**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

 

| **ý**                          | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                                                                           |
|-------------------------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                |                                                                                                                                                                                                                                                                                                   |
|                                | **For the quarterly period ended July  31, 2004**                                                                                                                                                                                                                                                      |
|                                |                                                                                                                                                                                                                                                                                                   |
| **OR**                              |
|                                |                                                                                                                                                                                                                                                                                                   |
| **o**                               | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                                                                          |
|                                |                                                                                                                                                                                                                                                                                                   |
|                                | **For the transition period from                         to                       ** |
|                                |                                                                                                                                                                                                                                                                                                   |
| **Commission File  Number 0-26686** |

 

**First Investors Financial Services Group, Inc.**

(Exact Name of Registrant as Specified in itsCharter)

 
| **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  September 13, 2004** |
|-------------------------------|--------|-----------------------------------------------|
| Common  Stock-$.001 Par Value |   | 5,000,269                                     |

 

 

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**FIRST INVESTORS FINANCIAL SERVICESGROUP, INC.**

**AND SUBSIDIARIES**

 

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

##### ** **

### **JULY 31, 2004**

 

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

 
| **Part I**     | **Financial Information** |                                                                                          |
|----------------|---------------------------|-----------------------------------------------------------------------------------------------|
|           |                      |
|           | Item 1.                   | Financial Statements                                                                          |   |
|           |                      |
|           |                      | Consolidated Balance Sheets as of April  30, 2003 and July 31, 2004                           |   |
|           |                      |                                                                                          |   |
|           |                      | Consolidated  Statements of Operations for the Three Months Ended July 31, 2003 and 2004      |   |
|           |                      |                                                                                          |   |
|           |                      | Consolidated  Statement of Shareholders’ Equity for the Three Months Ended July 31, 2004 |   |
|           |                      |                                                                                          |   |
|           |                      | Consolidated  Statements of Cash Flows for the Three Months Ended July 31, 2003 and 2004      |   |
|           |                      |                                                                                          |   |
|           |                      | 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 6.                   | Exhibits and Reports On Form 8-K                                                              |   |
|           |                      |
| **Signatures** |                      |

 

2

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**FIRST INVESTORS FINANCIAL SERVICESGROUP, INC. AND SUBSIDIARIES**

 

##### **CONSOLIDATED BALANCE SHEETS — APRIL 30, 2004 AND JULY 31, 2004**

 
|                                                                                                                                           |   | **April 30,  2004** |        | **July 31,  2004** |   |
|------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|-------------|--------------------|--------|
|                                                                                                                                           |   | **(Audited)**       |        | **(Unaudited)**    |   |
| **ASSETS**                                                                                                                                     |   |                |        |               |   |
| Receivables Held  for Investment, net                                                                                                          |   | $                   | 209,777,347 |               | $      | 210,122,864 |   |
| Receivables  Acquired for Investment, net                                                                                                      |   | 1,190,230           |        | 992,072            |   |
| Cash and  Short-Term Investments, including restricted cash of $19,036,747 and  $18,290,223                                                    |   | 21,055,237          |        | 18,530,633         |   |
| Accrued Interest  Receivable                                                                                                                   |   | 2,576,023           |        | 2,462,772          |   |
| Assets Held for  Sale                                                                                                                          |   | 851,426             |        | 888,690            |   |
| Other Assets:                                                                                                                                  |   |                |        |               |   |
| Funds held under  reinsurance agreement                                                                                                        |   | 4,182,134           |        | 4,377,302          |   |
| Deferred  financing costs and other assets, net of accumulated amortization and  depreciation of $5,759,477 and $6,154,746                     |   | 6,115,203           |        | 5,717,133          |   |
| Current income  taxes receivable                                                                                                               |   | 8,212               |        | 8,212              |   |
| Interest rate  derivative positions                                                                                                            |   | —              |        | 115,344            |   |
| Total assets                                                                                                                                   |   | $                   | 245,755,812 |               | $      | 243,215,022 |   |
|                                                                                                                                           |   |                |        |               |   |
| **LIABILITIES AND SHAREHOLDERS’  EQUITY**                                                                                                 |   |                |        |               |   |
| Debt:                                                                                                                                          |   |                |        |               |   |
| Warehouse credit  facilities                                                                                                                   |   | $                   | 42,705,810  |               | $      | 61,670,082 |   |
| Term Notes                                                                                                                                     |   | 164,718,190         |        | 142,966,523        |   |
| Working capital  facility                                                                                                                      |   | 8,761,143           |        | 8,759,543          |   |
| Other  Liabilities:                                                                                                                            |   |                |        |               |   |
| Accounts payable  and accrued liabilities                                                                                                      |   | 1,708,984           |        | 1,847,414          |   |
| Current income  taxes payable                                                                                                                  |   | —              |        | 22,822             |   |
| Deferred income  taxes payable                                                                                                                 |   | 558,000             |        | 558,000            |   |
| Total  liabilities                                                                                                                             |   | 218,452,127         |        | 215,824,384        |   |
|                                                                                                                                           |   |                |        |               |   |
| 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 at July 31, 2004 |   | 5,584               |        | 5,584              |   |
| Additional  paid-in capital                                                                                                                    |   | 18,754,608          |        | 18,754,608         |   |
| Retained  earnings                                                                                                                             |   | 10,515,258          |        | 10,602,211         |   |
| Less, treasury  stock, at cost, 583,400 and 583,400 shares                                                                                     |   | (1,971,765          | )           | (1,971,765         | )      |
| Total  shareholders’ equity                                                                                                               |   | 27,303,685          |        | 27,390,638         |   |
| Total  liabilities and shareholders’ equity                                                                                               |   | $                   | 245,755,812 |               | $      | 243,215,022 |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

 

3

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**FIRST INVESTORS FINANCIAL SERVICESGROUP, INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**For the Three Months Ended July 31,2003 and 2004**

**(Unaudited)**

 
|                                                           |   | **For the  Three Months  Ended July 31,** |      |
|----------------------------------------------------------------|--------|-------------------------------------------|-----------|
|                                                           |   | **2003**                                  |      | **2004** |   |
|                                                           |   |                                      |      |   |   |
| Interest Income                                                |   | $                                         | 8,070,436 |   | $ | 6,952,179 |   |
| Interest Expense                                               |   | 2,017,971                                 |      | 1,776,773 |   |
| Net interest income                                            |   | 6,052,465                                 |      | 5,175,406 |   |
| Provision for Credit Losses                                    |   | 3,391,963                                 |      | 2,442,105 |   |
| Net Interest Income After Provision for Credit Losses          |   | 2,660,502                                 |      | 2,733,301 |   |
| Other Income:                                                  |   |                                      |      |   |   |
| Servicing revenue                                              |   | 1,274,632                                 |      | 969,955 |   |
| Late fees and other                                            |   | 379,561                                   |      | 630,553 |   |
| Income from investment                                         |   | 247,869                                   |      | 193,706 |   |
| Other interest income                                          |   | 47,279                                    |      | 74,132 |   |
| Unrealized gain/(loss) on interest rate derivative positions   |   | 142,757                                   |      | (67,657 | ) |
| Total other income                                             |   | 2,092,098                                 |      | 1,800,689 |   |
| Operating Expenses:                                            |   |                                      |      |   |   |
| Salaries and benefits                                          |   | 2,218,389                                 |      | 2,063,445 |   |
| Operating expense                                              |   | 1,072,374                                 |      | 1,298,790 |   |
| General and administrative                                     |   | 995,283                                   |      | 922,821 |   |
| Other interest expense                                         |   | 129,140                                   |      | 112,000 |   |
| Total operating expenses                                       |   | 4,415,186                                 |      | 4,397,056 |   |
| Income Before Provision for Income Taxes and Minority Interest |   | 337,414                                   |      | 136,934 |   |
| Provision (Benefit) for Income Taxes:                          |   |                                      |      |   |   |
| Current                                                        |   | (2,302                                    | )         | 49,981 |   |
| Deferred                                                       |   | 128,804                                   |      | — |   |
| Total provision for income taxes                               |   | 126,502                                   |      | 49,981 |   |
| Minority Interest                                              |   | (9,167                                    | )         | — |   |
| Net Income                                                     |   | $                                         | 220,079   |   | $ | 86,953 |   |
|                                                           |   |                                      |      |   |   |
| Basic and Diluted Net Income per Common Share                  |   | $                                         | 0.04      |   | $ | 0.02 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

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

 

**CONSOLIDATEDSTATEMENT OF SHAREHOLDERS’ EQUITY**

 

**For the Three Months Ended July 31,2004**

**(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                |   | —            |   | —                           |   | 86,953                 |   | —                        |       | 86,953    |   |
| Balance at July  31, 2004 |   | $                 | 5,584  |                             | $      | 18,754,608             |   | $                             | 10,602,211 |      | $      | (1,971,765 | ) | $ | 27,390,638 |   |

 

Theaccompanying notes are an integral part of these consolidated financialstatements.

