasonably could have used, would have a material impact on our consolidated financial condition or results of operations. See our 2019 Form 10-K, as filed with the SEC, for more information on our critical accounting estimates. No material changes to our critical accounting estimates have occurred since December 31, 2019 unless listed below.

 

Loan Losses

 

Fair value of collateral has the potential to impact the calculation of the loan loss provision (the amount we have expensed over time in anticipation of loan losses we have not yet realized). Specifically, relevant to the allowance for loan loss reserve is the fair value of the underlying collateral supporting the outstanding loan balances. Fair value measurements are an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. Due to a rapidly changing economic market, an erratic housing market, the various methods that could be used to develop fair value estimates, and the various assumptions that could be used, determining the collateral’s fair value requires significant judgment.

 

Change in Fair Value Assumption 

September 30, 2020

Loan Loss

Provision Higher/(Lower)

 
Increasing fair value of the real estate collateral by 35%* $- 
Decreasing fair value of the real estate collateral by 35%** $5,192 

 

* Increases in the fair value of the real estate collateral do not impact the loan loss provision, as the value generally is not “written up.”

 

** Assumes the loans were nonperforming and a book amount of the loans outstanding of $47,984.

 

 21 
 

 

Foreclosed Assets

 

The fair value of real estate will impact our foreclosed asset value, which is recorded at 100% of fair value (after selling costs are deducted).

 

Change in Fair Value Assumption 

September 30, 2020

Foreclosed

Assets Higher/(Lower)

 
Increasing fair value of the foreclosed assets by 35%* $- 
Decreasing fair value of the foreclosed assets by 35%** $(1,292)

 

* Increases in the fair value of the foreclosed assets do not impact the carrying value, as the value generally is not “written up.” Those gains would be recognized at the sale of the asset.

 

** Assumes a book amount of the foreclosed assets of $3,690.

 

Interest Spread

 

The following table displays a comparison of our interest income, expense, fees, and spread:

 

  Three Months Ended  Nine Months Ended 
  September 30,  September 30, 
  2020  2019  2020  2019 
Interest Income       *       *       *       *
Estimated interest income $1,831   14% $

1,927

   

14

% $5,838   14% $

5,488

   

14

%
Estimated unearned interest income due to COVID-19  (355)  (3)%  

 

-

   

 

-

%  (757)  (2)%  

 

-

   

 

-

%
Write-offs due to COVID-19  -  -%  -   -%  (469)  (1)%  -   -%
Interest income on loans $1,476   11% $1,927   14% $4,612   11% $5,488   14%
                                 
Fee income on loans  433   3%  673   5%  1,229   3%  1,998   5%
Interest and fee income on loans  

 

1,909

   

 

14

%  

 

2,600

   

 

19

%  

 

5,841

   

 

14

%  

 

7,486

   

 

19

%
Interest expense unsecured  760   5%  696   4%  2,223   5%  1,954   4%
Interest expense secured  727   6%  746   4%  2,354   6%  2,196   4%
Amortization offering costs  33   -%  40   -%  112   -%  123   -%
Interest expense  1,520   12%  1,482   11%  4,689   11%  4,273   11%
Net interest income (spread)  389   3%  1,118   8%  1,152   3%  

 

3,213

   8%
                                 
Weighted average outstanding loan asset balance $51,881      $54,029      $55,124      $52,389     

 

* Annualized amount as percentage of the weighted average outstanding gross loan balance.

 

There are three main components that can impact our interest spread:

 

Difference between the interest rate received (on our loan assets) and the interest rate paid (on our borrowings). The loans we have originated have interest rates which are based on our cost of funds, with a minimum cost of funds of 7%. For most loans, the margin is fixed at 3%; however, for our development loans the margin is fixed at 7%. This component is also impacted by the lending of money with no interest cost (our equity).

 

Interest income on loans decreased to 11% for both the quarter and nine months ended September 30, 2020, respectively, compared to 14% for the same periods of 2019. The Company expensed $469 in interest income for the nine months ended September 30, 2020 due to impairment of loans associated with four of our borrowers directly related to COVID-19. In addition, estimated interest not earned during the quarter and nine months ended September 30, 2020 related to those borrowers was approximately $355 and $757, respectively.

 

 22 
 

 

The difference between estimated interest income on loans due to COVID-19 and the interest paid was 2% for both the quarter and nine months ended September 30, 2020 compared to the same periods of 2019, which is our standard margin.

 

We anticipate our standard margin to be 3% on all future construction loans and 7% on all development loans which yields a blended margin of approximately 3.4%.

 

Fee income. Our construction loan fee is 5% on the amount we commit to lend, which is amortized over the expected life of each loan. We do not recognize a loan fee on our development loans. When loans terminate before than their expected life, the remaining fee is recognized at the termination of the loan.

 

During both the quarter and nine months ended September 30, 2020, fee income on loans decreased 2% compared to the same periods of 2019. The decrease related primarily due to less loan originations.

 

Amount of nonperforming assets. Generally, we can have two types of nonperforming assets that negatively affect interest spread: loans not paying interest and foreclosed assets.

 

As of September 30, 2020 and 2019, we had 37 impaired loans in the aggregate amount of $11,854 and 10 impaired loans in the aggregate amount of $1,780 that were not paying interest, respectively. Non-performing assets not related to the impact of COVID-19 were $1,705. Due to the impact of COVID-19, the Company transferred the loan receivables balance of $9,728 as of June 30, 2020 for one of our largest borrowers into a non-performing asset. As of September 30, 2020, the amount due from this certain borrower is $8,058.

 

Foreclosed assets do not provide a monthly interest return. As of September 30, 2020 and 2019, foreclosed assets were $3,690 and $3,675, respectively, which resulted in a negative impact on our interest spread in both years.

 

The amount of nonperforming assets is expected to decrease in the fourth quarter of 2020 as we continue to sell our assets when construction is complete.

