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 September 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)
(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 November 10, 2010. No common stock was held by non-affiliates of
the issuer.
EOS Preferred Corporation
Table of Contents
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Page
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2
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3
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4
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5
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6
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16
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16
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20
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21
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23
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25
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25
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26
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26
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26
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27
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28
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29
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29
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30
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30
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30
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30
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30
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31
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32
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EX-31.1
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EX-31.2
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EX-32
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PART I
Item 1. Condensed Financial Statements
EOS Preferred Corporation
Balance Sheets
(Unaudited)
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September 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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62,379
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51,639
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Total cash and cash equivalents
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62,563
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51,823
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Loans held for sale, at fair value
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17,669
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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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7,858
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7,292
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Loans
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25,527
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29,823
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Accrued interest and other receivables
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135
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393
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Total assets
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$
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88,225
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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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419
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$
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344
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Dividends payable
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2,376
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Total liabilities
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2,795
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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, $.01 par value, 100 shares authorized, issued and outstanding
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Additional paid-in capital
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95,320
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95,320
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Accumulated deficit
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(9,905
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)
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(13,640
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)
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Total stockholders equity
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85,430
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81,695
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Total liabilities and stockholders equity
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$
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88,225
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$
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82,039
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See accompanying notes to condensed financial statements.
2
EOS Preferred Corporation
Statements of Operations
(Unaudited)
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Three Months Ended
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Nine Months Ended
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September 30,
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September 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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420
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$
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839
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$
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1,539
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$
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2,347
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Interest on interest-bearing deposits
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45
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75
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124
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468
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Total interest income
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465
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914
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1,663
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2,815
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Gain (loss) on loans held for sale
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2,715
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(541
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5,236
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(16,751
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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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3,180
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373
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6,899
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(13,021
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Operating expenses:
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Loan servicing and advisory services
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115
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35
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358
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123
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Other general and administrative
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150
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146
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430
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716
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Total operating expenses
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265
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181
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788
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839
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Net income (loss)
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2,915
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192
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6,111
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(13,860
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)
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Preferred stock dividends declared
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909
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909
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816
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Net income (loss) available to common stockholder
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$
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2,006
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$
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192
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$
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5,202
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$
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(14,676
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)
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See accompanying notes to condensed financial statements.
3
EOS Preferred Corporation
Statements of Changes in Stockholders Equity
(Unaudited)
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Nine Months ended September 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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6,111
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6,111
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Cumulative dividends
declared on preferred
stock, Series B
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(112
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)
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(112
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)
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Dividends declared on
preferred stock, Series D
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(797
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)
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(797
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Dividends declared on
common stock
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(1,467
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)
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(1,467
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Balance at
September 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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(9,905
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)
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$
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85,430
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Nine Months ended September 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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$
|
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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(13,860
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)
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(13,860
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)
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Cumulative dividends
declared 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 declared 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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|
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Balance at
September 30, 2009
|
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|
1
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|
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$
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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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$
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$
|
95,121
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|
$
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(14,676
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)
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$
|
80,460
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See accompanying notes to condensed financial statements.
4
EOS Preferred Corporation
Statements of Cash Flows
(Unaudited)
|
|
|
|
|
|
|
|
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|
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Nine Months Ended
|
|
|
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September 30,
|
|
|
|
2010
|
|
|
2009
|
|
|
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(In Thousands)
|
|
Cash flows from operating activities:
|
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|
|
|
|
|
|
|
Net income (loss)
|
|
$
|
6,111
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|
|
$
|
(13,860
|
)
|
Adjustments to reconcile net income (loss) to net cash from operating activities:
|
|
|
|
|
|
|
|
|
(Gain) loss on loans held for sale
|
|
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(5,236
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)
|
|
|
16,751
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|
Decrease in accrued interest and other receivable
|
|
|
258
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|
|
|
80
|
|
Increase in accrued expenses and other liabilities
|
|
|
75
|
|
|
|
135
|
|
Provision for loan losses
|
|
|
|
|
|
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(915
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)
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|
|
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|
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Net cash provided by operating activities
|
|
|
1,208
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|
|
2,191
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from investing activities:
|
|
|
|
|
|
|
|
|
Loan repayments
|
|
|
9,532
|
|
|
|
5,921
|
|
|
|
|
|
|
|
|
Cash provided by investing activities
|
|
|
9,532
|
|
|
|
5,921
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from financing activities:
|
|
|
|
|
|
|
|
|
Payment of preferred stock dividends
|
|
|
|
|
|
|
(1,631
|
)
|
|
|
|
|
|
|
|
Cash used in financing activities
|
|
|
|
|
|
|
(1,631
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net change in cash and cash equivalents
|
|
|
10,740
|
|
|
|
6,481
|
|
Cash and cash equivalents at beginning of period
|
|
|
51,823
|
|
|
|
43,757
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of period
|
|
$
|
62,563
|
|
|
$
|
50,238
|
|
|
|
|
|
|
|
|
See accompanying notes to condensed financial statements.