 

5

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FIRST INVESTORS FINANCIALSERVICES GROUP, INC. AND SUBSIDIARIES

 

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**For the Three Months Ended July 31,2003 and 2004**

**(Unaudited)**

 
|                                                                                     |   | **2003**    |      | **2004**    |   |
|------------------------------------------------------------------------------------------|--------|-------------|-----------|-------------|--------|
|                                                                                     |   |        |      |        |   |
| Cash Flows From Operating Activities:                                                    |   |        |      |        |   |
| Net income                                                                               |   | $           | 220,079   |        | $      | 86,953 |   |
| Adjustments to reconcile net income to net cash provided by operating  activities — |   |        |      |        |   |
| Depreciation and amortization expense                                                    |   | 944,893     |      | 1,002,154   |   |
| Provision for credit losses                                                              |   | 3,391,963   |      | 2,442,105   |   |
| Minority interest                                                                        |   | (9,167      | )         | —      |   |
| (Increase) decrease in:                                                                  |   |        |      |        |   |
| Accrued interest receivable                                                              |   | 156,124     |      | 113,251     |   |
| Restricted cash                                                                          |   | 298,799     |      | 746,524     |   |
| Deferred financing costs and other assets                                                |   | (52,116     | )         | (153,978    | )      |
| Funds held under reinsurance agreement                                                   |   | (328,008    | )         | (195,168    | )      |
| Current income tax receivable                                                            |   | (4,461      | )         | —      |   |
| Interest rate derivative positions                                                       |   | 1,011,996   |      | (115,344    | )      |
| Increase (decrease) in:                                                                  |   |        |      |        |   |
| Accounts payable and accrued liabilities                                                 |   | (30,761     | )         | 138,430     |   |
| Deferred income taxes payable                                                            |   | 257,673     |      | —      |   |
| Current income taxes payable                                                             |   | —      |      | 22,822      |   |
| Interest rate derivative positions                                                       |   | (1,283,184  | )         | —      |   |
| Net cash provided by operating activities                                                |   | 4,573,830   |      | 4,087,749   |   |
| Cash Flows From Investing Activities:                                                    |   |        |      |        |   |
| Origination of Receivables Held for Investment                                           |   | (29,201,027 | )         | (29,210,448 | )      |
| Principal payments from Receivables Held for Investment                                  |   | 20,240,718  |      | 24,158,794  |   |
| Principal payments from Receivables Acquired for Investment                              |   | 339,463     |      | 198,158     |   |
| Payments received on Assets Held for Sale                                                |   | 1,774,160   |      | 1,651,565   |   |
| (Purchase) sale of furniture and equipment                                               |   | (3,361      | )         | 125,097     |   |
| Net cash used in investing activities                                                    |   | (6,850,047  | )         | (3,076,834  | )      |
| Cash Flows From Financing Activities:                                                    |   |        |      |        |   |
| Proceeds from advances on—                                                          |   |        |      |        |   |
| Warehouse credit facilities                                                              |   | 50,364,471  |      | 32,703,706  |   |
| Principal payments made on—                                                         |   |        |      |        |   |
| Warehouse credit facilities                                                              |   | (35,932,938 | )         | (13,739,434 | )      |
| Term Notes                                                                               |   | (11,488,004 | )         | (21,751,667 | )      |
| Working capital facility                                                                 |   | (868,561    | )         | (1,600      | )      |
| Treasury stock purchased                                                                 |   | (84,630     | )         | —      |   |
| Net cash provided by (used in) financing activities                                      |   | 1,990,338   |      | (2,788,995  | )      |
| Decrease in Cash and Short-Term Investments                                              |   | (285,879    | )         | (1,778,080  | )      |
| Cash and Short-Term Investments at Beginning of Period                                   |   | 2,617,680   |      | 2,018,490   |   |
| Cash and Short-Term Investments at End of Period                                         |   | $           | 2,331,801 |        | $      | 240,410 |   |
| Supplemental Disclosures of Cash Flow Information:                                       |   |        |      |        |   |
| Cash paid during the period for—                                                    |   |        |      |        |   |
| Interest                                                                                 |   | $           | 1,890,571 |        | $      | 1,543,921 |   |
| Income Taxes                                                                             |   | 2,158       |      | —      |   |

 

The accompanying notesare an integral part of these consolidated financial statements

 

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

 

**NOTES TOUNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

 

##### **July 31, 2004**

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

 

*Organization.*  First Investors Financial Services Group, Inc. (First Investors)was established to serve as a holding company for First Investors FinancialServices, Inc. (FIFS) and FIFS’s wholly-owned subsidiaries, First InvestorsInsurance Company (FIIC), First Investors Auto Receivables Corporation (FIARC),F.I.R.C., Inc. (FIRC), First Investors Servicing Corporation (FISC), formerlyknown as Auto Lenders Acceptance Corporation (ALAC), FIFS Acquisition FundingCorp. LLC, Farragut Financial Corporation, and First Investors Auto FundingCorporation. First Investors, together with its wholly- and majority-ownedsubsidiaries, is hereinafter referred to as the Company.

 

FIFS began operations inMay 1989 and is principally involved in the business of originating and holdingfor investment retail installment contracts and promissory notes secured by newand used automobiles originated by factory authorized franchised dealers ordirectly through consumers. As of July 31, 2004, approximately 28%, 19%, and13% of receivables held for investment had been originated in Texas, Georgia,and Ohio, respectively. The Company currently operates in 28 states.

 

FIIC was organized underthe captive insurance company laws of the state of Vermont for the purpose ofreinsuring certain credit enhancement insurance policies that have been writtenby unrelated third party insurance companies.

 

On October 2, 1998, theCompany completed the acquisition of FISC and the operations of FISC areincluded in the consolidated results of the Company since the date ofacquisition. Headquartered in Atlanta, Georgia, FISC performed servicing andcollection activities on a portfolio of receivables originated for investmentas well as on a portfolio of receivables originated and sold pursuant to twoasset securitizations. As a result of the acquisition, the Company increasedthe total dollar value on its balance sheet of receivables, acquired aninterest in certain trust certificates related to the asset securitizations andacquired certain servicing rights along with furniture, fixtures, equipment andtechnology to perform the servicing and collection functions for the portfolioof receivables under management.

 

On August 8, 2000, theCompany entered into a partnership agreement whereby a subsidiary of theCompany was the general partner owning 70% of the partnership interests andFirst Union Investors, Inc. served as the limited partner and owned 30% of thepartnership interests.  On September 19,2003, First Investors Financial Services, Inc. purchased the limitedpartnership interests previously held by First Union Investors, Inc.  The Partnership consists primarily of aportfolio of loans previously owned or securitized by FISC and certain otherfinancial assets including charged-off accounts owned by FISC.

 

On December 24, 2002, theCompany purchased 40% of common stock and an investment in the junior mezzaninedebt of First Auto Receivables Corporation (“FARC”).  FARC purchased an approximately $197.5 million portfolio ofinstallment loan receivables from a subsidiary of Union AcceptanceCorporation.  FISC performs ongoingservicing and collection activities on the portfolio.

 

On March 19, 2003, FISCentered into a servicing agreement with an unrelated third party to service anapproximately $300 million portfolio of installment loan receivables purchasedfrom a subsidiary of Union Acceptance Corporation.

 

In total, at July 31,2004, FISC performs servicing and collection functions on a managed receivablesportfolio of approximately $466 million.

 

7

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

 

*Basis of Presentation*.  The consolidated financial statementsinclude the accounts of First Investors and its wholly-owned and majority-ownedsubsidiaries. All significant intercompany accounts and transactions have beeneliminated. Investments in which the Company exercises significant influence,but which it does not control (generally a 20% to 50% ownership interest), areaccounted for under the equity method of accounting, except for variableinterest entities for which the Company is considered the primary beneficiaryunder Financial Accounting Standards Board (“FASB”) Interpretation No. 46, *Consolidationof Variable Interest Entities, an interpretation of ARB No. 51*, asamended in December 2003 by Interpretation 46R.  As of July 31, 2004, the Company does not have any entities underFIN 46 as amended by Interpretation 46R.

 

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 July 31, 2004, and the results of its operations for the threemonths ended July 31, 2003 and 2004, and its cash flows for the three monthsended July 31, 2003 and 2004.

 

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. Interest income alsoincludes additional amounts received upon early payoffs of certain receivablesattributable to the difference between the principal balance of the receivablescalculated using the Rule of 78’s method and the principal balance of thereceivables calculated using the effective interest method. When a receivablebecomes 90 days past due, the income accrual is suspended until the paymentsbecome current. When a loan is charged off or the collateral is repossessed,the remaining income accrual is 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. Given the nature of the remaining cash flows of individual loans, theCompany determined that the timing of collections on these assets are much moreunpredictable than contractual cash flows from non-defaulted receivables,therefore in the periods subsequent to September 30, 2003 the Company followsthe guidance provided by Practice Bulletin 6*, Amortization of Discounts on Certain Acquired Loans*,and accounts for these assets utilizing the cost-recovery method.  Under this method, cash proceeds fromcollections are applied to first reduce the Company’s basis in the assets.  Cash collected in excess of this cost basisis recognized as income when received.

 

*Other Income*.  OtherIncome consists of income received from servicing activities, late fees andother loan-related fees, income from investments, reinvestment revenue andunrealized gain or loss on interest rate derivative positions.  Servicing revenue is accrued as services arerendered. Late fees and other loan-related fees are

 

8

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recognizedwhen received.  Income from investmentsand reinvestment revenue are accrued based on the respective interest rate ofsuch investment and unrealized gain or loss on interest rate derivatives is recognizedas changes occur in the derivatives fair value.

 

*Allowance for Credit Losses*.  The Company calculates the allowance forcredit losses in accordance with SFAS No. 5*, Accounting for Contingencies.*   SFAS No. 114, *Accounting for Creditors for Impairmentof a Loan* does not apply to loans currently held by the Companybecause they are comprised of a large group of smaller balance homogenous loansthat are evaluated collectively for impairment.

 

The Company initiates efforts to make customer contactwhen the customer is one day past due and becomes more aggressive as the loanbecomes more delinquent.  Managementreviews past due loans and considers various factors including payment history,job status and any events that may have occurred that prevent the customer frommaking a payment.  Through theevaluation, if it is determined that the loan is uncollectible, the collateralis typically repossessed.  Generallythis occurs at 90 to 120 days past due. Upon repossession, the uncollectible portion of the loan and 100% ofaccrued interest is written off.  Thefair value of the collateral is recorded in Assets Held for Sale.  In the event the collateral is unable to belocated, the Company will write off the entire balance after exhausting allcollection efforts.

 

The Company applies asystematic methodology in order to determine the amount of the allowance forcredit losses.  The specific methodologyutilized is a six-month migration analysis whereby the Company compares theaging status of each loan from six months prior to the aging loan status as ofthe reporting date.  These factors arethen applied to the aging status of each loan at the reporting date in order tocalculate the number of loans that are expected to migrate to impairedstatus.  The estimated number ofimpairments is then multiplied by estimated loss per loan, which is based onhistorical information.  The computedreserve is then 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.

 

*Stock-BasedCompensation*.  The Company has an employee stock optionplan and a non-employee director stock option plan, which are described morefully in Note 9.  The Company hasadopted the disclosure 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, *Accountingfor Stock Issued to Employees*which requires compensation cost to berecognized based on the excess, if any, between the quoted market price of thestock at the date of grant and the amount an employee must pay to acquire thestock. All options awarded under the Company’s plan are granted with anexercise price equal to or greater than the fair market value on the date ofthe grant.

