UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
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þ
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
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For the Quarterly Period Ended June 30, 2010
Commission File Number 000-25193
EOS PREFERRED CORPORATION
(Exact name of registrant as specified in its charter)
Massachusetts
(State or other jurisdiction of incorporation or organization)
04-3439366
(I.R.S. Employer
Identification Number)
1271
Avenue of the Americas, 46th Floor, New York, New York
(Address of principal executive offices)
10020
(Zip Code)
(212) 377-1503
(Registrants
telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes
þ
No
o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12
months (or for such shorter period that the registrant was required to submit and post such files).
Yes
o
No
o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated
filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
(Check one):
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Large accelerated filer
o
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Accelerated filer
o
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Non-accelerated filer
þ
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Smaller reporting company
o
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(Do not check if a smaller reporting company)
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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act). Yes
o
No
þ
The number of shares outstanding of the registrants sole class of common stock was 100
shares, $.01 par value per share, as of August 11, 2010. No common stock was held by non-affiliates
of the issuer.
EOS Preferred Corporation
Table of Contents
2
PART I
Item 1. Condensed Financial Statements
EOS Preferred Corporation
Balance Sheets
(Unaudited)
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June 30,
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December 31,
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2010
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2009
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(In Thousands)
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ASSETS
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Cash account with parent
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$
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184
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$
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184
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Interest-bearing deposits with parent
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57,446
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51,639
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Total cash and cash equivalents
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57,630
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51,823
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Loans held for sale, at fair value
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19,724
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22,531
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Loans held for sale, at lower of accreted cost or market value
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7,578
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7,292
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Loans
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27,302
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29,823
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Accrued interest and other receivables
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107
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393
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Total assets
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$
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85,039
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$
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82,039
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LIABILITIES AND STOCKHOLDERS EQUITY
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Accrued expenses and other liabilities
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$
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147
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$
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344
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Total liabilities
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147
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344
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Stockholders equity:
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Preferred stock, Series B, 8% cumulative, non-convertible; $.01 par value; $1,000 liquidation value per
share plus accrued dividends; 1,000 shares authorized, 937 shares issued and outstanding
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Preferred stock, Series D, 8.50% non-cumulative, exchangeable; $.01 par value; $25 liquidation value per
share; 1,725,000 shares authorized, 1,500,000 shares issued and outstanding
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15
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15
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Common stock, $.01 par value, 100 shares authorized, issued and outstanding
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Additional paid-in capital
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95,320
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95,320
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Accumulated deficit
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(10,443
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)
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(13,640
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)
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Total stockholders equity
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84,892
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81,695
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Total liabilities and stockholders equity
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$
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85,039
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$
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82,039
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See accompanying notes to condensed financial statements.
3
EOS Preferred Corporation
Statements of Operations
(Unaudited)
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Three Months Ended
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Six Months Ended
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June 30,
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June 30,
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2010
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2009
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2010
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2009
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(In Thousands)
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(In Thousands)
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Interest income:
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Interest and fees on loans
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$
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483
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$
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679
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$
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1,119
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$
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1,508
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Interest on interest-bearing deposits
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41
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202
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79
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393
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Total interest income
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524
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881
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1,198
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1,901
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Gain (loss) on loans held for sale
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756
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(1,029
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2,521
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(16,210
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Reduction in allowance for loan losses
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915
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Net revenue
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1,280
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(148
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3,719
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(13,394
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Operating expenses:
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Loan servicing and advisory services
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116
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44
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244
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88
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Other general and administrative
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133
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284
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278
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570
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Total operating expenses
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249
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328
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522
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658
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Net income (loss)
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1,031
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(476
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)
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3,197
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(14,052
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Preferred stock dividends
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816
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Net income (loss) available to common stockholder
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$
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1,031
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$
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(476
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$
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3,197
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$
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(14,868
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)
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See accompanying notes to condensed financial statements.
4
EOS Preferred Corporation
Statements of Changes in Stockholders Equity
(Unaudited)
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Six Months ended June 30, 2010
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Preferred Stock
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Preferred Stock
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Additional
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Retained Earnings/
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Total
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Series B
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Series D
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Common Stock
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Paid-in
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(Accumulated
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Stockholders
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Shares
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Amount
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Shares
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Amount
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Shares
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Amount
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Capital
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Deficit)
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Equity
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(In Thousands)
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Balance at December 31, 2009
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1
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$
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1,500
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$
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15
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$
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$
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95,320
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$
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(13,640
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)
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$
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81,695
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Net income
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3,197
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3,197
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Cumulative dividends on preferred stock, Series B
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Dividends on preferred stock, Series D
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Balance at June 30, 2010
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1
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$
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1,500
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$
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15
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$
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$
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95,320
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$
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(10,443
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)
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$
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84,892
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Six Months ended June 30, 2009
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Preferred Stock
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Preferred Stock
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Additional
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Retained Earnings/
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Total
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Series B
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Series D
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Common Stock
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Paid-in
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(Accumulated
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Stockholders
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Shares
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Amount
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Shares
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Amount
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Shares
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Amount
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Capital
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Deficit)
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Equity
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(In Thousands)
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Balance at December 31, 2008
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1
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$
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1,500
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$
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15
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$
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$
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95,121
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$
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$
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95,136
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Net loss
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(14,052
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)
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(14,052
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)
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Cumulative dividends on preferred stock, Series B
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(19
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)
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(19
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)
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Dividends on preferred stock, Series D
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(797
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)
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(797
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)
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Balance at June 30, 2009
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1
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$
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1,500
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$
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15
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$
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$
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95,121
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$
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(14,868
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)
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$
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80,268
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See accompanying notes to condensed financial statements.
5
EOS Preferred Corporation
Statements of Cash Flows
(Unaudited)
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Six Months Ended
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June 30,
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2010
|
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2009
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(In Thousands)
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Cash flows from operating activities:
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Net income (loss)
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$
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3,197
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$
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(14,052
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)
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Adjustments to reconcile net income (loss) to net cash from operating activities:
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(Gain) loss on loans held for sale
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(2,521
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)
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16,210
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Decrease in accrued interest and other receivable
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286
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33
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Increase (decrease) in accrued expenses and other liabilities
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(197
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)
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186
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Provision for loan losses
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(915
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)
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Increase in other assets
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(15
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)
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Net cash provided by operating activities
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|
765
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1,447
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Cash flows from investing activities:
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Loan repayments
|
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5,042
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3,624
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Cash provided by investing activities
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5,042
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3,624
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Cash flows from financing activities:
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Payment of preferred stock dividends
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(1,631
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)
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Cash used in financing activities
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(1,631
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)
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Net change in cash and cash equivalents
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5,807
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3,440
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Cash and cash equivalents at beginning of period
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51,823
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43,757
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Cash and cash equivalents at end of period
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$
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57,630
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$
|
47,197
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|
See accompanying notes to condensed financial statements.
6
EOS Preferred Corporation
Notes to Condensed Financial Statements
Three and Six Months Ended June 30, 2010 and 2009
NOTE 1. ORGANIZATION
EOS Preferred Corporation (referred to hereafter as the Company, EOS, we, us or our)
is a Massachusetts corporation with the principal business objective to hold mortgage assets that
will generate net income for distribution to stockholders. We may acquire additional mortgage
assets in the future, although management currently has no intention of acquiring additional
assets. The Company was organized on March 20, 1998, to acquire and hold real estate assets and
Aurora Bank FSB (Aurora Bank), an indirect wholly-owned subsidiary of Lehman Brothers Holdings
Inc. (LBHI; LBHI with its subsidiaries, Lehman Brothers), owns all of our common stock. Prior
to the merger with Aurora Bank, which is further discussed below, we were a subsidiary of Capital
Crossing Bank (Capital Crossing Bank), a federally insured Massachusetts trust company, the
Companys corporate name was Capital Crossing Preferred Corporation, and Capital Crossing Bank
owned all of our common stock. Effective June 21, 2010, we changed our corporate name to EOS
Preferred Corporation.
We operate in a manner intended to allow us to be taxed as a real estate investment trust, or
a REIT, under the Internal Revenue Code of 1986, as amended. As a REIT, EOS will not be required
to pay federal or state income tax if we distribute our earnings to our shareholders and continue
to meet a number of other requirements.
On March 31, 1998, Capital Crossing Bank capitalized the Company by transferring mortgage
loans valued at $140.7 million in exchange for 1,000 shares of 8% Cumulative Non-Convertible
Preferred Stock, Series B, valued at $1.0 million and 100 shares of our common stock valued at
$139.7 million. The carrying value of these loans approximated their fair values at the date of
contribution.
On May 11, 2004, the Company closed its public offering of 1,500,000 shares of 8.50%
Non-Cumulative Exchangeable Preferred Stock, Series D. Our net proceeds from the sale of Series D
preferred stock was $35.3 million. The Series D preferred stock became redeemable at our option on
July 15, 2009, with the prior consent of the Office of Thrift Supervision (the OTS). Our Series D
preferred stock is publically traded on the NASDAQ stock exchange under the ticker symbol EOSPN.
On February 14, 2007, Capital Crossing Bank was acquired by Aurora Bank through a two-step
merger transaction. An interim thrift subsidiary of Aurora Bank was merged into Capital Crossing
Bank. Immediately following such merger, Capital Crossing Bank was merged into Aurora Bank. Under
the terms of the agreement, Lehman Brothers paid $30.00 per share in cash in exchange for each
outstanding share of Capital Crossing Bank.
The Series B preferred stock and Series D preferred stock remain outstanding and remain
subject to their existing terms and conditions, including the call feature with respect to the
Series D preferred stock.
Business
Our principal business objective is to hold mortgage assets that will generate net income for
distribution to stockholders. We may acquire additional mortgage assets in the future, although
management currently has no intention of acquiring additional assets. All of the mortgage assets in
our loan portfolio at June 30, 2010 were acquired from Capital Crossing Bank or Aurora Bank and it
is anticipated that substantially all additional mortgage assets, if any are acquired in the
future, will be acquired from Aurora Bank. Aurora Bank administers our day-to-day activities in its
roles as servicer under the Master Service Agreement, as amended, entered into between Aurora Bank
and EOS (the MSA) and as advisor under the Advisory Agreement, as amended, entered into between
Aurora Bank and EOS (the AA).
7
Recent Developments
Asset Exchange.
