**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington, D.C. 20549**

** **

**FORM 10-Q**

** **

**ý****                                ****QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIESEXCHANGE ACT OF 1934**

 

**For thequarterly period ended January 31, 2005**

 

**OR**

 

**o****                                   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For thetransition period from                   to                  **

 

### **Commission FileNumber 0-26686**

 

**First Investors FinancialServices Group, Inc.**

(Exact Name of Registrant as Specified in its Charter)

 
| **Texas**                                                       | ** ** | **76-0465087**                       |
|-----------------------------------------------------------------|------------|--------------------------------------|
| (State or Other Jurisdiction of Incorporation  or Organization) |       | (I.R.S. Employer Identification No.) |
|                                                            |       |                                 |
| **675 Bering Drive, Suite 710  Houston, Texas**                 | ** ** | **77057**                            |
| (Address of Principal Executive Offices)                        |       | (Zip Code)                           |
|                                                            |       |                                 |
| **(713) 977-2600**                                              |
| (Registrant’s Telephone Number, Including Area Code)       |

 

Indicate by check mark whetherthe registrant (1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orfor 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 ý No o.

 

Indicate by check mark whetherthe registrant is an accelerated filer (as defined in Rule 12b-2 of theExchange Act). Yes o No ý.

 

Indicate the number of sharesoutstanding of each of the issuer’s classes of common stock, as of the latestpracticable date.

 

| **Class**                    | ** ** | **Shares Outstanding At  March 14, 2005** | ** ** |
|------------------------------|------------|-------------------------------------------|------------|
| Common Stock-$.001 Par Value |       | 4,411,693                                 |       |

 

 

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**FIRST INVESTORS FINANCIAL SERVICES GROUP, INC.**

**AND SUBSIDIARIES**

** **

##### **FORM 10-Q**

##### ** **

### **January31, 2005**

### ** **

##### **TABLE OF CONTENTS**

 
| **Part I**  | **Financial  Information** |                                                                                                         |
|------------------|----------------------------|--------------------------------------------------------------------------------------------------------------|
|             |                       |
|             | Item  1.                   | Financial  Statements                                                                                        |   |
|             |                       |                                                                                                         |   |
|             |                       | Consolidated  Balance Sheets as of April 30, 2004 and January 31, 2005                                       |   |
|             |                       |                                                                                                         |   |
|             |                       | Consolidated Statements of  Operations for the Three Months and Nine Months Ended January 31, 2004 and  2005 |   |
|             |                       |                                                                                                         |   |
|             |                       | Consolidated  Statement of Shareholders’ Equity for the Nine Months Ended January 31, 2005              |   |
|             |                       |                                                                                                         |   |
|             |                       | Consolidated  Statements of Cash Flows for the Nine Months Ended January 31, 2004 and 2005                   |   |
|             |                       |                                                                                                         |   |
|             |                       | Notes  to Unaudited Consolidated Financial Statements                                                        |   |
|             |                       |                                                                                                         |   |
|             | Item  2.                   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                  |   |
|             |                       |                                                                                                         |   |
|             | Item  3.                   | Quantitative  and Qualitative Disclosures About Market Risk                                                  |   |
|             |                       |                                                                                                         |   |
|             | Item 4.                    | Controls and Procedures                                                                                      |   |
|             |                       |                                                                                                         |
| **Part II**      | **Other  Information**     |                                                                                                         |
|             |                       |                                                                                                         |
|             | Item 5.                    | Other Information                                                                                            |   |
|             |                       |                                                                                                         |   |
|             | Item 6.                    | Exhibits and  Reports on Form 8-K                                                                            |   |
|             |                       |
| **Signatures**   |                       |

 

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**FIRST INVESTORS FINANCIAL SERVICES GROUP, INC. AND SUBSIDIARIES**

** **

##### **CONSOLIDATEDBALANCE SHEETS -- APRIL 30, 2004 AND JANUARY 31, 2005**

 
| ** **                                                                                                                                                              | ** ** | **April 30,  2004** | ** **  | **January 31,  2005** | ** **  |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------|-------------|-----------------------|-------------|
| ** **                                                                                                                                                              | ** ** | **(Audited)**       | ** **  | **(Unaudited)**       | ** **  |
| **ASSETS**                                                                                                                                                              | ** ** | ** **          | ** **  | ** **            | ** **  |
| Receivables Held  for Investment, net                                                                                                                                   |       | $                   | 209,777,347 |                  | $           | 230,941,033 |   |
| Receivables  Acquired for Investment, net                                                                                                                               |       | 1,190,230           |        | 720,660               |        |
| Cash and  Short-Term Investments                                                                                                                                        |       | 2,018,490           |        | 721,167               |        |
| Restricted Cash                                                                                                                                                         |       | 19,036,747          |        | 19,444,867            |        |
| Accrued Interest  Receivable                                                                                                                                            |       | 2,576,023           |        | 2,339,549             |        |
| Assets Held for  Sale                                                                                                                                                   |       | 851,426             |        | 864,617               |        |
| Other Assets:                                                                                                                                                           |       |                |        |                  |        |
| Funds held under  reinsurance agreement                                                                                                                                 |       | 4,182,134           |        | 4,818,003             |        |
| Deferred  financing costs and other assets, net of accumulated amortization and  depreciation of $5,759,477 and $6,600,513                                              |       | 6,115,203           |        | 5,635,405             |        |
| Current income  taxes receivable                                                                                                                                        |       | 8,212               |        | **—**            |        |
| Interest rate derivative  positions                                                                                                                                     | ** ** | **—**          |        | 844,495               |        |
| Total assets                                                                                                                                                            |       | $                   | 245,755,812 |                  | 266,329,796 |   |
|                                                                                                                                                                    |       |                |        |                  |        |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                                                           |       |                |        |                  |        |
| Debt:                                                                                                                                                                   |       |                |        |                  |        |
| Warehouse credit  facilities                                                                                                                                            |       | $                   | 42,705,810  |                  | $           | 123,100,407 |   |
| Term notes                                                                                                                                                              |       | 164,718,190         |        | 104,442,696           |        |
| Working capital  facility                                                                                                                                               |       | 8,761,143           |        | 10,500,000            |        |
| Other  Liabilities:                                                                                                                                                     |       |                |        |                  |        |
| Accounts payable  and accrued liabilities                                                                                                                               |       | 1,708,984           |        | 2,048,576             |        |
| Deferred income  taxes payable                                                                                                                                          |       | 558,000             |        | 848,069               |        |
| Total  liabilities                                                                                                                                                      |       | 218,452,127         |        | 240,939,748           |        |
|                                                                                                                                                                    |       |                |        |                  |        |
| Commitments and  Contingencies                                                                                                                                          | ** ** | **—**          |        | —                |        |
| Shareholders’  Equity:                                                                                                                                             |       |                |        |                  |        |
| Common stock,  $0.001 par value, 10,000,000 shares authorized, 5,583,669 issued; 5,000,269  outstanding at April 30, 2004 and 4,411,693 outstanding at January 31, 2005 |       | 5,584               |        | 5,584                 |        |
| Additional  paid-in capital                                                                                                                                             |       | 18,754,608          |        | 18,754,608            |        |
| Retained  earnings                                                                                                                                                      |       | 10,515,258          |        | 11,097,167            |        |
| Less, treasury  stock, at cost, 583,400 and 1,171,976 shares                                                                                                            |       | (1,971,765          | )           | (4,467,311            | )           |
| Total  shareholders’ equity                                                                                                                                        |       | 27,303,685          |        | 25,390,048            |        |
| Total  liabilities and shareholders’ equity                                                                                                                        |       | $                   | 245,755,812 |                  | $           | 266,329,796 |   |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

 

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**FIRST INVESTORS FINANCIAL SERVICES GROUP, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF INCOME**

**For the Three Months and Nine Months Ended January 31, 2004 and 2005**

**(Unaudited)**

 
| ** **                                                            | ** ** | **For the Three Months  Ended January 31,** | ** ** | **For the Nine Months  Ended January 31,** | ** ** |
|-----------------------------------------------------------------------|------------|---------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                            | ** ** | **2004**                                    | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
|                                                                  |       |                                        |       |                                       |       |   |   |   |   |
| Interest Income                                                       |       | $                                           | 7,499,053  |                                       | $          | 7,220,443 |   | $ | 23,493,418 |   | $ | 21,173,847 |   |
| Interest Expense                                                      |       | 2,341,708                                   |       | 1,964,382                                  |       | 6,249,121 |   | 5,569,934 |   |
| Net interest income                                                   |       | 5,157,345                                   |       | 5,256,061                                  |       | 17,244,297 |   | 15,603,913 |   |
| Provision for Credit Losses                                           |       | 3,324,302                                   |       | 2,574,748                                  |       | 9,986,006 |   | 7,459,259 |   |
| Net Interest Income After  Provision for Credit Losses                |       | 1,833,043                                   |       | 2,681,313                                  |       | 7,258,291 |   | 8,144,654 |   |
| Other Income:                                                         |       |                                        |       |                                       |       |   |   |   |   |
| Servicing revenue                                                     |       | 1,347,128                                   |       | 820,952                                    |       | 3,845,366 |   | 2,696,316 |   |
| Late fees and other                                                   |       | 321,652                                     |       | 1,089,385                                  |       | 1,170,658 |   | 2,925,877 |   |
| Income from investment                                                |       | 273,613                                     |       | 156,652                                    |       | 818,095 |   | 526,880 |   |
| Other interest income                                                 |       | 198,949                                     |       | 117,613                                    |       | 384,779 |   | 283,579 |   |
| Unrealized (loss) gain on interest rate derivative positions          |       | (26,923                                     | )          | 5,562                                      |       | (33,232 | ) | (232,192 | ) |
| Total other income                                                    |       | 2,114,419                                   |       | 2,190,164                                  |       | 6,185,666 |   | 6,200,460 |   |
| Operating Expenses:                                                   |       |                                        |       |                                       |       |   |   |   |   |
| Salaries and benefits                                                 |       | 2,094,524                                   |       | 2,304,304                                  |       | 6,476,663 |   | 6,582,945 |   |
| Operating expense                                                     |       | 1,150,655                                   |       | 1,028,275                                  |       | 3,424,759 |   | 3,652,384 |   |
| General and administrative                                            |       | 852,394                                     |       | 959,693                                    |       | 2,811,870 |   | 2,818,746 |   |
| Other interest expense                                                |       | 113,611                                     |       | 140,014                                    |       | 363,479 |   | 374,646 |   |
| Total operating expenses                                              |       | 4,211,184                                   |       | 4,432,286                                  |       | 13,076,771 |   | 13,428,721 |   |
| (Loss) Income Before Provision for Income Taxes and Minority Interest |       | (263,722                                    | )          | 439,191                                    |       | 367,186 |   | 916,393 |   |
| (Benefit) Provision for Income Taxes:                                 |       |                                        |       |                                       |       |   |   |   |   |
| Current                                                               |       | (26,517                                     | )          | (402,301                                   | )          | (9,397 | ) | (26,067 | ) |
| Deferred                                                              |       | (69,713                                     | )          | 562,606                                    |       | 147,620 |   | 360,551 |   |
| Total (benefit) provision for income taxes                            |       | (96,230                                     | )          | 160,305                                    |       | 138,223 |   | 334,484 |   |
| Minority Interest                                                     |       | —                                      |       | —                                     |       | (11,429 | ) | — |   |
| Net (Loss) Income                                                     |       | $                                           | (167,492   | )                                          | $          | 278,886 |   | $ | 240,392 |   | $ | 581,909 |   |
|                                                                  |       |                                        |       |                                       |       |   |   |   |   |
| Basic and Diluted Net (Loss) Income per Common Share                  |       | $                                           | (0.03      | )                                          | $          | 0.06 |   | $ | 0.05 |   | $ | 0.12 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

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**FIRST INVESTORS FINANCIAL SERVICES GROUP, INC. AND SUBSIDIARIES**

 

**CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY**

 

**For the Nine Months Ended January 31, 2005**

**(Unaudited)**

 
| ** **                   | ** ** | **Common Stock** | ** ** | **Additional  Paid-In  Capital** | ** ** | **Retained  Earnings** | ** ** | **Treasury  Stock, at cost** | ** ** | **Total**  | ** ** |
|------------------------------|------------|------------------|------------|----------------------------------|------------|------------------------|------------|------------------------------|------------|------------|------------|
| Balance at April 30, 2004    |       | $                | 5,584      |                             | $          | 18,754,608             |       | $                            | 10,515,258 |       | $          | (1,971,765 | ) | $ | 27,303,685 |   |
| Net income                   |       | —           |       | —                           |       | 581,909                |       | —                       |       | 581,909    |       |
| Treasury stock purchases     |       | —           |       | —                           |       | —                 |       | (2,495,546                   | )          | (2,495,546 | )          |
| Balance at  January 31, 2005 |       | $                | 5,584      |                             | $          | 18,754,608             |       | $                            | 11,097,167 |       | $          | (4,467,311 | ) | 25,390,048 |   |
|                              |            |                  |            |                                  |            |                        |            |                              |            |            |            |  |  |  |  |  |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

5

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**FIRSTINVESTORS FINANCIAL SERVICES GROUP, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**For the Nine Months Ended January 31, 2004 and2005**