5
EOS Preferred Corporation
Notes to Condensed Financial Statements
Three and Nine Months Ended September 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. We were organized on March 20, 1998, to acquire and hold real estate assets. 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 (discussed below), we were a subsidiary of Capital Crossing Bank (Capital
Crossing Bank), a federally insured Massachusetts trust company and our 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 (a
REIT) under the Internal Revenue Code of 1986, as amended (the IRC). 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 publicly traded on the National Association of Securities Dealers Automated
Quotation System (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 September 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).
6
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. 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 third party valuation specialists
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
7
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.
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 third party valuation specialists 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. A loan may be
returned from non-accrual status to an accruing status when doubt as to collectability has been
eliminated. The conditions necessary to return a loan to accrual status include all contractual
principal and interest payments are current, the ability of the borrower to fulfill the contractual
repayment terms is fully expected and the borrower sustains their repayment performance for a
reasonable period of time. Loans are charged off when deemed by management to be uncollectible.
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
8
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 accreted as interest income during the period the loans are
classified as held for sale but is 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.
Taxes
We have elected, for federal income tax purposes, to be treated as a REIT and intend to comply
with the provisions of 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 to stockholders, excluding net
capital gains, 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 September 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.
A REIT is subject to federal excise tax for any fiscal year in which distribution of 85% of
adjusted ordinary income does not occur. For the year ended December 31, 2009, the OTS had not
provided a non-objection determination to the declaration and payment of dividends and as a result, EOS was subject
to federal excise tax of $76,000. For the nine ended September 30, 2010, we have not accrued an
excise tax liability pending continuing efforts with the OTS for the resumption of normal payment
of dividends.
Significant Concentration of Credit Risk
We had cash and cash equivalents of $62.6 million as of September 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 September 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 interim reports during this fiscal
year, 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 interim reports during this fiscal year. 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 roll-forward 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
9
standards is
effective for our fiscal year ending December 31, 2010 and interim reports thereafter. As our loan
portfolio is classified as held for sale and carried at fair value or the lower of accreted cost or
market value, we do
not utilize an allowance for credit losses and this new guidance will have no impact on our
results of operations or financial position.
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.
During 2009 and 2010, an agreement was negotiated between Aurora Bank and LBHI to provide for
the settlement of the claims of Aurora Bank against LBHI (the Settlement Agreement). On September
1, 2010, a motion was filed by LBHI with the bankruptcy court requesting approval of the Settlement
Agreement. The motion was approved by the bankruptcy court on September 22, 2010. The Settlement
Agreement has not been executed pending regulatory approval. EOS is not a direct party to
the Settlement Agreement.
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, capital distributions, 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, maintain its capital ratios at the level 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 (www.ots.treas.gov).
During 2009, LBHI contributed additional capital to Aurora Bank, which improved Aurora Banks
capital position. At September 30, 2010, as set forth in 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 exchange of the Series B and Series D preferred stock for
preferred shares of Aurora Bank.
10
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 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.
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 B and Series D 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. The Board of Directors also voted not to declare or pay dividends on the common
stock that would have been payable for fiscal 2009.
On
September 9, 2010, the OTS provided a non-objection determination for a one-time declaration of dividends by
September 14, 2010 and the payment of these dividends between December 15, 2010 and December 31,
2010 in an amount sufficient to maintain qualification as a REIT for the 2009 tax year. The Board
of Directors of EOS declared such dividends on September 13, 2010, for the quarter ended September
30, 2010, consistent with the OTS non-objection determination. The dividends are payable to
shareholders of record as of October 29, 2010 and include cumulative dividends on the Series B
preferred stock of $120.00 per share, non-cumulative dividends on the Series D preferred stock of
$0.53125 per share and dividends on our common stock of $1,467.14 per share. At September 30, 2010, there were no dividends in arrears related to our Series B preferred
stock. Dividends on the Series D preferred stock are non-cumulative and as such, there were no
dividends in arrears.
The OTS has not approved or provided a non-objection to any further dividend distributions.
Aurora Bank and EOS have informed the OTS that failure to permit the distribution of sufficient
dividends for 2010 and in future years 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 in the tax year
when loss of REIT status occurs and in years thereafter. Aurora Bank and EOS will continue to work
with the OTS regarding the resumption of normal payment of dividends. There can be no assurance
that the OTS will grant any future 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.
NOTE 4. LOANS
As of September 30, 2010, the loan portfolio was comprised primarily of loans secured by
one-to-four family residential real estate loans, of which the largest portion was located in
California. Comparatively, as of September 30, 2009, a substantial portion of the loan portfolio
was comprised of loans secured by commercial and multi-family real estate located in California,
Nevada and the New England states.