 

SG&A Expenses

 

The following table displays our SG&A expenses:

 

  

Three Months

Ended September 30,

  

Nine Months

Ended September 30,

 
  2020  2019  2020  2019 
Selling, general and administrative expenses                
Legal and accounting $21  $37  $202  $211 
Salaries and related expenses  200   359   684   1,143 
Board related expenses  24   25   74   66 
Advertising  18   52   54   102 
Rent and utilities  13   11   36   36 
Loan and foreclosed asset expenses  69   132   303   179 
Travel  23   55   105   101 
Other  (1)  32   78   109 
Total SG&A $367  $703  $1,536  $1,947 

 

Our SG&A expense decreased $336 and $411 for the quarter and nine months ended September 30, 2020, respectively, compared to the same periods of 2019 due significantly to the following:

 

 Salaries and related expenses decreased for the quarter and nine months ended September 30, 2020 by $159 and $459, respectively, compared to the same periods of 2019. The decrease was due to the increase in deferred originations costs of $138 to $260 and $188 to $573 for the quarter and nine months ended September 30, 2020, respectively, compared to the same periods of 2019. In addition, profit sharing expense decreased by $66 and $210 to $0 for both the quarter and nine months ended September 30, 2020, respectively compared to the same period of 2019.

 

 23 
 

 

 

Loan and foreclosed asset expenses decreased $63 to $69 for the quarter ended September 30, 2020 compared to the same period of 2019. The decrease was primarily due to the completion and sale of our largest foreclosed asset during the quarter ended September 30, 2019.

 

Loan and foreclosed asset expenses increased $124 to $303 for the nine months ended September 30, 2020 compared to the same period of 2019 due to additional real estate owned asset expenses for taxes and insurance.

 

Loan Loss Provision

 

Our loan loss provision increased $67 to $70 and $1,464 to $1,665 for the quarter and nine months ended September 30, 2020, respectively, compared to the same periods of 2019. The increase in loan loss provision was primarily due to specific reserves for loan assets impaired due to the impact of the COVID-19 pandemic of $1,042 and special mention assets of $120.

 

Consolidated Financial Position

 

Loans Receivable

 

Commercial Loans – Construction Loan Portfolio Summary

 

We anticipate that the aggregate balance of our construction loan portfolio will increase as loans near maturity and as we have new loan originations.

 

The following is a summary of our loan portfolio to builders for home construction loans as of September 30, 2020:

 

State 

Number

of

Borrowers

  

Number of

Loans

  

Value of

Collateral(1)

  

Commitment

Amount

  

Gross Amount

Outstanding

  

Loan to

Value
Ratio(2)

  Loan Fee 
Arizona  2   3  $2,289  $1,290  $754   56%  5%
Connecticut  1   1   343   226   141   66%  5%
Delaware  1   1   585   410   142   70%  5%
Florida  17   108   30,425   24,375   17,485   80%  5%
Georgia  2   2   595   452   430   76%  5%
Idaho  1   2   700   490   259   70%  5%
Illinois  1   1   1,245   747   368   60%  5%
Indiana  1   1   347   243   233   70%  5%
Michigan  4   10   2,713   2,112   775   78%  5%
New Jersey  2   8   2,495   2,415   1,728   97%  5%
New York  3   3   2,433   1,235   1,252   51%  5%
North Carolina  6   20   5,118   3,542   1,640   69%  5%
Ohio  3   9   3,794   2,520   1,584   66%  5%
Oregon  1   2   1,267   887   475   70%  5%
Pennsylvania  3   20   19,193   12,102   8,925   63%  5%
South Carolina  8   20   5,878   4,419   2,438   75%  5%
Tennessee  3   5   2,169   1,463   297   67%  5%
Texas  4   7   2,405   1,684   1,167   70%  5%
Utah  2   6   2,558   1,822   1,469   71%  5%
Washington  1   5   1,769   1,162   474   66%  5%
Wisconsin  1   1   539   332   332   62%            5%
Total  67   235  $88,860  $63,928  $42,368   72%(3)  5%

 

 (1)The value is determined by the appraised value.
   
 (2)The loan to value ratio is calculated by taking the commitment amount and dividing by the appraised value.
   
 (3)Represents the weighted average loan to value ratio of the loans.

 

 24 
 

 

The following is a summary of our loan portfolio to builders for home construction loans as of December 31, 2019:

 

State 

Number

of

Borrowers

  

Number

of

Loans

  

Value of

Collateral(1)

  

Commitment

Amount

  

Gross

Amount

Outstanding

  

Loan to

Value

Ratio(2)

  Loan Fee 
Colorado  1   1  $630  $425  $424   67%  5%
Connecticut  1   1   340   224   55   66%  5%
Florida  17   112   32,259   24,031   16,826   74%  5%
Georgia  3   4   2,085   1,343   917   64%  5%
Idaho  1   1   310   217   173   70%  5%
Indiana  2   3   1,687   1,083   383   64%  5%
Michigan  4   11   3,696   2,566   1,820   69%  5%
New Jersey  3   6   1,925   1,471   1,396   76%  5%
New York  2   3   1,370   940   743   69%  5%
North Carolina  6   20   5,790   4,009   2,471   69%  5%
Ohio  3   9   4,117   2,664   2,153   65%  5%
Oregon  1   2   1,137   796   739   70%  5%
Pennsylvania  3   24   20,791   13,322   11,772   64%  5%
South Carolina  11   25   8,809   6,419   4,786   73%  5%
Tennessee  3   4   1,367   1,069   503   78%  5%
Texas  3   4   1,984   1,270   843   64%  5%
Utah  2   4   1,862   1,389   1,000   75%  5%
Virginia  1   3   1,245   815   734   65%  5%
Washington  1   2   1,040   728   445   70%  5%
Wisconsin  1   1   539   332   285   62%  5%
Wyoming  1   1   228   160   143   70%            5%
Total  70   241  $93,211  $65,273  $48,611   70%(3)  5%

 

 (1)The value is determined by the appraised value.
   
 (2)The loan to value ratio is calculated by taking the commitment amount and dividing by the appraised value.
   
 (3)Represents the weighted average loan to value ratio of the loans.