**(Unaudited)**

 
| ** **                                                                                         | ** ** | **2004**     | ** ** | **2005**     | ** ** |
|----------------------------------------------------------------------------------------------------|------------|--------------|------------|--------------|------------|
| ** **                                                                                         | ** ** | ** **   | ** ** | ** **   | ** ** |
| Cash Flows From Operating Activities:                                                              |       |         |       |         |       |
| Net income                                                                                         |       | $            | 240,392    |         | $          | 581,909 |   |
| Adjustments to reconcile net income to net cash (used in) provided by  operating activities — |       |         |       |         |       |
| Depreciation and amortization expense                                                              |       | 2,809,815    |       | 2,931,083    |       |
| Provision for credit losses                                                                        |       | 9,986,006    |       | 7,459,259    |       |
| Minority interest                                                                                  |       | (11,429      | )          | —       |       |
| (Increase) decrease in:                                                                            |       |         |       |         |       |
| Accrued interest receivable                                                                        |       | 696,434      |       | 236,474      |       |
| Restricted cash                                                                                    |       | (12,857,251  | )          | (408,120     | )          |
| Deferred financing costs and other assets                                                          |       | (1,919,718   | )          | (660,048     | )          |
| Funds held under reinsurance agreement                                                             |       | (1,007,425   | )          | (635,869     | )          |
| Current income tax receivable                                                                      |       | 962,041      |       | 8,212        |       |
| Interest rate derivative positions                                                                 |       | 3,789,285    |       | (844,495     | )          |
| Increase (decrease) in:                                                                            |       |         |       |         |       |
| Accounts payable and accrued liabilities                                                           |       | (38,338      | )          | 339,592      |       |
| Deferred income taxes payable                                                                      |       | 534,224      |       | 290,069      |       |
| Interest rate derivative positions                                                                 |       | (3,907,344   | )          | —       |       |
| Net cash (used in) provided by operating activities                                                |       | (723,308     | )          | 9,298,066    |       |
| Cash Flows From Investing Activities:                                                              |       |         |       |         |       |
| Origination of Receivables Held for Investment                                                     |       | (68,768,322  | )          | (104,941,043 | )          |
| Origination of Receivables Acquired for Investment                                                 |       | (328,787     | )          | —       |       |
| Principal payments from Receivables Held for Investment                                            |       | 64,960,757   |       | 69,888,379   |       |
| Principal payments from Receivables Acquired for Investment                                        |       | 836,061      |       | 469,570      |       |
| Payments received on Assets Held for Sale                                                          |       | 5,401,736    |       | 4,713,682    |       |
| Purchase of furniture and equipment                                                                |       | (136,567     | )          | (88,391      | )          |
| Net cash provided by (used in) investing activities                                                |       | 1,964,878    |       | (29,957,803  | )          |
| Cash Flows From Financing Activities:                                                              |       |         |       |         |       |
| Proceeds from advances on—                                                                    |       |         |       |         |       |
| Warehouse credit facilities                                                                        |       | 108,416,068  |       | 201,034,659  |       |
| Term notes                                                                                         |       | 139,661,000  |       | —       |       |
| Working capital facility                                                                           |       | —       |       | 2,043,863    |       |
| Principal payments made on—                                                                   |       |         |       |         |       |
| Warehouse credit facilities                                                                        |       | (207,670,589 | )          | (120,640,062 | )          |
| Term notes                                                                                         |       | (40,764,932  | )          | (60,275,494  | )          |
| Working capital facility                                                                           |       | (1,953,375   | )          | (305,006     | )          |
| Treasury stock purchased                                                                           |       | (105,630     | )          | (2,495,546   | )          |
| Net cash (used in) provided by financing activities                                                |       | (2,417,458   | )          | 19,362,414   |       |
| Decrease in Cash and Short-Term Investments                                                        |       | (1,175,888   | )          | (1,297,323   | )          |
| Cash and Short-Term Investments at Beginning of Period                                             |       | 2,617,680    |       | 2,018,490    |       |
| Cash and Short-Term Investments at End of Period                                                   |       | $            | 1,441,792  |         | $          | 721,167 |   |
| Supplemental Disclosures of Cash Flow Information:                                                 |       |         |       |         |       |
| Cash paid during the period for—                                                              |       |         |       |         |       |
| Interest                                                                                           |       | $            | 5,763,233  |         | $          | 4,755,179 |   |
| Income taxes                                                                                       |       | 5,815        |       | 33,963       |       |

 

The accompanying notes are an integral part of theseconsolidated financial statements

 

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**FIRSTINVESTORS FINANCIAL SERVICES GROUP, INC. AND SUBSIDIARIES**

 

**NOTES TOUNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

 

##### **January 31, 2005**

 

**1.****                The Company**

 

*Organization.*  First Investors Financial Services Group,Inc. (First Investors) was established to serve as a holding company for FirstInvestors Financial Services, Inc. (FIFS) and FIFS’s wholly-owned subsidiaries,First Investors Insurance Company (FIIC), First Investors Auto ReceivablesCorporation (FIARC), F.I.R.C., Inc. (FIRC), First Investors ServicingCorporation (FISC), formerly known as Auto Lenders Acceptance Corporation(ALAC), FIFS Acquisition Funding Corp. LLC, Farragut Financial Corporation, andFirst Investors Auto Funding Corporation. First Investors, together with itswholly- and majority-owned subsidiaries, is hereinafter referred to as theCompany.

 

FIFSbegan operations in May 1989 and is principally involved in the business oforiginating and holding for investment retail installment contracts andpromissory notes secured by new and used automobiles originated by factoryauthorized franchised dealers or directly through consumers. As of January 31,2005, approximately 31% and 18% of receivables held for investment had beenoriginated in Texas and Georgia, respectively. The Company currently operatesin 28 states.

 

FIICwas organized under the captive insurance company laws of the state of Vermontfor the purpose of reinsuring certain credit enhancement insurance policiesthat have been written by unrelated third party insurance companies.

 

OnOctober 2, 1998, the Company completed the acquisition of FISC and theoperations of FISC are included in the consolidated results of the Companysince the date of acquisition. Headquartered in Atlanta, Georgia, FISCperformed servicing and collection activities on a portfolio of receivablesoriginated for investment as well as on a portfolio of receivables originatedand sold pursuant to two asset securitizations. As a result of the acquisition,the Company increased the total dollar value on its balance sheet ofreceivables, acquired an interest in certain trust certificates related to theasset securitizations and acquired certain servicing rights along with furniture,fixtures, equipment and technology to perform the servicing and collectionfunctions for the portfolio of receivables under management.

 

OnAugust 8, 2000, the Company entered into a partnership agreement (Partnership)whereby a subsidiary of the Company was the general partner owning 70% of thepartnership interests and First Union Investors, Inc. served as the limitedpartner and owned 30% of the partnership interests.  On September 19, 2003, First InvestorsFinancial Services, Inc. purchased the limited partnership interests previouslyheld by First Union Investors, Inc.  ThePartnership consists primarily of a portfolio of loans previously owned orsecuritized by FISC and certain other financial assets including charged-offaccounts owned by FISC.

 

OnDecember 24, 2002, the Company purchased 40% of common stock and an investmentin the junior mezzanine debt of First Auto Receivables Corporation (FARC).  FARC purchased an approximately $197.5million portfolio of installment loan receivables from a subsidiary of UnionAcceptance Corporation.  FISC performsongoing servicing and collection activities on the portfolio.

 

OnMarch 19, 2003, FISC entered into a servicing agreement with an unrelated thirdparty to service an approximately $300 million portfolio of installment loanreceivables purchased from a subsidiary of Union Acceptance Corporation.

 

Intotal, at January 31, 2005, FISC performs servicing and collection functions ona managed receivables portfolio of approximately $448 million.

 

7

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**2.****                Interim Financial Information**

 

*Basis ofPresentation*.  Theconsolidated financial statements include the accounts of First Investors andits wholly-owned and majority-owned subsidiaries.  All significant intercompany accounts andtransactions have been eliminated. Investments in which the Company exercisessignificant influence, but which it does not control (generally a 20% to 50%ownership interest), are accounted for under the equity method of accounting, exceptfor variable interest entities for which the Company is considered the primarybeneficiary under Financial Accounting Standards Board (“FASB”) InterpretationNo. 46, *Consolidation of Variable Interest Entities, aninterpretation of ARB No. 51*, as amended in December 2003 byInterpretation 46R.  As of January 31,2005, the Company does not have any entities under which FIN 46 as amended byInterpretation 46R would apply.

 

The results for theinterim periods are not necessarily indicative of the results of operationsthat may be expected for the fiscal year. In the opinion of management, theinformation furnished reflects all adjustments which are of a normal recurringnature and are necessary for a fair presentation of the Company’s financialposition as of January 31, 2005, and the results of its operations for thethree and nine months ended January 31, 2004 and 2005, and its cash flows forthe nine months ended January 31, 2004 and 2005.

 

The consolidatedfinancial statements for the interim periods have been prepared pursuant to therules and regulations of the Securities and Exchange Commission. Certaininformation and footnote disclosures normally included in financial statementsprepared in accordance with accounting principles generally accepted in theUnited States of America have been condensed or omitted pursuant to such rulesand regulations, although the Company believes that the disclosures areadequate to make the information not misleading. These financial statementsshould be read in conjunction with the audited consolidated financialstatements included in the Company’s 2004 Annual Report on Form 10-K filed July26, 2004.

 

*Receivables Held for Investment*. Receivables Held for Investment represents the aggregate outstandingbalance of installment sales contracts and promissory notes originated by theCompany through its automobile dealer relationships or directly withconsumers.  The Company accrues interestincome monthly using the effective interest method.  When a receivable becomes 90 days past due,the income accrual is suspended until the payments become current. When a loanis charged off or the collateral is repossessed, the remaining income accrualis written off.

 

*Receivables Acquired for Investment*.  Inconnection with loans that were acquired in a portfolio purchase by thePartnership, the Company estimates the amount and timing of undiscountedexpected future principal and interest cash flows. For certain purchased loans,the amount paid for a loan reflects the Company’s determination that it isprobable the Company will be unable to collect all amounts due according to theloan’s contractual terms. Accordingly, at acquisition, the Company recognizesthe excess of the loan’s scheduled contractual principal and contractualinterest payments over its expected cash flows as an amount that should not beaccreted. The remaining amount, representing the excess of the loan’s expectedcash flows over the amount paid, is accreted into interest income over theremaining life of the loan.  As a resultof the amortization of the outstanding principal balance of the receivablesportfolio, the majority of the remaining cash flows projected constitutedefault collections from obligors.  Giventhe nature of the remaining cash flows of individual loans, the Companydetermined that the timing of collections on Receivables Acquired forInvestment was much more unpredictable than contractual cash flows fromnon-defaulted receivables.  Therefore,under the guidance provided by Practice Bulletin 6*, Amortizationof Discounts on Certain Acquired Loans*, Receivables Acquired forInvestment are accounted for under the cost-recovery method beginning September30, 2003.  Under the cost recoverymethod, cash proceeds from collections are applied to first reduce the Company’sbasis in the assets.  Cash collected inexcess of this cost basis is recognized as income when received.

 

*Other Income*.  Other Income consists of income received fromservicing activities, late fees and other loan-related fees, income from investments,loan origination fees, product sales, reinvestment revenue and unrealized gainor loss on interest rate derivative positions. Servicing revenue is accrued as services are rendered. Late fees andother loan-related fees are recognized when received.  Income from investments and reinvestmentrevenue are

 

8

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accrued based on the respective interest rate ofsuch investment and unrealized gain or loss on interest rate derivatives isrecognized as changes occur in the derivatives fair value.

 

*Allowancefor Credit Losses*.  TheCompany calculates the allowance for credit losses in accordance with SFAS No.5*, Accounting for Contingencies.*  SFAS No. 114, *Accountingfor Creditors for Impairment of a Loan* does not apply to loanscurrently held by the Company because they comprise a large group of smallerbalance homogenous loans that are evaluated collectively for impairment.

 

The Company initiatesefforts to make customer contact when the customer is one day past due andbecomes more aggressive as the loan becomes more delinquent.  Management reviews past due loans andconsiders various factors including payment history, job status and any eventsthat may have occurred that prevent the customer from making a payment.  Through the evaluation, if it is determinedthat the loan is uncollectible, the collateral is typically repossessed.  Generally this occurs at 90 to 120 days pastdue.  Upon repossession, theuncollectible portion of the loan and 100% of accrued interest is writtenoff.  The fair value of the collateral isrecorded in Assets Held for Sale.  In theevent the collateral is unable to be located, the Company will write off theentire balance after exhausting all collection efforts.

 

TheCompany applies a systematic methodology in order to determine the amount ofthe allowance for credit losses.  Thespecific methodology utilized is a six-month migration analysis whereby theCompany compares the aging status of each loan from six months prior to theaging loan status as of the reporting date. These factors are then applied to the aging status of each loan at thereporting date in order to calculate the number of loans that are expected tomigrate to impaired status.  Theestimated number of impairments is then multiplied by estimated loss per loan,which is based on historical information. The computed reserve is then compared to the amount recorded foradequacy.  The Company compares thesix-month result to prior six-month periods to compare trends and evaluate anyother internal or external factors that may affect collectibility. Theallowance for credit losses is based on estimates and qualitative evaluations,and ultimate losses will vary from current estimates. These estimates arereviewed periodically and as adjustments, either positive or negative, becomenecessary, are reported in earnings in the period they become known.

 

*Treasury Stock. *In September, 2004,the Board of Directors authorized the Company to repurchase up to $1.5 millionof the Company’s outstanding common stock. This plan was subsequently amended in December, 2004, authorizing therepurchase of an additional $1 million of the Company’s outstanding commonstock, resulting in the total authorization of $2.5 million to repurchase theCompany’s stock.  During the three andnine months ended January 31, 2005, the Company engaged in the followingtransactions:

 

| **Three Months Ended  January 31, 2005** | ** ** | **Nine Months Ended  January 31, 2005** | ** ** |
|------------------------------------------|------------|-----------------------------------------|------------|
| **# of Shares  Repurchased**             | ** ** | **Wtd. Avg.  Price/Share**              | ** ** | **# of Shares  Repurchased** | ** ** | **Wtd. Avg.  Price/Share** | ** ** |
| 587,676                                  |       | $                                       | 4.24       |   | 588,576 |   | $ | 4.24 |   |
|                                          |            |                                         |            |  |  |  |  |  |  |

 

As a result of the 587,676 shares repurchased during thethird quarter, the Company completed the $2.5 million authorized increase inthe share repurchase plan and, as a result, announced the conclusion of itsshare repurchase plan originally adopted in December 2001.  Since the inception of the plan, a total of1,171,976 shares were repurchased at a weighted average price of $3.81 pershare.

 

*Stock-BasedCompensation*.  The Company has an employee stock option planand a non-employee director stock option plan, which are described more fullyin Note 9.  The Company has adopted thedisclosure provisions of SFAS No. 148, *Accounting for Stock-BasedCompensation—Transition and Disclosure, an amendment of FASB Statement No. 123*.This pronouncement requires prominent disclosures in both annual and interimfinancial statements regarding the method of accounting for stock-basedemployee compensation and the effect of the method used on reported results.The Company accounts for stock compensation awards under the intrinsic valuemethod of Accounting Principles Board (“APB”) Opinion No. 25, *Accounting for Stock Issued to Employees*which requirescompensation cost to be recognized based on the excess, if any, between thequoted market price

 

9

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of the stock at the date of grant and the amount anemployee must pay to acquire the stock. All options awarded under the Company’splan are granted with an exercise price equal to or greater than the fairmarket value on the date of the grant.

 

The following tablepresents the Company’s net income per share had the Company adopted the fairvalue method of accounting for stock-based compensation under SFAS No. 123, *Accounting for Stock-Based Compensation*, as amended by SFASNo. 148.

 
| ** **                                                                                                                                           | ** ** | **For the Three Months  Ended January 31,** | ** ** | **For the Nine Months  Ended January 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                                                           | ** ** | **2004**                                    | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| Net (Loss) Income, as reported                                                                                                                       |       | $                                           | (167,492   | )                                          | $          | 278,886 |   | $ | 240,392 |   | $ | 581,909 |   |
| Deduct: Total stock option plan compensation expense determined under  fair value based method for awards granted, modified or settled, net of taxes |       | 32,562                                      |       | 44,933                                     |       | 79,256 |   | 125,643 |   |
| Pro Forma Net (Loss) Income                                                                                                                          |       | $                                           | (200,054   | )                                          | $          | 233,953 |   | $ | 161,136 |   | $ | 456,266 |   |
|                                                                                                                                                 |       |                                        |       |                                       |       |   |   |   |   |
| Basic and Diluted Net (Loss) Income per Common Share, as reported                                                                                    |       | $                                           | (0.03      | )                                          | $          | 0.06 |   | $ | 0.05 |   | $ | 0.12 |   |
| Basic and Diluted Net (Loss) Income per Common Share, pro forma                                                                                      |       | $                                           | (0.04      | )                                          | $          | 0.05 |   | $ | 0.03 |   | $ | 0.09 |   |

 

*Reclassifications*.Certain reclassifications have been made to the fiscal 2004 amounts to conformwith the fiscal 2005 presentation.