 

9

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The following table presents the Company’s net incomeper share had the Company adopted the fair value method of accounting forstock-based compensation under SFAS No. 123, *Accounting for Stock-Based Compensation*,as amended by SFAS No. 148.

 
|                                                                                                                                                  |   | **For the Three Months  Ended July 31,** |    |
|-------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------------|---------|
|                                                                                                                                                  |   | **2003**                                 |    | **2004** |   |
| Net Income as  reported                                                                                                                               |   | $                                        | 220,079 |   | $ | 86,953 |   |
| Deduct: Total  stock option plan compensation expense determined under fair value based  method for awards granted, modified or settled, net of taxes |   | (10,504                                  | )       | (36,339 | ) |
| Pro Forma Net  Income                                                                                                                                 |   | $                                        | 209,575 |   | $ | 50,614 |   |
|                                                                                                                                                  |   |                                     |    |   |   |
| Basic and  Diluted Net Income per Common Share, as reported                                                                                           |   | $                                        | 0.04    |   | $ | .02 |   |
| Basic and  Diluted Net Income per Common Share, pro forma                                                                                             |   | $                                        | 0.04    |   | $ | .01 |   |

 

*Reclassifications*. Certain reclassifications have been made to thefiscal 2003 amounts to conform with the fiscal 2004 presentation.

 

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

 

The receivables generally have terms between 48 and 72months and are collateralized by the underlying vehicles.  Net receivable balances consisted of thefollowing at April 30, 2004 and July 31, 2004:

 
|                                      |   | **April 30,  2004** |        | **July 31,  2004** |   |
|-------------------------------------------|--------|---------------------|-------------|--------------------|--------|
| Receivables                               |   | $                   | 207,489,339 |               | $      | 207,741,744 |   |
| Unamortized premium and deferred fees (1) |   | 4,487,394           |        | 4,583,182          |   |
| Allowance for credit losses               |   | (2,199,386          | )           | (2,202,062         | )      |
| Net receivables                           |   | $                   | 209,777,347 |               | $      | 210,122,864 |   |

 

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(1)  Includes premium and discounts paid to dealer plus deferredacquisition cost.

 

Activity in the allowance forcredit losses for the periods ended July 31, 2003 and 2004 was as follows:

 
|                           |   | **For the Three Months  Ended July 31,** |      |
|--------------------------------|--------|------------------------------------------|-----------|
|                           |   | **2003**                                 |      | **2004** |   |
| Balance, beginning of period   |   | $                                        | 2,397,216 |   | $ | 2,199,386 |   |
| Provision for credit losses    |   | 3,391,963                                |      | 2,442,105 |   |
| Charge-offs, net of recoveries |   | (3,362,057                               | )         | (2,439,429 | ) |
| Balance, end of period         |   | $                                        | 2,427,122 |   | $ | 2,202,062 |   |

 

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

 

Receivables Acquired forInvestment comprise loans previously originated by Auto Lenders AcceptanceCorporation and other third parties. 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 outstanding principalbalance of the receivables portfolio, the majority of the remaining cash flowsprojected constitute default collections from obligors.  Given the nature

 

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of the remaining cash flows of individual loans, theCompany determined 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*, Amortization of Discounts on CertainAcquired Loans*, Receivables Acquired for Investment will beaccounted for under the cost-recovery method beginning September 30, 2003.  Under this method, cash proceeds fromcollections are applied to first reduce the Company’s basis in the assets.  Cash collected in excess of this cost basisis recognized as income when received. Receivables Acquired for Investmentpreviously originated by Auto Lenders Acceptance Corporation were $979,496 and$870,766 as of April 30, 2004 and July 31, 2004, respectively.

 

On September 30, 2003 theCompany purchased $9.4 million of defaulted auto loan receivables from anunrelated third party.  These loans of$210,735 and $121,306 are included in Receivables Acquired for Investment onthe balance sheet as of April 30, 2004 and July 31, 2004 respectively, and areaccounted for using the cost-recovery method. The Company may, from time to time, consider similar acquisitions in thefuture.

 

**5.****              Debt**

 

The Company finances its loan origination through twowarehouse credit facilities. The Company’s credit facilities provide forone-year terms and have been renewed annually. Management of the Companybelieves that the credit facilities will continue to be renewed or extended orthat it would be able to secure alternate financing on satisfactory terms; however,there can be no assurance that it will be able to do so. In January 2002 theCompany issued $159 million in asset-backed notes (“Term Notes”) secured by adiscrete pool of receivables. On November 20, 2003, the Company issued $140million in Term Notes secured by a discrete pool of receivables.  Substantially all receivables retained bythe Company are pledged as collateral for the credit facilities and the TermNotes. The weighted average interest rate for the Company’s secured borrowingsincluding the effect of program fees, dealer fees, and other comprehensiveincome (loss) amortization was 3.5% and 2.8% for the periods ended July 31,2003 and 2004, respectively.

 

*WarehouseFacilities as of July 31, 2004*

 
| **Facility** |   | **Capacity** |        | **Outstanding** |   | **Interest  Rate** |   | **Fees**                                                                                              |   | **Insurance**           |   | **Borrowing  Rate At  July 31,  2004** |   |
|--------------|--------|--------------|-------------|-----------------|--------|--------------------|--------|-------------------------------------------------------------------------------------------------------|--------|-------------------------|--------|----------------------------------------|--------|
| FIARC        |   | $            | 150,000,000 |            | $      | 9,175,344          |   | Commercial paper rate  plus .3%                                                                       |   | .25% of Unused Facility |   | .35                                    | %      | 1.37 | % |
| FIRC         |   | $            | 65,000,000  | (1)             | $      | 52,494,738         |   | 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                              |   | 1.96 | % |

 

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(1)                                  Increasedfrom $50 million to $65 million in June, 2004, to allow for an increase in newloan originations.  Facility isscheduled to revert to $50 million on September 13, 2004.

 

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*WarehouseFacilities – Credit Enhancement as of July 31, 2004*

 
| **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 to maintaincredit enhancement insurance covering the receivables pledged as collateralunder the FIRC credit facility. The facility lenders are named as additionalinsureds under these policies. The coverages are obtained on each receivable atthe time it is purchased by the Company, and the applicable premiums areprepaid for the life of the receivable. Each receivable is covered by threeseparate 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 unaware of their existence. The Company’s ALPI insurance policy iswritten by National Union Fire Insurance Company of Pittsburgh (“NationalUnion”), which is a wholly-owned subsidiary of American International Group.

 

The premiums that the Company paid during the threemonths ended July 31, 2004 for its three credit enhancement insurancecoverages, of which the largest component is basic ALPI insurance, representedapproximately 3.7% of the principal amount of the receivables originated duringthe year. Aggregate premiums paid for ALPI coverage alone during the threemonths ended July 31, 2003 and 2004 were $714,470 and $1,071,409, respectively,and accounted for 2.4% and 3.7% of the aggregate principal balance of thereceivables originated during such respective periods.

 

In April 1994, the Company organized First InvestorsInsurance Company (the “Insurance Subsidiary”) under the captive insurancecompany laws of the State of Vermont. The Insurance Subsidiary is an indirectwholly-owned subsidiary of the Company and is a party to a reinsuranceagreement whereby the Insurance Subsidiary reinsures 100% of the risk under theCompany’s ALPI insurance policy. At the time each receivable is insured byNational Union, the risk is automatically reinsured to its full extent andapproximately 96% of the premium paid by the Company to National Union withrespect to such receivable is ceded to the Insurance Subsidiary. When a losscovered by the ALPI policy occurs, National Union pays it after the claim isprocessed, and National Union is then reimbursed in full by the InsuranceSubsidiary.  In addition to the monthlypremiums and liquidity reserves of the Insurance Subsidiary, a trust account ismaintained by National Union to secure the Insurance Subsidiary’s obligationsfor losses it has reinsured.

 

The result of the foregoing reinsurance structure isthat National Union, as the “fronting” insurer under the captive arrangement,is unconditionally obligated to the Company’s credit facility lenders for alllosses covered by the ALPI policy, and the Company, through its InsuranceSubsidiary, is obligated to indemnify National Union for all such losses. As ofJuly 31, 2004, the Insurance Subsidiary had capital and surplus of $2,612,455and unencumbered cash reserves of $1,383,013 in addition to the $3,274,011trust 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 InsuranceSubsidiary’s liability under the Reinsurance Agreement is cancelled withrespect to the transferred receivables. Any unearned premium associated withthe transferred receivables is returned to the Company. The Company believes thelosses its Insurance Subsidiary will be required to indemnify will be less thanthe premiums ceded to it. However, there can be no assurance that losses willnot exceed the premiums ceded and the capital and surplus of the InsuranceSubsidiary.

 

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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.

 

*WarehouseFacilities – Agents and Expirations*

* *
| **Facility** |   | **Agent** |   | **Expiration**   |   | **Event if  not Renewed**                                                                                                                                               |
|--------------|--------|-----------|--------|------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| FIARC        |   | Wachovia  |   | December 2, 2004 |   | Receivables pledged would be allowed to amortize;  however, no new receivables would be allowed to transfer from the FIRC  facility                                     |
| FIRC         |   | Wachovia  |   | December 2, 2004 |   | Convert to a term loan which would mature six months  thereafter and amortize monthly in accordance with the borrowing base with  the remaining balance due at maturity |

 

On December 4, 2003, theFIRC facility was renewed, under similar terms and conditions, at the $50million commitment level until December 2, 2004.  On June 15, 2004, the FIRC facility was extended to $65 million,  reverting back to $50 million on September13, 2004.  On January 29, 2004,following a short-term extension of the original maturity date, the FIARCfacility was renewed, under similar terms and conditions, to December 2,2004.  As of April 30, 2004 and July 31,2004, there was $0 and $9.2 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 July 31, 2004.

 
| **Term Notes** |   | **Issuance  Date** |   | **Issuance  Amount** |        | **Maturity  Date** |              | **Outstanding** |   | **Interest  Rate** |   |
|----------------|--------|--------------------|--------|----------------------|-------------|--------------------|-------------------|-----------------|--------|--------------------|--------|
| 2002-A         |   | January 29, 2002   |   | $                    | 159,036,000 |               | December 15, 2008 |            | $      | 36,395,776         |   | 3.46 | % |
| 2003-A         |   | November 11, 2003  |   | $                    | 139,661,000 |               | April 20, 2011    |            | $      | 106,570,747        |   | 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                                           |   | 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 |   | 96.5% initial advance  decreasing to 96.1% |   | Surety Bond   |

 

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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-A Term Notes”). The initial pool of automobile receivables transferredto the 2002 Auto Trust totaled $135,643,109, which was previously owned by FIRCand FIARC, secure the 2002-A Term Notes. In addition to the issuance of the Class A Notes, the 2002 Auto Trustalso issued $4,819,000 in Class B Notes that were retained by the Company andpledged to secure the Working 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 requires 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 July 31, 2004, theoutstanding principal balances on the 2002-A Term Notes were $44,335,659 and$36,395,776 respectively.