 

Commercial Loans – Real Estate Development Loan Portfolio Summary

 

The following is a summary of our loan portfolio to builders for land development as of September 30, 2020:

 

State 

Number

of Borrowers

  

Number

of

Loans

  Value of
Collateral(1)
  Commitment Amount(2)  

Gross

Amount

Outstanding

  

Loan to

Value
Ratio(3)

  

Interest

Spread

 
Pennsylvania  1   3  $8,425  $8,200  $7,583   90%  7%
Florida  2   2   843   898   730   87%  7 
North Carolina  1   1   400   260   136   34%  7 
South Carolina  1   2   1,080   1,250   704   65%            7 
Total  5   8  $10,748  $10,608  $9,153   86%(4)  7%

 

(1)The value is determined by the appraised value adjusted for remaining costs to be paid and third-party mortgage balances. Part of this collateral is $1,550 of preferred equity in our Company. In the event of a foreclosure on the property securing these loans, the portion of our collateral that is preferred equity in our Company might be difficult to sell, which could impact our ability to eliminate the loan balance.
  
(2)The commitment amount does not include unfunded letters of credit.
  
(3)The loan to value ratio is calculated by taking the outstanding amount and dividing by the appraised value calculated as described above.
  
(4)Represents the weighted average loan to value ratio of the loans.

 

 25 
 

 

The following is a summary of our loan portfolio to builders for land development as of December 31, 2019:

 

State 

Number

of

Borrowers

  

Number

of

Loans

  Value of
Collateral(1)
  Commitment Amount(2)  

Gross

Amount

Outstanding

  

Loan to

Value
Ratio(3)

  

Interest

Spread

 
Pennsylvania  1   3  $10,191  $7,000  $7,389   73%  7%
Florida  2   3   1,301   1,356   891   68%  7 
North Carolina  1   1   400   260   99   25%  7 
South Carolina  1   2   1,115   1,250   618   55%             7 
Total  5   9  $13,007  $9,866  $8,997   69%(4)  7%

 

(1)The value is determined by the appraised value adjusted for remaining costs to be paid and third-party mortgage balances. Part of this collateral is $1,470 of preferred equity in our Company. In the event of a foreclosure on the property securing these loans, the portion of our collateral that is preferred equity in our Company might be difficult to sell, which could impact our ability to eliminate the loan balance.
  
(2)The commitment amount does not include unfunded letters of credit.
  
(3)The loan to value ratio is calculated by taking the outstanding amount and dividing by the appraised value calculated as described above.
  
(4)Represents the weighted average loan to value ratio of the loans.

 

Combined Loan Portfolio Summary

 

Financing receivables are comprised of the following as of September 30, 2020 and December 31, 2019:

 

  September 30, 2020  December 31, 2019 
       
Loans receivable, gross $51,521  $57,608 
Less: Deferred loan fees  (1,116)  (856)
Less: Deposits  (1,400)  (1,352)
Plus: Deferred origination costs  375   204 
Less: Allowance for loan losses  (1,396)  (235)
         
Loans receivable, net $47,984  $55,369 

 

 26 
 

 

The allowance for loan losses at September 30, 2020 was $1,396, of which $163 is related to loans without specific reserves. The Company recorded specific reserves for loans impaired due to impacts from COVID-19 of $1,041, special mention loans of $120 and impaired loans not due to impacts from COVID-19 of $72. As of December 31, 2019, the allowance was $235, of which $230 related to loans without specific reserves. During the nine months ended September 30, 2020, we incurred $504 in direct charge-offs compared to $173 for the year ended December 31, 2019.

 

The following is a roll forward of combined loans:

 

  

Nine Months

Ended

September 30, 2020

  

Year

Ended

December 31, 2019

  

Nine Months

Ended

September 30, 2019

 
          
Beginning balance $55,369  $46,490  $46,490 
Additions  33,347   56,842   41,902 
Principal collections  (37,511)  (45,009)  (34,551)
Transferred to foreclosed assets  (279)  (3,352)  (2,006)
Transferred to real estate investments  (1,140)  -   - 
Change in builder deposit  (48)  157   25 
Loan loss provision  (1,665)  (49)  (201)
Change in loan fees, net  (89)  290   265 
Ending balance $47,984  $55,369  $51,924 

 

Finance Receivables – By risk rating:

 

  September 30, 2020  December 31, 2019 
       
Pass $37,314  $53,542 
Special mention  2,353   2,571 
Classified – accruing  -    
Classified – nonaccrual  11,854   1,495 
         
Total $51,521  $57,608 

 

Finance Receivables – Method of impairment calculation:

 

  September 30, 2020  December 31, 2019 
       
Performing loans evaluated individually $16,954  $26,233 
Performing loans evaluated collectively  22,713   29,880 
Non-performing loans without a specific reserve  4,120   1,467 
Non-performing loans with a specific reserve to COVID-19  7,015    
Other non-performing loans with a specific reserve  719   28 
         
Total evaluated collectively for loan losses $51,521  $57,608 

 

As of September 30, 2020 and December 31, 2019, there were no loans acquired with deteriorated credit quality.

 

 27 
 

 

Impaired Loans

 

The following is a summary of our impaired nonaccrual commercial construction loans as of September 30, 2020 and December 31, 2019.

 

  September 30, 2020  December 31, 2019 
       
Unpaid principal balance (contractual obligation from customer) $11,875  $1,495 
Charge-offs and payments applied  (21)  - 
Gross value before related allowance  11,854   1,495 
Related allowance  (1,122)  (8)
Value after allowance $10,732  $1,487 

 

Below is an aging schedule of loans receivable as of September 30, 2020, on a recency basis:

 

  

No.

Loans

  

Unpaid

Balances

  % 
Current loans (current accounts and accounts on which more than 50% of an original contract payment was made in the last 59 days)  208  $39,883   78%
60-89 days  -   -   -%
90-179 days  32   10,149   20%
180-269 days  3   1,489   2%
             
Subtotal  243  $51,521   100%
             
Interest only accounts (Accounts on which interest, deferment, extension and/or default charges were received in the last 60 days)  -  $-   -%
             
Partial Payment accounts (Accounts on which the total received in the last 60 days was less than 50% of the original contractual monthly payment. “Total received” to include interest on simple interest accounts, as well as late charges on deferment charges on pre-computed accounts.)  -  $-   -%
             
Total  243  $51,521   100%

 

Below is an aging schedule of loans receivable as of September 30, 2020, on a contractual basis:

 

  

No.