 

**3.****              Receivables Held for Investment**

 

The receivables generallyhave terms between 48 and 72 months and are collateralized by the underlyingvehicles.  Net receivable balancesconsisted of the following at April 30, 2004 and January 31, 2005:

 
| ** **                                | ** ** | **April 30,  2004** | ** **  | **January 31,  2005** | ** ** |
|-------------------------------------------|------------|---------------------|-------------|-----------------------|------------|
| Receivables                               |       | $                   | 207,489,339 |                  | $          | 227,611,249 |   |
| Unamortized premium and deferred fees (1) |       | 4,487,394           |        | 5,742,463             |       |
| Allowance for credit losses               |       | (2,199,386          | )           | (2,412,679            | )          |
| Net receivables                           |       | $                   | 209,777,347 |                  | $          | 230,941,033 |   |

    

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(1)          Includes premium and discounts paid to dealerplus deferred acquisition cost.

 

Activityin the allowance for credit losses for the periods ended January 31, 2004 and2005 was as follows:

 
| ** **                     | ** ** | **For the Nine Months  Ended January 31,** | ** ** |
|--------------------------------|------------|--------------------------------------------|------------|
| ** **                     | ** ** | **2004**                                   | ** ** | **2005** | ** ** |
| Balance, beginning of period   |       | $                                          | 2,397,216  |   | $ | 2,199,386 |   |
| Provision for credit losses    |       | 9,986,006                                  |       | 7,459,260 |   |
| Charge-offs, net of recoveries |       | (10,121,583                                | )          | (7,245,967 | ) |
| Balance, end of period         |       | $                                          | 2,261,639  |   | $ | 2,412,679 |   |

 

10

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**4.****              Receivables Acquired for Investment**

 

ReceivablesAcquired for Investment comprise loans previously originated by Auto LendersAcceptance Corporation and another third party. Loans originated by Auto Lenders Acceptance Corporation include aportfolio of warehouse loans and a portfolio of loans that were previouslysecuritized.  The securitized loans weresubsequently redeemed and funded through one of the Company’s creditfacilities.  Receivables Acquired forInvestment previously originated by Auto Lenders Acceptance Corporation werepurchased at a discount relating to credit quality.  As a result of the amortization of the outstandingprincipal balance of the receivables portfolio, the majority of the remainingcash flows projected constitute default collections from obligors.  Given the nature of the remaining cash flowsof individual loans, the Company determined that the timing of collections onReceivables Acquired for Investment was much more unpredictable thancontractual cash flows from non-defaulted receivables.  Therefore, under the guidance provided byPractice Bulletin 6*, Amortization ofDiscounts on Certain Acquired Loans*, Receivables Acquired forInvestment are accounted for under the cost-recovery method beginning September30, 2003.  Under the cost recoverymethod, cash proceeds from collections are applied to first reduce the Company’sbasis in the assets.  Cash collected inexcess of this cost basis is recognized as income when received. ReceivablesAcquired for Investment previously originated by Auto Lenders AcceptanceCorporation were $979,496 and $671,935 as of April 30, 2004 and January 31,2005, respectively.

 

OnSeptember 30, 2003 the Company purchased $9.4 million of defaulted auto loanreceivables from an unrelated third party. These loans of $210,734 and $48,725 are included in Receivables Acquiredfor Investment on the balance sheet as of April 30, 2004 and January 31, 2005respectively, and are accounted for using the cost-recovery method.  The Company may, from time to time, considersimilar acquisitions in the future.

 

**5.****              Debt**

 

The Company finances itsloan origination through two warehouse credit facilities. The Company’s creditfacilities provide for one-year terms and have been renewed annually.Management of the Company believes that the credit facilities will continue tobe renewed or extended or that it would be able to secure alternate financingon satisfactory terms; however, there can be no assurance that it will be ableto do so. In January 2002 the Company issued $159 million in asset-backed notes(“Term Notes”) secured by a discrete pool of receivables. On November 20, 2003,the Company issued $140 million in Term Notes secured by a discrete pool ofreceivables.  Substantially allreceivables retained by the Company are pledged as collateral for the creditfacilities and the Term Notes. The weighted average interest rate for theCompany’s secured borrowings including the effect of program fees, dealer fees,and other comprehensive income (loss) amortization was 3.54% and 3.96% for thethree months ended January 31, 2005 and 2004 3.48% and 3.58% for the ninemonths ended January 31, 2005 and 2004, respectively.

 

*Warehouse Facilities as ofJanuary 31, 2005*

 
| **Facility** | ** ** | **Capacity** | ** **  | **Outstanding** | ** ** | **Interest Rate** | ** ** | **Fees**                                                                                              | ** ** | **Insurance**           | ** ** | **Borrowing  Rate At  January 31,  2005** | ** ** |
|--------------|------------|--------------|-------------|-----------------|------------|-------------------|------------|-------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-------------------------------------------|------------|
| FIARC        |       | $            | 150,000,000 |            | $          | 89,120,297        |       | Commercial paper rate  plus .3%                                                                       |       | .25% of Unused Facility |       | .35                                       | %          | 3.05 | % |
| FIRC         | ** ** | $            | 50,000,000  |            | $          | 33,980,110        |       | Option of a) Base Rate,  which is the higher of prime rate or fed funds plus .5% or b) LIBOR plus .5% |       | .25% of Unused Facility |       | See below                                 |       | 2.44 | % |

 

11

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*Warehouse Facilities – CreditEnhancement as of January 31, 2005*

 
| **Facility** | ** ** | **Cash Reserve**               | ** ** | **Advance   Rate** | ** ** | **Insurance**            | ** ** |
|--------------|------------|--------------------------------|------------|--------------------|------------|--------------------------|------------|
| FIARC        |       | 1% of outstanding  receivables |       | 94                 | %          | Surety Bond              |       |
| FIRC         |       | 1% of borrowings               |       | 100                | %          | Default Insurance (ALPI) |       |

 

FIRC- In order to obtain a lower cost of funding, the Company has agreed tomaintain credit enhancement insurance covering the receivables pledged ascollateral under the FIRC credit facility. The facility lenders are named asadditional insureds under these policies. The coverages are obtained on eachreceivable at the time it is originated by the Company, and the applicablepremiums are prepaid for the life of the receivable. Each receivable is coveredby multiple credit insurance policies, consisting of basic default insurance undera standard auto loan protection policy (known as “ALPI” insurance) togetherwith certain supplemental coverages relating to physical damage and otherrisks. Solely at its expense, the Company carries these coverages and neitherthe vehicle purchasers nor the dealers are charged for the coverages, nor arethey usually aware of their existence. The Company’s ALPI insurance policy iswritten by National Union Fire Insurance Company of Pittsburgh (“National Union”),which is a wholly-owned subsidiary of American International Group.

 

The premiums that theCompany paid during the three months and nine months ended January 31, 2005 forits three credit enhancement insurance coverages, of which the largestcomponent is basic ALPI insurance, represented approximately 2.9% of theprincipal amount of the receivables originated during the periods. Aggregatepremiums paid for ALPI coverage alone were $1,028,980 and $606,135 during thethree months ended and $2,645,416 and $2,216,261 for nine months ended January31, 2005 and 2004, respectively, and accounted for 2.7% and 3.6% during thethree months ended and 2.5% and 3.2% for the nine months ended January 31, 2005and 2004, respectively, of the principal amount of the receivables originatedduring such respective periods.

 

In April 1994, theCompany organized First Investors Insurance Company (the “Insurance Subsidiary”)under the captive insurance company laws of the State of Vermont. The InsuranceSubsidiary is an indirect wholly-owned subsidiary of the Company and is a partyto a reinsurance agreement whereby the Insurance Subsidiary reinsures 100% ofthe risk under the Company’s ALPI insurance policy. At the time each receivableis insured by National Union, the risk is automatically reinsured to its fullextent and approximately 96% of the premium paid by the Company to NationalUnion with respect to such receivable is ceded to the Insurance Subsidiary.When a loss covered by the ALPI policy occurs, National Union pays it after theclaim is processed, and National Union is then reimbursed in full by theInsurance Subsidiary.  In addition to themonthly premiums and liquidity reserves of the Insurance Subsidiary, a trustaccount is maintained by National Union to secure the Insurance Subsidiary’sobligations for losses it has reinsured.

 

The result of theforegoing reinsurance structure is that National Union, as the “fronting”insurer under the captive arrangement, is unconditionally obligated to theCompany’s credit facility lenders for all losses covered by the ALPI policy,and the Company, through its Insurance Subsidiary, is obligated to indemnifyNational Union for all such losses. As of January 31, 2005, the InsuranceSubsidiary had capital and surplus of $2,451,776 and unencumbered cash reservesof $1,790,632 in addition to the $3,300,508 trust account.

 

The ALPI coverage as wellas the Insurance Subsidiary’s liability under the Reinsurance Agreement,remains in effect for each receivable that is pledged as collateral under thewarehouse credit facility. Once receivables are transferred from FIRC to FIARCand financed under the commercial paper facility, ALPI coverage and theInsurance Subsidiary’s liability under the Reinsurance Agreement is cancelledwith respect to the transferred receivables. Any unearned premium associatedwith the transferred receivables is returned to the Company. The Companybelieves the losses its Insurance Subsidiary will be required to indemnify willbe less than the premiums ceded to it. However, there can be no assurance thatlosses will not exceed the premiums ceded and the capital and surplus of theInsurance Subsidiary.

 

12

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FIARC– Credit Enhancement for the FIARC warehouse facility is provided to thecommercial paper investors by a cash reserve account equal to 1% of thereceivables held by FIARC and, additionally, a surety bond issued by MBIA. TheCompany is not a guarantor of, or otherwise a party to, such commercial paper.

 

*Warehouse Facilities – Agents andExpirations*

 
| **Facility** | ** ** | **Agent** | ** ** | **Expiration**     | ** ** | **Event if not Renewed**                                                                                                                                                 |
|--------------|------------|-----------|------------|--------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| FIARC        |       | Wachovia  |       | February 15,  2006 |       | Receivables pledged  would be allowed to amortize; however, no new receivables would be allowed to  transfer from the FIRC facility                                      |
| FIRC         |       | Wachovia  |       | December 1, 2005   |       | Convert to a term loan  which would mature nine months thereafter and amortize monthly in accordance  with the borrowing base with the remaining balance due at maturity |

 

OnDecember 4, 2003, the FIRC facility was renewed, under similar terms andconditions, at the $50 million commitment level until December 2, 2004, and wassubsequently extended until December 1, 2005. On June 15, 2004, the FIRC facility was extended to $65 million, andreverted back to $50 million on September 13, 2004.  On January 29, 2004, following a short-termextension of the original maturity date, the FIARC facility was renewed, undersimilar terms and conditions, to December 2, 2004, and was subsequentlyextended until February 15, 2006.  As ofApril 30, 2004 and January 31, 2005, there was $0 and $34 million,respectively, outstanding.

 

Management presentlyintends to seek further extensions to these warehouse facilities prior to thecurrent expiration dates.  Managementfurther considers its relationship with its lenders to be satisfactory and hasno reason to believe that the FIRC and FIARC facilities will not be renewed ateach of their respective expiration dates.

 

The following tablecontains pertinent information on the Term Notes as of January 31, 2005.

 
| **Term Notes** | ** ** | **Issuance Date**  | ** ** | **Issuance   Amount** | ** **  | **Maturity Date** | ** **         | **Outstanding** | ** ** | **Interest   Rate** | ** ** |
|----------------|------------|--------------------|------------|-----------------------|-------------|-------------------|--------------------|-----------------|------------|---------------------|------------|
| 2002-A         |       | January 29, 2002   |       | $                     | 159,036,000 |              | December 15,  2008 |            | $          | 23,636,247          |       | 3.46 | % |
| 2003-A         |       | November 11,  2003 |       | $                     | 139,661,000 |              | April 20, 2011     |            | $          | 80,806,448          |       | 2.58 | % |

 

Credit enhancement on thetwo Term Notes is as follows:

 

| **Facility** | ** ** | **Cash Reserve**                                                                                                    | ** ** | **Advance Rate**                           | ** ** | **Insurance** |
|--------------|------------|---------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|---------------|
| 2002-A       |       | 2% of Initial  Pool Balance including Pre-Funding Amount of $25 million                                             |       | 99% initial  advance decreasing to 97%     |       | Surety Bond   |
| 2003-A       |       | 0.5% of Initial  Pool Balance increasing to 2% of Initial Pool Balance including Pre-Funding  Amount of $30 million |       | 96.5% initial  advance decreasing to 96.1% |       | Surety Bond   |

 

Term Notes- On January 29, 2002, the Company, through its indirect, wholly-ownedsubsidiary First Investors Auto Owner Trust 2002-A (“2002 Auto Trust”)completed the issuance of $159,036,000 of 3.46% Class A asset-backed notes (“2002-ATerm Notes”). The initial pool of automobile receivables transferred to the2002 Auto Trust totaled $135,643,109, which was previously owned by FIRC andFIARC, secure the 2002-A Term

 

13

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Notes.  In addition to theissuance of the Class A Notes, the 2002 Auto Trust also issued $4,819,000 inClass B Notes that were retained by the Company and pledged to secure theWorking Capital Facility as further described below.  Proceeds from the issuance, which totaled$159,033,471 were used to (i) fund a $25,000,000 pre-funding account to be usedfor future loan originations; (ii) repay all outstanding borrowings under theFIARC commercial paper facility, (iii) reduce the outstanding borrowings underthe FIRC credit facility, (iv) pay transaction fees related to the 2002-A TermNote issuance, and (v) fund a cash reserve account of 2% or $2,712,862 of theinitial receivables pledged which will serve as a portion of the creditenhancement for the transaction. The Class A Term Notes bear interest at 3.46%and require monthly principal reductions sufficient to reduce the balance ofthe Class A Term Notes to 97% of the outstanding balance of the underlyingreceivables pool. The final maturity of the 2002-A Term Notes is December 15,2008.  The Class B Notes do not bearinterest but require principal reductions sufficient to reduce the balance ofthe Class B Notes to 3% of the outstanding balance of the underlyingreceivables pool.  A surety bond issuedby MBIA Insurance Corporation provides credit enhancement for the Class ANotes.  In the event that certain assetquality covenants are not met, the reserve account target level will increaseto 6% of the then current principal balance of the receivables pool.  As of April 30, 2004 and January 31, 2005,the outstanding principal balances on the 2002-A Term Notes were $44,335,659 and$23,636,247, respectively.