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 September 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 by valuation method
and in total is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2010
|
|
|
December 31, 2009
|
|
|
|
Carrying
|
|
|
Unpaid Principal
|
|
|
Carrying
|
|
|
Unpaid Principal
|
|
|
|
Value
|
|
|
Balance
|
|
|
Value
|
|
|
Balance
|
|
|
|
|
|
|
|
(In Thousands)
|
|
|
|
|
|
Total mortgage loans, held for sale:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial real estate
|
|
$
|
6,945
|
|
|
$
|
10,199
|
|
|
$
|
6,380
|
|
|
$
|
11,324
|
|
Multi-family residential
|
|
|
695
|
|
|
|
1,062
|
|
|
|
693
|
|
|
|
1,203
|
|
One-to-four family residential
|
|
|
17,887
|
|
|
|
23,901
|
|
|
|
22,750
|
|
|
|
32,386
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
25,527
|
|
|
$
|
35,162
|
|
|
$
|
29,823
|
|
|
$
|
44,913
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Portion carried at fair value:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial real estate
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
Multi-family residential
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One-to-four family residential
|
|
|
17,669
|
|
|
|
23,574
|
|
|
|
22,531
|
|
|
|
32,007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
17,669
|
|
|
|
23,574
|
|
|
|
22,531
|
|
|
|
32,007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Portion carried at lower of accreted cost or
market value (1):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial real estate
|
|
$
|
6,945
|
|
|
$
|
10,199
|
|
|
$
|
6,380
|
|
|
$
|
11,324
|
|
Multi-family residential
|
|
|
695
|
|
|
|
1,062
|
|
|
|
693
|
|
|
|
1,203
|
|
One-to-four family residential
|
|
|
218
|
|
|
|
327
|
|
|
|
219
|
|
|
|
379
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
7,858
|
|
|
|
11,588
|
|
|
|
7,292
|
|
|
|
12,906
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(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:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 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
|
|
$
|
746
|
|
|
$
|
801
|
|
|
$
|
318
|
|
|
$
|
792
|
|
Multi-family residential
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
One-to-four family residential
|
|
|
455
|
|
|
|
810
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total loans in non-accrual status
|
|
$
|
1,201
|
|
|
$
|
1,611
|
|
|
$
|
318
|
|
|
$
|
792
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of September 30, 2010, there were nine loans due from nine borrowers in non-accrual status.
As of December 31, 2009, there were seven loans due from five borrowers in non-accrual status.
Activity in the allowance for loan losses follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
|
Nine Months Ended September 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 effective 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 provides for fees 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 $225,000 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 September 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.
13
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 September 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 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 loan portfolio was estimated based upon analyses prepared by management
and third party valuation specialists. The valuation specialists use 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 specialists also consider 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 September 30, 2010.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
|
|
|
|
|
|
|
Net Transfers
|
|
|
Net Gains
|
|
|
Balance
|
|
|
|
June 30, 2010
|
|
|
Payments
|
|
|
In / Out
|
|
|
(Losses) (1)
|
|
|
September 30, 2010
|
|
|
|
|
|
|
|
|
|
|
|
(In Thousands)
|
|
|
|
|
|
|
|
|
|
Loans Held for Sale:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial real estate
|
|
$
|
6,642
|
|
|
$
|
(236
|
)
|
|
$
|
|
|
|
$
|
539
|
|
|
$
|
6,945
|
|
Multi-family residential
|
|
|
705
|
|
|
|
(79
|
)
|
|
|
|
|
|
|
69
|
|
|
|
695
|
|
One-to-four family residential
|
|
|
19,955
|
|
|
|
(4,175
|
)
|
|
|
|
|
|
|
2,107
|
|
|
|
17,887
|
|
|
|
|
Total
|
|
$
|
27,302
|
|
|
$
|
(4,490
|
)
|
|
$
|
|
|
|
$
|
2,715
|
|
|
$
|
25,527
|
|
|
|
|
(1)
|
|
Net Gains and Losses are included in Gain (loss) on loans held for sale on the Statements of
Operations.