Loans

  

Unpaid

Balances

  % 
Contractual Terms - All current Direct Loans and Sales Finance Contracts with installments past due less than 60 days from due date.  208  $39,883   78%
60-89 days  -   -   -%
90-179 days  32   10,149   20%
180-269 days  3   1,489   2%
             
Subtotal  243  $51,521   100%
             
Interest only accounts (Accounts on which interest, deferment, extension and/or default charges were received in the last 60 days)  -  $-   -%
             
Partial Payment accounts (Accounts on which the total received in the last 60 days was less than 50% of the original contractual monthly payment. “Total received” to include interest on simple interest accounts, as well as late charges on deferment charges on pre-computed accounts.)  -  $-   -%
             
Total  243  $51,521   100%

 

 28 
 

 

Below is an aging schedule of loans receivable as of December 31, 2019, on a recency basis:

 

  

No.

Loans

  

Unpaid

Balances

  % 
Current loans (current accounts and accounts on which more than 50% of an original contract payment was made in the last 59 days)  246  $56,113   97%
60-89 days        %
90-179 days  4   1,495   3%
180-269 days        %
             
Subtotal  250  $57,608   100%
             
Interest only accounts (Accounts on which interest, deferment, extension and/or default charges were received in the last 60 days)    $   %
             
Partial Payment accounts (Accounts on which the total received in the last 60 days was less than 50% of the original contractual monthly payment. “Total received” to include interest on simple interest accounts, as well as late charges on deferment charges on pre-computed accounts.)    $   %
             
Total  250  $57,608   100%

 

Below is an aging schedule of loans receivable as of December 31, 2019, on a contractual basis:

 

  

No.

Loans

  

Unpaid

Balances

  % 
Contractual Terms - All current Direct Loans and Sales Finance Contracts with installments past due less than 60 days from due date.  246  $56,113   97%
60-89 days  -   -   -%
90-179 days  4   1,495   3%
180-269 days  -   -   -%
             
Subtotal  250  $57,608   100%
             
Interest only accounts (Accounts on which interest, deferment, extension and/or default charges were received in the last 60 days)  -  $-   -%
             
Partial Payment accounts (Accounts on which the total received in the last 60 days was less than 50% of the original contractual monthly payment. “Total received” to include interest on simple interest accounts, as well as late charges on deferment charges on pre-computed accounts.)  -  $-   -%
             
Total  250  $57,608   100%

 

 29 
 

 

Foreclosed Assets

 

Below is a roll forward of foreclosed assets:

 

  

Nine Months
Ended

September 30,
2020

  

Year

Ended

December 31,
2019

  

Nine Months
Ended

September 30,
2019

 
          
Beginning balance $4,916  $5,973  $5,973 
Additions from loans  279   3,352   2,006 
Additions for construction/development  801   763   608 
Sale proceeds  (2,246)  (4,543)  (4,543)
Loss on sale  (86)  (274)  (274)
Gain on foreclosure  -   203   181 
Gain on sale of foreclosed assets  138   -   - 
Impairment gain on foreclosed assets  68   -   - 
Impairment gain on foreclosed assets due to COVID-19  27   -   - 
Loss on foreclosure  (2)  -   (169)
Impairment loss on foreclosed assets  (114)  -   (107)
Impairment loss on foreclosed assets due to COVID-19  (91)  (558)  - 
Ending balance $3,690  $4,916  $3,675 

 

Customer Interest Escrow

 

Below is a roll forward of interest escrow:

 

  

Nine Months

Ended

September 30, 2020

  

Year Ended

December 31, 2019

  

Nine Months

Ended

September 30, 2019

 
          
Beginning balance $643  $939  $939 
Preferred equity dividends  73   136   100 
Additions from Pennsylvania loans  819   1,107   964 
Additions from other loans  308   768   570 
Interest, fees, principal or repaid to borrower  (1,396)  (2,307)  (1,659)
Ending balance $447  $643  $914 

 

Related Party Borrowings

 

As of September 30, 2020, the Company had $1,249, $250, and $1,000 available to borrow against the line of credit from Daniel M. Wallach (our Chief Executive Officer and chairman of the board of managers) and his wife, the line of credit from the 2007 Daniel M. Wallach Legacy Trust, and the line of credit from William Myrick (our Executive Vice President of Sales), respectively. A more detailed description is included in Note 6 to the 2019 Financial Statements. These borrowings are in notes payable secured, net of deferred financing costs on the interim condensed consolidated balance sheet.

 

Secured Borrowings

 

New Lines of Credit

 

During September 2020, we entered into an amended line of credit agreement (the “Eppinger LOC Agreement”) with Jeffrey Eppinger. The original line of credit from Mr. Eppinger was one of the New LOC Agreements described in the 2019 Form 10-K. Pursuant to the Eppinger LOC Agreement, Mr. Eppinger will provide us with a revolving line of credit of $1,500, an increase of $500. Principal for the New LOC Agreements, as amended, will not exceed $5,500. All other terms were unchanged.

 

 30 
 

 

Lines of Credit from Affiliates

 

As of September 30, 2020, the Company had borrowed $1 on its lines of credit from affiliates, which have a total limit of $2,500.

 

None of our lines of credit (including with related parties and non-related parties) have given us notice of nonrenewal, and the lines will continue to automatically renew unless notice is given by a lender.

 

Secured Deferred Financing Costs

 

The Company had secured deferred financing costs of $9 and $5 as of September 30, 2020 and December 31, 2019, respectively. Amortization expense for secured deferred financing costs was immaterial for the quarter and nine months ended September 30, 2020 and for the year ended December 31, 2019.