On November 18, 2009, EOS and our parent, Aurora Bank, entered into an Asset
Exchange Agreement (the November Asset Exchange) pursuant to which Aurora Bank agreed to assign
various one-to-four family residential mortgage loans (Residential Loans) to us in exchange for
our assignment of certain commercial and multi-family mortgage loans to Aurora Bank. Pursuant to
the November Asset Exchange, the Residential Loans assigned to us were to be of equal or greater
value than the commercial and multi-family loans assigned to Aurora Bank. The November Asset
Exchange was subject to the receipt of a non-objection from the OTS, which was granted on August
17, 2009. The November Asset Exchange was consummated on November 18, 2009 (with an effective date
as of November 1, 2009) which resulted in us receiving residential mortgage loans, including jumbo
mortgage loans having a closing value of $199,000 greater than the value of the commercial and
multi-family loans transferred to Aurora Bank.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of presentation
These condensed financial statements are unaudited and have been prepared in accordance with
the rules and regulations of the Securities and Exchange Commission (SEC) relating to interim
financial statements and in conformity with accounting principles generally accepted in the United
States of America (GAAP). Certain information and note disclosures normally included in annual
financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to
these rules and regulations, although we believe that the disclosures made are adequate to make the
information not misleading. Certain prior period amounts may have been reclassified to conform to
current period presentation. It is the opinion of management that these condensed financial
statements reflect all adjustments that are normal and recurring and that are necessary for a fair
presentation of the results for the interim periods presented. These condensed financial statements
included in this Form 10-Q should be read in conjunction with the financial statements and notes
thereto included in our Annual Report on Form 10-K as of, and for the year ended December 31, 2009.
Interim results are not necessarily indicative of results to be expected for the entire year.
Use of estimates
In preparing financial statements in conformity with GAAP, management is required to make
estimates and assumptions that affect the reported amounts of assets and liabilities as of the date
of the balance sheet and reported amounts of revenues and expenses during the reporting period.
Material estimates that are particularly susceptible to significant change in the near term relate
to the determination of the fair value of loans held for sale. The fair value of the loan portfolio
was estimated based upon an internal analysis by management and a third party valuation specialist
which considered, among other things, information, to the extent available, about then current sale
prices, bids, credit quality, liquidity and other available information for loans with similar
characteristics as our loan portfolio. For a more detailed discussion of the basis for the
estimates of the fair value of our loan portfolio, please see Note 6.
Cash and Cash Equivalents
Cash and cash equivalents include cash and interest bearing deposits held at Aurora Bank with
original maturities of ninety days or less. The majority of the cash is held in a money market
account that bears interest at rates determined by Aurora Bank which generally follow federal funds
rates. The money market account has a limitation on the number of monthly withdrawals, but there is
no limit on the amount of the withdrawals either individually or in the aggregate.
Loans Held for Sale
On February 5, 2009, EOS and Aurora Bank entered into an Asset Exchange Agreement (the
February 2009 Asset Exchange) pursuant to which we agreed to transfer the entire loan portfolio
secured primarily by commercial real estate and multi-family residential real estate to Aurora Bank
in exchange for loans secured primarily by residential real estate. As a result, during the first
quarter of 2009 we reclassified all of our loan assets as held for sale, recorded a fair value
adjustment and reported these loans at the lower of the their accreted cost or market value. The
February 2009 Asset Exchange was terminated prior to its consummation.
8
Effective November 1, 2009, EOS and Aurora Bank entered into and consummated the November
Asset Exchange pursuant to which we agreed to an exchange of loans with Aurora Bank, though with a
lesser quantity of loans than the February 2009 Asset Exchange. We continue to report the portion
of the loan assets that were retained after the November Asset Exchange at the lower of their
accreted cost or market value. For these retained loans, the carrying value of the loans will be
recognized only up to the cost on the date they were classified as held for sale. We have elected
the fair value option for the loans that were received from the November Asset Exchange as we
believe it provides the best measurement of asset value for each reporting date. For these acquired
loans, the carrying value of the loans will be equivalent to fair
value and recognized as an unrealized gain or loss relative to the
cost of the loans. Such recognition is included in the determination
of net income in the period in which the change occurred.
The fair value of our loan portfolio is estimated based upon an analysis prepared by
management and a third party valuation specialist which considers, among other factors,
information, to the extent available, about then current sale prices, bids, credit quality,
liquidity and other available information for loans with similar characteristics as our loan
portfolio. The geographical location and geographical concentration of the loans in our portfolio
is considered in the analysis. The valuation of the loan portfolio involves a significant level of
management estimation and judgment, the degree of which is dependent on the terms of the loans and
the availability of market prices and inputs.
Loans are generally placed in non-accrual status when, in managements judgment, full payment
of principal or interest by the borrower is in doubt, or generally when the loan is ninety days or
more past due as to either principal or interest. Previously accrued but unpaid interest is
reversed and charged against interest income. Interest payments received on non-accrual loans are
recorded as interest income unless there is doubt as to the collectability of the recorded
investment. In those cases, cash received is recorded as a reduction of principal.
Discounts on Acquired Loans
Prior to February 5, 2009, our loan assets were classified as held for investment and recorded
at accreted cost, which accounted for the amortization of any purchase discount and deferred fees,
less an allowance for loan losses. We reviewed acquired loans for differences between contractual
cash flows and cash flows expected to be collected from our initial investment in the acquired
loans to determine if those differences were attributable, at least in part, to credit quality. If
those differences were attributable to credit quality, the loans contractually required payments
receivable in excess of the amount of its cash flows expected at acquisition, or nonaccretable
discount, was not accreted into income. We recognized the excess of all cash flows expected at
acquisition over our initial investment in the loan as interest income using the interest method
over the term of the loan.
Allowance for Loan Losses
Prior to February 5, 2009, our loan assets were classified as held for investment and recorded
at accreted cost, which accounted for the amortization of any purchase discount and deferred fees,
less an allowance for loan losses. Since the loan portfolio is now classified as held for sale and
recorded either at fair value, or the lower of its accreted cost or market value, we no longer
maintain an allowance for loan losses. In prior periods, arriving at an appropriate level of
allowance for loan losses required a high degree of judgment. The allowance for loan losses was
increased or decreased through a provision for loan losses.
Revenue Recognition
We recognize interest income on loans as revenue as it is earned. This revenue is included in
Interest and fees on loans on the Statements of Operations. Any remaining discount relating to the
purchase of the loans by us is not amortized as interest income during the period the loans are
classified as held for sale but recognized when the related loan is paid in full or sold. Accrual
status loans include any loan which returns to performing status from non-performing status.
9
Taxes
We have elected, for federal income tax purposes, to be treated as a REIT and intend to comply
with the provisions of the Internal Revenue Code of 1986, as amended (the IRC). Accordingly, we
will not be subject to corporate income taxes to the extent we
distribute at least 90% of our net taxable income, excluding net capital gains, to
stockholders and as long as certain assets, income, distribution and stock ownership tests are met
in accordance with the IRC. Management has evaluated the requirements for REIT status and believes
that as of June 30, 2010 we qualify as a REIT for federal and state income tax purposes. As such,
no provision for income taxes is included in the accompanying financial statements.
Following the payment of the first quarter 2009 dividends to our Series B and Series D
preferred shareholders, the OTS required Aurora Bank, our parent, to submit a formal request for
non-objection determination to permit the resumption of normal payment of dividends which was made
on July 28, 2009. In order to qualify as a REIT, distributions must be declared on or before
September 15, 2010 and paid on or before December 31, 2010. Aurora Bank and EOS have informed the
OTS that failure to permit the distribution of dividends will cause EOS to fail to qualify as a
REIT. If EOS no longer qualifies as a REIT, we will be subject to federal and state income taxes
for the 2009 tax year of approximately $1.3 million, excluding penalties and interest, and we will
be subject to federal and state income taxes for 2010 and future years. Aurora Bank and EOS
continue to be engaged in dialogue with the OTS regarding the resumption of dividend payments.
For the year ended December 31, 2009, we were subject to federal excise tax equal to 4% of the
undistributed portion of adjusted ordinary income. The federal excise tax liability resulted from
us not distributing 85% of our 2009 ordinary income. For the three months ended June 30, 2010 and
six months ended June 30, 2010, we have not accrued an excise tax liability pending a decision by
the OTS on our request for the payment of dividends. EOS will be subject to federal excise tax for
any fiscal year in which distribution of 85% of ordinary income does not occur.
Significant Concentration of Credit Risk
We had cash and cash equivalents of $57.6 million as of June 30, 2010. These funds were held
in interest bearing and non-interest bearing accounts with Aurora Bank. The Federal Deposit
Insurance Corporation (FDIC) provides coverage on these accounts which as of June 30, 2010 was
limited to $250,000. Cash in excess of FDIC coverage limitations is subject to credit risk.
Recent Accounting Pronouncements
In January 2010, the Financial Accounting Standards Board (FASB) issued a standards update
on improving disclosures about fair value measurements. The update requires expanded disclosures
including the techniques and inputs used to measure fair value, transfers in and out of Levels 1
and 2, and disaggregation of components within the reconciliation of Level 3 fair value
measurements. This update to the standards is effective for this interim report, except for the
disaggregation of components within the reconciliation of Level 3 items, which is effective for our
fiscal year beginning January 1, 2011 and for interim periods within that fiscal year. We have
included the applicable disclosures in Note 6, Fair Value Measurements.
In February 2010, the FASB issued a standards update on improving disclosures about subsequent
events so that SEC filers no longer are required to disclose the date through which subsequent
events have been evaluated in originally issued and revised financial statements. This update to
the standards is effective for this interim report. The adoption of this update to the standards
did not impact our financial statements as it only impacts the footnote disclosures. We have
included the applicable disclosures in Note 7, Subsequent Events.
In July 2010, the FASB issued a standards update requiring additional disclosures about the
allowance for credit losses and the credit quality of the loan portfolio. The additional
disclosures include a rollforward of the allowance for credit losses on a disaggregated basis and
more information, by type of receivable, on credit quality indicators including aging and troubled
debt restructurings as well as significant purchases and sales. This update to the standards is
effective for our annual report beginning December 31, 2010 and interim reports therafter. This new
guidance will have no impact on our results of operations or financial position.