|
The table presented below summarizes the change in balance sheet carrying value associated
with Level 3 loans during the nine months ended September 30, 2010.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
|
|
|
|
|
|
|
Net Transfers
|
|
|
Net Gains
|
|
|
Balance
|
|
|
|
December 31, 2009
|
|
|
Payments
|
|
|
In / Out
|
|
|
(Losses) (1)
|
|
|
September 30, 2010
|
|
|
|
|
|
|
|
|
|
|
|
(In Thousands)
|
|
|
|
|
|
|
|
|
|
Loans Held for Sale:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial real estate
|
|
$
|
6,380
|
|
|
$
|
(901
|
)
|
|
$
|
|
|
|
$
|
1,466
|
|
|
$
|
6,945
|
|
Multi-family residential
|
|
|
693
|
|
|
|
(140
|
)
|
|
|
|
|
|
|
142
|
|
|
|
695
|
|
One-to-four family residential
|
|
|
22,750
|
|
|
|
(8,491
|
)
|
|
|
|
|
|
|
3,628
|
|
|
|
17,887
|
|
|
|
|
Total
|
|
$
|
29,823
|
|
|
$
|
(9,532
|
)
|
|
$
|
|
|
|
$
|
5,236
|
|
|
$
|
25,527
|
|
|
|
|
(1)
|
|
Net Gains and Losses are included in Gain (loss) on loans held for sale on the Statements 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
14
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.
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 third party valuation specialists 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:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2010
|
|
|
December 31, 2009
|
|
|
|
|
|
|
|
Fair
|
|
|
|
|
|
|
Fair
|
|
|
|
Carrying Value
|
|
|
Value
|
|
|
Carrying Value
|
|
|
Value
|
|
|
|
|
|
|
|
(In Thousands)
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
62,563
|
|
|
$
|
62,563
|
|
|
$
|
51,823
|
|
|
$
|
51,823
|
|
Loans
|
|
|
25,527
|
|
|
|
25,527
|
|
|
|
29,823
|
|
|
|
29,823
|
|
Accrued interest and other receivables
|
|
|
135
|
|
|
|
135
|
|
|
|
393
|
|
|
|
393
|
|
NOTE 7. SUBSEQUENT EVENTS
We assessed events that occurred subsequent to September 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 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 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 Quarterly Report on Form 10-Q 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 LBHI, owns all of our common stock.
Capital Crossing Bank was our sole common stockholder until February 14, 2007. As of September 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 September 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
September 30, 2010, our loan portfolio had a carrying value of $25.5 million and a UPB of $35.2
million. There were no loans purchased or sold during the three months ended September 30, 2010.
16
Residential loans constituted approximately 70% of the total carrying value of our loan
portfolio at September 30, 2010. Commercial mortgage and multifamily loans constituted the
remaining approximately 30%. 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 September 30, 2010, 95.3% of the carrying value of all loans was in accrual
status.
Properties underlying our current mortgage assets are concentrated; the largest portion,
located in California, comprises approximately 39% of the total carrying value of the loan
portfolio as of September 30, 2010. Beginning in 2007 and continuing through the present time, the
housing and real estate sectors in California have been hit particularly hard by the economic
downturn 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 September 30, 2010, we had total assets of $88.2 million, including cash and cash
equivalents of $62.6 million, and total liabilities of $2.8 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 $19.9 million to $5.2 million for the
nine months ended September 30, 2010, compared to a net loss of $14.7 million for the same period
in 2009. The increase between these 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 $22.0 million. In the first
nine months of 2010 there was a gain on loans held for sale of $5.2 million as compared to
a loss of $16.8 million in the first nine months 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 nine
months of 2010 resulted from an increase in the fair value measurement of the loan
portfolio as of September 30, 2010 as compared to December 31, 2009. The increase in the
fair value measurement during 2010 was primarily due to a decrease in the
discount rates used to value the loan portfolio.
|
|
|
|
A decrease in interest income of $1.2 million resulting mainly from a decrease in
average loan balances, the discontinuance of the accretion of purchase discount and fees on
loans as a result of the loans being reclassified as held for sale during the first quarter
of 2009 and a decrease in the amount of interest income accreted on loan payoffs.
|
|
|
|
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.
|
|
|
|
An increase of $0.1 million in preferred stock dividends. The preferred stock dividends
declared on September 13, 2010 were comprised of dividends for Series B and Series D
preferred stock for the third quarter of 2010 along with cumulative dividends in arrears on
the Series B preferred stock for the second, third and fourth quarters of 2009 and the
first and second quarters of 2010. Dividends on the Series D preferred stock are
non-cumulative and as such, there were no dividends in arrears.
|
17
|
|
|
A decrease in operating expenses of $0.1 million during the first nine months of 2010
as decreases in legal fees incurred in connection with the February 2009 Asset Exchange
Agreement and accounting fees were partially offset by increases in loan servicing and
advisory services.
|
Impact of Economic Downturn
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 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
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 impact 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 through the remainder of 2010 and
into 2011.
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. 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 OTS, primarily in regards to the declaration and payment of dividends.