 

Summary

 

The borrowings secured by loan assets are summarized below:

 

  September 30, 2020  December 31, 2019 
  

Book Value of

Loans which Served as
Collateral

  

Due from Shepherd’s
Finance to Loan Purchaser or

Lender

  Book Value of Loans which Served as Collateral  Due from Shepherd’s Finance to Loan Purchaser or Lender 
Loan Purchaser                
Builder Finance, Inc. $8,860  $6,202  $13,711  $9,375 
S.K. Funding, LLC  7,063   4,791   10,394   6,771 
                 
Lender                
Stephen K. Shuman  1,722   1,325   1,785   1,325 
Jeffrey Eppinger  3,170   1,500   1,821   1,000 
Hardy Enterprises, Inc.  1,726   1,000   1,684   1,000 
Gary Zentner  389   250   472   250 
R. Scott Summers  1,416   847   841   628 
Paul Swanson  8,304   5,862   8,377   5,824 
Total $32,650  $21,777  $39,085  $26,173 

 

Unsecured Borrowings

 

Unsecured Notes through the Public Offering (“Notes Program”)

 

On March 22, 2019, we terminated our second public offering and commenced our third public offering of fixed rate subordinated notes (the “Notes”). The effective interest rate on borrowings through our Notes Program at September 30, 2020 and December 31, 2019 was 10.31% and 10.56%, respectively, not including the amortization of deferred financing costs. We generally offer four durations at any given time, ranging from 12 to 48 months from the date of issuance. There are limited rights of early redemption. Our 36-month Note has a mandatory early redemption option, subject to certain conditions. The following table shows the roll forward of our Notes Program:

 

 31 
 

 

  Nine Months
Ended
September 30,
2020
  Year Ended
December 31,
2019
  Nine Months
Ended
September 30,
2019
 
          
Gross Notes outstanding, beginning of period $20,308  $17,348  $17,348 
Notes issued  6,454   11,127   9,201 
Note repayments / redemptions  (5,443)  (8,167)  (5,793)
             
Gross Notes outstanding, end of period $21,319  $20,308  $20,756 
             
Less deferred financing costs, net  435   416   425 
             
Notes outstanding, net $20,884  $19,892  $20,331 

 

The following is a roll forward of deferred financing costs:

 

  

Nine Months

Ended

September 30,
2020

  

Year

Ended

December 31,
2019

  

Nine Months

Ended

September 30,
2019

 
          
Deferred financing costs, beginning balance $786  $1,212  $1,212 
Additions  131   365   336 
Disposals  -   (791)  - 
Deferred financing costs, ending balance  917   786   1,548 
Less accumulated amortization  (482)  (370)  (1,123)
Deferred financing costs, net $435  $416  $425 

 

The following is a roll forward of the accumulated amortization of deferred financing costs:

 

  

Nine Months

Ended

September 30,
2020

  

Year

Ended

December 31,
2019

  

Nine Months
Ended

September 30,
2019

 
          
Accumulated amortization, beginning balance $370  $1,000  $1,000 
Additions  112   161   123 
Disposals  -   (791)  - 
Accumulated amortization, ending balance $482  $370  $1,123 

 

 32 
 

 

Other Unsecured Debts

 

Our other unsecured debts are detailed below:

 

       Principal Amount Outstanding as of 
Loan Maturity
Date
 Interest
Rate(1)
  September 30,
2020
  December 31, 2019 
Unsecured Note with Seven Kings Holdings, Inc. Demand(2)  9.5% $500  $500 
Unsecured Line of Credit from Paul Swanson October 2020(6)  10.0%  1,138   1,176 
Subordinated Promissory Note October 2020  9.5%  563   563 
Subordinated Promissory Note December 2021  10.5%  146   146 
Subordinated Promissory Note April 2024  10.0%  100   100 
Subordinated Promissory Note April 2021  10.0%  174   174 
Subordinated Promissory Note August 2022  11.0%  200   200 
Subordinated Promissory Note March 2023  11.0%  169   169 
Subordinated Promissory Note April 2020  6.5%  -   500 
Subordinated Promissory Note February 2021  11.0%  600   600 
Subordinated Promissory Note Demand  5.0%  -   500 
Subordinated Promissory Note December 2020  5.0%  3   3 
Subordinated Promissory Note December 2023  11.0%  20   - 
Subordinated Promissory Note February 2024  11.0%  20   - 
Senior Subordinated Promissory Note March 2022(3)  10.0%  370   400 
Senior Subordinated Promissory Note March 2022(4)  1.0%  728   728 
Junior Subordinated Promissory Note March 2022(4)  22.5%  417   417 
Senior Subordinated Promissory Note October 2020(5)  1.0%  279   279 
Junior Subordinated Promissory Note October 2020(5)  20.0%  173   173 
        $5,600  $6,628 

 

(1) Interest rate per annum, based upon actual days outstanding and a 365/366-day year.

 

(2) Due six months after lender gives notice.

 

(3) Lender may require us to repay $20 of principal and all unpaid interest with 10 days’ notice.

 

(4) These notes were issued to the same holder and, when calculated together, yield a blended rate of 11% per annum.

 

(5) These notes were issued to the same holder and, when calculated together, yield a blended rate of 10% per annum.

 

(6) Amount due in October 2020 is $1,000 with the remainder due in November 2020.

 

Paycheck Protection Program Loan

 

On May 5, 2020 the Company entered into a loan agreement (the “PPP Loan”) with LCA Bank Corporation to borrow $361 pursuant to the Paycheck Protection Program (“PPP”), created under the Coronavirus Aid, Relief, and Economic Security Act, or CARES Act. The PPP is intended to provide loans to qualified businesses to cover payroll and certain other identified costs. The loan has an interest rate of 1.0% and a term of 24 months. No payments are due for the first six months, although interest accrues, and monthly payments, which include interest, are due over the next 18 months to pay off the loan. Funds from the loan may only be used for certain purposes, including payroll, benefits, rent, and utilities. All or a portion of the loan may be forgivable, as provided by the terms of the PPP. The loan is evidenced by a promissory note, which contains customary events of default relating to, among other things, payment defaults and breaches of representations. We may prepay the loan at any time prior to maturity with no prepayment penalties.

 

Economic Injury Disaster Loan Advance (the “EIDL Advance”)

 

The Economic Injury Disaster Loan Emergency Advance is a $10 grant for companies that successfully submit an EIDL (“Economic Injury Disaster Loan”) application. During April 2020, the Company received the grant (the “EIDL Advance”) which may be used for payroll and other certain operating expenses. The EIDL Advance will reduce the forgiveness of the PPP Loan depending on certain parameters required by the CARES Act.