 

On November 20, 2003, the Company, through itsindirect, wholly-owned subsidiary First Investors Auto Owner Trust 2003-A(“2003 Auto Trust”) completed the issuance of $139,661,000 of 2.58% Class Aasset-backed notes (“2003-A Term Notes”). The initial pool of automobilereceivables transferred to the 2003 Auto Trust totaled $114,726,891, which waspreviously owned by FIRC and FIARC, secure the 2003-A Term Notes.  In addition to the issuance of the Class ANotes, the 2003 Auto Trust also issued $5,065,891 in Class B Notes that wereretained by the Company and pledged to secure the Working Capital Facility asfurther described below.  Proceeds fromthe issuance, which totaled $139,656,629 were used to (i) fund a $30,000,000pre-funding account to be used for future loan originations; (ii) repay alloutstanding borrowings under the FIARC commercial paper facility, (iii) reducethe outstanding borrowings under the FIRC credit facility, (iv) pay transactionfees related to the 2003-A Term Note issuance, and (v) fund an initial cashreserve account of 0.5% or $573,635 of the initial receivables pledged.  The Class A Term Notes bear interest at2.58% and requires monthly principal reductions sufficient to reduce thebalance of the Class A Term Notes to 96.1% of the outstanding balance of theunderlying receivables pool. The final maturity of the 2003-A Term Notes isApril 20, 2011.  The Class B Notes donot bear interest but require principal reductions sufficient to reduce thebalance of the Class B Notes to 3.9% of the outstanding balance of theunderlying receivables pool.  A suretybond issued by MBIA Insurance Corporation provides credit enhancement for theClass A Notes.  In the event that certainasset quality 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 July 31, 2004, theoutstanding principal balances on the 2003-A Term notes were $120,382,531 and$106,570,747 respectively.

 

*Working Capital Facility*.  On December 6, 2001, the Company enteredinto an agreement with Wachovia Securities to refinance the $11,175,000outstanding balance of the working capital term loan previously provided byBank of America and Wachovia and increase the size of the facility to $13.5million.  The renewal facility wasprovided to a special-purpose, wholly-owned subsidiary of the Company, FirstInvestors Residual Funding LP.   Thefacility originally consisted of a $9 million revolving tranche and a $4.5million term loan tranche which amortizes monthly.  The term loan tranche of this working capital facility wasevidenced by the Class B Notes issued in conjunction with the 2002 Auto Trustfinancing. The remaining $9 million of the $13.5 million working capitalfacility revolves monthly in accordance with a borrowing base consisting of theover-collateralization amount and reserve accounts for each of the Company’sother credit facilities.  The facilityis secured 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

 

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the term loan tranche wasincreased to the greater of $250,000 or the principal distributions made underthe Class B Notes 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.  At April 30, 2004 and July 31,2004, there was $8,761,143 and $8,759,543 respectively, outstanding under thisfacility.

 

The Company presentlyintends to seek a renewal of the working capital facility from its lender priorto maturity.  Should the facility not berenewed, the outstanding balance of the receivables would be amortized inaccordance with the borrowing base. Management considers its relationship with its lenders to besatisfactory and has no reason to believe that this credit facility will not berenewed.  If the facility is notrenewed, however, or if material changes are made to its terms and conditions,it could have a material adverse effect on the Company.

 

*Shareholder Loans. *OnDecember 3, 2001 the Company entered into an agreement with one of itsshareholders who is a member of its Board of Directors under which the Companymay, from time to time, borrow up to $2.5 million.  The proceeds of the borrowings will be utilized to fund certainprivate and open market purchases of the Company’s common stock pursuant to aStock Repurchase Plan authorized by the Board of Directors and for generalcorporate purposes.  Borrowings underthe facility bear interest at a fixed rate of 10% per annum.  The facility is unsecured and expresslysubordinated to the Company’s senior credit facilities. The facility matures onDecember 3, 2008 but may be repaid at any time unless the Company is in defaulton one of its other credit facilities. There were no amounts outstanding under this facility as of April 30,2004 and July 31, 2004 respectively.

 

*Loan Covenants*.  The documentation governing these credit facilities and TermNotes contains numerous covenants relating to the Company’s business, themaintenance of credit enhancement insurance covering the receivables (ifapplicable), the observance of certain financial covenants, the avoidance ofcertain levels of delinquency experience and other matters. The breach of thesecovenants, if not cured within the time limits specified, could precipitateevents of default that might result in the acceleration of the FIRC creditfacility, the Term Notes and the working capital facility or the termination ofthe commercial paper facilities. The Company was not in default with respect toany financial covenants governing these financing arrangements at July 31,2004.

 

*Interest Rate Management*.  The Company’s warehouse credit facilitiesand working capital facilities bear interest at floating interest rates whichare reset 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 June 2004, as arequirement of the FIARC commercial paper facility, the Company entered into aninterest rate cap transaction with a rate cap of 5%, with a notional balancethat amortizes over six years, for a total purchase price of $183,000.  The interest rate cap was not designated asa hedge, and accordingly, changes in the fair value of the interest rate capsare recorded as unrealized gains or losses and reflected in net income.  As of July 31, 2004, the value of theinterest rate cap is $115,343 and is recorded under other assets as interestrate derivative positions.  During thequarter ended July 31, 2004, the Company recorded an unrealized loss of $67,657that is included as a separate caption of other income.

 

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Duringfiscal year 2004, as a requirement of the FIARC commercial paper facility, theCompany entered into various interest rate cap transactions at cap ratesranging from 6.5% to 7.5% with a notional balance that amortized over five tosix year periods. The interest rate caps were not designated as hedges and,accordingly, changes in the fair value of the interest rate caps are recordedas unrealized gains or losses and reflected in net income.  On December 2, 2003, the Company terminated allinterest rate caps outstanding in exchange for proceeds of $356,000.  The caps were terminated following therepayment of all outstandings under the FIARC facility following the issuanceof the 2003-A Term Notes.  As a result,a realized loss of $14,000 was incurred relative to the aggregate market valueof the interest rate caps.

 

On June 1, 2001, the Companyentered into interest rate swaps with an aggregate notional amount of $100million and a maturity date of April 15, 2004. Under the terms of these swaps, the Company will pay a floating ratebased on one month LIBOR and receive a fixed rate of 5.025%.  Management elected to enter into these swapagreements to offset the uneconomical position of the existing pay fixed swapcreated by rapidly declining market interest rates.  In connection with the decision to enter into the $100 millionfloating rate swap, the Company elected to change the designation of the $100million fixed rate swap from a cash flow hedge and not account for theinstrument as a hedge under SFAS No. 133.  As a result, the change in fair value of the swaps is reflected in netincome for periods subsequent to May 31, 2001.

 

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

 

Earnings per shareamounts are based on the weighted average number of shares of common stock andpotential dilutive common shares outstanding during the period. The weightedaverage number of shares used to compute basic and diluted earnings per sharefor the three months ended July 31, 2003 and 2004, are as follows:

 
|                                                               |   | **For the Three Months Ended  July 31,** |   |
|--------------------------------------------------------------------|--------|------------------------------------------|--------|
|                                                               |   | **2003**                                 |   | **2004** |   |
| Weighted average shares:                                           |   |                                     |   |   |   |
| Weighted average shares outstanding for basic earnings per share   |   | 5,023,758                                |   | 5,000,269 |   |
| Effect of dilutive stock options and warrants                      |   | 47,238                                   |   | 147,989 |   |
| Weighted average shares outstanding for diluted earnings per share |   | 5,070,996                                |   | 5,148,258 |   |

 

For the three monthsended July 31, 2003 and 2004, the Company had 575,987 and 838,998 respectively,of stock options and stock warrants which were not included in the computationof diluted earnings per share because to do so would have been antidilutive forthe period presented.

 

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

 

On December 24, 2002, theCompany invested $475,061 for a 40% ownership interest in First AutoReceivables Corporation (“FARC”) and $712,591 for junior mezzanine investmentsof FARC.  FARC purchased a $197.5million automobile loan portfolio from UAFC-2 Corporation, a subsidiary ofUnion Acceptance Corporation, with proceeds from $186 million in senior bridgedebt, $8.9 million of senior mezzanine debt, $1.8 million of junior mezzaninedebt and $1.2 million of equity.   Thebridge debt interest rate is LIBOR plus 1%, the senior mezzanine interest rateis 22.5% and the junior mezzanine interest rate is 25%.

 

The Companyaccounts for its ownership investment in FARC using the equity method inaccordance with APB Opinion 18.  Inaddition to the equity and debt investments, the Company performs loanservicing and collection activities on the portfolio.  For the three months ended July 31, 2003 and 2004, the Companyrecognized $371,803 and $263,087 respectively of servicing revenue, $0 and$27,473 of interest income respectively, and $247,869 and $193,706 respectivelyof equity in the income from investment in FARC.  For the

 

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three months endedJuly 31, 2004, the equity investment in FARC of $968,327 and junior mezzaninedebt of $716,675 are included in Deferred Financing Costs and Other Assets onthe 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 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 excess of contractual cash flows overthe original expected cash flows is recognized as a future yield adjustment.Future decreases 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 will have a materialeffect on its financial statements.

 

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

 

*Preferred Stock*.  The Company has authorized 1,000,000 shares of preferred stockwith a $1.00 par value.  As of July 31,2004, no shares have been issued.

 

*Employee**Stock Option Plan*. In June1995, the Board of Directors adopted the Company’s 1995 Employee Stock OptionPlan (the Plan). The Plan is administered by the Compensation Committee of theBoard of Directors and provides that options may be granted to officers andother key employees for the purchase of up to 300,000 shares of common stock,subject to adjustment in the event of certain changes in capitalization. OnSeptember 10, 2002, the number of shares of common stock available for issuancewas increased to 500,000. Options may be granted either as incentive stockoptions (which are intended to qualify for certain favorable tax treatment) oras non-qualified stock options.  TheCompensation Committee selects the persons to receive options and determinesthe exercise price, the duration, any conditions on exercise and other terms ofthe options. In the case of options intended to be incentive stock options, theexercise price may not be less than 100% of the fair market value per share ofcommon stock on the date of grant. With respect to non-qualified stock options,the exercise price may be fixed as low as 50% of the fair market value pershare at the time of grant. In no event may the duration of an option exceed 10years and no option may be granted after the expiration of 10 years from theadoption of the Plan. As of April 30, 2004 and July 31, 2004, a total of282,500 and 373,000, respectively, options had been issued and remainedoutstanding leaving a remaining 217,500 and 127,000, respectively, availableunder the plan.