During 2009 and 2010, an agreement was negotiated between Aurora Bank and LBHI to provide for
the settlement of the claims of Aurora Bank against LBHI (the Settlement Agreement). On September
1, 2010, a motion was filed by LBHI with the bankruptcy court requesting approval of the Settlement
Agreement. The motion was approved by the bankruptcy court on September 22, 2010. The Settlement
Agreement has not been executed pending regulatory approval. EOS is not a direct party to the
Settlement Agreement.
Asset Exchange
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 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
18
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 the Order against Aurora Bank. 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, capital distributions, 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 PCA Directive to Aurora Bank. The PCA Directive requires Aurora Bank to, among other
things, maintain its capital ratios at the level 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).
At September 30, 2010, as set forth in 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.
Dividend Payments
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, during 2009 our Board of Directors
voted not to declare or pay the Series B and Series D 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. The Board of Directors also voted not to declare or pay dividends on the common stock that
would have been payable for fiscal 2009.
On September 9, 2010,
the OTS provided a non-objection determination for a one-time declaration of dividends by
September 14, 2010 and the payment of these dividends between December 15, 2010 and December 31,
2010 in an amount sufficient to maintain qualification as a REIT for the 2009 tax year. The Board
of Directors of EOS declared such dividends on September 13, 2010, for the quarter ended September
30, 2010, consistent with the OTS non-objection determination. The dividends are payable to
shareholders of record as of October 29, 2010 and include cumulative dividends on the Series B
preferred stock of $120.00 per share, non-cumulative dividends on the Series D preferred stock of
$0.53125 per share and dividends on the common stock of $1,467.14 per share. At September 30, 2010, there were no dividends in arrears related to our Series B preferred
stock. Dividends on the Series D preferred stock are non-cumulative and as such, there were no
dividends in arrears.
The
OTS has not approved or provided a non-objection determination to any further dividend distributions.
Aurora Bank and EOS have informed the OTS that failure to permit the distribution of sufficient
dividends for 2010 and in future
19
years 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 in the tax year
when loss of REIT status occurs and in years thereafter. There can be no assurance that
non-objection from the OTS will be granted on any future request 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. Aurora Bank and EOS will continue to work with the OTS regarding the resumption of
normal payment of dividends. There can be no assurance that the OTS
will grant any future non-objection request, nor can there be any
assurance that any further dividends will be paid or that EOS will
continue to qualify as REIT.
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.
20
Results of Operations for the Three Months Ended September 30, 2010 and 2009
Interest income
The yields on our interest-earning assets are summarized as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
|
|
2010
|
|
|
2009
|
|
|
|
Average Balance
|
|
|
Interest
|
|
|
Yield
|
|
|
Average Balance
|
|
|
Interest
|
|
|
Yield
|
|
|
|
(In Thousands)
|
|
|
|
|
|
|
|
|
|
|
(In Thousands)
|
|
|
|
|
|
|
|
|
|
Loans (1)
|
|
$
|
36,253
|
|
|
$
|
420
|
|
|
|
4.63
|
%
|
|
$
|
45,376
|
|
|
$
|
839
|
|
|
|
7.34
|
%
|
Interest-bearing deposits
|
|
|
60,352
|
|
|
|
45
|
|
|
|
0.30
|
%
|
|
|
48,482
|
|
|
|
75
|
|
|
|
0.62
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest-earning assets
|
|
$
|
96,605
|
|
|
$
|
465
|
|
|
|
1.93
|
%
|
|
$
|
93,858
|
|
|
$
|
914
|
|
|
|
3.86
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(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 September 30, 2010 compared to the
three months ended September 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 September 30, 2010 was $36.3
million compared to $45.4 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 2.71% in the three months ended September 30, 2010 compared to the corresponding period
in 2009. The yield from regularly scheduled interest and accretion income decreased to 4.59% for
the three months ended September 30, 2010 from 5.60% 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 September 30, 2010, interest and fee income recognized on loan payoffs
decreased $194,000 or 98%, to $4,000 from $198,000 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.
21
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
|
|
2010
|
|
|
2009
|
|
|
|
Interest Income
|
|
|
Yield
|
|
|
Interest Income
|
|
|
Yield
|
|
|
|
|
|
|
|
(In Thousands)
|
|
|
|
|
|
Regularly scheduled interest and accretion income
|
|
$
|
416
|
|
|
|
4.59
|
%
|
|
$
|
641
|
|
|
|
5.60
|
%
|
Interest and fee income recognized on loan pay-offs:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accretable discount
|
|
|
4
|
|
|
|
0.04
|
|
|
|
192
|
|
|
|
1.68
|
|
Other interest and fee income
|
|
|
|
|
|
|
|
|
|
|
6
|
|
|
|
0.06
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4
|
|
|
|
0.04
|
|
|
|
198
|
|
|
|
1.74
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest from loans
|
|
$
|
420
|
|
|
|
4.63
|
%
|
|
$
|
839
|
|
|
|
7.34
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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
Following the reclassification of the loan portfolio as held for sale in February of 2009, we
no longer maintain an allowance for loan losses.