 

Redeemable Preferred Equity and Members’ Capital

 

We strive to maintain a reasonable (about 15%) balance between (1) redeemable preferred equity plus members’ capital and (2) loan assets, net. The ratio of redeemable preferred equity plus members’ capital to loan assets, net was 9.8% and 12.9% as of September 30, 2020 and December 31, 2019, respectively. The ratio decreased significantly due to losses related to COVID-19. We anticipate this ratio to increase as we retain earnings for the remainder of 2020.

 

 33 
 

 

Priority of Borrowings

 

The following table displays our borrowings and a ranking of priority. The lower the number, the higher the priority.

 

  Priority Rank  September 30, 2020  December 31, 2019 
Borrowing Source            
Purchase and sale agreements and other secured borrowings  1  $22,762  $26,806 
Secured lines of credit from affiliates  2   1   189 
Unsecured line of credit (senior)  3   -   500 
PPP Loan and EIDL Advance  3   371   - 
Other unsecured debt (senior subordinated)  4   1,377   1,407 
Unsecured Notes through our public offering, gross  5   21,319   20,308 
Other unsecured debt (subordinated)  5   3,633   4,131 
Other unsecured debt (junior subordinated)  6   590   590 
             
Total     $50,053  $53,931 

 

Liquidity and Capital Resources

 

Our primary liquidity management objective is to meet expected cash flow needs while continuing to service our business and customers. Combined loans outstanding as of September 30, 2020 and December 31, 2019 were 243 and 250, respectively. Gross loans receivable as of September 30, 2020 and December 31, 2019 totaled $51,521 and $57,608, respectively. Our unfunded commitments to extend credit, which have similar collateral, credit, and market risk to our outstanding loans, were $21,560 and $16,662 as September 30, 2020 and December 31, 2019, respectively.

 

We anticipate an increase in our gross loan receivables over the 12 months subsequent to September 30, 2020 by directly increasing originations by funding new loans to borrowers in stronger markets. Competition has declined and, therefore, we believe the ability to return to historical levels may be achieved through 2021.

 

To fund our combined loans, we rely on secured debt, unsecured debt, and equity, which are described in the following table:

 

Source of Liquidity 

As of

September 30, 2020

  

As of

December 31, 2019

 
Secured debt, net of deferred financing costs $22,753  $26,991 
Unsecured debt, net of deferred financing costs  26,484   26,520 
Equity  4,753   7,147 

 

Secured debt, net of deferred financing costs decreased $4,238 to $22,753 as of September 30, 2020 compared to December 31, 2019 which consisted of a decrease in borrowings secured by loans and affiliate lines of $4,050 and $188, respectively. We anticipate increasing our secured debt by roughly half of the increase in loan asset balances over the 12 months subsequent to September 30, 2020 through our existing loan purchase and sale agreements and additional lines of credit.

 

We anticipate that the other half of the loan asset growth will come from a combination of decreases in nonperforming assets, many of which are not used as collateral in secured lines, and increases in our unsecured debt and equity. Unsecured debt, net of deferred financing costs decreased $36 to $26,484 as of September 30, 2020 compared to December 31, 2019 due primarily to a decrease in other unsecured debts of $1,027 which was offset by an increased participation in our Notes Program of $991.

 

 34 
 

 

In addition, in May 2020, we borrowed approximately $361 pursuant to the Paycheck Protection Program (“PPP”), created under the Coronavirus Aid, Relief, and Economic Security Act, or CARES Act. The PPP is intended to provide loans to qualified businesses to cover payroll and certain other identified costs. Funds from the loan may only be used for certain purposes, including payroll, benefits, rent, and utilities. All or a portion of the loan may be forgivable, as provided by the terms of the PPP.

 

Equity decreased $2,394 to $4,753 as of September 30, 2020 compared to $7,147 as of December 31, 2019. The decrease was due primarily to the decline in net income for Class A common equity of $2,495. Equity increased $112 during the quarter ended September 30, 2020 compared to the quarter ended June 30, 2020. We anticipate an increase in our equity during the 12 months subsequent to September 30, 2020, through retaining earnings and the issuance of additional Series C cumulative preferred equity (“Series C Preferred Units”). If we are not able to increase our equity through retained earnings or the issuance of additional Series C Preferred Units, we will rely more heavily on raising additional funds through the Notes Program.

 

If we anticipate the ability to not fund our projected increases in loan balances as discussed above, we may reduce new loan originations to reduce need for additional funds.

 

Contractual Obligations

 

The following table shows the maturity of outstanding debt as of September 30, 2020:

 

Year Maturing  Total Amount Maturing  Public
Offering
  Other
Unsecured(1)
  Secured Borrowings 
2020  $25,431  $974  $2,676  $21,781 
2021   13,257   12,073   1,168   16 
2022   5,541   3,706   1,819   16 
2023   1,119   824   189   106 
2024 and thereafter   4,705   3,742   120   843 
Total  $50,053  $21,319  $5,972  $22,762 

 

 (1)Other Unsecured includes our PPP Loan of $361 and EIDL Advance of $10 of which $21, $247, and $103, collectively, matures during 2020, 2021, and 2022, respectively. All or a portion of the PPP Loan may be forgiven.

 

The total amount maturing through the year ending December 31, 2020 is $25,431, which consists of secured borrowings of $21,781 and unsecured borrowings of $3,650.

 

Secured borrowings maturing through year ending December 31, 2020 significantly consist of loan purchase and sale agreements with two loan purchasers (Builder Finance, Inc. and S. K. Funding, LLC) and six lenders. Our secured borrowings are classified as maturing during 2020 primarily because the related collateral is demand loans. The following lists our secured facilities with maturity and renewal dates:

 

 Swanson – $5,862 due July 2021, will automatically renew unless notice is given;
 Shuman – $1,325 due July 2021, will automatically renew unless notice is given;
 S. K. Funding, LLC – $3,500 of the total due July 2021, will automatically renew unless notice is given;
 S. K. Funding, LLC – $1,291 with no expiration date;
 Builder Finance, Inc. – $6,202 with no expiration date;
 New LOC Agreements – $3,596 generally one-month notice and six months to reduce principal balance to zero;
 Mortgage payable – $4 due monthly; and
 Wallach LOC – $1 with no expiration date.