 

On November 20, 2003, theCompany, through its indirect, wholly-owned subsidiary First Investors AutoOwner Trust 2003-A (“2003 Auto Trust”) completed the issuance of $139,661,000of 2.58% Class A asset-backed notes (“2003-A Term Notes”). The initial pool ofautomobile receivables transferred to the 2003 Auto Trust totaled $114,726,891,which was previously owned by FIRC and FIARC, secure the 2003-A TermNotes.  In addition to the issuance ofthe Class A Notes, the 2003 Auto Trust also issued $5,065,891 in Class B Notesthat were retained by the Company and pledged to secure the Working CapitalFacility as further described below. Proceeds from the issuance, which totaled $139,656,629 were used to (i)fund a $30,000,000 pre-funding account to be used for future loan originations;(ii) repay all outstanding borrowings under the FIARC commercial paperfacility, (iii) reduce the outstanding borrowings under the FIRC creditfacility, (iv) pay transaction fees related to the 2003-A Term Note issuance,and (v) fund an initial cash reserve account of 0.5% or $573,635 of the initialreceivables pledged.  The Class A TermNotes bear interest at 2.58% and require monthly principal reductionssufficient to reduce the balance of the Class A Term Notes to 96.1% of theoutstanding balance of the underlying receivables pool. The final maturity ofthe 2003-A Term Notes is April 20, 2011. The Class B Notes do not bear interest but require principal reductionssufficient to reduce the balance of the Class B Notes to 3.9% of theoutstanding balance of the underlying receivables pool.  A surety bond issued by MBIA InsuranceCorporation provides credit enhancement for the Class A Notes.  In the event that certain asset qualitycovenants are not met, the reserve account target level will increase to 6% ofthe then current principal balance of the receivables pool.  As of April 30, 2004 and January 31, 2005,the outstanding principal balances on the 2003-A Term notes were $120,382,531and $80,806,448, respectively.

 

*WorkingCapital Facility*.  OnDecember 6, 2001, the Company entered into an agreement with WachoviaSecurities to refinance the $11,175,000 outstanding balance of a workingcapital term loan previously provided by Bank of America and Wachovia andincrease the size of the facility to $13.5 million.  The renewal facility was provided to aspecial-purpose, wholly-owned subsidiary of the Company, First InvestorsResidual Funding LP.  The facilityoriginally consisted of a $9 million revolving tranche and a $4.5 million termloan tranche which amortizes monthly. The term loan tranche of this working capital facility was evidenced bythe Class B Notes issued in conjunction with the 2002 Auto Trust financing. Theremaining $9 million of the $13.5 million working capital facility revolvesmonthly in accordance with a borrowing base consisting of theover-collateralization amount and reserve accounts for each of the Company’sother credit facilities.  The facility issecured solely by the residual cash flow and cash reserve accounts related tothe Company’s warehouse credit facilities, the acquisition facility and theexisting and future term note facilities. During 2002, the facility was modified to increase the interest ratefrom LIBOR plus 1.5% to LIBOR plus 2.25%. The commitment fee paid on the total available amount of the facilitywas maintained at 1.5%.  In addition, themonthly principal amortization under the term loan tranche was increased to thegreater of $250,000 or the principal distributions made under the Class B Notesissued under the 2002 Auto Trust financing. On December 4, 2003, the Working Capital Facility was extended toDecember 2, 2004.  Under the terms of theextension, the monthly amortization requirement was replaced with therequirement that outstandings under the facility could not exceed the lesser ofa borrowing base

 

14

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or the $9 million facility limit. On October 26, 2004, the Working Capital Facility was extended untilOctober 10, 2005, increasing the commitment amount to $13.5 million.  The interest rate remained at LIBOR plus2.25% and the commitment fee paid on the total available amount of the facilitywas maintained at 1.5%.  At April 30, 2004and January 31, 2005, there was $8,761,143 and $10,500,000, respectively, outstandingunder this facility.

 

TheCompany presently intends to seek a renewal of the working capital facilityfrom its lender prior to maturity. Should the facility not be renewed, the outstanding balance of thereceivables would be amortized in accordance with the borrowing base.  Management considers its relationship withits lenders to be satisfactory and has no reason to believe that this creditfacility will not be renewed.  If thefacility is not renewed, however, or if material changes are made to its termsand conditions, it could have a material adverse effect on the Company.

 

*ShareholderLoans.*  On December 3,2001 the Company entered into an agreement with one of its shareholders who isa member of its Board of Directors under which the Company may, from time totime, borrow up to $2.5 million.  OnDecember 6, 2004, the original $2.5 million shareholder loan was replaced witha $2.5 million loan containing identical terms and conditions between theCompany and a limited partnership that is affiliated with a current shareholderand member of the board of directors. The proceeds of the borrowings will be utilized to fund certain privateand open market purchases of the Company’s common stock pursuant to a StockRepurchase Plan authorized by the Board of Directors and for general corporatepurposes.  Borrowings under the facilitybear interest at a fixed rate of 10% per annum. The facility is unsecured and expressly subordinated to the Company’ssenior credit facilities. The facility matures on December 3, 2008 but may berepaid at any time unless the Company is in default on one of its other creditfacilities.  There were no amountsoutstanding under this facility as of April 30, 2004 and January 31, 2005 respectively.

 

*LoanCovenants*.  The documentationgoverning these credit facilities and Term Notes contains numerous covenantsrelating to the Company’s business, the maintenance of credit enhancementinsurance covering the receivables (if applicable), the observance of certainfinancial covenants, the avoidance of certain levels of delinquency experienceand other matters. The breach of these covenants, if not cured within the timelimits specified, could precipitate events of default that might result in theacceleration of the FIRC credit facility, the Term Notes and the workingcapital facility or the termination of the commercial paper facilities. The Companywas not in default with respect to any financial covenants governing thesefinancing arrangements at January 31, 2005.

 

*InterestRate Management*.  TheCompany’s warehouse credit facilities and working capital facilities bearinterest at floating interest rates which are reset on a short-term basis whilethe secured Term Notes bear interest at a fixed rate of interest. The Company’sreceivables bear interest at fixed rates that do not generally vary with achange in market interest rates. Since a primary contributor to the Company’sprofitability is its ability to manage its net interest spread, the Companyseeks to maximize the net interest spread while minimizing exposure to changesin interest rates. In connection with managing the net interest spread, theCompany may periodically enter into interest rate swaps or caps to minimize theeffects of market interest rate fluctuations on the net interest spread. To theextent that the Company has outstanding floating rate borrowings or has electedto convert a portion of its borrowings from fixed rates to floating rates, theCompany will be exposed to fluctuations in short-term interest rates.

 

Duringthe nine months ended January 31, 2005, as a requirement of the FIARCcommercial paper facility, the Company entered into seven interest rate captransactions, with strike rates of 5%. The aggregate initial notional amounts of the caps were $97,056,198which amortize over six years.  TheCompany paid an aggregate of $1,076,687 in premiums to purchase thesecaps.  The interest rate caps were notdesignated as hedges, and accordingly, changes in the fair value of theinterest rate caps are recorded as unrealized gains or losses and reflected innet income.  As of January 31, 2005, thecombined value of the interest rates caps were $844,495 and are recorded underother assets as interest rate derivative positions.  During the three months ended January 31,2005, the Company recorded a combined unrealized gain of $5,562 and during thenine months ended January 31, 2005, the Company recorded a combined unrealizedloss of $232,192 that is included as a separate caption under other income.

 

15

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During fiscal year 2004, as a requirement of the FIARCcommercial paper facility, the Company entered into various interest rate captransactions at cap rates ranging from 6.5% to 7.5% with a notional balancethat amortized over five to nine year periods. The interest rate caps were notdesignated as hedges and, accordingly, changes in the fair value of theinterest rate caps were recorded as unrealized gains or losses and reflected innet income.  On December 2, 2003, the Companyterminated all interest rate caps outstanding in exchange for proceeds of$356,000.  The caps were terminatedfollowing the repayment of all outstanding principal under the FIARC facilityfollowing the issuance of the 2003-A Term Notes.  As a result, a realized loss of $14,000 wasincurred relative to the aggregate market value of the interest rate caps.

 

OnJune 1, 2001, the Company entered into interest rate swaps with an aggregatenotional amount of $100 million and a maturity date of April 15, 2004.  Under the terms of these swaps, the Companypaid a floating rate based on one month LIBOR and received a fixed rate of5.025%.  Management elected to enter intothese swap agreements to offset the uneconomical position of the existing payfixed rate swap created by rapidly declining market interest rates.  In connection with the decision to enter intothe $100 million pay floating rate swap, the Company elected to change thedesignation of the $100 million pay fixed rate swap from a cash flow hedge and notaccount for the instrument as a hedge under SFAS No. 133.  As a result, the change in fair value of theswaps is reflected in net income for periods subsequent to May 31, 2001.

 

**6.****              Earnings Per Share**

 

Earnings per share amounts are based on the weightedaverage number of shares of common stock and potential dilutive common sharesoutstanding during the period. The weighted average number of shares used tocompute basic and diluted earnings per share for the three and nine monthsended January 31, 2005 and 2004, are as follows:

 
| ** **                                                         | ** ** | **For the Three Months Ended  January 31,** | ** ** | **For the Nine Months Ended  January 31,** | ** ** |
|--------------------------------------------------------------------|------------|---------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                         | ** ** | **2004**                                    | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2005** | ** ** |
| Weighted average shares:                                           |       |                                        |       |                                       |       |   |   |   |   |
| Weighted average shares outstanding for basic earnings per share   |       | 5,004,236                                   |       | 4,747,197                                  |       | 5,011,088 |   | 4,915,815 |   |
| Effect of dilutive stock options and warrants                      |       | 77,291                                      |       | 71,740                                     |       | 69,042 |   | 96,832 |   |
| Weighted average shares outstanding for diluted earnings per share |       | 5,081,527                                   |       | 4,818,937                                  |       | 5,080,130 |   | 5,012,647 |   |

 

Forthe three and nine months ended January 31, 2004 and 2005, the Company had259,500 and 468,000, respectively, of stock options and stock warrants whichwere not included in the computation of diluted earnings per share.  These were not included in the computation ofearnings per share because to do so would have been antidilutive for theperiods presented.

 

**7.****              Investment in First Auto Receivables Corporation**

 

OnDecember 24, 2002, the Company invested $475,061 for a 40% ownership interestin First Auto Receivables Corporation (“FARC”) and $712,591 for juniormezzanine investments of FARC.  FARCpurchased a $197.5 million automobile loan portfolio from UAFC-2 Corporation, asubsidiary of Union Acceptance Corporation, with proceeds from $186 million insenior bridge debt, $8.9 million of senior mezzanine debt, $1.8 million ofjunior mezzanine debt and $1.2 million of equity.  The bridge debt interest rate is LIBOR plus1%, the senior mezzanine interest rate is 22.5% and the junior mezzanineinterest rate is 25%.

 

The Company accounts forits ownership investment in FARC using the equity method in accordance with APBOpinion 18.  In addition to the equityand debt investments, the Company performs loan servicing and

 

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collection activities on the portfolio. The Company recognized servicing revenue of  $266,359 and $207,505 for the three monthsended and $1,087,922 and $707,997 for the nine months ended January 31, 2004and 2005, respectively, interest income of $28,589 and $27,473 for the threemonths ended and $134,874 and $82,418 for the nine months ended January 31,2004 and 2005, respectively, and equity in earnings in FARC of $273,612 and$156,652 for the three months ended and $818,095 and $526,880 for the ninemonths ended January 31, 2004 and 2005, respectively.  As of April 30, 2004 and January 31, 2005,the equity investment in FARC of $968,327 and junior mezzanine debt of $716,675are included in Deferred Financing Costs and Other Assets on the balance sheet.

 

**8.****              NewAccounting Pronouncements**

 

In December 2003, theAmerican Institute of Certified Public Accountants issued Statement of Position(SOP) 03-3,*Accounting for Certain Loans or Debt SecuritiesAcquired in a Transfer*. SOP 03-3 addresses the accounting for loansacquired through a transfer (including a business combination) that havedifferences between their expected cash flows and their contractual cash flows,due in part to credit quality. The SOP requires that the excess of the expectedcash flows at acquisition to be collected over the acquirer’s initialinvestment be recognized on a level-yield basis over the loan’s life. Anyfuture revised estimate of cash flows in excess of the original cash flows isrecognized as a future yield adjustment. Future decreases in actual cash flowsover the original expected cash flows are recognized as impairment and expensedimmediately. Valuation allowances can not be created or “carried over” in theinitial accounting for loans acquired that are within the scope of the SOP. SOP03-3 is effective for loans acquired in fiscal years beginning after December15, 2004.  The Company does notanticipate SOP 03-3 will have a material effect on its financial statements.

 

In December 2004,the FASB issued SFAS No. 123(R), *Share-Based Payment*-arevision to SFAS No. 123, *Accounting for Stock-BasedCompensation*(“SFAS No. 123(R)”) that addresses the accounting forshare-based payment transactions in which an enterprise receives employeeservices in exchange for (a) equity instruments of the enterprise or (b)liabilities that are based on the fair value of the enterprise’s equityinstruments or that may be settled by the issuance of such equity instruments.SFAS No. 123(R) eliminates the ability to account for share-based compensationtransactions using APB Opinion No. 25, *Accounting for StockIssued to Employees*, and generally requires instead that suchtransactions be accounted for using a fair-value-based method.

 

SFAS No. 123(R) iseffective as of the beginning of the first interim or annual reporting periodthat begins after June 15, 2005. SFAS 123(R) applies to all awards grantedafter the required effective date and to such awards modified, repurchased, orcancelled after that date. The cumulative effect of initially applying SFAS No.123(R), if any, is recognized as of the required effective date. As of therequired effective date, all public entities that used the fair-value-basedmethod for either recognition or disclosure under SFAS No. 123 will apply SFASNo. 123(R) using a modified version of prospective application. Under thattransition method, compensation cost is recognized on or after the requiredeffective date for the portion of outstanding awards for which the requisiteservice has not yet been rendered, based on the grant-date fair value of thoseawards calculated under SFAS No. 123 for either recognition or pro formadisclosures. For periods before the required effective date, those entities mayelect to apply a modified version of retrospective application under which financialstatements for prior periods are adjusted on a basis consistent with the proforma disclosures required for those periods by SFAS No. 123. The Company hasnot yet completed its evaluation of the impact that SFAS No. 123(R) will haveon its financial position and results of operations.

 

**9.****                 ****Shareholders’ Equity**

 

*Preferred Stock*.  The Company has authorized 1,000,000 sharesof preferred stock with a $1.00 par value. As of January 31, 2005, no shares have been issued.