Operating expenses
Loan servicing and advisory expenses increased $80,000, to $115,000 for the three
months ended September 30, 2010 from $35,000 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 increased $4,000, to $150,000 for the three
months ended September 30, 2010 from $146,000 in the same period in 2009.
Preferred stock dividends declared
Preferred stock dividends declared were $909,000 for the three months ended September 30, 2010
compared to $0 in the same period in 2009. On September 9, 2010,
the OTS provided a non-objection determination for
a one-time declaration and payment of dividends in an amount sufficient to maintain qualification as a
REIT for the 2009 tax year. The Board of Directors of EOS declared such dividends on September 13,
2010, for the quarter ended September 30, 2010, consistent with the OTS non-objection
determination. The dividends included $18,000 of dividends on the Series B preferred stock for the
third quarter of 2010, $797,000 of dividends on the Series D preferred stock for the third quarter
of 2010 and $94,000 of cumulative dividends in arrears on the Series B preferred stock for the
second, third and fourth quarters of 2009 and the first and second quarters of 2010. At September
30, 2010, there were no dividends in arrears related to our Series B preferred stock. Dividends on
the Series D preferred stock are non-cumulative and as such, there were no dividends in arrears.
The OTS has not approved or provided a non-objection to any further dividend distributions.
Additionally, any future dividends on the preferred stock will be payable only when, as and if
declared by the Board of Directors.
22
Results of Operations for the Nine Months Ended September 30, 2010 and 2009
Interest income
The yields on our interest-earning assets are summarized as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
|
|
2010
|
|
|
2009
|
|
|
|
Average
|
|
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
|
|
|
|
Balance
|
|
|
Interest
|
|
|
Yield
|
|
|
Balance
|
|
|
Interest
|
|
|
Yield
|
|
|
|
(In Thousands)
|
|
|
|
|
|
|
(In Thousands)
|
|
|
|
|
|
Loans (1)
|
|
$
|
39,478
|
|
|
$
|
1,539
|
|
|
|
5.20
|
%
|
|
$
|
47,155
|
|
|
$
|
2,347
|
|
|
|
6.65
|
%
|
Interest-bearing deposits
|
|
|
55,902
|
|
|
|
124
|
|
|
|
0.30
|
%
|
|
|
46,349
|
|
|
|
468
|
|
|
|
1.35
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest-earning assets
|
|
$
|
95,380
|
|
|
$
|
1,663
|
|
|
|
2.32
|
%
|
|
$
|
93,504
|
|
|
$
|
2,815
|
|
|
|
4.03
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(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 nine months ended September 30, 2010 compared to the
nine months ended September 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 nine months ended September 30, 2010 totaled $39.6
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 1.45% in the nine months ended September 30, 2010 compared to the corresponding period in
2009. The yield from regularly scheduled interest and accretion income decreased to 4.77% for the
nine months ended September 30, 2010 from 5.79% 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 accretion 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 nine months ended September 30, 2010, interest and fee income
recognized on loan payoffs decreased $176,000, or 58%, to $128,000 from $304,000 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 nine 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.
23
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended September 30,
|
|
|
|
2010
|
|
|
2009
|
|
|
|
Interest
|
|
|
|
|
|
|
Interest
|
|
|
|
|
|
|
Income
|
|
|
Yield
|
|
|
Income
|
|
|
Yield
|
|
|
|
|
|
|
|
(In Thousands)
|
|
|
|
|
|
Regularly scheduled interest and accretion income
|
|
$
|
1,411
|
|
|
|
4.77
|
%
|
|
$
|
2,043
|
|
|
|
5.79
|
%
|
Interest and fee income recognized on loan pay-offs:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accretable discount
|
|
|
128
|
|
|
|
0.43
|
|
|
|
278
|
|
|
|
0.79
|
|
Other interest and fee income
|
|
|
|
|
|
|
|
|
|
|
26
|
|
|
|
0.07
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
128
|
|
|
|
0.43
|
|
|
|
304
|
|
|
|
0.86
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total interest from loans
|
|
$
|
1,539
|
|
|
|
5.20
|
%
|
|
$
|
2,347
|
|
|
|
6.65
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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
Following the reclassification of the loan portfolio as held for sale in February of 2009, we
no longer maintain an allowance for loan losses. We recorded reductions in the allowance for loan
losses of $915,000 for the nine months ended September 30, 2009 as a result of the
reclassification.