 

The exercise price of the option is payable in fullupon exercise and payment may be in cash, by delivery of shares of common stock(valued at their fair market value at the time of exercise), or by acombination of cash and shares. 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* -In September 2002, the Non-Employee Stock Option Plan was established tofurther align the interests of the Company’s directors with the interests ofthe shareholders, 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 stockare available for issuance.  Optiontypes will be 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 theCompany’s annual financial performance exceeds parameters established by theBoard.  No discretionary grants havebeen awarded.  As of April 30, 2004 andJuly 31, 2004, a total of 270,000 and 390,000, respectively,

 

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options had been issuedunder the plan, leaving a remaining 230,000 and 110,000, respectively,available for issuance.  In addition tothe options granted above, there were an additional 20,000 options granted to adirector in 1995, before the adoption of the Non-Employee Stock Option Plan.

 

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

 

**Critical Accounting Policies**

 

Financial Reporting Release No. 60, which was issuedby the Securities and Exchange Commission (“SEC”), requires all registrants todiscuss critical accounting policies or methods used in the preparation offinancial statements.  Note 2 to theconsolidated financial statements includes a summary of the significantaccounting policies and methods used in the preparation of the Company’sconsolidated financial statements.

 

The preparation of financial statements includes theuse of estimates and assumptions that affect the reported amounts of assets andliabilities and the reported amounts of net revenues and expenses during thereporting 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 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 cashflows, the Company determined that the timing of collections on these assetsare much more unpredictable than contractual cash flows from non-defaultedreceivables, therefore; in the periods subsequent to September 30, 2003 theCompany follows the guidance provided by Practice Bulletin 6*,Amortization of Discounts on Certain Acquired Loans*, and accountsfor these assets utilizing the cost-recovery method.  Under this method, cash proceeds from collections are applied tofirst reduce the Company’s basis in the assets.  Cash collected in excess of this cost basis is recognized asincome when received.

 

*Other Income*.  Other Income consists of income received from servicingactivities, late fees and other loan-related fees, income from investments,reinvestment revenue and unrealized loss on interest rate derivative positions.  Servicing revenue is accrued as services arerendered. Late fees and other loan-related fees are recognized whenreceived.  Income from investments andreinvestment revenue are accrued based on the respective interest rate of suchinvestment and unrealized loss on interest rate derivatives is recognized whenincurred.

 

*Allowance for Credit Losses*.  The Company calculates the allowance forcredit losses in accordance with SFAS No. 5*, Accounting for Contingencies.*   SFAS No. 114, *Accounting for Creditors for Impairmentof a Loan* does not apply to loans currently held by the Companybecause they are composed of a large group of smaller balance homogenous loansthat are evaluated collectively for impairment.

 

The Company initiates efforts to make customer contactwhen the customer is one day past due and become more aggressive as the loanbecomes further past due.  Managementreviews past due loans and considers various factors including payment history,job status and any events that may have occurred that prevent the customer frommaking a payment.  Through theevaluation, if it is determined that the loan is uncollectible, the collateralis typically repossessed.  Generallythis occurs when a loan is 90 to 120 days past due.   Upon repossession, the

 

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uncollectible portion ofthe loan and 100% of accrued interest is written off.  The fair value of the collateral is recorded as an Assets Heldfor Sale.  Fair value is determined byestimating the proceeds of the collateral, which primarily are composed ofauction proceeds on the sale of the automobile less selling relatedexpenses.  After collection of allproceeds, the Company records an adjustment, positive or negative, based on thedifference between the fair value estimate and the true proceeds received.   In the event the collateral is unable to belocated, the Company will write off the entire balance after exhausting allcollection efforts.

 

The Company applies a systematic methodology in orderto 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 the 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 to prior six-monthperiods to compare trends and evaluate any other internal or external factorsthat may affect collectibility. The allowance for credit losses is based onestimates and qualitative evaluations and ultimate losses will vary fromcurrent 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 optionplan and a non employee director stock option plan. The Company has adopted thedisclosure provisions of SFAS No. 148, *Accounting for Stock-Based Compensation—Transitionand Disclosure, an amendment of FASB Statement No. 123*. Thispronouncement 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, *Accountingfor Stock Issued to Employees*which requires compensation cost to berecognized based on the excess, if any, between the quoted market price of thestock at the date of grant and the amount an employee must pay to acquire thestock. All options awarded under the Company’s plan are granted with anexercise price equal to or greater than the fair market value on the date ofthe grant.

 

**ManagedReceivables**

 

The Company’s managed receivables are (dollars inthousands):

 
|                                                                                |   | **As of or for the  Three Months Ended  July 31,** |    |
|-------------------------------------------------------------------------------------|--------|----------------------------------------------------|---------|
|                                                                                |   | **2003**                                           |    | **2004** |   |
| Receivables Held for Investment:                                                    |   |                                               |    |   |   |
| Number                                                                              |   | 18,497                                             |    | 16,226 |   |
| Principal balance                                                                   |   | $                                                  | 228,973 |   | $ | 207,742 |   |
| Average principal balance of receivables outstanding during the  three-month period |   | $                                                  | 227,982 |   | $ | 206,950 |   |
| Receivables Acquired for Investment:                                                |   |                                               |    |   |   |
| Number                                                                              |   | 250                                                |    | 654 |   |
| Principal balance                                                                   |   | $                                                  | 499     |   | $ | 992 |   |
| Other Servicing:                                                                    |   |                                               |    |   |   |
| Number                                                                              |   | 24,135                                             |    | 17,363 |   |
| Principal balance                                                                   |   | $                                                  | 388,956 |   | $ | 257,164 |   |
| Total Managed Receivables Portfolio:                                                |   |                                               |    |   |   |
| Number                                                                              |   | 42,882                                             |    | 34,243 |   |
| Principal balance                                                                   |   | $                                                  | 618,429 |   | $ | 465,898 |   |
| Average principal balance of receivables outstanding during the  three-month period |   | $                                                  | 639,301 |   | $ | 478,580 |   |

 

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The followingtable sets forth information with regard to the Company’s net interest spread,which represents the difference between the effective yield on Receivables Heldfor Investment and the Company’s average cost of debt utilized to fund thesereceivables, and its net interest margin (averages based on month-endbalances):

 
|                                                   |   | **Three Months Ended  July 31,** |   |
|--------------------------------------------------------|--------|----------------------------------|--------|
|                                                   |   | **2003**                         |   | **2004** |   |
| Receivables Held for Investment:                       |   |                             |   |   |   |
| Effective yield on Receivables Held for Investment (1) |   | 14.2                             | %      | 13.4 | % |
| Average cost of debt (2)                               |   | 3.5                              | %      | 3.4 | % |
| Net interest spread (3)                                |   | 10.7                             | %      | 10.0 | % |
| Net interest margin (4)                                |   | 10.6                             | %      | 10.0 | % |

 

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(1)                                  Represents interest income as a percentage ofaverage Receivables Held for Investment outstanding.

 

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

 

(3)                                  Represents yield on Receivables Held forInvestment less average cost of debt.

 

(4)                                  Represents net interest income as a percentage ofaverage Receivables Held for Investment outstanding.

 

Net interest income isthe difference between interest earned from the receivables portfolio andinterest expense incurred on the credit facilities used to acquire thereceivables. Net interest income was $5.2 million for the three months endedJuly 31, 2004, a decrease of 14% when compared to amounts reported for thethree months ended July 31, 2003.

 

The amount of net interest income is the result of therelationship between the average principal amount of receivables held andaverage rate earned thereon and the average principal amount of debt incurredto finance such receivables and the average rates paid thereon. Changes in theprincipal amount and rate components associated with the receivables and debtcan be segregated to analyze the periodic changes in net interest income. Thefollowing table analyzes the changes attributable to the principal amount andrate components of net interest income (dollars in thousands):

 
|                             |   | **Three  Months Ended  July 31, 2003 to 2004** |   |
|----------------------------------|--------|------------------------------------------------|--------|
|                             |   | **Increase  (Decrease)  Due to  Change in**    |   |   |   |
|                             |   | **Average  Principal  Amount**                 |   | **Average  Rate** |   | **Total  Net Increase  (Decrease)** |   |
|                             |   |                                           |   |   |   |   |   |
| Receivables Held for Investment: |   |                                           |   |   |   |   |   |
| Interest income                  |   | $                                              | (382   | ) | $ | (745 | ) | $ | (1,127 | ) |
| Interest expense                 |   | (26                                            | )      | (215 | ) | (241 | ) |
| Net interest income              |   | $                                              | (356   | ) | $ | (530 | ) | $ | (886 | ) |

 

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**Results of Operations**

 

*Three Months Ended July 31, 2004 and 2003 (dollars inthousands)*

 

*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 derived fromother activities; and (5) the ability of the Company to control operatingexpenses relative to the total amount of the managed portfolio.

 

*Executive Summary. *Net income for the threemonths ended July 31, 2004 was $87 compared to $220 for year the three monthsended July 31, 2003.  Basic and dilutedearnings per common share were $0.02 and $0.04 for the three months ended July31, 2004 and July 31, 2003, respectively. The decline in net income for the three months ended July 31, 2004compared to July 31, 2003 is due to several factors including (i) a decline ineffective yields, (ii) a decline in Receivables Held for Investment, (iii) adecline in loan servicing income and (iv) an unrealized gain on interest ratederivatives for the three months ended July 31, 2003 versus an unrealized lossfor the three months ended July 31, 2004.

 

*Interest Income*. Interest income for the three months ended July31, 2004 decreased to $6,952 compared to $8,070 for the three months ended July31, 2003.

 

The level of interest income, aprimary driver of financial results, is impacted by the average outstandingbalance of the portfolio of Receivables Held for Investment, the weightedaverage interest rate on receivables originated by the Company, the mix ofdirect and indirect lending activities and the level of early prepayments andcharge-offs.  Interest income onReceivables Held for Investment decreased****14% for the three months ended July 31,2004 compared to the three months ended July 31, 2003.  The reduction in yield for the three monthsended July 31, 2004 is due to (i) an increase in interest written-off forimpaired loans (ii) a decrease of 63 basis points in the weighted averageinterest rate on the performing portfolio which reflects the Company’sincreased focus on receivables originated directly to consumers which typicallycarry lower interest rates and (iii) a 9% decrease in the average portfoliooutstanding for the period ended July 31, 2004 compared the period ended July31, 2003.