10
NOTE 3. BANKRUPTCY OF LBHI AND REGULATORY ACTIONS INVOLVING AURORA BANK
Bankruptcy of Lehman Brothers Holding Inc.
Bankruptcy of Lehman Brothers Holdings Inc.
On September 15, 2008, LBHI filed a voluntary
petition under Chapter 11 of the U.S. Bankruptcy Code. The bankruptcy filing of LBHI materially and
adversely affected the capital and liquidity of Aurora Bank, our parent company. This has led to
increased regulatory constraints being placed on Aurora Bank by its bank regulatory authorities,
primarily the OTS. Certain of these constraints apply to Aurora Banks subsidiaries, including EOS.
As more fully discussed below, both the bankruptcy filing of LBHI and the increased regulatory
constraints placed on Aurora Bank have negatively impacted our ability to conduct our business
according to our business objectives.
Regulatory Actions Involving Aurora Bank
Aurora Bank Regulatory Actions and Capital Levels.
On January 26, 2009, the OTS entered a
cease and desist order against Aurora Bank (the Order). The Order, among other things, required
Aurora Bank to file various privileged prospective operating plans with the OTS to manage the
liquidity and operations of Aurora Bank going forward, including a strategic plan. The Order
requires Aurora Bank to ensure that each of its subsidiaries, including EOS, complies with the
Order, including the operating restrictions contained in the Order. These operating restrictions,
among other things, restrict transactions with affiliates, contracts outside the ordinary course of
business and changes in senior executive officers, board members or their employment arrangements
without prior written notice to the OTS. On February 4, 2009 the OTS issued a prompt corrective
action directive to Aurora Bank (the PCA Directive). The PCA Directive requires Aurora Bank to,
among other things, raise its capital ratios such that it will be deemed to be adequately
capitalized and places additional constraints on Aurora Bank and its subsidiaries, including EOS.
More detailed information can be found in the Order and the PCA Directive themselves, copies of
which are available on the OTS website.
During 2009, LBHI contributed additional capital to Aurora Bank, which improved Aurora Banks
capital position. At June 30, 2010, according to a public filing with the OTS, Aurora Banks
capital ratios were above the thresholds required to achieve the
well-capitalized designation. However, due to the continuation of the provisions of the Order and
the PCA Directive, Aurora Bank was deemed to be adequately capitalized. The classification of
Aurora Banks capitalization level is subject to review and acceptance by the OTS. The Order and
the PCA Directive were still effective as of the date of issuance of this interim report. The OTS
may direct in writing at any time the automatic exchange of the Series B and Series D preferred
stock for preferred shares of Aurora Bank.
Dividend Payments.
Following the payment of the first quarter 2009 dividends to our Series B
and Series D preferred shareholders, the OTS required Aurora Bank to submit a formal request for
non-objection determination to permit the resumption of normal payment of dividends. Beginning in
March 2009, dialogue and correspondence commenced with the OTS relating specifically to the
resumption of dividend payments, which resulted in the submission of the formal request on July 28,
2009. Aurora Bank and EOS have informed the OTS that failure to permit the distribution of
dividends will cause EOS to fail to qualify as a REIT. Aurora Bank and EOS continue to be engaged in
dialogue with the OTS regarding the resumption of dividend payments. There can be no assurance that
the OTS will grant the non-objection request, nor can there be any assurance that any further
dividends will be paid or that EOS will continue to qualify as a REIT. As a result of the notice
from the OTS, our Board of Directors (the Board of Directors) voted not to declare or pay the
Series D and Series B preferred stock dividends that would have been payable for the second, third
and fourth quarters of 2009 and the first and second quarters of 2010. At June 30, 2010, we had
$94,000 of dividends in arrears related to our 8% Series B preferred stock. The Series D preferred
stock is non-cumulative and as such, there are no dividends in arrears.
NOTE 4. LOANS
As of June 30, 2010, the loan portfolio was comprised primarily of loans secured by
one-to-four family residential real estate loans, the majority of which were located in California.
Comparatively, as of June 30, 2009, a substantial portion of the loan portfolio was comprised of
loans secured by commercial and multi-family real estate located in California, New England and
Nevada.
On November 18, 2009, EOS and Aurora Bank entered into and consummated the November Asset
Exchange pursuant to which we agreed to transfer 93 loans secured primarily by commercial real
estate and multi-family residential real estate to Aurora Bank in exchange for 74 loans secured
primarily by residential real estate. There were no other acquisitions, sales or exchanges of loans
during 2009 and through June 30, 2010.
We use the term carrying value to reflect loans valued at the lower of their accreted cost or
market value, or at their fair value, as applicable to the individual loans valuation method as
selected by us in accordance with accounting standards.
11
A summary of the carrying value and unpaid principal balance (UPB) of loans is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2010
|
|
|
December 31, 2009
|
|
|
|
Carrying
|
|
|
Unpaid Principal
|
|
|
Carrying
|
|
|
Unpaid Principal
|
|
|
|
Value
|
|
|
Balance
|
|
|
Value
|
|
|
Balance
|
|
|
|
|
|
|
|
(In Thousands)
|
|
|
|
|
|
Mortgage loans, held for sale:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial real estate
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
Multi-family residential
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One-to-four family residential
|
|
|
19,724
|
|
|
|
27,717
|
|
|
|
22,531
|
|
|
|
32,007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total loans held for sale, at fair value
|
|
|
19,724
|
|
|
|
27,717
|
|
|
|
22,531
|
|
|
|
32,007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mortgage loans, held for sale (1):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial real estate
|
|
$
|
6,642
|
|
|
$
|
10,535
|
|
|
$
|
6,380
|
|
|
$
|
11,324
|
|
Multi-family residential
|
|
|
705
|
|
|
|
1,142
|
|
|
|
693
|
|
|
|
1,203
|
|
One-to-four family residential
|
|
|
231
|
|
|
|
353
|
|
|
|
219
|
|
|
|
379
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total loans held for sale, at lower of accreted cost
or market value
|
|
|
7,578
|
|
|
|
12,030
|
|
|
|
7,292
|
|
|
|
12,906
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total mortgage loans, held for sale:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial real estate
|
|
$
|
6,642
|
|
|
$
|
10,535
|
|
|
$
|
6,380
|
|
|
$
|
11,324
|
|
Multi-family residential
|
|
|
705
|
|
|
|
1,142
|
|
|
|
693
|
|
|
|
1,203
|
|
One-to-four family residential
|
|
|
19,955
|
|
|
|
28,070
|
|
|
|
22,750
|
|
|
|
32,386
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total loans
|
|
$
|
27,302
|
|
|
$
|
39,747
|
|
|
$
|
29,823
|
|
|
$
|
44,913
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
|
Though the table compares the carrying value of these loans against UPB, these loans are
carried at the lower of accreted cost or market value and the carrying value cannot exceed the
cost of these loans which for all loans is less than UPB.
|
A summary of the loans in non-accrual status is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2010
|
|
|
December 31, 2009
|
|
|
|
Carrying
|
|
|
Unpaid Principal
|
|
|
Carrying
|
|
|
Unpaid Principal
|
|
|
|
Value
|
|
|
Balance
|
|
|
Value
|
|
|
Balance
|
|
|
|
|
|
|
|
(In Thousands)
|
|
|
|
|
|
Mortgage loans in non-accrual status:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial real estate
|
|
$
|
516
|
|
|
$
|
718
|
|
|
$
|
318
|
|
|
$
|
792
|
|
Multi-family residential
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One-to-four family residential
|
|
|
163
|
|
|
|
337
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total loans in non-accrual status
|
|
$
|
679
|
|
|
$
|
1,055
|
|
|
$
|
318
|
|
|
$
|
792
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of June 30, 2010, there were eight loans representing six borrowers in non-accrual status;
as of December 31, 2009, there were seven loans representing five borrowers in non-accrual status.
Activity in the allowance for loan losses follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30,
|
|
|
Six Months Ended June 30,
|
|
|
|
2010
|
|
|
2009
|
|
|
2010
|
|
|
2009
|
|
|
|
(In Thousands)
|
|
|
(In Thousands)
|
|
Balance at beginning of period
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
915
|
|
Reversal of allowance
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(915
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at end of end of period
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
12
NOTE 5. RELATED PARTY TRANSACTIONS
Aurora Bank administers our day-to-day activities in its roles as servicer under the MSA and
as advisor under the AA. Both the MSA and the AA were amended on March 29, 2010 with retroactive
effect as of January 1, 2010.
Prior to the amendment of the MSA, Aurora Bank in its role as servicer received an annual
servicing fee equal to 0.20%, payable monthly, on the gross average UPB of loans serviced for the
immediately preceding month. The amendment to the MSA changed the calculation of fees which are
then payable to each subservicer. Prior to the amendment of the AA on March 29, 2010, Aurora Bank
in its role as advisor received an annual advisory fee equal to 0.05%, payable monthly, of the
gross average UPB of our loans for the immediately preceding month, plus reimbursement for certain
expenses incurred by Aurora Bank as advisor. The amendment of the AA changed the management fee to
$25,000 per month. The 2010 year to date total of $150,000 is included in Loan servicing and
advisory services on the Statement of Operations.
NOTE 6. FAIR VALUE MEASUREMENTS
Fair Value Measurements
Prior to February 5, 2009, our loan assets were classified as held for investment and recorded
at accreted cost, and we amortized any purchase discount and deferred fees, less a provision to the
allowance for loan losses. As a result of entering into the February 2009 Asset Exchange, our loans
were reclassified as held for sale and were reported at the lower of their accreted cost or market
value. A valuation allowance was recorded to recognize the excess of accreted cost over fair value.
As of June 30, 2010 and December 31, 2009, our portfolio of loans consisted of two categories.
For the loans acquired through the November Asset Exchange, we elected the fair value option. These
loans are reported at fair value and reflected in Loans held for sale, at fair value on the Balance
Sheets. The amount by which the carrying value of our loan assets changes as a result of an updated
valuation is recorded as an unrealized gain or loss and is included in the determination of net
income in the period in which the change occurs. Loans not transferred to Aurora Bank as part of
November Asset Exchange continue to be reported at the lower of their accreted cost or market value
and reflected in Loans held for sale, at lower of accreted cost or market value on the Balance
Sheets. The carrying value of those loans will be recognized only up to the accreted cost on the
date they were classified as held for sale.