 

*Employee**Stock Option Plan*. In June 1995, the Board of Directorsadopted the Company’s 1995 Employee Stock Option Plan (the Plan). The Plan isadministered by the Compensation Committee of the Board of Directors andprovides that options may be granted to officers and other key employees forthe purchase of up to 300,000 shares of common stock, subject to adjustment inthe event of certain changes in capitalization. On September 10,

 

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2002, the number ofshares of common stock available for issuance was increased to 500,000. Optionsmay be granted either as incentive stock options (which are intended to qualifyfor certain favorable tax treatment) or as non-qualified stock options.  The Compensation Committee selects thepersons to receive options and determines the exercise price, the duration, anyconditions on exercise and other terms of the options. In the case of optionsintended to be incentive stock options, the exercise price may not be less than100% of the fair market value per share of common stock on the date of grant.With respect to non-qualified stock options, the exercise price may be fixed aslow as 50% of the fair market value per share at the time of grant. In no eventmay the duration of an option exceed 10 years and no option may be grantedafter the expiration of 10 years from the adoption of the Plan. As of April 30,2004 and January 31, 2005, a total of 282,500 and 370,500, respectively,options had been issued and remained outstanding leaving a remaining 217,500and 129,500, respectively, available under the plan.  All stock options issued to date under thePlan have been issued as incentive stock options with an exercise price equalto the fair market value of the underlying common stock on the date of thegrant.

 

Theexercise price of the option is payable in cash upon exercise.  At the discretion of the CompensationCommittee, options may be issued in tandem with stock appreciation rightsentitling the option holder to receive an amount in cash or in shares of commonstock, or a combination thereof, equal in value to any increase since the dateof grant in the fair market value of the common stock covered by the option.

 

*Non-Employee Director Stock Option Plan* - InSeptember 2002, the Non-Employee Stock Option Plan was established to furtheralign the interests of the Company’s directors with the interests of theshareholders, as well as attracting and retaining qualified directors.  The Board of Directors administers the planand the options will not be qualified as incentive stock options.  A total of 500,000 shares of common stock areavailable for issuance.  Option grantswill be both automatic and discretionary. Automatic grants of 20,000 shares for each non-employee director, or100,000 shares total, were approved in September 2002.  Subsequent automatic grants of an option topurchase 20,000 shares shall be made to each non-employee director on July 15theach year, beginning July 15, 2003. The plan also gives the Board of Directorsdiscretionary authority to provide for additional option grants if the Company’sannual financial performance exceeds parameters established by the Board.  No discretionary grants have beenawarded.  As of April 30, 2004 andJanuary 31, 2005, a total of 270,000 and 390,000, respectively, options hadbeen issued under the plan, leaving a remaining 230,000 and 110,000,respectively, available for issuance.  Inaddition to the options granted above, there were an additional 20,000 optionsgranted to a director in 1995, before the adoption of the Non-Employee StockOption Plan.  Alloptions issued under this plan were issued with an exercise price equal to thefair market value of the of the underlying common stock on the date of thegrant

 

**10.****       Subsequent Events**

 

OnFebruary 28, 2005, the Company notified the note holders of the 2002-Asecuritization of its intent to exercise its prepayment call provisioneffective March 15, 2005.  The Companyintends to finance the call through its FIRC and FIARC loan facilities, andthus believes there will be a minimal cash impact.

 

**11.****       Other Events**

 

OnNovember 16, 2004, the Company received a letter from NASDAQ, indicating thatthe NASDAQ is reviewing the Company’s eligibility for listing on the NASDAQNational Market as a consequence of failure to meet the minimum 400 round lotshareholder requirement of Marketplace Rule 4450(a)(4).  In the letter, NASDAQ stated that the Companyhad until December 1, 2004, to provide an acceptable plan to regain compliance,or the staff will initiate delisting of the Company’s common stock.  As a result of this action, and afterconsidering the costs and benefits associated with the continued listing on theNASDAQ National Market, the Company has elected to delist itself from theNASDAQ National Market electing instead to list its shares on the over-the-counterbulletin board market.  The Company hasmaintained its registration under the Securities and Exchange Act of 1934 andcontinues to file Forms 10-Q, 10-K, and 8-K with the Securities and Exchange Commission and mail an annualreport to stockholders following each fiscal year end.

 

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

 

**CriticalAccounting Policies**

 

Financial Reporting Release No. 60, which wasissued by the Securities and Exchange Commission (“SEC”), requires allregistrants to discuss critical accounting policies or methods used in thepreparation of financial statements. Note 2 to the consolidated financial statements includes a summary ofthe significant accounting policies and methods used in the preparation of theCompany’s consolidated financial statements.

 

The preparation of financial statementsincludes the use of estimates and assumptions that affect the reported amountsof assets and liabilities and the reported amounts of net revenues and expensesduring the reporting periods. The following is a review of the more significantassumptions and estimates, as well as the accounting policies and methods usedin the preparation of the consolidated financial statements.

 

*Receivables Held for Investment*.  The Company accrues interest income monthlyusing the effective interest method. Interest income also includes additionalamounts received upon early payoffs of certain receivables attributable to thedifference between the principal balance of the receivables calculated usingthe Rule of 78’s method and the principal balance of the receivables calculatedusing the effective interest method. When a receivable becomes 90 days pastdue, the income accrual is suspended until the payments become current. When aloan is charged off or the collateral is repossessed, the remaining incomeaccrual is written off.

 

*Receivables Acquired for Investment*.  The Company estimates the amount and timingof undiscounted expected future principal and interest cash flows. For certainpurchased loans, the amount paid for a loan reflects the Company’sdetermination that it is probable the Company will be unable to collect allamounts due according to the loan’s contractual terms. Accordingly, atacquisition, the Company recognizes the excess of the loan’s scheduledcontractual principal and contractual interest payments over its expected cashflows as an amount that should not be accreted. The remaining amount,representing the excess of the loan’s expected cash flows over the amount paid,is accreted into interest income over the remaining life of the loan.  As a result of the amortization of theoutstanding principal balance of the receivables portfolio, the majority of theremaining cash flows projected constitute default collections from obligors.  Given the nature of the remaining cash flowsof individual loans, the Company determined that the timing of collections onReceivables Acquired for Investment was much more unpredictable thancontractual cash flows from non-defaulted receivables.  Therefore, under the guidance provided byPractice Bulletin 6*, Amortization ofDiscounts on Certain Acquired Loans*, Receivables Acquired forInvestment are accounted for under the cost-recovery method beginning September 30,2003.  Under the cost recovery method,cash proceeds from collections are applied to first reduce the Company’s basisin the assets.  Cash collected in excessof this cost basis is recognized as income when received.

 

*Other Income*.  Other Income consists of income received fromservicing activities, late fees and other loan-related fees, income frominvestments, reinvestment revenue and unrealized loss on interest ratederivative positions.  Servicing revenueis accrued as services are rendered. Late fees and other loan-related fees arerecognized when received.  Income frominvestments and reinvestment revenue are accrued based on the respectiveinterest rate of such investment and unrealized loss on interest ratederivatives is recognized when incurred.

 

*Allowance for Credit Losses*.  The Company calculates the allowance forcredit losses in accordance with SFAS No. 5*, Accounting forContingencies.*   SFAS No. 114,*Accounting for Creditors for Impairment of a Loan*does not apply to loans currently held by the Company because they are composedof a large group of smaller balance homogenous loans that are evaluatedcollectively for impairment.

 

The Company initiates efforts to makecustomer contact when the customer is one day past due and become moreaggressive as the loan becomes further past due.  Management reviews past due loans andconsiders various factors including payment history, job status and any eventsthat may have occurred that prevent the customer from making a payment.  Through the evaluation, if it is determinedthat the loan is uncollectible, the collateral is typically repossessed.  Generally this occurs when a loan is 90 to120 days past due.   Upon repossession,the uncollectible portion of the loan and 100% of accrued interest is writtenoff.  The fair value of the collateral isrecorded as an Assets Held for Sale. Fair value is determined by estimating the proceeds of the collateral,which

 

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primarily are composed of auction proceeds on the sale of theautomobile less selling related expenses. After collection of all proceeds, the Company records an adjustment,positive or negative, based on the difference between the fair value estimateand the true proceeds received.   In theevent the collateral is unable to be located, the Company will write off theentire balance after exhausting all collection efforts.

 

The Company applies a systematic methodologyin order to determine the amount of the allowance for credit losses.  The specific methodology utilized is asix-month migration analysis whereby the Company compares the aging status ofeach loan from six months prior to the aging loan status as of the reportingdate.  These factors are then applied tothe aging status of each loan at the reporting date in order to calculate thenumber of loans that are expected to migrate to impaired status.  The estimated number of impairments is thenmultiplied by estimated loss per loan, which is based on historicalinformation.  The computed reserve isthen compared to the amount recorded for adequacy.  The Company compares the six-month result toprior six-month periods to compare trends and evaluate any other internal orexternal factors that may affect collectibility. The allowance for credit lossesis based on estimates and qualitative evaluations, and ultimate losses willvary from current estimates. These estimates are reviewed periodically and asadjustments, either positive or negative, become necessary, are reported inearnings in the period they become known.

 

*Stock-Based Compensation*.  The Company has an employee stock option planand a non employee director stock option plan. The Company has adopted thedisclosure provisions of SFAS No. 148, *Accounting for Stock-BasedCompensation—Transition and Disclosure, an amendment of FASB Statement No. 123*.This pronouncement requires prominent disclosures in both annual and interimfinancial statements regarding the method of accounting for stock-basedemployee compensation and the effect of the method used on reported results.The Company accounts for stock compensation awards under the intrinsic valuemethod of Accounting Principles Board (“APB”) Opinion No. 25, *Accounting for Stock Issued to Employees*which requirescompensation cost to be recognized based on the excess, if any, between thequoted market price of the stock at the date of grant and the amount anemployee must pay to acquire the stock. All options awarded under the Company’splan are granted with an exercise price equal to or greater than the fairmarket value on the date of the grant.

 

**Managed Receivables**

 

The Company’s managed receivables are(dollars in thousands):

 
| ** **                                                                          | ** ** | **As of or  for the  Periods Ended  January 31,** | ** ** |
|-------------------------------------------------------------------------------------|------------|--------------------------------------------------------|------------|
| ** **                                                                          | ** ** | **2004**                                               | ** ** | **2005** | ** ** |
| Receivables Held for Investment:                                                    |       |                                                   |       |   |   |
| Number                                                                              |       | 17,173                                                 |       | 16,672 |   |
| Principal balance                                                                   |       | $                                                      | 213,362    |   | $ | 227,611 |   |
| Average principal balance of receivables outstanding during the  nine-month period  |       | $                                                      | 223,507    |   | $ | 214,121 |   |
| Average principal balance of receivables outstanding during the  three-month period |       | $                                                      | 218,320    |   | $ | 222,886 |   |
| Receivables Acquired for Investment:                                                |       |                                                   |       |   |   |
| Number                                                                              |       | 743                                                    |       | 654 |   |
| Principal balance                                                                   |       | $                                                      | 1,476      |   | $ | 721 |   |
| Other Servicing:                                                                    |       |                                                   |       |   |   |
| Number                                                                              |       | 20,268                                                 |       | 15,461 |   |
| Principal balance                                                                   |       | $                                                      | 313,551    |   | $ | 220,078 |   |
| Total Managed Receivables Portfolio:                                                |       |                                                   |       |   |   |
| Number                                                                              |       | 38,184                                                 |       | 32,787 |   |
| Principal balance                                                                   |       | $                                                      | 528,389    |   | $ | 448,419 |   |
| Average principal balance of receivables outstanding during the  nine-month period  |       | $                                                      | 595,744    |   | $ | 463,995 |   |
| Average principal balance of receivables outstanding during the  three-month period |       | $                                                      | 549,788    |   | $ | 452,408 |   |
|                                                                                     |            |                                                        |            |  |  |  |  |  |

 

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The following table sets forth informationwith regard to the Company’s net interest spread, which represents thedifference between the effective yield on Receivables Held for Investment andthe Company’s average cost of debt utilized to fund these receivables, and itsnet interest margin (averages based on month-end balances):

 
| ** **                                                   | ** ** | **Three  Months Ended  January 31,** | ** ** | **Nine  Months Ended  January 31,** | ** ** |
|--------------------------------------------------------------|------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                   | ** ** | **2004**                                  | ** ** | **2005**                                 | ** ** | **2004** | ** ** | **2005** | ** ** |
| Receivables Held for Investment:                             |       |                                      |       |                                     |       |   |   |   |   |
| Effective yield on Receivables Held  for Investment (1) |       | 13.7                                      | %          | 13.0                                     | %          | 14.0 | % | 13.2 | % |
| Average cost of debt (2)                                     |       | 4.0                                       | %          | 3.5                                      | %          | 3.6 | % | 3.5 | % |
| Net interest spread (3)                                      |       | 9.7                                       | %          | 9.5                                      | %          | 10.4 | % | 9.7 | % |
| Net interest margin (4)                                      |       | 9.5                                       | %          | 9.4                                      | %          | 10.3 | % | 9.7 | % |

 

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(1)          Represents interest income as a percentage of average Receivables Heldfor Investment outstanding.

 

(2)         Represents interest expense as a percentage ofaverage debt outstanding.

 

(3)          Represents effective yield on Receivables Held for Investment lessaverage cost of debt.

 

(4)          Represents net interest income as a percentage of average ReceivablesHeld for Investment outstanding.

 

Net interest income is the difference betweeninterest earned from the receivables portfolio and interest expense incurred onthe credit facilities used to finance the receivables. Net interest income was$5.3 million and $15.6 million for the three and nine months ended January 31,2005, respectively, an increase of 2.1% when compared to the amounts reportedfor the three months ended January 31, 2004, and a decrease of 9.5% forthe nine months ended January 31, 2005 when compared to the amountsreported for the nine months ended January 31, 2004.

 

The amount of net interest income is theresult of the relationship between the average principal amount of receivablesheld and the average rate earned thereon and the average principal amount ofdebt incurred to finance such receivables and the average rates paid thereon.Changes in the principal amount and rate components associated with thereceivables and debt can be segregated to analyze the periodic changes in netinterest income. The following table analyzes the changes attributable to theprincipal amount and rate components of net interest income (dollars inthousands):

 
| ** **                        | ** ** | **Three Months Ended  January 31, 2004 to 2005** | ** ** | **Nine Months Ended  January 31, 2004 to 2005** | ** ** |
|-----------------------------------|------------|-------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                        | ** ** | **Increase (Decrease) Due to  Change in**             | ** ** | **Increase (Decrease) Due to  Change in**            | ** ** |
| ** **                        | ** ** | **Average  Principal  Amount**                        | ** ** | **Average  Rate**                                    | ** ** | **Total Net** | ** ** | **Average  Principal  Amount** | ** ** | **Average Rate** | ** ** | **Total Net** | ** ** |
|                              |       |                                                  |       |                                                 |       |   |   |   |   |   |   |   |   |
| Receivables  Held for Investment: |       |                                                  |       |                                                 |       |   |   |   |   |   |   |   |   |
| Interest income                   |       | $                                                     | 157        |                                                 | $          | (436 | ) | $ | (279 | ) | $ | (8,489 | ) | $ | 6,169 |   | $ | (2,320 | ) |
| Interest expense                  |       | $                                                     | (147       | )                                                    | $          | (231 | ) | $ | (378 | ) | $ | (2,433 | ) | $ | 1,753 |   | $ | (680 | ) |
| Net interest income               |       | $                                                     | 304        |                                                 | $          | (205 | ) | $ | 99 |   | $ | (6,056 | ) | $ | 4,416 |   | $ | (1,640 | ) |
|                                   |            |                                                       |            |                                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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**Results of Operations**

 

*Three Months and Nine MonthsEnded January 31, 2005 and 2004 (dollars in thousands)*

 

*Key Factors.*Thecritical factors affecting the Company’s profitability during any period are (i) loan origination volume and thecorresponding growth in Receivables Held For Investment; (2) the level of netinterest spread, which is defined as the difference between the effective yieldon Receivables Held for Investment and the cost of funds under the Company’scredit facilities and securitizations utilized to finance these receivables;(3) the level of provision for credit losses; (4) the amount of income derivedfrom other activities; and (5) the ability of the Company to control operatingexpenses relative to the total amount of the managed portfolio.