 

 35 
 

 

Unsecured borrowings due by December 31, 2020 consist of Notes issued pursuant to the Notes Program and other unsecured debt of $974 and $2,676, respectively. To the extent that Notes issued pursuant to the Notes Program are not reinvested upon maturity, we will be required to fund the maturities, which we anticipate funding through the issuance of new Notes in our Notes Program. Historically, approximately 80% of our Note holders reinvest upon maturity. Our other unsecured debt has historically renewed. For more information on other unsecured borrowings, see Note 6 – Borrowings. If other unsecured borrowings are not renewed in the future, we anticipate funding such maturities through investments in our Notes Program.

 

Summary

 

We have the funding available to address the loans we have today, including our unfunded commitments. We anticipate growing our assets through the net sources and uses (12-month liquidity) listed above as well as future capital increases from debt, redeemable preferred equity, and regular equity. Our expectation to grow loan asset balances is subject to changes due to changes in demand, competition, and COVID-19. Although our secured debt is almost entirely listed as currently due because of the underlying collateral being demand notes, the vast majority of our secured debt is either contractually set to automatically renew unless notice is given or, in the case of purchase and sale agreements, has no end date as to when the purchasers will not purchase new loans (although they are never required to purchase additional loans).

 

Inflation, Interest Rates, and Housing Starts

 

Since we are in the housing industry, we are affected by factors that impact that industry. Housing starts impact our customers’ ability to sell their homes. Faster sales generally mean higher effective interest rates for us, as the recognition of fees we charge is spread over a shorter period. Slower sales generally mean lower effective interest rates for us. Slower sales also are likely to increase the default rate we experience.

 

Housing inflation generally has a positive impact on our operations. When we lend initially, we are lending a percentage of a home’s expected value, based on historical sales. If those estimates prove to be low (in an inflationary market), the percentage we loaned of the value actually decreases, reducing potential losses on defaulted loans. The opposite is true in a deflationary housing price market. It is our opinion that values are average in many of the housing markets in the U.S. today, and our lending against these values is safer than loans made by financial institutions in 2006 to 2008. Our analysis of the COVID-19 impact on housing in the markets in which we do business is mixed. In many markets, our customers see demand as outpacing new housing starts. In Orlando, Florida (which is our second highest geographic concentration risk by borrower), there has been a significant lack of demand for housing sold by customers who sell more affordable homes, which has resulted in losses that we recognized in the third quarter of 2020. We note that nationwide, fewer first-time home buyers will qualify for government backed loans due to FICO score and other criteria changes.

 

Interest rates have several impacts on our business. First, rates affect housing (starts, home size, etc.). High long-term interest rates may decrease housing starts, having the effects listed above. Higher interest rates will also affect our investors. We believe that there will be a spread between the rate our Notes yield to our investors and the rates the same investors could get on deposits at FDIC insured institutions. We also believe that the spread may need to widen if these rates rise. For instance, if we pay 7% above average CD rates when CDs are paying 0.5%, when CDs are paying 3%, we may have to have a larger than 7% difference. This may cause our lending rates, which are based on our cost of funds, to be uncompetitive. High interest rates may also increase builder defaults, as interest payments may become a higher portion of operating costs for the builder. Higher short-term rates may increase the rates builders are charged by banks faster than our rates to the builder will grow, which might be a benefit for us. Below is a chart showing three-year U.S. treasury rates, which are being used by us here to approximate CD rates. The rates we are paying our investors are going down due to COVID-19, including the rate on our three-month Note which has additional redemption options but lower returns, because other alternative investments are paying lower rates. This in turn will lower the rates to our borrowers over time. We also anticipate lower cost secured funding in the fourth quarter of 2020 which will also lower both our cost of funds and the rate we charge our customers.

 

 36 
 

 

Housing prices are also generally correlated with housing starts, so that increases in housing starts usually coincide with increases in housing values, and the reverse is generally true. Below is a graph showing single family housing starts from 2000 through today.

 

 

 37 
 

 

Source: U.S. Census Bureau

 

To date, changes in housing starts, CD rates, and inflation have not had a material impact on our business.

 

Off-Balance Sheet Arrangements

 

As of both September 30, 2020 and December 31, 2019, we had no off-balance sheet transactions, nor do we currently have any such arrangements or obligations.

.

 

ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

 

We are a smaller reporting company as defined by Rule 12b-2 of the Securities Exchange Act of 1934 and are not required to provide the information under this item.

 

ITEM 4.CONTROLS AND PROCEDURES

 

Disclosure Controls and Procedures

 

As of the end of the period covered by this report, management including our Chief Executive Officer (our principal executive officer) and Acting Chief Financial Officer (our principal financial officer) evaluated the effectiveness of the design and operation of our disclosure controls and procedures. Based upon, and as of the date of, the evaluation, our CEO (our principal executive officer) and Acting CFO (our principal financial officer) concluded that the disclosure controls and procedures were effective as of the end of the period covered by this report to ensure that information required to be disclosed in the reports we file and submit under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported as and when required. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports we file and submit under the Exchange Act is accumulated and communicated to our management, including our CEO (our principal executive officer) and Acting CFO (our principal financial officer), as appropriate to allow timely decisions regarding required disclosure.

 

Internal Control over Financial Reporting

 

There has been no change in our internal controls over financial reporting during the quarter ended September 30, 2020 that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.

 

PART II - OTHER INFORMATION

 

ITEM 1.LEGAL PROCEEDINGS

 

None.

 

ITEM 1A.RISK FACTORS

 

Not applicable.