Accounting standards define fair value and establish a fair value hierarchy that prioritizes
the inputs to valuation techniques used to measure fair value. The fair value is the price at which
an asset or liability could be exchanged in a current transaction between knowledgeable, willing
parties in an orderly market. Where available, fair value is based on observable market prices or
inputs or derived from such prices or inputs. Where observable prices or inputs are not available,
other valuation methodologies are applied.
Accounting standards require the categorization of financial assets and liabilities based on a
hierarchy of the inputs to the valuation techniques used to measure fair value. The hierarchy gives
the highest priority to quoted prices in active markets for identical assets or liabilities (Level
1) and the lowest priority to valuation methods using unobservable inputs (Level 3). The three
levels are described below:
Level 1 Inputs are unadjusted, quoted prices in active markets for identical assets or
liabilities at the measurement date.
Level 2 Inputs are either directly or indirectly observable for the asset or liability through
correlation with market data at the measurement date and for the duration of the instruments
anticipated life.
Level 3 Inputs reflect managements best estimate of what market participants would use in
pricing the asset or liability at the measurement date. Consideration is given to the risk
inherent in the valuation technique and the risk inherent in the inputs to the model.
The categorization within the fair value hierarchy is based on the lowest level of significant
input to its valuation. In the fair value determination of our loans at June 30, 2010, all of our
loans held for sale were categorized as Level 3. Considerable judgment may be required in
interpreting data used to develop the estimates of fair value. Accordingly, the estimates presented
herein are not
13
necessarily indicative of the amounts that could be realized in an actual current market
exchange. The use of different market assumptions and/or estimation methodologies may have an
effect on the estimated fair value.
The fair value of our residential loan portfolio was estimated based upon analyses prepared by
management and a third party valuation specialist. The valuation specialist uses various
proprietary cash flow models to derive its fair value estimates. These models consider significant
inputs such as loan type, loan age, loan to value ratio, payment history, and property location, as
well as significant assumptions such as estimated rates of loan delinquency, potential recovery,
discount rate, and the impact of interest rate reset. The third party valuation specialist also
considers discussions with industry professionals to identify recent trade quotes or prices in
estimating the amount at which a third party might purchase the loans and their yield requirements.
Management also considers market information and quotes received
from third parties, when available. The
valuation of the loan portfolio involves a significant level of management estimation and judgment,
the degree of which is dependent on the terms of the loans and the availability of market prices
and inputs.
The table presented below summarizes the change in balance sheet carrying value associated
with Level 3 loans during the three months ended June 30, 2010.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
|
|
|
|
|
|
Net Transfers
|
|
Net Gains
|
|
Balance
|
|
|
March 31, 2010
|
|
Payments
|
|
In / Out
|
|
(Losses) (1)
|
|
June 30, 2010
|
|
|
|
|
|
|
|
|
|
|
(In Thousands)
|
|
|
|
|
|
|
|
|
Loans Held for Sale:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial real estate
|
|
$
|
6,916
|
|
|
$
|
(316
|
)
|
|
$
|
|
|
|
$
|
42
|
|
|
$
|
6,642
|
|
Multi-family residential
|
|
|
743
|
|
|
|
(42
|
)
|
|
|
|
|
|
|
4
|
|
|
|
705
|
|
One-to-four family residential
|
|
|
20,502
|
|
|
|
(1,257
|
)
|
|
|
|
|
|
|
710
|
|
|
|
19,955
|
|
|
|
|
Total
|
|
$
|
28,161
|
|
|
$
|
(1,615
|
)
|
|
$
|
|
|
|
$
|
756
|
|
|
$
|
27,302
|
|
|
|
|
(1)
|
|
Net Gains and Losses are included in Gain (loss) on loans held for sale on the Statement of
Operations.
|
The table presented below summarizes the change in balance sheet carrying value associated
with Level 3 loans during the six months ended June 30, 2010.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
|
|
|
|
|
|
Net Transfers
|
|
Net Gains
|
|
Balance
|
|
|
December 31, 2009
|
|
Payments
|
|
In / Out
|
|
(Losses) (1)
|
|
June 30, 2010
|
|
|
|
|
|
|
|
|
|
|
(In Thousands)
|
|
|
|
|
|
|
|
|
Loans Held for Sale:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial real estate
|
|
$
|
6,380
|
|
|
$
|
(665
|
)
|
|
$
|
|
|
|
$
|
927
|
|
|
$
|
6,642
|
|
Multi-family residential
|
|
|
693
|
|
|
|
(61
|
)
|
|
|
|
|
|
|
73
|
|
|
|
705
|
|
One-to-four family residential
|
|
|
22,750
|
|
|
|
(4,316
|
)
|
|
|
|
|
|
|
1,521
|
|
|
|
19,955
|
|
|
|
|
Total
|
|
$
|
29,823
|
|
|
$
|
(5,042
|
)
|
|
$
|
|
|
|
$
|
2,521
|
|
|
$
|
27,302
|
|
|
|
|
(1)
|
|
Net Gains and Losses are included in Gain (loss) on loans held for sale on the Statement of
Operations.
|
Fair Value of Financial Instruments
Accounting standards require disclosure of estimated fair values of all financial instruments
where it is practicable to estimate such values. In determining the fair value measurements for
financial assets we utilize quoted prices, when available. If quoted prices are
not available, we estimate fair value using present value or other valuation techniques that
utilize inputs that are observable for the asset either directly or indirectly, when
available. When observable inputs are not available, inputs may be used that are unobservable and,
therefore, reflect our own assumptions about the assumptions market participants would use in
pricing the asset based on the best information available in the circumstances.
Accounting standards exclude certain financial instruments and all nonfinancial instruments
from disclosure requirements. Accordingly, the aggregate fair value amounts presented may not
represent the underlying value of the entire company.
14
The following methods and assumptions were used by us in estimating fair value of financial
instruments:
Cash and cash equivalents:
The carrying value of cash and interest-bearing deposits approximate
fair value because of the short-term nature of these instruments.
Loans:
The fair value of our loan portfolio was estimated based upon an analysis prepared by
management and a third party valuation specialist which considered, among other factors,
information, to the extent available, about the then current sale prices, bids, credit quality,
liquidity and other available information for loans with similar characteristics as our loan
portfolio. The valuation of the loan portfolio involves a considerable level of management
estimation and judgment, the degree of which is dependent on the terms of the loans and the
availability of market prices and inputs.
Accrued interest and other receivables:
The carrying value of accrued interest and other
receivables approximates fair value because of the short-term nature
of these financial assets.
The estimated fair values, and related carrying value, of our financial instruments are as
follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2010
|
|
December 31, 2009
|
|
|
|
|
|
|
Fair
|
|
|
|
|
|
Fair
|
|
|
Carrying Value
|
|
Value
|
|
Carrying Value
|
|
Value
|
|
|
|
|
|
|
(In Thousands)
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
57,630
|
|
|
$
|
57,630
|
|
|
$
|
51,823
|
|
|
$
|
51,823
|
|
Loans
|
|
|
27,302
|
|
|
|
27,302
|
|
|
|
29,823
|
|
|
|
29,823
|
|
Accrued interest and other
receivables
|
|
|
107
|
|
|
|
107
|
|
|
|
393
|
|
|
|
393
|
|
NOTE 7. SUBSEQUENT EVENTS
We assessed events that occurred subsequent to June 30, 2010 for potential disclosure and
recognition on the financial statements. No additional events have occurred that would require
disclosure in or adjustment to our financial statements.
15
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
This report for EOS Preferred Corporation (hereafter referred to as the Company, EOS,
we, us and our) contains certain statements that constitute forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995. Words such as
expects, anticipates, believes, estimates and other similar expressions or future or
conditional verbs such as will, should, would, and could are intended to identify such
forward-looking statements. These statements are not historical facts, but instead represent our
current expectations, plans or forecasts of our future results, growth opportunities, business
outlook, loan growth, credit losses, liquidity position and other similar matters, including, but
not limited to, the ability to pay dividends with respect to the Series B and Series D preferred
stock, future bank regulatory actions that may impact us and the effect of the bankruptcy of LBHI
on us. These statements are not guarantees of future results or performance and involve certain
risks, uncertainties and assumptions that are difficult to predict and often are beyond our
control. Actual outcomes and results may differ materially from those expressed in, or implied by,
any forward-looking statement. You should not place undue reliance on any forward-looking statement
and should consider all uncertainties and risks, including, among other things, the risks set forth
herein and in our Annual Report on Form 10-K for the year ended December 31, 2009, as well as those
discussed in any of our other subsequent Securities and Exchange Commission (SEC) filings.
Forward-looking statements speak only as of the date they are made, and we undertake no obligation
to update any forward-looking statement to reflect the impact of circumstances or events that arise
after the date the forward-looking statement was made.
Possible events or factors could cause results or performance to differ materially from what
is expressed in our forward-looking statements. These possible events or factors include, but are
not limited to, those risk factors discussed under Item 1A Risk Factors in our Annual Report on
Form 10-K for the year ended December 31, 2009 or in Item 1A of this Quarterly Report on Form 10-Q,
and the following: limitations by regulatory authorities on our ability to implement our business
plan and restrictions on our ability to pay dividends; further regulatory limitations on the
business of Aurora Bank that are applicable to us; negative economic conditions that adversely
affect the general economy, housing prices, the job market, consumer confidence and spending habits
which may affect, among other things, the credit quality of our loan portfolios (the degree of the
impact of which is dependent upon the duration and severity of these conditions); the level and
volatility of interest rates; changes in consumer, investor and counterparty confidence in, and the
related impact on, financial markets and institutions; legislative and regulatory actions which may
adversely affect our business and economic conditions as a whole; the impact of litigation and
regulatory investigations; various monetary and fiscal policies and regulations; changes in
accounting standards, rules and interpretations and the impact on our financial statements; and
changes in the nature and quality of the types of loans held by us.
The following discussion of our financial condition, results of operations, capital resources
and liquidity should be read in conjunction with the condensed financial statements and related
notes included elsewhere in this report and the audited financial statements and related notes
included in our Annual Report on Form 10-K for the year ended December 31, 2009 as filed with the
SEC.