 

*Executive Summary. *Net income (loss)for the three and nine months ended January 31, 2005 was $279 and $582respectively, compared to $(167) and $240 for the three and nine months ended January 31,2004, respectively.  Basic and dilutedearnings per common share were $0.06 and $0.12 for the three and nine monthsended January 31, 2005, respectively, compared to $(0.03) and $0.05 forthe three and nine months ended January 31, 2004, respectively.  The increase in net income for the threemonths ended January 31, 2005 compared to January 31, 2004 is due to(i) a lower provision for loan losses, (ii) an increase in other income fromproduct sales and loan related fee collections, (iii) lower operating expenses,and (iv) an increase in average Receivables Held for Investment, partiallyoffset by several factors including (i) a decline in effective yields, (ii) adecline in loan servicing income, (iii) an increase in salaries and benefitsand (iv) an increase in general and administrative expenses.  The increase in net income for the ninemonths ended January 31, 2005 compared to January 31, 2004 is due toseveral factors, including (i) a lower provision for loan losses and (ii) anincrease in other income from product sales and loan related fee collections,partially offset by several factors including (i) a decline in effectiveyields, (ii) a decline in average Receivables Held for Investment, (iii) adecline in loan servicing income, (iv) an increase in the unrealized loss oninterest rate derivatives and (v)  adecrease in income from investment.

 

*Interest Income*. Interest income for the three and nine monthsended January 31, 2005 decreased to $7,220 and $21,174 compared to $7,499and $23,493 for the three and nine months ended January 31, 2004,respectively.

 

The level ofinterest income, a primary driver of financial results, is impacted by theaverage outstanding balance of the portfolio of Receivables Held forInvestment, the weighted average interest rate on Receivables Held forInvestment, the mix of direct and indirect receivables within Receivables Heldfor Investment, and the level of prepayments and charge-offs.  Interest income on Receivables Held forInvestment decreased****4% and 15%,respectively for the three and nine months ended January 31, 2005,compared to the three and nine months ended January 31, 2004.  The reduction in yield for the three monthsended January 31, 2005 is primarily due to a decrease in the weightedaverage interest rate of 78 basis points, partially offset by an increasein average Receivables Held for Investment. The reduction in yield for the ninemonths ended January 31, 2005 is primarily due to (i) a decrease in theweighted average interest rate of 83 basis points, and (ii) a decline inaverage Receivables Held for Investment.  The decline in the weighted average interestrate reflects the Company’s increased focus on receivables originated directlyto consumers which typically carry lower interest rates.

 

*Interest Expense*. Interest expense for the three and nine monthsended January 31, 2005 decreased****to $1,964 and$5,570 compared to $2,342 and $6,249 for the three and nine months ended January 31,2004, respectively. Interest expense on Receivables Held for Investmentdecreased 16% and 11% for the three and nine months ended January 31,2005, respectively.  The reduction ininterest expense is primarily due to (i) a decrease in the average debtoutstanding of $14,826, or 6% for the three months ended January 31, 2005and $19,546, or 8% for the nine months ended January 31, 2005,respectively, compared to the three and nine months ended January 31, 2004primarily as a result of a the Company’s decision to lock in interest rates on$140 million of debt in November 2003 through the issuance of Term Notesin which an additional $28 million of debt was incurred due to securitizingloans that were not previously secured through other facilities and (ii) thetermination of swap agreements in April 2004. These events were partiallyoffset by (i) the Company’s decision to lock in interest rates on $140 millionof debt in November 2003 through the issuance of Term Notes to minimizethe risk of future interest rate increases as longer term fixed rate Term Notestypically carry higher interest rates than shorter term floating rate debt and(ii) an increase in overall market interest rates as a result of the currenteconomic environment and market rate increases adopted by the Federal ReserveBoard.

 

*Provision for Credit Losses*. The provision for credit losses for the three and nine months ended January 31,2005, respectively, decreased to $2,575 and $7,459 as compared to $3,324 and$9,986 for the three and nine

 

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months ended January 31, 2004. The decrease inprovision for credit losses is primarily due to (i) improving economic trends,(ii) a change in portfolio mix to loans originated directly with the customerwhich typically have a lower loss frequency and (iii) the increase in recoveryrates on repossessions and non-collateralized defaults.

 

Net charge-offs for thethree and nine months ended January 31, 2005 decreased to $2,473 and$7,246, respectively, compared to $3,427 and $10,122 for the three and ninemonths ended January 31, 2004.  Thedecrease in net charge-offs for the three and nine months ended January 31,2005 is primarily due to (i) a decrease in loss frequency and loss severityfrom repossessions and (ii) an increase in recoveries from defaulted loans.

 

The level of provision forcredit losses is a key driver of overall financial performance and should bepositively impacted by improvement in general economic conditions, improvementsin wholesale used car prices and lower net losses resulting from stricterunderwriting controls adopted by the Company during 2000 and 2001.  Any additional economic deterioration orfurther decline in wholesale used car prices will negatively impact provisionexpense as will increases in the outstanding balance of receivables held forinvestment.

 

*Servicing Revenue*.  Servicing revenue decreased to $821 and$2,696****for the three and nine months ended January 31,2005, respectively, compared to $1,347 and $3,845 for three and nine months endedJanuary 31, 2004.  The decrease inservicing revenue for the three and nine months ended January 31, 2005compared to the same periods in 2004 is due to the decrease in principalbalance of the servicing portfolio, partially offset by revenues related toincentive servicing fees that were not present in 2004 and have been realizeddue to the favorable performance of the related serviced portfolio. Revenuederived from servicing activities will increase or decrease in directproportion to the average outstanding balance of serviced receivables.

 

*Late Fees and Other Income*Latefees and other income increased to $1,089 and $2,926 for the three and ninemonths ended January 31, 2005, compared to $322 and $1,171 for the threeand nine months ended January 31, 2004.  The increase is attributableto (i) increased collections and payments allocated to late fees and otherincome as a result of changes made to the methodology under which the Companyallocated cash received to interest, uncollected fees and principal, (ii)an increase in loans originated for a third party (iii) an increase in incomereceived related to GAP insurance and extended service contracts sold toconsumers in connection with the Company’s direct lending activities and (iv)an increase in collection efforts.  Income derived from late fees and collectionactivities are recognized when received, and therefore can be potentiallyvolatile from period to period based on overall cash collection, seasonality,delinquency rates and other factors.

 

Late fees and other incomeare driven by a number of factors including overall delinquency rates, thepercentage of customers utilizing electronic payment methods and growth ratesin the Company’s direct lending business which will affect the ability of the Companyto generate fee income from marketing insurance and warranty products.

 

*Unrealized Gain/(Loss) on Interest Rate DerivativePositions*.  In accordance withSFAS No. 133, the Company is required to record interest rate derivativepositions at fair value.  An unrealizedgain of $6 and an unrealized loss of $232 for the three and nine months ended January 31,2005, respectively, compared to an unrealized loss of $27 and $33 for the threeand nine months ended January 31, 2004, are principally due to changes inthe fair value of the Company’s derivative positions.

 

*Salaries and Benefit Expenses*. Salaries and benefit expense increased to$2,304 and $6,583 for the three and nine months ended January 31, 2005,respectively, compared to $2,095 and $6,477 for the three and nine months endedJanuary 31, 2004, respectively.  Theincrease is primarily due to additional permanent and temporary staffing tosupport a $20,895 and $36,173  increasein new loan originations during the three and nine months ended January 31,2005, respectively, partially offset by a decrease in bonuses paid tocollection personnel.

 

*Operating Expenses.* Operating expenses decreased to $1,028 for thethree months ended January 31, 2005, compared to $1,151 for the threemonths ended January 31, 2004.  Thedecrease is due to refining the Company’s direct lending business, resulting inincreased efficiencies, partially offset by an increase in postage costs due tothe Company’s decision to grow the direct lending business. Operating expensesincreased to $3,652 for the nine months ended January 31, 2005, comparedto $3,425 for the nine months ended January 31, 2004.  The increase is due to an increase in postageand credit bureau costs due to the Company’s decision to grow the directlending business, partially offset by refining the direct lending business,resulting in increased efficiencies.

 

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*General and AdministrativeExpenses.* Generaland administrative expenses increased to $960 and $2,819 for the three and ninemonths ended January 31, 2005, compared to $852 and $2,812 for the threeand nine months ended January 31, 2004. The three and nine months ended January 31, 2005 experienced anincrease in professional fees during the three and nine months ended January 31,2004, partially offset by a general decline in occupancy, travel, depreciationand amortization expense.

 

# **Liquidity and Capital Resources**

# ** **

The Company finances its loan originationthrough two warehouse credit facilities. The Company’s credit facilitiesprovide for one-year terms and have been renewed annually. Management of theCompany believes that the credit facilities will continue to be renewed orextended or that it would be able to secure alternate financing on satisfactoryterms; however, there can be no assurance that it will be able to do so. In January 2002the Company issued $159 million in asset-backed notes (“Term Notes”) secured bya discrete pool of receivables. On November 20, 2003, the Company issued$140 million in Term Notes secured by a discrete pool of receivables.  Substantially all receivables retained by theCompany are pledged as collateral for the credit facilities and the Term Notes.The weighted average interest rate for the Company’s secured borrowings includingthe effect of program fees, dealer fees, and other comprehensive income (loss)amortization was 3.54% and 3.96% for the three months ended January 31,2005 and 2004 3.48% and 3.58% for the nine months ended January 31, 2005and 2004, respectively.

 

*Warehouse Facilities as of January 31,2005*

 
| **Facility** | ** ** | **Capacity** | ** **  | **Outstanding** | ** ** | **Interest Rate** | ** ** | **Fees**                                                                                               | ** ** | **Insurance**            | ** ** | **Borrowing  Rate At  January 31,  2005** | ** ** |
|--------------|------------|--------------|-------------|-----------------|------------|-------------------|------------|--------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|------------------------------------------------|------------|
| FIARC        | ** ** | $            | 150,000,000 |            | $          | 89,120,297        |       | Commercial  paper rate plus .3%                                                                        |       | .25% of  Unused Facility |       | .35                                            | %          | 3.05 | % |
| FIRC         | ** ** | $            | 50,000,000  |            | $          | 33,980,110        |       | Option of a)  Base Rate, which is the higher of prime rate or fed funds plus .5% or b)  LIBOR plus .5% |       | .25% of  Unused Facility |       | See below                                      |       | 2.44 | % |

 

*Warehouse Facilities – Credit Enhancement asof January 31, 2005*

 
| **Facility** | ** ** | **Cash Reserve**               | ** ** | **Advance  Rate** | ** ** | **Insurance**             | ** ** |
|--------------|------------|--------------------------------|------------|-------------------|------------|---------------------------|------------|
| FIARC        |       | 1% of  outstanding receivables |       | 94                | %          | Surety Bond               |       |
| FIRC         |       | 1% of  borrowings              |       | 100               | %          | Default  Insurance (ALPI) |       |

 

FIRC - In order toobtain a lower cost of funding, the Company has agreed to maintain credit enhancementinsurance covering the receivables pledged as collateral under the FIRC creditfacility. The facility lenders are named as additional insureds under thesepolicies. The coverages are obtained on each receivable at the time it isoriginated by the Company, and the applicable premiums are prepaid for the lifeof the receivable. Each receivable is covered by multiple credit insurancepolicies, consisting of basic default insurance under a standard auto loanprotection policy (known as “ALPI” insurance) together with certainsupplemental coverages relating to physical damage and other risks. Solely atits expense, the Company carries these coverages and neither the vehiclepurchasers nor the dealers are charged for the coverages, nor are they usually awareof their existence. The

 

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Company’s ALPI insurance policy is written by National Union FireInsurance Company of Pittsburgh (“National Union”), which is a wholly-ownedsubsidiary of American International Group.

 

The premiums that the Company paid during thethree months and nine months ended January 31, 2005 for its three creditenhancement insurance coverages, of which the largest component is basic ALPIinsurance, represented approximately 2.9% of the principal amount of thereceivables originated during the periods. Aggregate premiums paid for ALPIcoverage alone were $1,028,980 and $606,135 during the three months ended and$2,645,416 and $2,216,261 for nine months ended January 31, 2005 and 2004,respectively, and accounted for 2.7% and 3.6% during the three months ended and2.5% and 3.2% for the nine months ended January 31, 2005 and 2004,respectively, of the principal amount of the receivables originated during suchrespective periods.

 

In April 1994, the Company organizedFirst Investors Insurance Company (the “Insurance Subsidiary”) under thecaptive insurance company laws of the State of Vermont. The InsuranceSubsidiary is an indirect wholly-owned subsidiary of the Company and is a partyto a reinsurance agreement whereby the Insurance Subsidiary reinsures 100% ofthe risk under the Company’s ALPI insurance policy. At the time each receivableis insured by National Union, the risk is automatically reinsured to its fullextent and approximately 96% of the premium paid by the Company to NationalUnion with respect to such receivable is ceded to the Insurance Subsidiary.When a loss covered by the ALPI policy occurs, National Union pays it after theclaim is processed, and National Union is then reimbursed in full by theInsurance Subsidiary.  In addition to themonthly premiums and liquidity reserves of the Insurance Subsidiary, a trustaccount is maintained by National Union to secure the Insurance Subsidiary’sobligations for losses it has reinsured.

 

The result of the foregoing reinsurancestructure is that National Union, as the “fronting” insurer under the captivearrangement, is unconditionally obligated to the Company’s credit facilitylenders for all losses covered by the ALPI policy, and the Company, through itsInsurance Subsidiary, is obligated to indemnify National Union for all suchlosses. As of January 31, 2005, the Insurance Subsidiary had capital andsurplus of $2,451,776 and unencumbered cash reserves of $1,790,632 in additionto the $3,300,508 trust account.