 

 38 
 

 

ITEM 2.UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

 (a)Reinvestments in Partial Series C Cumulative Preferred Units
   
  Investors in the Series C cumulative preferred units (“Series C Preferred Units”) may elect to reinvest their distributions in additional Series C Preferred Units (the “Series C Reinvestment Program”). Pursuant to the Series C Reinvestment Program, we issued the following Series C Preferred Units as of September 30, 2020:

 

Owner Units  Amount 
Daniel M. and Joyce S. Wallach  1.3314226  $133,142.26 
Gregory L. and Madeline M. Sheldon  0.3158608   31,586.08 
BLDR, LLC  0.4307552   43,075.52 
Schultz Family Living Trust  0.1071557   10,715.57 
Jeffrey L. Eppinger  0.3636120   36,361.20 
Fernando Ascencio and Lorraine Carol Ascencio  0.2004889   20,048.89 
Total  2.7492952  $274,929.52 

 

The proceeds received from the sales of the partial Series C Preferred Units in these transactions were used for the funding of construction loans. The transactions in Series C Preferred Units described above were effected in private transactions exempt from the registration requirements of the Securities Act under Section 4(a)(2) of the Securities Act of 1933 (the “Securities Act”). The transactions described above did not involve any public offering, were made without general solicitation or advertising, and the buyer represented to us that he/she/it is an “accredited investor” within the meaning of Rule 501 of Regulation D promulgated under the Securities Act, with access to all relevant information necessary to evaluate the investment in the Series C Preferred Units.

 

Issuance of Partial Series B Cumulative Preferred Units

 

We previously entered into an agreement with the Hoskins Group (consisting of Benjamin Marcus Homes, LLC, Investor’s Mark Acquisitions, LLC, and Mark L. Hoskins) pursuant to which we sell the Hoskins Group 0.1 Series B cumulative preferred units (“Series B Preferred Units”) upon the closing of certain lots. We issued 0.3 Series B Preferred Units to the Hoskins Group during the quarter ended September 30, 2020.

 

The proceeds received from the sales of the Series B Preferred Units in those transactions were used for the funding of construction loans. The transactions in Series B Preferred Units described above were effected in private transactions exempt from the registration requirements of the Securities Act under Section 4(a)(2) of the Securities Act. The transactions described above did not involve any public offering, were made without general solicitation or advertising, and the buyers represented to us that they are an “accredited investor” within the meaning of Rule 501 of Regulation D promulgated under the Securities Act, with access to all relevant information necessary to evaluate the investment in the Series B Preferred Units.

 

 (b)We registered up to $70,000,000 in Fixed Rate Subordinated Notes (“Notes”) in our current public offering, which is our third public offering of Notes (SEC File No. 333-224557, effective March 22, 2019). As of September 30, 2020, we had issued $15,198,000 in Notes pursuant to our current public offering. As of September 30, 2020, we incurred expenses of $484,000 in connection with the issuance and distribution of the Notes in our current public offering, which were paid to third parties. These expenses were not for underwriters or discounts, but were for advertising, printing, and professional services. Net offering proceeds as of September 30, 2020 were $14,714,000, all of which was used to increase loan balances.

 

(c)None.

 

ITEM 3.DEFAULTS UPON SENIOR SECURITIES

 

None.

 

ITEM 4.MINE SAFETY DISCLOSURES

 

Not applicable.

 

 39 
 

 

ITEM 5.OTHER INFORMATION

 

 (a)During the quarter ended September 30, 2020, there was no information required to be disclosed in a report on Form 8-K which was not disclosed in a report on Form 8-K.
   
 (b)During the quarter ended September 30, 2020, there were no material changes to the procedures by which members may recommend nominees to our board of managers.

 

ITEM 6.EXHIBITS

 

The exhibits required to be filed with this report are set forth on the Exhibit Index hereto and incorporated by reference herein.

 

EXHIBIT INDEX

 

The following exhibits are included in this report on Form 10-Q for the period ended September 30, 2020 (and are numbered in accordance with Item 601 of Regulation S-K).

 

Exhibit

No.

 

 

Name of Exhibit
3.1 Certificate of Conversion, incorporated by reference to Exhibit 3.1 to the Registrant’s Registration Statement on Form S-1, filed on May 11, 2012, Commission File No. 333-181360
   
3.2 Certificate of Formation, incorporated by reference to Exhibit 3.2 to the Registrant’s Registration Statement on Form S-1, filed on May 11, 2012, Commission File No. 333-181360
   
3.3 Second Amended and Restated Operating Agreement of the Company, incorporated by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K, filed on November 13, 2017, Commission File No. 333-203707
   
3.4 Amendment No. 1 to the Registrant’s Second Amended and Restated Operating Agreement, dated as of March 21, 2019, incorporated by reference to Exhibit 3.4 to the Company’s Quarterly Report on Form 10-Q, filed on May 9, 2019, Commission File No. 333-203707
   
3.5 Amendment No. 2 to Second Amended and Restated Limited Liability Company Agreement of the Registrant, incorporated by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K, filed March 31, 2020, Commission File No. 333-224557
   
4.1 Indenture Agreement (including Form of Note) dated March 22, 2019, incorporated by reference to Exhibit 4.1 to the Company’s Post-Effective Amendment No. 1, filed on March 22, 2019, Commission File No. 333-224557
   
4.2 Amendment No. 1 to Indenture Agreement (including Form of Note) dated February 4, 2020, incorporated by reference to Exhibit 4.1 to the Registrant’s Post-Effective Amendment No. 4, filed on February 4, 2020, Commission File No. 333-224557
   
31.1* Certification of Principal Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
   
31.2* Certification of Principal Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
   
32.1* Certification of Principal Executive Officer, pursuant to 18 U.S.C. Section 1350, as created by Section 906 of the Sarbanes-Oxley Act of 2002
   
32.2* Certification of Principal Financial Officer, pursuant to 18 U.S.C. Section 1350, as created by Section 906 of the Sarbanes-Oxley Act of 2002
   
101.INS** XBRL Instance Document
   
101.SCH** XBRL Schema Document
   
101.CAL** XBRL Calculation Linkbase Document
   
101.DEF** XBRL Definition Linkbase Document
   
101.LAB** XBRL Labels Linkbase Document
   
101.PRE** XBRL Presentation Linkbase Document

 

* Filed herewith.

 

** Pursuant to Regulation 406T of Regulation S-T, these Interactive Data Files are deemed not filed or part of a registration statement or prospectus for purpose of Section 11 or 12 of the Securities Act of 1933, as amended, or Section 18 of the Securities Exchange Act of 1934, as amended, and are otherwise not subject to liability.

 

 40 
 

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

SHEPHERD’S FINANCE, LLC

(Registrant)

  
Dated: November 5, 2020By:/s/ Catherine Loftin
  Catherine Loftin
  Acting Chief Financial Officer

 

 41