Executive Level Overview
Aurora Bank, an indirect wholly-owned subsidiary of Lehman Brothers Holdings Inc. (LBHI and
together with its subsidiaries, Lehman Brothers), owns all of EOS common stock. Capital Crossing
Bank was the sole common stockholder of the Company until February 14, 2007. As of June 30, 2010,
the Series B preferred stock and Series D preferred stock remain outstanding and remain subject to
their existing terms and conditions, including the call feature with respect to the Series D
preferred stock.
All of the mortgage assets in our loan portfolio at June 30, 2010 were acquired from Capital
Crossing Bank or Aurora Bank and it is anticipated that substantially all additional mortgage
assets, if any are acquired in the future, will be acquired from Aurora Bank. As of June 30, 2010,
our loan portfolio had a carrying value of $27.3 million and an unpaid principal balance (UPB) of
$39.7 million. There were no loans purchased or sold during the three months ended June 30, 2010.
Residential loans constituted approximately 73% of the total carrying value of our loan
portfolio at June 30, 2010. Commercial mortgage and multifamily loans constituted the remaining
approximately 27%. Commercial mortgage loans are generally subject to greater risks than other
types of loans. Our commercial mortgage loans, like most commercial mortgage loans, generally lack
standardized terms, tend to have shorter maturities than other mortgage loans and may not be fully
amortizing. As of June 30, 2010, 97.5% of the carrying value of all loans was in accrual status.
16
Properties underlying our current mortgage assets are concentrated primarily in California and
comprised approximately 42% of the total carrying value of the loan portfolio as of June 30, 2010.
Beginning in 2007 and through the present, the housing and real estate sectors in California have
been hit particularly hard by the recession with higher overall foreclosure rates than the national
average. If California experiences continued or further adverse economic, political or business
conditions, or natural hazards, we will likely experience higher rates of loss and delinquency on
our mortgage loans than if our loans were more geographically diverse.
At June 30, 2010, we had total assets of $85.0 million, including cash and cash equivalents of
$57.6 million, and total liabilities of less than $0.2 million. Comparatively, at December 31,
2009, we had total assets of $82.0 million, including cash and cash equivalents of $51.8 million,
and total liabilities of less than $0.4 million.
Decisions regarding the utilization of our cash are based, in large part, on our future
commitments to pay preferred stock and common stock dividends. Future decisions regarding mortgage
asset acquisitions and returns of capital will be based on the level of preferred stock and common
stock dividends at that time and the required level of income necessary to generate adequate
dividend coverage and other factors determined to be relevant at that time.
Net income available to the common shareholder increased $18.1 million to $3.2 million for the
six months ended June 30, 2010, compared to a net loss of $14.9 million for the same period in
2009. The increase between the two year-to-date periods in net income available to the common
shareholder was primarily the result of the following:
|
|
|
An increase in the gain (loss) on loans held for sale of $18.7 million. In the first half
of 2010 there was a gain on loans held for sale of $2.5 million as compared to a loss of
$16.2 million in the first half of 2009. A loss on loans held for sale was recorded in the
first quarter of 2009 as a result of the reclassification of our loan portfolio to held for
sale in connection with the February 2009 Asset Exchange Agreement and the resultant change
in fair value of the loan portfolio. The gain in the first half of 2010 resulted from an
increase in the fair value measurement of the loan portfolio as of June 30, 2010 as compared
to December 31, 2009. The increase in the fair value measurement during 2010 was primarily
due to a decrease in expected loss rates on the loan portfolio.
|
|
|
|
|
A decrease in the prior years provision for loan losses on loans held for investment of
$0.9 million. In the first half of 2009 the provision for loan losses decreased by $0.9
million to $0 as a result of the reclassification of the loan portfolio to held for sale.
|
|
|
|
|
A decrease in interest income of $0.7 million resulting mainly from the discontinuance of
the amortization of purchase discount and fees on loans as a result of the loans being
reclassified as held for sale during the first half of 2009 and a decrease in average loan
balances.
|
|
|
|
|
A decrease of $0.8 million in preferred stock dividends.
|
|
|
|
|
A decrease in operating expenses of $0.2 million mainly attributable to a decrease in
legal fees incurred in connection with the
February 2009 Asset Exchange Agreement.
|
Impact of Economic Recession
The U.S. economy has been in an economic downturn since 2008 which has dramatically impacted
the housing market with falling home prices and increasing foreclosures. Combined with high levels
of unemployment and underemployment, these economic forces have negatively impacted the credit
performance of mortgage loans and resulted in significant write-downs of asset values by financial
institutions, including government-sponsored entities as well as major commercial and investment
banks.
Reflecting concern about the stability of the financial markets generally and the strength of
counterparties, many lenders and institutional investors have reduced or ceased providing funding
to borrowers, including to other financial institutions. This market turmoil and tightening of
credit have led to an increased level of delinquencies, decreased consumer spending, lack of
confidence, increased market volatility and widespread reduction of business activity generally.
The resulting economic pressure on borrowers and lack of confidence in the financial markets have
negatively impacted the credit quality of our commercial loan portfolio and our residential loan
portfolio. The depth and breadth of the downturn as well as the resulting impacts on the credit
quality of both our
commercial and residential loan portfolios remain unclear. We expect, however, continued
market turbulence and economic uncertainty to continue throughout 2010.
17
Bankruptcy of LBHI
On September 15, 2008, LBHI filed a voluntary petition for relief under Chapter 11 of the U.S.
Bankruptcy Code. Aurora Bank is an indirect subsidiary of LBHI. Aurora Bank has not been placed
into bankruptcy, reorganization, conservatorship or receivership and EOS has not filed for
bankruptcy protection. In addition, the timing and amount of any payments received by Aurora Bank
with respect to debts owed to Aurora Bank by LBHI may be limited by the bankruptcy of LBHI, which
could in turn negatively impact the assets, capital levels and regulatory capital ratios of Aurora
Bank. We are dependent in virtually every phase of our operations on the management of Aurora Bank
and as a subsidiary of Aurora Bank we are subject to regulation by federal banking authorities. The
bankruptcy of LBHI and its potential negative effects on Aurora Bank has resulted in increased
oversight over EOS by the Office of Thrift Supervision (the OTS).
Asset Exchange
On November 18, 2009, EOS and our parent, Aurora Bank, entered into an Asset Exchange
Agreement (the November Asset Exchange) pursuant to which Aurora Bank agreed to assign various
single family residential mortgage loans (Residential Loans) to us in exchange for our assignment
of certain commercial and multi-family mortgage loans to Aurora Bank. Pursuant to the November
Asset Exchange, the Residential Loans assigned to us would be of equal or greater value to the
commercial and multi-family loans assigned to Aurora Bank. The November Asset Exchange was subject
to non-objection by the OTS, which was granted on August 17, 2009. The November Asset Exchange was
consummated on November 18, 2009 (with an effective date of November 1, 2009) which resulted in us
receiving residential mortgage loans, including jumbo mortgage loans, having a closing value of
$199,000 greater than the value of the commercial and multi-family mortgage loans transferred to
Aurora Bank. There can be no assurance that the Residential Loans transferred to us will maintain
their current value, or in the future, continue to exceed the value of the commercial and
multi-family mortgage loans transferred to Aurora Bank. The November Asset Exchange altered the mix
within our loan portfolio to consist primarily of residential mortgage assets.
Regulatory Actions Involving Aurora Bank
On January 26, 2009, the OTS entered a cease and desist order against Aurora Bank (the
Order). The Order, among other things, required Aurora Bank to file various privileged
prospective operating plans with the OTS to manage the liquidity and operations of Aurora Bank
going forward. The Order requires Aurora Bank to ensure that each of its subsidiaries, including
EOS, complies with the Order, including the operating restrictions contained in the Order. These
operating restrictions, among other things, restrict transactions with affiliates, contracts
outside the ordinary course of business and changes in senior executive officers, board members or
their employment arrangements without prior written notice to the OTS. In addition, on February 4,
2009 the OTS issued a prompt corrective action directive to Aurora Bank (the PCA Directive). The
PCA Directive requires Aurora Bank to, among other things, raise its capital ratios such that it
will be deemed to be adequately capitalized and places additional constraints on Aurora Bank and
its subsidiaries, including EOS. The Order and the PCA Directive have resulted in increased
oversight by the OTS of Aurora Bank and EOS, and may result in further restrictions on our ability
to conduct our business. The Order and the PCA Directive were still effective as of the date of
issuance of this interim report. More detailed information can be found in the Order and the PCA
Directive themselves, copies of which are available on the OTS website (www.ots.treas.gov).
On June 26, 2009, the OTS notified Aurora Bank that, as a result of the Order and the PCA
Directive, the prior approval of the OTS is currently required before payment of dividends on the
Series D preferred stock are made. The terms of the Series B preferred stock provide that dividends
payable to the Series B holders are junior in priority to the payment of dividends to the Series D
holders. Therefore, as a result of the notice from the OTS, our Board of Directors (the Board of
Directors) voted not to declare or pay the Series D and Series B preferred stock dividends that
would have been payable for the second, third and fourth quarters of 2009 and the first and second
quarters of 2010. Aurora Bank has made a formal request to the OTS to approve the payment of future
dividends on the preferred stock and responded to requests from the OTS for additional information
on the payment of these dividends; however, the OTS has not yet ruled on this request and there can
be no assurance that such approval will be received from the OTS or when or if such OTS approval
requirement will be removed. Furthermore, even if approval is received from the OTS, any future
dividends on the preferred stock will be payable only when, as and if declared by the Board of
Directors. At June 30, 2010, we had $94,000 of
dividends in arrears related to EOSs 8% Series B preferred stock. The Series D preferred
stock is non-cumulative and as such, there are no dividends in arrears.
18
At June 30, 2010,
according to a public filing with the OTS, Aurora Banks
capital ratios were above the thresholds required to achieve the
well-capitalized designation. However, due to the continuation of the provisions of the Order and
the PCA Directive, Aurora Bank was deemed to be adequately capitalized. The classification of
Aurora Banks capitalization level is subject to review and acceptance by the OTS. The Order and
the PCA Directive were still effective as of the date of issuance of this interim report.