 

The ALPI coverage as well as the InsuranceSubsidiary’s liability under the Reinsurance Agreement, remains in effect foreach receivable that is pledged as collateral under the warehouse creditfacility. Once receivables are transferred from FIRC to FIARC and financedunder the commercial paper facility, ALPI coverage and the Insurance Subsidiary’sliability under the Reinsurance Agreement is cancelled with respect to thetransferred receivables. Any unearned premium associated with the transferredreceivables is returned to the Company. The Company believes the losses itsInsurance Subsidiary will be required to indemnify will be less than thepremiums ceded to it. However, there can be no assurance that losses will notexceed the premiums ceded and the capital and surplus of the InsuranceSubsidiary.

 

FIARC – CreditEnhancement for the FIARC warehouse facility is provided to the commercialpaper investors by a cash reserve account equal to 1% of the receivables heldby FIARC and, additionally, a surety bond issued by MBIA. The Company is not aguarantor of, or otherwise a party to, such commercial paper.

 

*Warehouse Facilities – Agents and Expirations*

 
| **Facility** | ** ** | **Agent** | ** ** | **Expiration**          | ** ** | **Event if not Renewed**                                                                                                                                                 | ** ** |
|--------------|------------|-----------|------------|-------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| FIARC        |       | Wachovia  |       | February 15,  2006 |       | Receivables pledged would be allowed to  amortize; however, no new receivables would be allowed to transfer from the  FIRC facility                                      |       |
| FIRC         |       | Wachovia  |       | December 1,  2005  |       | Convert to a term loan which would mature  nine months thereafter and amortize monthly in accordance with the borrowing  base with the remaining balance due at maturity |       |

 

On December 4, 2003, the FIRC facility wasrenewed, under similar terms and conditions, at the $50 million commitmentlevel until December 2, 2004, and was subsequently extended until December 1,2005.  On June 15, 2004, the FIRCfacility was extended to $65 million, and reverted back to $50 million on September 13,2004.  On January 29, 2004,following a short-term extension of the original maturity date, the FIARC facilitywas

 

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renewed, under similar terms and conditions, to December 2,2004, and was subsequently extended until February 15, 2006.  As of April 30, 2004 and January 31,2005, there was $0 and $34 million, respectively, outstanding.

 

Management presently intends to seek furtherextensions to these warehouse facilities prior to the current expirationdates.  Management further considers itsrelationship with its lenders to be satisfactory and has no reason to believethat the FIRC and FIARC facilities will not be renewed at each of theirrespective expiration dates.

 

The following table contains pertinent information on the Term Notes asof January 31, 2005.

 
| **Term Notes** | ** ** | **Issuance Date**       | ** ** | **Issuance   Amount** | ** **  | **Maturity Date** | ** **              | **Outstanding** | ** ** | **Interest   Rate** | ** ** |
|----------------|------------|-------------------------|------------|-----------------------|-------------|-------------------|-------------------------|-----------------|------------|---------------------|------------|
| 2002-A         |       | January 29,  2002  |       | $                     | 159,036,000 |              | December 15,  2008 |            | $          | 23,636,247          |       | 3.46 | % |
| 2003-A         |       | November 11,  2003 |       | $                     | 139,661,000 |              | April 20,  2011    |            | $          | 80,806,448          |       | 2.58 | % |
|                |            |                         |            |                       |             |                   |                         |                 |            |                     |            |  |  |  |  |

 

Credit enhancement on the two Term Notes is as follows:

 
| **Facility** | ** ** | **Cash Reserve**                                                                                                    | ** ** | **Advance   Rate**                         | ** ** | **Insurance** | ** ** |
|--------------|------------|---------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|---------------|------------|
| 2002-A       |       | 2% of  Initial Pool Balance including Pre-Funding Amount of $25 million                                             |       | 99% initial  advance decreasing to 97%     |       | Surety Bond   |       |
| 2003-A       |       | 0.5% of  Initial Pool Balance increasing to 2% of Initial Pool Balance including  Pre-Funding Amount of $30 million |       | 96.5%  initial advance decreasing to 96.1% |       | Surety Bond   |       |

 

Term Notes - On January 29,2002, the Company, through its indirect, wholly-owned subsidiary FirstInvestors Auto Owner Trust 2002-A (“2002 Auto Trust”) completed the issuance of$159,036,000 of 3.46% Class A asset-backed notes (“2002-A Term Notes”). Theinitial pool of automobile receivables transferred to the 2002 Auto Trusttotaled $135,643,109, which was previously owned by FIRC and FIARC, secure the2002-A Term Notes.  In addition to theissuance of the Class A Notes, the 2002 Auto Trust also issued $4,819,000 inClass B Notes that were retained by the Company and pledged to secure the WorkingCapital Facility as further described below. Proceeds from the issuance, which totaled $159,033,471 were used to (i)fund a $25,000,000 pre-funding account to be used for future loan originations;(ii) repay all outstanding borrowings under the FIARC commercial paperfacility, (iii) reduce the outstanding borrowings under the FIRC creditfacility, (iv) pay transaction fees related to the 2002-A Term Note issuance,and (v) fund a cash reserve account of 2% or $2,712,862 of the initialreceivables pledged which will serve as a portion of the credit enhancement forthe transaction. The Class A Term Notes bear interest at 3.46% and requiremonthly principal reductions sufficient to reduce the balance of the Class ATerm Notes to 97% of the outstanding balance of the underlying receivablespool. The final maturity of the 2002-A Term Notes is December 15,2008.  The Class B Notes do not bearinterest but require principal reductions sufficient to reduce the balance ofthe Class B Notes to 3% of the outstanding balance of the underlyingreceivables pool.  A surety bond issuedby MBIA Insurance Corporation provides credit enhancement for the Class ANotes.  In the event that certain assetquality covenants are not met, the reserve account target level will increaseto 6% of the then current principal balance of the receivables pool.  As of April 30, 2004 and January 31,2005, the outstanding principal balances on the 2002-A Term Notes were$44,335,659 and $23,636,247, respectively.

 

On November 20, 2003, the Company,through its indirect, wholly-owned subsidiary First Investors Auto Owner Trust2003-A (“2003 Auto Trust”) completed the issuance of $139,661,000 of 2.58%Class A asset-backed notes (“2003-A Term Notes”). The initial pool ofautomobile receivables transferred to the 2003 Auto Trust totaled $114,726,891,which was previously owned by FIRC and FIARC, secure the 2003-A TermNotes.  In addition to the issuance ofthe Class A Notes, the 2003 Auto Trust also issued $5,065,891 in Class B Notesthat

 

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were retained by the Company and pledged to secure the Working CapitalFacility as further described below. Proceeds from the issuance, which totaled $139,656,629 were used to (i)fund a $30,000,000 pre-funding account to be used for future loan originations;(ii) repay all outstanding borrowings under the FIARC commercial paperfacility, (iii) reduce the outstanding borrowings under the FIRC creditfacility, (iv) pay transaction fees related to the 2003-A Term Note issuance,and (v) fund an initial cash reserve account of 0.5% or $573,635 of the initialreceivables pledged.  The Class A TermNotes bear interest at 2.58% and require monthly principal reductionssufficient to reduce the balance of the Class A Term Notes to 96.1% of theoutstanding balance of the underlying receivables pool. The final maturity ofthe 2003-A Term Notes is April 20, 2011. The Class B Notes do not bear interest but require principal reductionssufficient to reduce the balance of the Class B Notes to 3.9% of theoutstanding balance of the underlying receivables pool.  A surety bond issued by MBIA InsuranceCorporation provides credit enhancement for the Class A Notes.  In the event that certain asset qualitycovenants are not met, the reserve account target level will increase to 6% ofthe then current principal balance of the receivables pool.  As of April 30, 2004 and January 31,2005, the outstanding principal balances on the 2003-A Term notes were$120,382,531 and $80,806,448, respectively.

 

*Working Capital Facility*.  On December 6, 2001, the Company enteredinto an agreement with Wachovia Securities to refinance the $11,175,000outstanding balance of a working capital term loan previously provided by Bankof America and Wachovia and increase the size of the facility to $13.5 million.  The renewal facility was provided to aspecial-purpose, wholly-owned subsidiary of the Company, First InvestorsResidual Funding LP.   The facilityoriginally consisted of a $9 million revolving tranche and a $4.5 million termloan tranche which amortizes monthly. The term loan tranche of this working capital facility was evidenced bythe Class B Notes issued in conjunction with the 2002 Auto Trust financing. Theremaining $9 million of the $13.5 million working capital facility revolvesmonthly in accordance with a borrowing base consisting of theover-collateralization amount and reserve accounts for each of the Company’sother credit facilities.  The facility issecured solely by the residual cash flow and cash reserve accounts related tothe Company’s warehouse credit facilities, the acquisition facility and theexisting and future term note facilities. During 2002, the facility was modified to increase the interest ratefrom LIBOR plus 1.5% to LIBOR plus 2.25%. The commitment fee paid on the total available amount of the facilitywas maintained at 1.5%.    In addition,the monthly principal amortization under the term loan tranche was increased tothe greater of $250,000 or the principal distributions made under the Class BNotes issued under the 2002 Auto Trust financing.  On December 4, 2003, the Working CapitalFacility was extended to December 2, 2004. Under the terms of the extension, the monthly amortization requirementwas replaced with the requirement that outstandings under the facility couldnot exceed the lesser of a borrowing base or the $9 million facilitylimit.  On October 26, 2004, theWorking Capital Facility was extended until October 10, 2005, increasingthe commitment amount to $13.5 million. The interest rate remained at LIBOR plus 2.25% and the commitment feepaid on the total available amount of the facility was maintained at 1.5%.  At April 30, 2004 and January 31,2005, there was $8,761,143 and $10,500,000, respectively, outstanding underthis facility.

 

The Company presently intends to seek a renewal of theworking capital facility from its lender prior to maturity.  Should the facility not be renewed, theoutstanding balance of the receivables would be amortized in accordance withthe borrowing base.  Management considersits relationship with its lenders to be satisfactory and has no reason tobelieve that this credit facility will not be renewed.  If the facility is not renewed, however, orif material changes are made to its terms and conditions, it could have a materialadverse effect on the Company.

 

*Shareholder Loans.*  On December 3, 2001 the Company enteredinto an agreement with one of its shareholders who is a member of its Board ofDirectors under which the Company may, from time to time, borrow up to $2.5million.  On December 6, 2004, theoriginal $2.5 million shareholder loan was replaced with a $2.5 million loancontaining identical terms and conditions between the Company and a limitedpartnership that is affiliated with a current shareholder and member of theboard of directors.  The proceeds of theborrowings will be utilized to fund certain private and open market purchasesof the Company’s common stock pursuant to a Stock Repurchase Plan authorized bythe Board of Directors and for general corporate purposes.  Borrowings under the facility bear interestat a fixed rate of 10% per annum.  Thefacility is unsecured and expressly subordinated to the Company’s senior creditfacilities. The facility matures on December 3, 2008 but may be repaid atany time unless the Company is in default on one of its other creditfacilities.  There were no amountsoutstanding under this facility as of April 30, 2004 and January 31,2005 respectively.

 

*Loan Covenants*.  The documentation governing these creditfacilities and Term Notes contains numerous covenants relating to the Company’sbusiness, the maintenance of credit enhancement insurance covering the

 

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receivables (if applicable), the observance of certain financial covenants,the avoidance of certain levels of delinquency experience and other matters.The breach of these covenants, if not cured within the time limits specified,could precipitate events of default that might result in the acceleration ofthe FIRC credit facility, the Term Notes and the working capital facility orthe termination of the commercial paper facilities. The Company was not indefault with respect to any financial covenants governing these financingarrangements at January 31, 2005.

 

*Interest Rate Management*.  The Company’s warehouse credit facilities andworking capital facilities bear interest at floating interest rates which arereset on a short-term basis while the secured Term Notes bear interest at afixed rate of interest. The Company’s receivables bear interest at fixed ratesthat do not generally vary with a change in market interest rates. Since aprimary contributor to the Company’s profitability is its ability to manage itsnet interest spread, the Company seeks to maximize the net interest spreadwhile minimizing exposure to changes in interest rates. In connection withmanaging the net interest spread, the Company may periodically enter intointerest rate swaps or caps to minimize the effects of market interest ratefluctuations on the net interest spread. To the extent that the Company hasoutstanding floating rate borrowings or has elected to convert a portion of itsborrowings from fixed rates to floating rates, the Company will be exposed tofluctuations in short-term interest rates.

 

During the ninemonths ended January 31, 2005, as a requirement of the FIARC commercialpaper facility, the Company entered into seven interest rate cap transactions,with strike rates of 5%.  The aggregateinitial notional amounts of the caps were $97,056,198 which amortize over sixyears.  The Company paid an aggregate of$1,076,687 in premiums to purchase these caps. The interest rate caps were not designated as hedges, and accordingly,changes in the fair value of the interest rate caps are recorded as unrealizedgains or losses and reflected in net income. As of January 31, 2005, the combined value of the interest ratescaps were $844,495 and are recorded under other assets as interest ratederivative positions.  During the threemonths ended January 31, 2005, the Company recorded a combined unrealizedgain of $5,562 and during the nine months ended January 31, 2005, theCompany recorded a combined unrealized loss of $232,192 that is included as aseparate caption under other income.

 

During fiscal year 2004,as a requirement of the FIARC commercial paper facility, the Company enteredinto various interest rate cap transactions at cap rates ranging from 6.5% to7.5% with a notional balance that amortized over five to nine year periods. Theinterest rate caps were not designated as hedges and, accordingly, changes inthe fair value of the interest rate caps were recorded as unrealized gains orlosses and reflected in net income.  On December 2,2003, the Company terminated all interest rate caps outstanding in exchange forproceeds of $356,000.  The caps wereterminated following the repayment of all outstanding principal under the FIARCfacility following the issuance of the 2003-A Term Notes.  As a result, a realized loss of $14,000 wasincurred relative to the aggregate market value of the interest rate caps.

 

On June 1,2001, the Company entered into interest rate swaps with an aggregate notionalamount of $100 million and a maturity date of April 15, 2004.  Under the terms of these swaps, the Companypaid a floating rate based on one month LIBOR and received a fixed rate of5.025%.  Management elected to enter intothese swap agreements to offset the uneconomical position of the existing payfixed rate swap created by rapidly declining market interest rates.  In connection with the decision to enter intothe $100 million pay floating rate swap, the Company elected to change thedesignation of the $100 million pay fixed rate swap from a cash flow hedge andnot account for the instrument as a hedge under SFAS No. 133.   As a result, the change in fair value of theswaps is reflected in net income for periods subsequent to May 31, 2001.

 

**Delinquency and Credit LossExperience**

 

The Company’s results of operations, financialcondition and liquidity may be adversely affected by nonperforming receivables.The Company seeks to manage its risk of credit loss through (i) prudent creditevaluations, (ii) risk management activities, (iii) effective collectionprocedures, and (iv) by maximizing recoveries on defaulted loans. The allowancefor credit losses of $2,412,679 as of January 31, 2005 and $2,199,386 asof April 30, 2004 as a percentage of Receivables Held for Investment of$227,611,249 as of January 31, 2005 and $207,489,339 as of April 30,2004 was 1.1% and 1.1% respectively.