 

*Interest Expense*. Interest expense for the three months endedJuly 31, 2004 decreased to $1,777 compared to $2,018 for the three months endedJuly 31, 2003. Interest expense on Receivables Held for Investment decreased12% for the three months ended July 31, 2004. The reduction in interest expense is primarily due to (i) the averagedebt outstanding decreased $24,686 or 11% for the three months ended July 31,2004 compared to the three months ended July 31, 2003 as a result of a 9%decrease in the average portfolio of Receivables Held for Investment and (ii)the termination 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 minimize therisk 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 ReserveSystem.

 

*Provision for Credit Losses*. The provision for credit losses for the threemonths ended July 31, 2004 decreased to $2,442 as compared to $3,392 for thethree months ended July 31, 2003. The decrease in provision for credit lossesis primarily due to (i) the Company’s assessment of economic conditions and theability of customers to maintain comparable employment (ii) the decrease in theaverage Receivables Held for Investment of 9% and (iii) the increase inrecovery rates on repossessions and defaults.

 

Netcharge-offs for the three months ended July 31, 2004 decreased to $2,439compared to $3,362 for the three months ended July 31, 2003.  The decrease in net charge-offs for thethree months ended July 31, 2004 is primarily due to (i) a 9% decrease in theaverage Receivables Held for Investment (ii) a decrease in loss frequency andseverity from repossessions and (iii) an increase in recoveries from defaultedloans.

 

Thelevel of provision for credit losses is a key driver of overall financialperformance and should be positively impacted by improvement in generaleconomic conditions, improvements in wholesale used car prices and lower netlosses resulting from stricter underwriting controls adopted by the Companyduring 2000 and 2001.

 

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Anyadditional economic deterioration or further decline in wholesale used car priceswill negatively impact provision expense as will increases in the outstandingbalance of receivables held for investment.

 

*Servicing Revenue*.  Servicing revenue decreased to $970****forthe three months ended July 31, 2004 compared to $1.275 for three months endedJuly 31, 2003.  The decrease inservicing revenue for the three months ended July 31, 2004 is due to thedecrease in principal balance of the servicing portfolio, partially offset byrevenues related to an incentive servicing fee that were not present in 2003.Revenue derived from servicing activities will increase or decrease in directproportion to the average outstanding balance of serviced receivables.

 

*Late Fees and Other Income*. Late fees and other income increased to $631for the three months ended July 31, 2004, compared to $380 for the three monthsended July 31, 2003.  The increase isattributable to (i) an increase in loans originated for a third party (ii)income received related to GAP insurance and extended service contracts sold toconsumers in connection with the Company’s direct lending activities that werenot present during the three months ended July 31, 2003, (iii) an increase incollection efforts and (iv) interest income from FARC which was not presentduring the three months ended July 31, 2003.

 

Latefees and other income are driven by a number of factors including overalldelinquency rates, the percentage of customers utilizing electronic paymentproducts and growth rates in the Company’s direct lending business which willaffect the ability of the Company to generate fee income from marketinginsurance and warranty products.

 

*Unrealized (Loss)/Gain on Interest Rate Derivative Positions*.  In conjunction with the adoption of SFAS133, the Company is required to report the fair value of interest ratederivative positions.  An unrealizedloss of $(68) for the three months ended July 31, 2004, compared to anunrealized gain of $143 for the three months ended July 31, 2003 areprincipally due to changes in the fair value of the Company’s derivativeposition.

 

*Salaries and Benefit Expenses*. Salaries and benefit expense decreased to$2,063 for the three months ended July 31, 2004, compared to $2,218 for thethree months ended July 31, 2003.  Thedecrease is primarily due to (i) a decrease in staff associated with a decreasein the Company’s serviced portfolio, (ii) a decrease in overtime as the Companyis maintaining a lower level of delinquent loans and (iii) a decrease in costsassociated with new hires.

 

*Operating Expenses.* Operating expenses increased to $1,299 for thethree months ended July 31, 2004, compared to $1,072 for the three months endedJuly 31, 2003.  An increase in printing,credit bureau and postage costs is due to the Company’s decision to grow thedirect lending business in fiscal year 2005. Overall operating expenses are generally correlated to the total numberof receivables managed by the Company.

 

*General and Administrative.* General and administrative expenses decreased to$923 for the three months ended July 31, 2004, compared to $995 for the threemonths ended July 31, 2003.  The threemonths ended July 31, 2004 experienced a general decline in occupancy, travel,depreciation and amortization expense. General and administrative costs tend to be more fixed in nature and notas dependent on the overall level of managed receivables.

 

*Other Interest Expense*. Other interest expense, related to workingcapital, decreased to $112 for the three months ended July 31, 2004, comparedto $129 for the three months ended July 31, 2003. The decrease was primarilydue to the shareholder loan having a $0 outstanding balance for the threemonths ended July 31, 2004, while there was an average balance of $747outstanding for the three months ended July 31, 2003.

 

# **Liquidity andCapital Resources**

# ** **

*Sources and Uses of Cash Flows*.  The Company’s business requires significantcash flow to support its operating activities. The principal cash requirementsinclude (i) amounts necessary to acquire receivables from dealers and fundrequired reserve accounts, (ii) amounts necessary to fund premiums for creditenhancement insurance or other credit enhancement required by the Company’sfinancing programs, and (iii) amounts necessary to fund costs to retainreceivables, primarily interest expense. The Company also requires asignificant amount of cash flow for working capital to fund fixed operatingexpenses, primarily salaries and benefits.

 

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The Company’s most significant cash flow requirementis for the origination of receivables. The Company originated $29.2 million ofreceivables to be held for investment for the three months ended July 31, 2004compared to $29.2 million for the three months ended July 31, 2003.

 

The Company funds loan originations through acombination of two warehouse credit facilities. The FIRC credit facilitygenerally permits the Company to borrow up to the outstanding principal balanceof qualified receivables, not to exceed $65 million.  Receivables that have accumulated in the FIRC credit facility maybe transferred to the FIARC commercial paper facility at the option of theCompany. The FIARC commercial paper facility provides an additional financingsource of up to $150 million. Additionally, the Company has transferredreceivables from the warehouse credit facilities and issued term notes.Substantially all of the Company’s receivables are pledged to collateralizethese credit facilities and term notes. The Company is obligated to meet certain financial covenants.  Noncompliance may significantly affect cashflow.

 

The Company’s most significant source of cash flow isthe principal and interest payments received from its receivables portfolios.The Company received such payments in the amount of $24.2****million during the threemonths ended July 31, 2004 and $20.2 million during the three months ended July31, 2003.  Such cash flow funds wereused to repay amounts borrowed under the Company’s credit facilities and otherholding costs, primarily interest expense, and servicing and custodialfees.  During the three months endedJuly 31, 2004 and 2003, the Company required net cash of $3.1 million and $6.7million, respectively, as the receivables originated exceeded portfoliocollections.  The Company relies onborrowed funds to provide cash flow in periods of growth.  As of July 31, 2004, the Company had $153.3million of available capacity in the FIRC and FIARC credit facilities to fundfuture growth.

 

In addition to the cash flow generated from the principal and interest collectionson its receivables portfolio, the Company collects servicing fees funded fromeach of the credit facilities. Servicing fees range from 1.4% to 2.5% of the outstanding principalbalance of the loans in the portfolio. Cash flow and servicing fees are received after month end, but relate tothe prior month activity.  Thus uponfiling of the monthly servicing statements, a portion of the restricted cash isconverted to cash available to fund operations.   At July 31, 2004 and 2003, the Company’s unencumbered cash was$240,410 and $2,331,800 respectively. The decrease in available cash is primarily due to an increase inexpenditures related to the Company’s direct lending business.  Management believes the unencumbered cashand cash inflows and amounts available under the working capital facility areadequate to fund cash requirements for operations.  In addition, as of July 31, 2004, the Company had $140.8 millionavailable under the FIARC warehouse facility.

 

*Capitalization*. The Company expects to relyprimarily on its credit facilities and the issuance of secured term notes toacquire and retain receivables. The Company believes its existing creditfacilities have adequate capacity to fund the increase of the receivablesportfolio expected in the foreseeable future. While the Company has no reasonto believe that these facilities will not continue to be available, theirtermination could have a material adverse effect on the Company’s operations ifsubstitute financing on comparable terms was not obtained.

 

*Financing Arrangements. *The Company finances its loan origination through twowarehouse credit facilities. The Company’s credit facilities provide forone-year terms and have been renewed annually. Management of the Companybelieves that the credit facilities will continue to be renewed or extended orthat it would be able to secure alternate financing on satisfactory terms;however, there can be no assurance that it will be able to do so. In January2002 the Company issued $159 million in asset-backed notes (“Term Notes”)secured by a discrete pool of receivables. On November 20, 2003, the Companyissued $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 3.5% and 2.8% for theperiods ended July 31, 2003 and 2004, respectively.

 

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*WarehouseFacilities as of July 31, 2004*

 
| **Facility** |   | **Capacity** |        | **Outstanding** |   | **Interest  Rate** |   | **Fees**                                                                                              |   | **Insurance**           |   | **Borrowing  Rate At  July 31,  2004** |   |
|--------------|--------|--------------|-------------|-----------------|--------|--------------------|--------|-------------------------------------------------------------------------------------------------------|--------|-------------------------|--------|----------------------------------------|--------|
| FIARC        |   | $            | 150,000,000 |            | $      | 9,175,344          |   | Commercial paper rate  plus .3%                                                                       |   | .25% of Unused Facility |   | .35                                    | %      | 1.37 | % |
| FIRC         |   | $            | 65,000,000  | (1)             | $      | 52,494,738         |   | 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                              |   | 1.96 | % |

 

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(1)                                  Increasedfrom $50 million to $65 million in June, 2004, to allow for an increase in newloan originations.  Facility isscheduled to revert to $50 million on September 13, 2004.