Application of Critical Accounting Policies and Estimates
Our discussion and analysis of financial condition and results of operations are based
upon our condensed financial statements, which have been prepared in accordance with U.S. generally
accepted accounting principles, or GAAP. The preparation of these condensed financial statements in
conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts
of assets and liabilities at the date of the condensed financial statements and the reported amount
of revenues and expenses in the reporting period. Our actual results may differ from these
estimates. We describe below those accounting policies that require material subjective or complex
judgments and that have the most significant impact on our financial condition and results of
operations. Our management evaluates these estimates on an ongoing basis, based upon information
currently available and on various assumptions management believes are reasonable as of the date on
the front cover of this report. We have provided a comprehensive summary of our significant
accounting policies in Note 2 to our financial statements included in our Annual Report on Form
10-K for the year ended December 31, 2009. We have provided a summary of relevant recent accounting
pronouncements in Note 2 of this interim report.
19
Results of Operations for the Three Months Ended June 30, 2010 and 2009
Interest income
The yields on our interest-earning assets are summarized as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30,
|
|
|
|
2010
|
|
|
2009
|
|
|
|
Average
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
|
|
|
|
Balance
|
|
|
Interest
|
|
|
Yield
|
|
|
Balance
|
|
|
Interest
|
|
|
Yield
|
|
|
|
(In Thousands)
|
|
|
|
|
|
|
(In Thousands)
|
|
|
|
|
|
Loans (1)
|
|
$
|
39,900
|
|
|
$
|
483
|
|
|
|
4.84
|
%
|
|
$
|
47,229
|
|
|
$
|
679
|
|
|
|
5.77
|
%
|
Interest-bearing deposits
|
|
|
54,958
|
|
|
|
41
|
|
|
|
0.30
|
|
|
|
46,124
|
|
|
|
202
|
|
|
|
1.75
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest-earning assets
|
|
$
|
94,858
|
|
|
$
|
524
|
|
|
|
2.21
|
%
|
|
$
|
93,353
|
|
|
$
|
881
|
|
|
|
3.79
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
|
For purposes of providing a meaningful yield comparison, the foregoing table reflects the
average accreted cost of the loans or alternatively, the UPB for loans acquired in the
November Asset Exchange, and not the fair value of the loan portfolio. Loans in non-accrual
status are excluded from average balance calculations.
|
The decline in interest income from the three months ended June 30, 2010 compared to the three
months ended June 30, 2009 was the combined result of the decrease in the average balance of loans
and the decrease in the yield on loans and deposits.
The
average balance of our loans for the three months ended June 30,
2010 totaled $39.9
million compared to $47.2 million for the corresponding period in 2009. The decrease is primarily
attributable to loan payments and the November Asset Exchange. The
yield on the loan portfolio decreased 0.93% in the three months
ended June 30, 2010 compared to the corresponding period in 2009. The yield from regularly
scheduled interest and accretion income decreased to 4.72% for the three months ended June 30, 2010
from 5.63% for the same period in 2009 primarily due to a change in mix of assets to lower yielding
and lower risk assets from the November Asset Exchange. For the three months ended June 30, 2010,
interest and fee income recognized on loan payoffs decreased $4,000 or 25%, to $12,000 from $16,000
for the corresponding period in 2009. The level of interest and fee income recognized on loan
payoffs varies for numerous reasons, as further discussed below.
For interest-bearing deposits, the increase in the average balance was mainly due to cash
flows from loan repayments slightly offset by operating expenses. The rate earned on
interest-bearing deposits has remained unchanged since its decrease in July 2009 from 1.75% to
0.30%, resulting in a decrease in interest income and yield for the comparable three month period.
Prior to February 5, 2009, when a loan was paid off, the excess of any cash received over the
net investment was recorded as interest income. In addition to the amount of purchase discount that
was recognized at that time, income may also have included interest owed by the borrower prior to
our acquisition of the loan, interest collected on non-performing loans, prepayment fees and other
loan fees. For periods after February 5, 2009, when a loan is paid off, the excess of any cash
received over the net investment is considered in the assessment of the gain or loss on loans held
for sale. The following table sets forth, for the periods indicated, the components of interest and
fees on loans. There can be no assurance regarding future interest income, including the yields and
related level of such income, or the relative portion attributable to loan payoffs as compared to
other sources.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended June 30,
|
|
|
|
2010
|
|
|
2009
|
|
|
|
Interest
|
|
|
|
|
|
|
Interest
|
|
|
|
|
|
|
Income
|
|
|
Yield
|
|
|
Income
|
|
|
Yield
|
|
|
|
|
|
|
|
(In Thousands)
|
|
|
|
|
|
Regularly scheduled interest and accretion income
|
|
$
|
471
|
|
|
|
4.72
|
%
|
|
$
|
663
|
|
|
|
5.63
|
%
|
Interest and fee income recognized on loan pay-offs:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accretable discount
|
|
|
12
|
|
|
|
0.12
|
|
|
|
|
|
|
|
|
|
Other interest and fee income
|
|
|
|
|
|
|
|
|
|
|
16
|
|
|
|
0.14
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
12
|
|
|
|
0.12
|
|
|
|
16
|
|
|
|
0.14
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest from loans
|
|
$
|
483
|
|
|
|
4.84
|
%
|
|
$
|
679
|
|
|
|
5.77
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
20
The amount of loan pay-offs and related discount income is influenced by several factors,
including the interest rate environment, the real estate market in particular areas, the timing of
transactions, and circumstances related to individual borrowers and loans. The amount of individual
loan payoffs is often a result of negotiations between us and the borrower. Based upon credit risk
analysis and other factors, we will, in certain instances, accept less than the full amount
contractually due in accordance with the loan terms.
Change in allowance for loan losses
We did not record any change in the allowance for loan losses for the three months ended June
30, 2010 or for the same period in 2009. Since the loan portfolio is now classified as held for
sale and recorded either at fair value, or the lower of its accreted cost or at market value, we no
longer maintain an allowance for loan losses.
Operating expenses
Loan servicing and advisory expenses increased $72,000, or 164%, to $116,000 for the three
months ended June 30, 2010 from $44,000 in the same period in 2009. The increase in 2010 is
primarily due to increased fees under the AA, as amended.
Other general and administrative expenses decreased $151,000, or 53% to $133,000 for the three
months ended June 30, 2010 from $284,000 in the same period in 2009. The net decrease in 2010 is
primarily attributable to a decrease in legal fees as 2009 included legal fees incurred in
connection with the February 2009 Asset Exchange Agreement.
Preferred stock dividends
Preferred stock dividends remained at $0 for the three months ended June 30, 2010 compared to
$0 in the same period in 2009. Dividends that would have been payable for the second quarter of
2010 and 2009 were not declared or paid as a result of the Order and the PCA Directive. Aurora Bank
has made a formal request to the OTS to approve the payment of future dividends on the preferred
stock and responded to requests from the OTS for additional information on the payment of these
dividends; however, the OTS has not yet ruled on this request and there can be no assurance that
such approval will be received from the OTS or when or if such OTS approval requirement will be
removed. If the OTS does not approve this request, we will be prohibited from paying future
dividends, which could result in us failing to qualify as a real estate investment trust, or a
REIT. Furthermore, even if approval is received from the OTS, any future dividends on the
preferred stock will be payable only when, as and if declared by the Board of Directors. Subject to
directives of the OTS, we intend to pay dividends on preferred stock and common stock in amounts
necessary to continue to preserve our status as a REIT under the Internal Revenue Code.
21
Results of Operations for the Six Months Ended June 30, 2010 and 2009
Interest income
The yields on our interest-earning assets are summarized as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended June 30,
|
|
|
|
2010
|
|
|
2009
|
|
|
|
Average
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
|
|
|
|
Balance
|
|
|
Interest
|
|
|
Yield
|
|
|
Balance
|
|
|
Interest
|
|
|
Yield
|
|
|
|
(In Thousands)
|
|
|
|
|
|
|
(In Thousands)
|
|
|
|
|
|
Loans (1)
|
|
$
|
41,248
|
|
|
$
|
1,119
|
|
|
|
5.43
|
%
|
|
$
|
48,060
|
|
|
$
|
1,508
|
|
|
|
6.33
|
%
|
Interest-bearing deposits
|
|
|
53,580
|
|
|
|
79
|
|
|
|
0.30
|
|
|
|
45,265
|
|
|
|
393
|
|
|
|
1.75
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest-earning assets
|
|
$
|
94,828
|
|
|
$
|
1,198
|
|
|
|
2.53
|
%
|
|
$
|
93,325
|
|
|
$
|
1,901
|
|
|
|
4.11
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
|
For purposes of providing a meaningful yield comparison, the foregoing table reflects the
average accreted cost of the loans or alternatively, the UPB for loans acquired in the
November Asset Exchange, and not the fair value of the loan portfolio. Loans in non-accrual
status are excluded from average balance calculations.
|
The decline in interest income from the six months ended June 30, 2010 compared to the six
months ended June 30, 2009 was the combined result of the decrease in the average balance of loans
and the decrease in the yield on loans and deposits.
The
average balance of our loans for the six months ended June 30,
2010 totaled $41.2 million
compared to $48.1 million for the corresponding period in 2009. The decrease is primarily
attributable to loan payments and the November Asset Exchange. The
yield on the loan portfolio decreased 0.90% in the six months
ended June 30, 2010 compared to the corresponding period in 2009. The yield from regularly
scheduled interest and accretion income decreased to 4.83% for the six months ended June 30, 2010
from 5.89% for the same period in 2009 primarily due to a change in mix
of assets to lower yielding and lower risk assets from the November
Asset Exchange and a reduction in interest income resulting
from the discontinuance of the amortization of purchase discount and fees on loans as a result of
the loans being reclassified to held for sale during the first quarter of 2009. For the six
months ended June 30, 2010, interest and fee income recognized on loan payoffs increased $18,000,
or 17%, to $124,000 from $106,000 for the corresponding period in 2009. The level of interest and
fee income recognized on loan payoffs varies for numerous reasons, as further discussed below.
For interest-bearing deposits, the increase in the average balance was mainly due to cash
flows from loan repayments slightly offset by operating expenses. The rate earned on
interest-bearing deposits has remained unchanged since its decrease in July 2009 from 1.75% to
0.30%, resulting in a decrease in interest income and yield for the comparable six month period.