 

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The Company considers a loan to be delinquent when theborrower fails to make a scheduled payment of principal and interest. Accrualof interest is suspended when the payment from the borrower is over 90 dayspast due. Generally, repossession procedures are initiated 90 to 120 days afterthe payment default.

 

The Company retains the credit risk associated withthe receivables originated. The Company purchases credit enhancement insurancefrom third party insurers, which covers the risk of loss upon default andcertain other risks. The Company established a captive insurance subsidiary toreinsure certain risks under the credit enhancement insurance coverage for allreceivables.  In addition, receivablesfinanced under the Auto Trust and FIARC commercial paper facilities do notcarry default insurance.  Provisions forcredit losses of $2,574,748 and $7,459,259 for the three and nine months ended January 31,2005 compared to and $3,324,302 and $9,986,006 for the three and nine monthsended January 31, 2004 have been recorded.

 

The Company calculates the allowance forcredit losses in accordance with SFAS No. 5*, Accounting forContingencies.*   SFAS No. 114,*Accounting for Creditors for Impairment of a Loan*does not apply to loans currently held by the Company because they are composedof a large group of smaller balance homogenous loans that are evaluatedcollectively for impairment.

 

The Company applies a systematic methodologyin order to determine the amount of the allowance for credit losses.  The specific methodology utilized is asix-month migration analysis whereby the Company compares the aging status ofeach loan from six months prior to the aging loan status as of the reportingdate.  These factors are then applied tothe aging status of each loan at the reporting date in order to calculate thenumber of loans that are expected to migrate to impaired status.  The estimated number of impairments is thenmultiplied by estimated loss per loan, which is based on historicalinformation.  The computed reserve isthen compared to the amount recorded for adequacy.  The Company compares the six-month result toprior six-month periods to compare trends and evaluate any other internal orexternal factors that may affect collectibility. The allowance for creditlosses is based on estimates and qualitative evaluations, and ultimate losseswill vary from current estimates. These estimates are reviewed periodically andas adjustments, either positive or negative, become necessary, are reported inearnings in the period they become known.

 

The following table sets forth certaininformation regarding the Company’s delinquency and charge-off experience overits last two fiscal years (dollars in thousands):

 
| ** **                                                                                | ** ** | **As of or for the Nine Months  Ended January  31,** | ** ** |
|-------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                                | ** ** | **2004**                                             | ** ** | **2005** | ** ** |
| ** **                                                                                | ** ** | **Number   of Loans**                                | ** ** | **Amount** | ** ** | **Number   of Loans** | ** ** | **Amount** | ** ** |
| Receivables  Held for Investment:                                                         |       |                                                 |       |   |   |   |   |   |   |
| Delinquent  amount outstanding (1):                                                       |       |                                                 |       |   |   |   |   |   |   |
| 30 - 59 days                                                                              |       | 224                                                  |       | $ | 2,166 |   | 263 |   | $ | 2,488 |   |
| 60 - 89 days                                                                              |       | 101                                                  |       | 1,108 |   | 76 |   | 629 |   |
| 90 days or  more                                                                          |       | 321                                                  |       | 3,489 |   | 183 |   | 1,469 |   |
| Total  delinquencies                                                                      |       | 646                                                  |       | $ | 6,763 |   | 522 |   | $ | 4,586 |   |
| Total  delinquencies as a percentage of outstanding receivables.                          |       | 3.8                                                  | %          | 3.1 | % | 3.1 | % | 2.0 | % |
|                                                                                      |       |                                                 |       |   |   |   |   |   |   |
| Net charge-offs  as a percentage of average receivables outstanding during the period (2) |       |                                                 |       | 6.0 | % |   |   | 4.5 | % |

 

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(1)                                  Delinquent amounts outstanding do not includeloans in bankruptcy status since collection activity is limited and highlyregulated for bankrupt accounts.

 

(2)                                  Thepercentages have been annualized and are not necessarily indicative of theresults for a full year.

 

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The lower annualized charge-off rate resultsfrom an improving economic environment coupled with an increase in the Company’sdirect to consumer lending program and higher recovery rates on repossessions.

 

As of January 31, 2005, there were 379 accountstotaling $3,869,214 that were in bankruptcy status and were more than 30 dayspast due.  As of January 31, 2004,there were 475 accounts totaling $4,562,290 that were in bankruptcy status andwere more than 30 days past due.  As of January 31,2005 and 2004, 89% and 90%, respectively, of the bankruptcy delinquencies filedfor protection under Chapter 13.

 

**New Accounting Pronouncements**

 

In December 2003, the American Instituteof Certified Public Accountants issued Statement of Position (SOP) 03-3,*Accounting for Certain Loans or Debt Securities Acquired in a Transfer*.SOP 03-3 addresses the accounting for loans acquired through a transfer(including a business combination) that have differences between their expectedcash flows and their contractual cash flows, due in part to credit quality. TheSOP requires that the excess of the expected cash flows at acquisition to becollected over the acquirer’s initial investment be recognized on a level-yieldbasis over the loan’s life. Any future revised estimate of cash flows in excessof the original cash flows is recognized as a future yield adjustment. Futuredecreases in actual cash flows over the original expected cash flows arerecognized as impairment and expensed immediately. Valuation allowances can notbe created or “carried over” in the initial accounting for loans acquired thatare within the scope of the SOP. SOP 03-3 is effective for loans acquired infiscal years beginning after December 15, 2004.  The Company does not anticipate SOP 03-3 willhave a material effect on its financial statements.

 

In December 2004, the FASB issued SFASNo. 123(R), *Share-Based Payment*-a revision to SFASNo. 123, *Accounting for Stock-Based Compensation*(“SFASNo. 123(R)”) that addresses the accounting for share-based payment transactionsin which an enterprise receives employee services in exchange for (a) equityinstruments of the enterprise or (b) liabilities that are based on the fairvalue of the enterprise’s equity instruments or that may be settled by theissuance of such equity instruments. SFAS No. 123(R) eliminates the ability toaccount for share-based compensation transactions using APB Opinion No. 25, *Accounting for Stock Issued to Employees*, and generallyrequires instead that such transactions be accounted for using afair-value-based method.

 

SFAS No. 123(R) is effective as of thebeginning of the first interim or annual reporting period that begins after June 15,2005. SFAS 123(R) applies to all awards granted after the required effectivedate and to such awards modified, repurchased, or cancelled after that date.The cumulative effect of initially applying SFAS No. 123(R), if any, isrecognized as of the required effective date. As of the required effectivedate, all public entities that used the fair-value-based method for eitherrecognition or disclosure under SFAS No. 123 will apply SFAS No. 123(R) using amodified version of prospective application. Under that transition method,compensation cost is recognized on or after the required effective date for theportion of outstanding awards for which the requisite service has not yet beenrendered, based on the grant-date fair value of those awards calculated underSFAS No. 123 for either recognition or pro forma disclosures. For periodsbefore the required effective date, those entities may elect to apply amodified version of retrospective application under which financial statementsfor prior periods are adjusted on a basis consistent with the pro formadisclosures required for those periods by SFAS No. 123. The Company has not yetcompleted its evaluation of the impact that SFAS No. 123(R) will have on itsfinancial position and results of operations.

 

**Forward Looking Information**

 

Statements and financial discussion and analysisincluded in this report that are not historical are considered to beforward-looking in nature. Forward-looking statements involve a number of risksand uncertainties that may cause actual results to differ materially fromanticipated results. Specific factors that could cause such differences includeunexpected fluctuations in market interest rates, changes in economic conditions,changes in the competition for loans, or the inability to renew or obtainfinancing. Further information concerning risks and uncertainties is includedin this report and the company’s other reports filed with the Securities andExchange Commission.

 

The Company believes the factors discussed inits reports are important factors that could cause actual results to differmaterially from those expressed in any forward looking statement made herein orelsewhere by the Company or on its behalf. The factors listed are not necessarily all of the importantfactors.  Unpredictable or

 

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unknown factors not discussed could also have material adverse effectson actual results.  The Company does notintend to update its description of important factors each time a potentialimportant factor arises.  The Companyadvises its stockholders that they should: (1) be aware that important factors not described herein could affectthe accuracy of our forward looking statements, and (2) use caution and commonsense when analyzing our forward looking statements in this document orelsewhere.  All of such forward lookingstatements are qualified in their entirety by this cautionary statement.

 

**ITEM 3.****                             *QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK***

 

The market risk discussion and the estimatedamounts generated from the analysis that follows are forward-looking statementsof market risk assuming certain adverse market conditions occur. Actual resultsin the future may differ materially due to changes in the Company’s product anddebt mix, developments in the financial markets, and further utilization by thecompany of risk-mitigating strategies such as hedging.

 

The Company’s operating revenues are derivedalmost entirely from the collection of interest on the receivables it retainsand its primary expense is the interest that it pays on borrowings incurred topurchase and retain such receivables. The Company’s credit facilities bearinterest at floating rates which are reset on a short-term basis, whereas itsreceivables bear interest at fixed rates which do not generally vary withchanges in interest rates. The Company is therefore exposed primarily to marketrisks associated with movements in interest rates on its credit facilities. TheCompany believes that it takes the necessary steps to appropriately reduce thepotential impact of interest rate increases on the Company’s financial positionand operating performance.

 

The Company relies almost exclusively on revolvingcredit facilities to fund its origination of receivables. Periodically, the Companywill transfer receivables from a revolving to a term credit facility. Currentlyall of the Company’s credit facilities bear interest at floating rates tied toeither a commercial paper index or LIBOR.

 

As of January 31, 2005, the Company had$133.6 million of floating rate secured debt outstanding under the FIRCwarehouse and working capital facilities. For every 1% increase in commercial paper rates or LIBOR, annual after-taxearnings would decrease by approximately $.9 million assuming the Companymaintains a level amount of floating rate debt and assuming an immediateincrease in rates.  As of January 31,2004, the Company had $49.5 million of floating rate secured debt outstandingnet of swap and cap agreements. For every 1% increase in commercial paper ratesor LIBOR, annual after-tax earnings would have decreased by approximately $.3million assuming the Company maintains a level amount of floating rate debt andassuming an immediate increase in rates.

 

**ITEM 4.****                             CONTROLS AND PROCEDURES**

 

In accordancewith Exchange Act Rules 13a-15 and 15d-15, we carried out an evaluation, underthe supervision and with the participation of management, including our ChiefExecutive Officer and Chief Financial Officer, of the effectiveness of theCompany’s disclosure controls and procedures as of the end of the periodcovered by this report.  Based on thatevaluation, the Company’s Chief Executive Officer and Chief Financial Officerconcluded that our disclosure controls and procedures were effective as ofJanuary 31, 2005 to provide reasonable assurance that information required tobe disclosed in the Company’s reports filed or submitted under the Exchange Actis recorded, processed, summarized and reported within the time periodsspecified in the Securities and Exchange Commission’s rules and forms.

 

There has been no change in the Company’sinternal controls over financial reporting that occurred during the threemonths ended January 31, 2005 that has materially affected, or is reasonablylikely to materially affect, the Company’s internal controls over financialreporting.

 

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###### **PART II**

###### ** **

##### **OTHER INFORMATION**

##### ** **

**ITEM 5.****                             *OTHER INFORMATION***

 

On November 16,2004, the Company received a letter from NASDAQ, indicating that the NASDAQ isreviewing the Company’s eligibility for listing on the NASDAQ National Marketas a consequence of failure to meet the minimum 400 round lot shareholderrequirement of Marketplace Rule 4450(a)(4). In the letter, NASDAQ stated that the Company had until December 1,2004, to provide an acceptable plan to regain compliance, or the staff willinitiate delisting of the Company’s common stock.  As a result of this action, and afterconsidering the costs and benefits associated with the continued listing on theNASDAQ National Market, the Company has elected to delist itself from theNASDAQ National Market electing instead to list its shares on the over-the-counterbulletin board market.  The Company hasmaintained its registration under the Securities and Exchange Act of 1934 andcontinues to file Forms 10-Q, 10-K, and 8-K with the Securities and Exchange Commission and mail anannual report to stockholders following each fiscal year end.

 

**ITEM 6.****                             *EXHIBITS AND REPORTS ON FORM 8-K***

 

(a)          Exhibits

 
| 10.114               |   | Amended and restated Security  Agreement dated February 18, 2005 between First Investors Auto  Receivables Corporation, First Investors Financial Services, Inc., First  Investors Servicing Corporation, Variable Funding Capital Corporation,  Wachovia Capital Markets, LLC, MBIA Insurance Corporation, and Wells Fargo  Bank, National Association. |
|----------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                 |   |                                                                                                                                                                                                                                                                                                                                                          |
| 10.115               |   | Amended and restated Insurance  Agreement dated February 18, 2005 between MBIA Insurance Corporation,  First Investors Auto Receivables Corporation, First Investors Financial  Services, Inc., First Investors Servicing Corporation, and Wells Fargo Bank,  National Association.                                                                      |
|                 |   |                                                                                                                                                                                                                                                                                                                                                          |
| 31.1                 |   | Certification of Chief  Executive Officer pursuant to section 302 of the Sarbanes-Oxley Act of  2002.                                                                                                                                                                                                                                                    |
|                 |   |                                                                                                                                                                                                                                                                                                                                                          |
| 31.2                 |   | Certification of Chief  Financial Officer pursuant to section 302 of the Sarbanes-Oxley Act of  2002.                                                                                                                                                                                                                                                    |
|                 |   |                                                                                                                                                                                                                                                                                                                                                          |
| 32.1                 |   | Certification of Chief  Executive Officer pursuant to section 906 of the Sarbanes-Oxley Act of  2002.                                                                                                                                                                                                                                                    |
|                 |   |                                                                                                                                                                                                                                                                                                                                                          |
| 32.2                 |   | Certification of Chief  Financial Officer pursuant to section 906 of the Sarbanes-Oxley Act of  2002.                                                                                                                                                                                                                                                    |
|                 |   |                                                                                                                                                                                                                                                                                                                                                          |
| Filed with this 10-Q |   |                                                                                                                                                                                                                                                                                                                                                          |   |
|                      |        |                                                                                                                                                                                                                                                                                                                                                               |  |  |  |

 

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(b)         Reports on Form 8-K

 

Form 8-K filed November 19, 2004, pressrelease announcing preliminary results for the quarter end October 31,2004 and a NASDAQ notice of potential delisting from The National MarketExchange.

 

Form 8-K filed March 10, 2005, pressrelease announcing the quarter end January 31, 2005 financial results.

 

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### **SIGNATURES**

### ** **

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
|                      | First Investors Financial Services Group, Inc.   |
|---------------------------|--------------------------------------------------|
|                      | (Registrant)                                     |
|                      |                                             |
| Date: March 14, 2005 | By: /s/ TOMMY A. MOORE, JR.                      |
|                      | Tommy A. Moore, Jr.                              |
|                      | President and Chief Executive Officer            |
|                      |                                             |
| Date: March 14, 2005 | By: /s/ BENNIE H. DUCK                           |
|                      | Bennie H. Duck                                   |
|                      | Secretary, Treasurer and Chief Financial Officer |

 

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