 

*WarehouseFacilities – Credit Enhancement as of July 31, 2004*

 

| **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 to maintaincredit enhancement insurance covering the receivables pledged as collateralunder the FIRC credit facility. The facility lenders are named as additionalinsureds under these policies. The coverages are obtained on each receivable atthe time it is purchased by the Company, and the applicable premiums areprepaid for the life of the receivable. Each receivable is covered by threeseparate 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 unaware of their existence. The Company’s ALPI insurance policy iswritten by National Union Fire Insurance Company of Pittsburgh (“NationalUnion”), which is a wholly-owned subsidiary of American International Group.

 

The premiums that the Company paid during the threemonths ended July 31, 2004 for its three credit enhancement insurancecoverages, of which the largest component is basic ALPI insurance, representedapproximately 3.7% of the principal amount of the receivables originated duringthe year. Aggregate premiums paid for ALPI coverage alone during the threemonths ended July 31, 2003 and 2004 were $714,470 and $1,071,409, respectively,and accounted for 2.4% and 3.7% of the aggregate principal balance of thereceivables originated during such respective periods.

 

In April 1994, the Company organized First InvestorsInsurance Company (the “Insurance Subsidiary”) under the captive insurancecompany laws of the State of Vermont. The Insurance Subsidiary is an indirectwholly-owned subsidiary of the Company and is a party to a reinsuranceagreement whereby the Insurance Subsidiary reinsures 100% of the risk under theCompany’s ALPI insurance policy. At the time each receivable is insured byNational Union, the risk is automatically reinsured to its full extent andapproximately 96% of the premium paid by the Company to National Union withrespect to such receivable is ceded to the Insurance Subsidiary. When a losscovered by the ALPI policy occurs, National Union pays it after the claim isprocessed, and National Union is then reimbursed in full by the InsuranceSubsidiary.  In addition to the monthlypremiums and liquidity reserves of the Insurance Subsidiary, a trust account ismaintained by National Union to secure the Insurance Subsidiary’s obligationsfor losses it has reinsured.

 

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The result of the foregoing reinsurance structure isthat National Union, as the “fronting” insurer under the captive arrangement,is unconditionally obligated to the Company’s credit facility lenders for alllosses covered by the ALPI policy, and the Company, through its InsuranceSubsidiary, is obligated to indemnify National Union for all such losses. As ofJuly 31, 2004, the Insurance Subsidiary had capital and surplus of $2,612,455and unencumbered cash reserves of $1,383,013 in addition to the $3,274,011trust 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 InsuranceSubsidiary’s liability under the Reinsurance Agreement is cancelled withrespect to the transferred receivables. Any unearned premium associated withthe transferred receivables is returned to the Company. The Company believesthe losses its Insurance Subsidiary will be required to indemnify will be lessthan the premiums ceded to it. However, there can be no assurance that losseswill not exceed the premiums ceded and the capital and surplus of the InsuranceSubsidiary.

 

FIARC –Credit Enhancement 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.

 

*WarehouseFacilities – Agents and Expirations*

 
| **Facility** |   | **Agent** |   | **Expiration**   |   | **Event if  not Renewed**                                                                                                                                               |
|--------------|--------|-----------|--------|------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| FIARC        |   | Wachovia  |   | December 2, 2004 |   | Receivables pledged would be allowed to amortize;  however, no new receivables would be allowed to transfer from the FIRC  facility                                     |
| FIRC         |   | Wachovia  |   | December 2, 2004 |   | Convert to a term loan which would mature six months  thereafter and amortize monthly in accordance with the borrowing base with  the remaining balance due at maturity |

 

On December 4, 2003, theFIRC facility was renewed, under similar terms and conditions, at the $50million commitment level until December 2, 2004.  On June 15, 2004, the FIRC facility was extended to $65million,  reverting back to $50 millionon September 13, 2004.  On January 29,2004, following a short-term extension of the original maturity date, the FIARCfacility was renewed, under similar terms and conditions, to December 2,2004.  As of April 30, 2004 and July 31,2004, there was $0 and $9.2 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 July 31, 2004.

 
| **Term Notes** |   | **Issuance  Date** |   | **Issuance  Amount** |        | **Maturity  Date** |              | **Outstanding** |   | **Interest  Rate** |   |
|----------------|--------|--------------------|--------|----------------------|-------------|--------------------|-------------------|-----------------|--------|--------------------|--------|
| 2002-A         |   | January 29, 2002   |   | $                    | 159,036,000 |               | December 15, 2008 |            | $      | 36,395,776         |   | 3.46 | % |
| 2003-A         |   | November 11, 2003  |   | $                    | 139,661,000 |               | April 20, 2011    |            | $      | 106,570,747        |   | 2.58 | % |

 

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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                                            |   | 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 |   | 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-A Term Notes”). The initial pool of automobile receivables transferredto the 2002 Auto Trust totaled $135,643,109, which was previously owned by FIRCand FIARC, secure the 2002-A Term Notes. In addition to the issuance of the Class A Notes, the 2002 Auto Trustalso issued $4,819,000 in Class B Notes that were retained by the Company andpledged to secure the Working 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 requires 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 July 31, 2004, theoutstanding principal balances on the 2002-A Term Notes were $44,335,659 and$36,395,776 respectively.

 

On November 20, 2003, the Company, through itsindirect, wholly-owned subsidiary First Investors Auto Owner Trust 2003-A(“2003 Auto Trust”) completed the issuance of $139,661,000 of 2.58% Class Aasset-backed notes (“2003-A Term Notes”). The initial pool of automobilereceivables transferred to the 2003 Auto Trust totaled $114,726,891, which waspreviously owned by FIRC and FIARC, secure the 2003-A Term Notes.  In addition to the issuance of the Class ANotes, the 2003 Auto Trust also issued $5,065,891 in Class B Notes that wereretained by the Company and pledged to secure the Working Capital Facility asfurther described below.  Proceeds from theissuance, which totaled $139,656,629 were used to (i) fund a $30,000,000pre-funding account to be used for future loan originations; (ii) repay alloutstanding borrowings under the FIARC commercial paper facility, (iii) reducethe outstanding borrowings under the FIRC credit facility, (iv) pay transactionfees related to the 2003-A Term Note issuance, and (v) fund an initial cashreserve account of 0.5% or $573,635 of the initial receivables pledged.  The Class A Term Notes bear interest at2.58% and requires monthly principal reductions sufficient to reduce thebalance of the Class A Term Notes to 96.1% of the outstanding balance of theunderlying receivables pool. The final maturity of the 2003-A Term Notes isApril 20, 2011.  The Class B Notes donot bear interest but require principal reductions sufficient to reduce thebalance of the Class B Notes to 3.9% of the outstanding balance of theunderlying receivables pool.  A suretybond issued by MBIA Insurance Corporation provides credit enhancement for theClass A Notes.  In the event thatcertain asset quality covenants are not met, the reserve account target levelwill increase to 6% of the then current principal balance of the receivablespool.  As of April 30, 2004 and July 31,2004, the outstanding principal balances on the 2003-A Term notes were$120,382,531 and $106,570,747 respectively.

 

*Working Capital Facility*.  On December 6, 2001, the Company enteredinto an agreement with Wachovia Securities to refinance the $11,175,000outstanding balance of the working capital term loan previously provided

 

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by Bank of America andWachovia 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 the over-collateralizationamount and reserve accounts for each of the Company’s other creditfacilities.  The facility is securedsolely by the residual cash flow and cash reserve accounts related to theCompany’s warehouse credit facilities, the acquisition facility and the existingand future term note facilities.  During2002, the facility was modified to increase the interest rate from LIBOR plus1.5% to LIBOR plus 2.25%.  Thecommitment fee paid on the total available amount of the facility wasmaintained 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 ofthe extension, the monthly amortization requirement was replaced with therequirement that outstandings under the facility could not exceed the lesser ofa borrowing base or the $9 million facility limit.  At April 30, 2004 and July 31, 2004, there was $8,761,143 and$8,759,543 respectively, outstanding under this facility.

 

The Company presentlyintends to seek a renewal of the working capital facility from its lender priorto maturity.  Should the facility not berenewed, the outstanding balance of the receivables would be amortized inaccordance with the borrowing base. Management considers its relationship with its lenders to besatisfactory and has no reason to believe that this credit facility will not berenewed.  If the facility is notrenewed, however, or if material changes are made to its terms and conditions,it could have a material adverse effect on the Company.

 

*Shareholder Loans. *OnDecember 3, 2001 the Company entered into an agreement with one of itsshareholders who is a member of its Board of Directors under which the Companymay, from time to time, borrow up to $2.5 million.  The proceeds of the borrowings will be utilized to fund certainprivate and open market purchases of the Company’s common stock pursuant to aStock Repurchase Plan authorized by the Board of Directors and for generalcorporate purposes.  Borrowings underthe facility bear interest at a fixed rate of 10% per annum.  The facility is unsecured and expresslysubordinated to the Company’s senior credit facilities. The facility matures onDecember 3, 2008 but may be repaid at any time unless the Company is in defaulton one of its other credit facilities. There were no amounts outstanding under this facility as of April 30,2004 and July 31, 2004 respectively.

 

*Loan Covenants*.  The documentation governing these credit facilities and TermNotes contains numerous covenants relating to the Company’s business, themaintenance of credit enhancement insurance covering the receivables (ifapplicable), the observance of certain financial covenants, the avoidance ofcertain levels of delinquency experience and other matters. The breach of thesecovenants, if not cured within the time limits specified, could precipitateevents of default that might result in the acceleration of the FIRC creditfacility, the Term Notes and the working capital facility or the termination ofthe commercial paper facilities. The Company was not in default with respect toany financial covenants governing these financing arrangements at July 31,2004.

 

*Interest Rate Management*.  The Company’s warehouse credit facilitiesand working capital facilities bear interest at floating interest rates whichare reset 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 June 2004, as arequirement of the FIARC commercial paper facility, the Company entered into aninterest rate cap transaction with a rate cap of 5%, with a notional balancethat amortizes over six years, for a total purchase price of $183,000.  The interest rate cap was not designated asa hedge, and accordingly, changes in the fair value of the interest rate capsare recorded as unrealized gains or losses and reflected in net income.  As of July 31, 2004, the value of theinterest rate cap is $115,343 and is recorded under other assets as interestrate derivative positions.  During thequarter ended July 31, 2004, the Company recorded an unrealized loss of $67,657that is included as a separate caption of other income.