Operating expenses
Loan servicing and advisory expenses increased $235,000, to $358,000 for the nine
months ended September 30, 2010 from $123,000 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 $286,000, to $430,000 for the nine
months ended September 30, 2010 from $716,000 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 declared
Preferred stock dividends declared were $909,000 for the nine months ended September 30, 2010
compared to $816,000 in the same period in 2009. On September 9, 2010, the OTS provided
a non-objection determination for a one-time declaration and payment of dividends in an amount sufficient to maintain
qualification as a REIT for the 2009 tax year. The Board of Directors of EOS declared such
dividends on September 13, 2010, for the quarter ended September 30, 2010, consistent with the OTS
non-objection determination and included dividends on the Series B and Series D preferred stock for
the third quarter of 2010 along with cumulative dividends in arrears on the Series B preferred
stock for the second, third and fourth quarters of 2009 and the first and second quarters of 2010.
At September 30, 2010, there were no dividends in arrears related to our Series B preferred stock.
The Series D preferred stock is non-cumulative and as such, there were no dividends in arrears. The
OTS has not approved or provided a non-objection to any further dividend distributions.
Additionally, any future dividends on the preferred stock will be payable only when, as and if
declared by the Board of Directors.
24
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 $10.8 million to $62.4 million as of September 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:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2010
|
|
|
December 31, 2009
|
|
|
|
Carrying
|
|
|
Percentage
|
|
|
Carrying
|
|
|
Percentage
|
|
|
|
Value
|
|
|
of Total
|
|
|
Value
|
|
|
of Total
|
|
|
|
|
|
|
|
(In Thousands)
|
|
|
|
|
|
Mortgage loans:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial real estate
|
|
$
|
6,945
|
|
|
|
27.2
|
%
|
|
$
|
6,380
|
|
|
|
21.4
|
%
|
Multi-family residential
|
|
|
695
|
|
|
|
2.7
|
|
|
|
693
|
|
|
|
2.3
|
|
One-to-four family residential
|
|
|
17,887
|
|
|
|
70.1
|
|
|
|
22,750
|
|
|
|
76.3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
25,527
|
|
|
|
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 MSA with Aurora Bank.
As of September 30, 2010, there were nine loans due from nine borrowers in non-accrual status
that totaled $1,201,000. As of December 31, 2009, there were seven loans due from five borrowers in
non-accrual status that totaled $318,000. 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, falling interest rates
would tend to reduce the amount of interest earned 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.
25
Significant Concentration of Credit Risk
We had cash and cash equivalents of $62.6 million as of September 30, 2010. These funds were
held in interest bearing and non-interest bearing accounts with Aurora Bank. The FDIC provides
coverage on these accounts which as of September 30, 2010 was limited to $250,000. Cash in excess
of FDIC coverage limitations is subject to credit risk.
Concentration of credit risk primarily arises with respect to the geographical distribution of
our loan portfolio. Our balance sheet exposure to geographic concentrations directly affects the
credit risk of the loans within our loan portfolio. At September 30, 2010, 39% 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 economic downturn 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 and subject
to regulatory approval, we may raise such funds through additional equity offerings, debt financing
or retention of cash flow (after consideration of provisions of the IRC requiring the distribution
by a REIT of at least 90% of our net taxable income to stockholders, 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 September 30,
2010. Additional shares of preferred stock ranking on 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.
26
See Item 3. Quantitative and Qualitative Disclosures About Market Risk and the discussion
regarding market risk and other maturity and repricing information of our assets, in particular,
for more information about how EOS is positioned to react to changing interest rates and
inflationary trends.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that have or are reasonably likely to have a
current or future effect on our financial condition, changes in financial condition, revenues or
expenses, results of operations, liquidity, capital expenditures or capital resources that are
material to investors.
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. Our
market risk arises primarily from interest rate risk inherent in
holding loans and interest-earning deposits. A period of rising
interest rates would tend to result in an increase in net interest income and conversely, a period
of falling interest rates would tend to adversely affect net interest income.
Aurora Bank actively monitors our interest rate risk exposure pursuant to the AA, as amended,
and reports to our management. Aurora Bank reviews, among other things, the sensitivity of our
assets to interest rate changes, the book and market values of assets, any purchase and sale
activity, and anticipated loan pay-offs. 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. As of September 30, 2010, only
interest-earning assets were evaluated since we had no interest-bearing liabilities. The following
table sets forth our interest rate sensitive assets categorized by repricing dates and weighted
average yields at September 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.