Prior to February 5, 2009, when a loan was paid off, the excess of any cash received over the
net investment was recorded as interest income. In addition to the amount of purchase discount that
was recognized at that time, income may also have included interest owed by the borrower prior to
our acquisition of the loan, interest collected on non-performing loans, prepayment fees and other
loan fees. For periods after February 5, 2009, when a loan is paid off, the excess of any cash
received over the net investment is considered in the assessment of the gain or loss on loans held
for sale. The following table sets forth, for the periods indicated, the components of interest and
fees on loans. There can be no assurance regarding future interest income, including the yields and
related level of such income, or the relative portion attributable to loan payoffs as compared to
other sources.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months Ended June 30,
|
|
|
|
2010
|
|
|
2009
|
|
|
|
Interest
|
|
|
|
|
|
|
Interest
|
|
|
|
|
|
|
Income
|
|
|
Yield
|
|
|
Income
|
|
|
Yield
|
|
|
|
|
|
|
|
(In Thousands)
|
|
|
|
|
|
Regularly scheduled interest and accretion income
|
|
$
|
995
|
|
|
|
4.83
|
%
|
|
$
|
1,402
|
|
|
|
5.89
|
%
|
Interest and fee income recognized on loan pay-offs:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accretable discount
|
|
|
124
|
|
|
|
0.60
|
|
|
|
86
|
|
|
|
0.36
|
|
Other interest and fee income
|
|
|
|
|
|
|
|
|
|
|
20
|
|
|
|
0.08
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
124
|
|
|
|
0.60
|
|
|
|
106
|
|
|
|
0.44
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest from loans
|
|
$
|
1,119
|
|
|
|
5.43
|
%
|
|
$
|
1,508
|
|
|
|
6.33
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
22
The amount of loan pay-offs and related discount income is influenced by several factors,
including the interest rate environment, the real estate market in particular areas, the timing of
transactions, and circumstances related to individual borrowers and loans. The amount of individual
loan payoffs is often a result of negotiations between us and the borrower. Based upon credit risk
analysis and other factors, we will, in certain instances, accept less than the full amount
contractually due in accordance with the loan terms.
Reductions in allowance for loan losses
We recorded reductions in the allowance for loan losses of $915,000 for the six months ended
June 30, 2009 to reflect the reclassification of loans held for sale in 2009. Since the loan
portfolio is now classified as held for sale and recorded either at fair value, or the lower of its
accreted cost or at market value, we no longer maintain an allowance for loan losses.
Operating expenses
Loan servicing and advisory expenses increased $156,000, or 177%, to $244,000 for the six
months ended June 30, 2010 from $88,000 in the same period in 2009. The increase in 2010 is
primarily due to increased fees under the AA, as amended.
Other general and administrative expenses decreased $292,000, or 51% to $278,000 for the six
months ended June 30, 2010 from $570,000 in the same period in 2009. The net decrease in 2010 is
primarily attributable to a decrease in legal fees as 2009 included legal fees incurred in
connection with the February 2009 Asset Exchange Agreement.
Preferred stock dividends
Preferred stock dividends decreased by 100% to $0 for the six months ended June 30, 2010
compared to $816,000 in the same period in 2009 because the dividends that would have been payable
for the first quarter and second quarter of 2010 were not declared or paid as a result of the Order
and the PCA Directive. Aurora Bank has made a formal request to the OTS to approve the payment of
future dividends on the preferred stock and responded to requests from the OTS for additional
information on the payment of these dividends; however, the OTS has not yet ruled on this request
and there can be no assurance that such approval will be received from the OTS or when or if such
OTS approval requirement will be removed. If the OTS does not approve this request, we will be
prohibited from paying future dividends, which could result in us failing to qualify as a REIT.
Furthermore, even if approval is received from the OTS, any future dividends on the preferred stock
will be payable only when, as and if declared by the Board of Directors. Subject to directives of
the OTS, we intend to pay dividends on preferred stock and common stock in amounts necessary to
continue to preserve our status as a REIT under the Internal Revenue Code.
23
Changes in Financial Condition
Interest-bearing Deposits with Parent
Interest-bearing deposits with parent consist entirely of money market accounts. The balance
of interest-bearing deposits increased $5.8 million to $57.4 million as of June 30, 2010 compared
to $51.6 million as of December 31, 2009. The increase in the balance of interest-bearing deposits
is the result of cash flows from loan repayments and net cash from operating activities.
Loan Portfolio
The loan portfolio is summarized as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2010
|
|
|
December 31, 2009
|
|
|
|
Carrying
|
|
|
Percentage
|
|
|
Carrying
|
|
|
Percentage
|
|
|
|
Value
|
|
|
of Total
|
|
|
Value
|
|
|
of Total
|
|
|
|
|
|
|
|
(In Thousands)
|
|
|
|
|
|
Mortgage loans:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial real estate
|
|
$
|
6,642
|
|
|
|
24.3
|
%
|
|
$
|
6,380
|
|
|
|
21.4
|
%
|
Multi-family residential
|
|
|
705
|
|
|
|
2.6
|
|
|
|
693
|
|
|
|
2.3
|
|
One-to-four family residential
|
|
|
19,955
|
|
|
|
73.1
|
|
|
|
22,750
|
|
|
|
76.3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
27,302
|
|
|
|
100.0
|
%
|
|
$
|
29,823
|
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
We have historically acquired primarily performing commercial real estate and multi-family
residential mortgage loans. On November 18, 2009, EOS and our parent, Aurora Bank, entered into the
November Asset Exchange pursuant to which Aurora Bank agreed to assign various single family
residential mortgage loans to EOS in exchange for our assignment of certain commercial and
multi-family mortgage loans to Aurora Bank. The November Asset Exchange altered the mix within our
loan portfolio to consist primarily of residential mortgage assets.
We intend that each loan acquired from Aurora Bank in the future, if any, will be a whole
loan, and will be originated or acquired by Aurora Bank in the ordinary course of business. We also
intend that all loans held by us will be serviced pursuant to the Master Service Agreement, as
amended (the MSA) with Aurora Bank.
Loans in non-accrual status totaled $679,000 as of June 30, 2010 representing eight loans and
six borrowers. Loans in non-accrual status totaled $318,000 as of December 31, 2009 representing
seven loans and five borrowers. Loans generally are placed in non-accrual status and the accrual of
interest is generally discontinued when the collectability of principal and interest is neither
probable nor estimable and generally occurs when the loan is ninety days or more past due as to
either principal or interest. Unpaid interest income previously accrued on such loans is reversed
against current period interest income. A loan is returned to accrual status when it is brought
current in accordance with managements anticipated cash flows at the time of acquisition and
collection of principal and interest is probable and estimable.
Interest Rate Risk
The majority of our loan portfolio consists of variable rate loans with contractual interest
rates that are affected by changes in market interest rates. In addition, negative fluctuations in
interest rates could reduce the amount of interest paid on our interest bearing cash deposits,
which could negatively impact the amount of cash available to pay dividends on preferred stock and
common stock. We are not able to precisely quantify the potential impact on operating results or
funds available for distribution to stockholders from material changes in interest rates.
Significant Concentration of Credit Risk
We had cash and cash equivalents of $57.6 million as of June 30, 2010. These funds were held
in interest bearing and non-interest bearing accounts with Aurora Bank. The Federal Deposit
Insurance Corporation (FDIC) provides coverage on these accounts which as of June 30, 2010 was
limited to $250,000. Cash in excess of FDIC coverage limitations is subject to credit risk.
24
Concentration of credit risk generally arises with respect to our loan portfolio when a number
of borrowers engage in similar business activities, or activities in the same geographical region.
Concentration of credit risk indicates the relative sensitivity of our performance to both positive
and negative developments affecting a particular industry. Our balance sheet exposure to geographic
concentrations directly affects the credit risk of the loans within our loan portfolio.
At June 30, 2010, 42% of the carrying value of our mortgage loans consisted of loans
collateralized by properties located in California. Consequently, the portfolio may experience a
higher default rate in the event of adverse economic, political or business developments or natural
hazards in California that may affect the ability of property owners to make payments of principal
and interest on the underlying mortgages. The housing and real estate sectors in California have
been particularly impacted by the recession with higher overall foreclosure rates than the national
average. If California experiences further adverse economic, political or business conditions, or
natural hazards, we will likely experience higher rates of loss and delinquency on our mortgage
loans than if our loans were more geographically diverse.
Liquidity Risk Management
The objective of liquidity management is to ensure the availability of sufficient cash flows
to meet all of our financial commitments. In managing liquidity risk, we take into account various
legal limitations placed on a REIT. Our principal liquidity need is to pay dividends on our
preferred shares and common shares.
If and to the extent that any additional assets are acquired in the future, such acquisitions
are intended to be funded primarily through repayment of mortgage assets by individual borrowers
and cash on hand. We do not have and do not anticipate having any material capital expenditures. To
the extent that the Board of Directors determines that additional funding is required, we may raise
such funds through additional equity offerings, debt financing or retention of cash flow (after
consideration of provisions of the Internal Revenue Code requiring the distribution by a REIT of at
least 90% of our net taxable income, excluding net capital gains, and taking into account taxes
that would be imposed on undistributed income), or a combination of these methods. We do not
currently intend to incur any indebtedness. Our organizational documents limit the amount of
indebtedness which we are permitted to incur without the approval of the Series D preferred
stockholders to no more than 100% of the total stockholders equity of EOS. Any such debt may
include intercompany advances made by Aurora Bank to us.
We may also issue additional series of preferred stock, subject to OTS approval. However, we
may not issue additional shares of preferred stock ranking senior to the Series D preferred stock
without the consent of holders of at least two-thirds of the Series D preferred stock outstanding
at that time. Although EOSs charter does not prohibit or otherwise restrict Aurora Bank or its
affiliates from holding and voting shares of Series D preferred stock, to our knowledge, there were
no shares of Series D preferred stock held by Aurora Bank or its affiliates as of June 30, 2010.
Additional shares of preferred stock ranking on a parity with the Series D preferred stock may not
be issued without the approval of a majority of our independent directors.
Impact of Inflation and Changing Prices
Our asset and liability structure is substantially different from that of an industrial
company in that virtually all of our assets are monetary in nature. Management believes the impact
of inflation on financial results depends upon our ability to react to changes in interest rates
and by such reaction, reduce the inflationary impact on performance. Interest rates do not
necessarily move in the same direction, or at the same magnitude, as the prices of other goods and
services.