 

Duringfiscal year 2004, as a requirement of the FIARC commercial paper facility, theCompany entered into various interest rate cap transactions at cap ratesranging from 6.5% to 7.5% with a notional balance that amortized over five tosix year periods. The interest rate caps were not designated as hedges and,accordingly, changes in the

 

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fairvalue of the interest rate caps are recorded as unrealized gains or losses andreflected 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 outstandings under the FIARC facilityfollowing the issuance of the 2003-A Term Notes.  As a result, a realized loss of $14,000 was incurred relative tothe aggregate market value of the interest rate caps.

 

On June 1, 2001, the Companyentered into interest rate swaps with an aggregate notional amount of $100million and a maturity date of April 15, 2004. Under the terms of these swaps, the Company will pay a floating ratebased on one month LIBOR and receive a fixed rate of 5.025%.  Management elected to enter into these swapagreements to offset the uneconomical position of the existing pay fixed swapcreated by rapidly declining market interest rates.  In connection with the decision to enter into the $100 millionfloating rate swap, the Company elected to change the designation of the $100million fixed rate swap from a cash flow hedge and not account for theinstrument as a hedge under SFAS No. 133.  As a result, the change in fair value of the swaps is reflected in netincome for periods subsequent to May 31, 2001.

 

**Delinquency and Credit Loss Experience**

 

The Company’s results ofoperations, financial condition and liquidity may be adversely affected bynonperforming receivables. The Company seeks to manage its risk of credit lossthrough (i) prudent credit evaluations, (ii) risk management activities, (iii)effective collection procedures, and (iv) by maximizing recoveries on defaultedloans. The allowance for credit losses of $2,202,062 as of July 31, 2004 and$2,427,122 as of July 31, 2003 as a percentage of Receivables Held forInvestment of $207,741,744 as of July 31, 2004 and $207,489,339 as of April 30,2004 was 1.1% and 1.1% respectively.

 

The Company considers aloan to be delinquent when the borrower fails to make a scheduled payment ofprincipal and interest. Accrual of interest is suspended when the payment fromthe borrower is over 90 days past due. Generally, repossession procedures areinitiated 90 to 120 days after the payment default.

 

The Company retains thecredit risk associated with the receivables originated. The Company purchasescredit enhancement insurance from third party insurers which covers the risk ofloss upon default and certain other risks. The Company established a captiveinsurance subsidiary to reinsure certain risks under the credit enhancementinsurance coverage for all receivables. In addition, receivables financed under the Auto Trust and FIARCcommercial paper facilities do not carry default insurance.  Provisions for credit losses of $2,442,105and $3,391,963 have been recorded for the three months ended July 31, 2004 andJuly 31, 2003, respectively.

 

The Company calculates the allowance for credit lossesin accordance with SFAS No. 5*, Accounting for Contingencies.*   SFAS No. 114, *Accounting for Creditors for Impairmentof a Loan* does not apply to loans currently held by the Companybecause they are comprised of a large group of smaller balance homogenous loansthat are evaluated collectively for impairment.

 

The Company applies a systematic methodology in orderto 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 in the next sixmonths.  The estimated number ofimpairments is then multiplied by estimated loss per loan, which is based onhistorical information.  The computedreserve is then 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

 

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current estimates. Theseestimates are reviewed periodically and as adjustments, either positive ornegative, become necessary, are reported in earnings in the period they becomeknown.

 

The following table sets forth certain informationregarding the Company’s delinquency and charge-off experience over its last twofiscal years (dollars in thousands):

 
|                                                                                      |   | **For the  three months ended July 31,** |   |
|-------------------------------------------------------------------------------------------|--------|------------------------------------------|--------|
|                                                                                      |   | **2003**                                 |   | **2004** |   |
|                                                                                      |   | **Number  of Loans**                     |   | **Amount** |   | **Number  of Loans** |   | **Amount** |   |
| Receivables Held  for Investment:                                                         |   |                                     |   |   |   |   |   |   |   |
| Delinquent  amount outstanding (1):                                                       |   |                                     |   |   |   |   |   |   |   |
| 30 - 59 days                                                                              |   | 321                                      |   | $ | 2,926 |   | 318 |   | $ | 2,753 |   |
| 60 - 89 days                                                                              |   | 113                                      |   | 1,088 |   | 78 |   | 669 |   |
| 90 days or more                                                                           |   | 376                                      |   | 3,709 |   | 211 |   | 2,167 |   |
| Total  delinquencies                                                                      |   | 810                                      |   | $ | 7,723 |   | 607 |   | $ | 5,589 |   |
| Total  delinquencies as a percentage of outstanding receivables.                          |   | 4.4                                      | %      | 3.4 | % | 3.7 | % | 2.7 | % |
| Net charge-offs  as a percentage of average receivables outstanding during the period (2) |   |                                     |   | 5.9 | % |   |   | 4.7 | % |

 

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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.

 

The lower annualizedcharge-off rate results from an improving economic environment coupled with anincrease in the Company’s direct to consumer lending program.

 

As of July 31, 2004,there were 519 accounts totaling $4,793,472 that were in bankruptcy status andwere more than 30 days past due.  As ofJuly 31, 2003, there were 712 accounts totaling $6,940,863 that were in bankruptcystatus and were more than 30 days past due. As of July 31, 2004 and 2003, 93% and 88%, respectively, of thebankruptcy delinquencies filed for protection under Chapter 13.

 

**New Accounting Pronouncements**

 

In December 2003, theAmerican Institute of 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 excess of contractual cash flows overthe original expected cash flows is recognized as a future yield adjustment.Future decreases 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 will have a materialeffect on its financial statements.

 

**Forward Looking Information**

 

Statements and financialdiscussion and analysis included in this report that are not historical areconsidered to be forward-looking in nature. Forward-looking statements involvea number of risks and uncertainties that may

 

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cause actual results todiffer materially from anticipated results. Specific factors that could causesuch differences include unexpected fluctuations in market interest rates,changes in economic conditions, changes in the competition for loans, or theinability to renew or obtain financing. Further information concerning risksand uncertainties is included in this report and the company’s other reportsfiled with the Securities and Exchange Commission.

 

The Company believes the factors discussed in itsreports 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 unknownfactors not discussed could also have material adverse effects on actualresults.  The Company does not intend toupdate its description of important factors each time a potential importantfactor arises.  The Company advises itsstockholders that they should:  (1) beaware that important factors not described herein could affect the accuracy ofour forward looking statements, and (2) use caution and common sense whenanalyzing our forward looking statements in this document or elsewhere.  All of such forward looking statements arequalified in their entirety by this cautionary statement.

 

**ITEM 3****.****                             *QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK***

 

The market riskdiscussion and the estimated amounts generated from the analysis that followsare forward-looking statements of market risk assuming certain adverse marketconditions occur. Actual results in the future may differ materially due tochanges in the Company’s product and debt mix, developments in the financialmarkets, and further utilization by the company of risk-mitigating strategiessuch as hedging.

 

The Company’s operatingrevenues are derived almost entirely from the collection of interest on thereceivables it retains and its primary expense is the interest that it pays onborrowings incurred to purchase and retain such receivables. The Company’scredit facilities bear interest at floating rates which are reset on ashort-term basis, whereas its receivables bear interest at fixed rates which donot generally vary with changes in interest rates. The Company is thereforeexposed primarily to market risks associated with movements in interest rateson its credit facilities. The Company believes that it takes the necessarysteps to appropriately reduce the potential impact of interest rate increaseson the Company’s financial position and operating performance.

 

The Company relies almostexclusively on revolving credit facilities to fund its origination ofreceivables. Periodically, the Company will transfer receivables from arevolving to a term credit facility. Currently all of the Company’s creditfacilities in bear interest at floating rates tied to either a commercial paperindex or LIBOR.

 

As of July 31, 2004, theCompany had $70.4 million of floating rate secured debt outstanding under theFIRC warehouse and working capital facilities. For every 1% increase in LIBOR annual after-tax earnings would decreaseby approximately $.7 million assuming the Company maintains a level amount offloating rate debt and assuming an immediate increase in rates.  As of July 31, 2003, the Company had $164.2million of floating rate secured debt outstanding net of swap and capagreements. For every 1% increase in commercial paper rates or LIBOR, annualafter-tax earnings would decrease by approximately $1.0 million assuming theCompany maintains a level amount of floating rate debt and assuming animmediate increase in rates.

 

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

 

In accordance with Exchange Act Rules 13a-15 and15d-15, we carried out an evaluation, under the supervision and with theparticipation of management, including our Chief Executive Officer and ChiefFinancial Officer, of the effectiveness of our disclosure controls andprocedures as of the end of the period covered by this report.  Based on that evaluation, our ChiefExecutive Officer and Chief Financial Officer concluded that our disclosurecontrols and procedures were effective as of July 31, 2004 to providereasonable assurance that information required to be disclosed in our reportsfiled or submitted under the Exchange Act is recorded, processed, summarizedand reported within the time periods specified in the Securities and ExchangeCommission’s rules and forms.

 

There has been no change in our internal controls overfinancial reporting that occurred during the three months ended July 31, 2004that has materially affected, or is reasonably likely to materially affect, ourinternal controls over financial reporting.

 

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

 

##### **OTHER INFORMATION**

 

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

 

(a)          Exhibits

 

31.1            Certification of Chief Executive Officer pursuantto section 302 of the Sarbanes-Oxley Act of 2002.

 

31.2            Certification of Chief Financial Officer pursuantto section 302 of the Sarbanes-Oxley Act of 2002.

 

32.1            Certification of Chief Executive Officer pursuantto section 906 of the Sarbanes-Oxley Act of 2002.

 

32.2            Certification of Chief Financial Officer pursuantto section 906 of the Sarbanes-Oxley Act of 2002.

 

Filedwith this 10-Q

 

(b)         Reports on Form 8-K

 

Form 8-K filed July 8, 2004, press releaseannouncing fiscal year end April 30, 2004 financial results.

 

### **SIGNATURES**

 

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

 
|                           | First  Investors Financial Services Group, Inc.   |
|--------------------------------|---------------------------------------------------|
|                           | (Registrant)                                      |
|                           |                                              |
| Date:  September 13, 2004 | By:  /s/TOMMY A. MOORE, JR.                       |
|                           | Tommy  A. Moore, Jr.                              |
|                           | President  and Chief Executive Officer            |
|                           |                                              |
| Date:  September 13, 2004 | By:  /s/BENNIE H. DUCK                            |
|                           | Bennie  H. Duck                                   |
|                           | Secretary,  Treasurer and Chief Financial Officer |

 

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