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September 30, 2010
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Within 1
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1 2
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2 3
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3 4
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4 5
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Over 5
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Total
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Total
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Overnight
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Year
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Years
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Years
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Years
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Years
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Years
|
|
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UPB
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Fair Value
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(In Thousands)
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Interest-bearing deposits
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$
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62,379
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$
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|
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$
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|
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$
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|
|
|
$
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|
|
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$
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|
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$
|
|
|
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$
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62,379
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|
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$
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62,379
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Weighted average yield
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.30
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%
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Fixed rate loans (1)
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|
|
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1,062
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|
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559
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|
|
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758
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|
|
|
445
|
|
|
|
635
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|
|
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7,069
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10,528
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6,942
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Weighted average yield
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6.08
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%
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4.96
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%
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5.02
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%
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4.78
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%
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6.12
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%
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4.37
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%
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Adjustable rate loans (1)
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23,023
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23,023
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17,384
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Weighted average yield
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4.97
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%
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|
|
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Total rate sensitive assets
|
|
$
|
62,379
|
|
|
$
|
24,085
|
|
|
$
|
559
|
|
|
$
|
758
|
|
|
$
|
445
|
|
|
$
|
635
|
|
|
$
|
7,069
|
|
|
$
|
95,930
|
|
|
$
|
86,705
|
|
|
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(1)
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Loans are presented at UPB and exclude non-accrual loans.
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At September 30, 2010, the fair value of loans in accrual status was $24.3 million with a UPB
of $33.6 million and approximately 71% of the fair value of loans in accrual status in our
portfolio were floating rate loans with contractual interest rates that may fluctuate based on
changes in market interest rates. Based on our experience, management applies the assumption that,
on average, approximately 32.7% and 4.7% of residential and commercial loans, respectively, will
prepay annually. The fair value of interest-bearing deposits approximates carrying value.
27
Item 4T. 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
September 30, 2010. Based on this evaluation, our President and Chief Financial Officer concluded
that, as of September 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 September 30, 2010 that has
materially affected, or is reasonably likely to materially affect, our internal control over
financial reporting.
28
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
Reports on
Form 10-Q
for the quarterly periods ended March 31, 2010 and June 30, 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
If the OTS does not approve the declaration and payment of sufficient dividends for 2010 and in the
future, we would be prohibited from declaring and paying sufficient dividends for 2010 and in the
future and therefore may fail to qualify as a REIT.
In order to continue to qualify as a REIT under the IRC, EOS generally is required each year
to distribute to its stockholders at least 90% of its net taxable income to stockholders, 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
declaration of sufficient dividends to EOS shareholders prior to the latest possible declaration
date of September 15, 2011 and if the OTS does not permit the payment of sufficient dividends to
EOS shareholders prior to the latest possible payment date of December 30, 2011, EOS will fail to
qualify as a REIT for the 2010 tax year. If EOS no longer qualifies as a REIT, we will be subject
to federal and state income taxes in the tax year when loss of REIT status occurs and in years
thereafter.
On June 26, 2009, Aurora Bank, our parent, 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) 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. The Board of
Directors also voted not to declare or pay dividends on the common stock that would have been
payable for fiscal 2009.
On July 28, 2009 Aurora Bank submitted a formal request for non-objection determination to
permit the payment of dividends. On September 9, 2010, the OTS
provided a non-objection determination for a one-time
declaration of and payment of dividends in an amount sufficient to maintain qualification as a REIT
for the 2009 tax year. The Board of Directors of EOS declared such dividends on September 13, 2010,
for the quarter ended September 30, 2010, consistent with the OTS non-objection determination.
The OTS has not approved or provided a non-objection to any further dividend distributions.
There can be no assurance that non-objection from the OTS will be granted on any future request 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 Series B and Series D 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
29
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. Aurora Bank and EOS will continue to work with the OTS regarding the resumption
of normal payment of dividends. There can be no assurance that the OTS
will grant any future non-objection request, nor can there be any
assurance that any further dividends will be paid or that EOS will
continue to qualify as REIT.
Item 2. Unregistered Sales of Equity Securities
Not applicable.
Item 3. Defaults Upon Senior Securities
Not applicable.
Item 4. (Removed and Reserved)
Item 5. Other Information
Not applicable.
Item 6. Exhibits
|
|
|
3.1
|
|
Restated Articles of Organization of EOS Preferred Corporation.*
|
|
|
|
3.2
|
|
Amended and Restated By-Laws of EOS Preferred Corporation.*
|
|
|
|
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.
|
|
|
|
*
|
|
Incorporated by reference herein from the exhibit of the same description filed on August 13,
2010 on Form 10-Q.
|
30
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: November 12, 2010
|
By:
|
/s/ Thomas OSullivan
|
|
|
|
Thomas OSullivan
|
|
|
|
President
(Principal Executive Officer)
|
|
|
|
|
|
Date: November 12, 2010
|
By:
|
/s/ Robert J. Leist, Jr.
|
|
|
|
Robert J. Leist, Jr.
|
|
|
|
Chief Financial Officer
(Principal Financial Officer)
|
|
31
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.*
|
|
|
|
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.
|
|
|
|
*
|
|
Incorporated by reference herein from the exhibit of the same description filed on August 13,
2010 on Form 10-Q.
|
32
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