Various information shown elsewhere in this interim report will assist the reader in
understanding how EOS is positioned to react to changing interest rates and inflationary trends. In
particular, the discussion of market risk and other maturity and repricing information of our
assets is contained in Item 3. Quantitative and Qualitative Disclosures About Market Risk below.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Market risk is the risk of loss from adverse changes in market prices and interest rates. It
is our objective to attempt to manage risks associated with interest rate movements. As of June 30,
2010, approximately 75% of the fair value of our loan portfolio was comprised of floating rate
loans with contractual interest rates that may fluctuate based on changes in market interest rates.
In addition, negative fluctuations in interest rates could reduce the amount of interest paid on
our interest bearing cash deposits. Our market risk
arises primarily from interest rate risk
inherent in holding loans. To that end, Aurora Bank actively monitors our interest rate risk
exposure pursuant to the AA, as amended, and reports to our management.
25
Aurora Bank reviews, among other things, the sensitivity of our assets to interest rate
changes, the book and market values of assets, purchase and sale activity, and anticipated loan
pay-offs and reports the findings to our management. Aurora Banks senior management also approves
and establishes pricing and funding decisions with respect to our overall asset and liability
composition.
Our methods for evaluating interest rate risk include an analysis of our interest-earning
assets maturing or repricing within a given time period. Since we have no interest-bearing
liabilities, a period of rising interest rates would tend to result in an increase in net interest
income. A period of falling interest rates would tend to adversely affect net interest income.
The following table sets forth our interest rate sensitive assets categorized by repricing
dates and weighted average yields at June 30, 2010. For fixed rate instruments, the repricing date
is the maturity date. For adjustable rate instruments, the repricing date is deemed to be the
earliest possible interest rate adjustment date. Assets that are subject to immediate repricing are
placed in the overnight column.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2010
|
|
|
|
|
|
|
|
Within 1
|
|
|
1 2
|
|
|
2 3
|
|
|
3 4
|
|
|
4 5
|
|
|
Over 5
|
|
|
Total
|
|
|
Total
|
|
|
|
Overnight
|
|
|
Year
|
|
|
Years
|
|
|
Years
|
|
|
Years
|
|
|
Years
|
|
|
Years
|
|
|
UPB
|
|
|
Fair Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(In Thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing deposits
|
|
$
|
57,446
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
57,446
|
|
|
$
|
57,446
|
|
Weighted average yield
|
|
|
.30
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed rate loans (1)
|
|
|
249
|
|
|
|
1,013
|
|
|
|
551
|
|
|
|
428
|
|
|
|
505
|
|
|
|
473
|
|
|
|
6,577
|
|
|
|
9,796
|
|
|
|
6,089
|
|
Weighted average yield
|
|
|
14.50
|
%
|
|
|
6.12
|
%
|
|
|
4.77
|
%
|
|
|
4.25
|
%
|
|
|
5.01
|
%
|
|
|
5.42
|
%
|
|
|
4.12
|
%
|
|
|
|
|
|
|
|
|
|
Adjustable rate loans (1)
|
|
|
390
|
|
|
|
26,657
|
|
|
|
1,666
|
|
|
|
123
|
|
|
|
60
|
|
|
|
|
|
|
|
|
|
|
|
28,896
|
|
|
|
20,534
|
|
Weighted average yield
|
|
|
4.47
|
%
|
|
|
4.91
|
%
|
|
|
5.38
|
%
|
|
|
4.79
|
%
|
|
|
7.39
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total rate sensitive assets
|
|
$
|
58,085
|
|
|
$
|
27,670
|
|
|
$
|
2,217
|
|
|
$
|
551
|
|
|
$
|
565
|
|
|
$
|
473
|
|
|
$
|
6,577
|
|
|
$
|
96,138
|
|
|
$
|
84,069
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
|
Loans are presented at UPB and exclude non-accrual loans.
|
Based on our experience, management applies the assumption that, on average, approximately
23.6% and 5.3% of residential and commercial loans, respectively, will prepay annually. At June 30,
2010, the fair value of net loans was $27.3 million with a UPB of $39.7 million. The fair value of
interest-bearing deposits approximates carrying value.
Item 4. Controls and Procedures
Our management, with the participation of our President and Chief Financial Officer, evaluated
the effectiveness of EOSs disclosure controls and procedures (as defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act)), as of June
30, 2010. Based on this evaluation, our President and Chief Financial Officer concluded that, as of
June 30, 2010, our disclosure controls and procedures were (1) designed to ensure that material
information relating to EOS is made known to the President and Chief Financial Officer by others
within the entity, particularly during the period in which this report was being prepared, and (2)
effective, in that they provide reasonable assurance that information required to be disclosed by
us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized,
and reported within the time periods specified in the SECs rules and forms.
No change to our internal control over financial reporting (as defined in Rules 13a-15(f) and
15d-15(f) under the Exchange Act) occurred during the quarter ended June 30, 2010 that has
materially affected, or is reasonably likely to materially affect, our internal control over
financial reporting.
26
PART II
Item 1. Legal Proceedings
From time to time, we may be involved in routine litigation incidental to our business,
including a variety of legal proceedings with borrowers, which would contribute to our expenses,
including the costs of carrying non-performing assets. We are currently not a party to any material
proceedings.
Item 1A. Risk Factors
A number of risk factors, including, without limitation, the risk factors found in Item 1A of
our Annual Report on
Form 10-K
for the annual period ended December 31, 2009 and our Quarterly
Report on
Form 10-Q
for the quarterly period ended March 31, 2010, may cause our actual results to
differ materially from anticipated future results, performance or achievements expressed or implied
in any forward-looking statements contained in this Quarterly Report on
Form 10-Q
or any other
report filed by us with the SEC. All of these factors should be carefully reviewed, and the reader
of this Quarterly Report on
Form 10-Q
should be aware that there may be other factors that could
cause difference in future results, performance or achievements.
Risk Factor
On June 26, 2009, Aurora Bank was notified that prior approval of the OTS was required before
EOS could pay future dividends on its Series D preferred stock. Furthermore, the terms of the
Series B preferred stock provide that dividends payable to the Series B holders are junior in
priority to the payment of dividends to the Series D holders. Accordingly, the Board of Directors
of EOS (the Board of Directors) has voted not to declare or pay the Series D preferred stock
dividend or the Series B preferred stock dividend that would have been payable for the second,
third and fourth quarters of 2009 and the first and second quarters of 2010. There can be no
assurance that approval for the payment of future dividends on the Series D preferred stock will be
received from the OTS or when or if such OTS approval requirement will be removed. Furthermore, any
future dividends on the Series D preferred stock or the Series B preferred stock will be payable
only when, as and if declared by the Board of Directors. The terms of the Series D preferred stock
provide that dividends on the Series D preferred stock are not cumulative and if no dividend is
declared for a quarterly dividend period, the holders of the Series D preferred stock will have no
right to receive a dividend for that period, and EOS will have no obligation to pay a dividend for
that period, whether or not dividends are declared and paid for any future period.
In order to continue to qualify as a real estate investment trust, or a REIT, under the
Internal Revenue Code of 1986, as amended, EOS generally is required each year to distribute to its
stockholders at least 90% of its net taxable income, excluding net capital gains. As a REIT, EOS
generally is not required to pay federal or state income tax if it continues to meet this and a
number of other requirements. If the OTS does not permit the normal resumption of dividend payments
to EOS shareholders prior to the declaration date of September 15, 2010, EOS will fail to qualify
as a REIT and be subject to federal and state income taxes.
Item 2. Unregistered Sales of Equity Securities
Not applicable.
Item 3. Defaults Upon Senior Securities
Not applicable.
Item 4. (Removed and Reserved)
Not applicable.
27
Item 5. Other Information
Corporate Governance
Effective June 21, 2010, EOS changed its corporate name from Capital Crossing Preferred
Corporation to EOS Preferred Corporation. The Company filed an Articles of Amendment with the
Commonwealth of Massachusetts to effect the change in corporate name. EOS reported its change in
corporate name on Form 8-K, filed June 25, 2010 and is incorporated by reference herein. On August
10, 2010, the Board of Directors of EOS adopted a restatement of the Articles of Organization and a
restatement of the By-Laws to reflect the change in corporate name. The amended and restated
Articles of Organization and the amended and restated By-Laws are attached hereto as Exhibits 3.1
and 3.2, respectively.
On August 10, 2010, the Board of Directors of EOS adopted the EOS Preferred Corporation Code
of Conduct, a copy of which is attached as Exhibit 14.
Item 6. Exhibits
|
|
|
3.1
|
|
Restated Articles of Organization of EOS Preferred Corporation.
|
|
|
|
3.2
|
|
Amended and Restated By-Laws of EOS Preferred Corporation.
|
|
|
|
14
|
|
EOS Code of Conduct.
|
|
|
|
31.1
|
|
Certification pursuant to Exchange Act Rules 13a-15(e) and 15d-15(e) of the President.
|
|
|
|
31.2
|
|
Certification pursuant to Exchange Act Rules 13a-15(e) and 15d-15(e) of the Chief
Financial Officer.
|
|
|
|
32
|
|
Certification pursuant to 18 U.S.C. Section 1350 of the President and Chief Financial
Officer.
|
28
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, EOS Preferred Corporation
has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
|
|
|
|
|
EOS PREFERRED CORPORATION
|
|
|
Date: August 13, 2010
|
By:
|
/s/ Thomas OSullivan
|
|
|
|
Thomas OSullivan
|
|
|
|
President
(Principal Executive Officer)
|
|
|
|
|
|
Date: August 13, 2010
|
By:
|
/s/ Robert J. Leist, Jr.
|
|
|
|
Robert J. Leist, Jr.
|
|
|
|
Chief Financial Officer
(Principal Financial Officer)
|
|
29
EXHIBIT INDEX
|
|
|
Exhibit
|
|
Item
|
3.1
|
|
Restated Articles of Organization of EOS Preferred Corporation.
|
|
|
|
3.2
|
|
Amended and Restated By-Laws of EOS Preferred Corporation.
|
|
|
|
14
|
|
EOS Code of Conduct.
|
|
|
|
31.1
|
|
Certification pursuant to Exchange Act Rules 13a-15(e) and 15d-15(e) of the President.
|
|
|
|
31.2
|
|
Certification pursuant to Exchange Act Rules 13a-15(e) and 15d-15(e) of the Chief
Financial Officer.
|
|
|
|
32
|
|
Certification pursuant to 18 U.S.C. Section 1350 of the President and Chief Financial
Officer.
|
30
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