Our principal executive offices are located in owned premises at 8500 College Boulevard, Overland Park, Kansas 66210, and our telephone number is (913) 661-0123. This facility also serves Brooke Capital Corporation as a center for training franchisees and employees and serves as the administrative offices of Brooke Savings Bank. Brooke Investments, Inc. leases offices at 10950 Grandview Drive, Overland Park, Kansas 66210 which serve as the principal executive offices, the national sales office, the Kansas City regional franchise sales office and a franchise customer service center for Brooke Capital. Aleritas Capital Corp. (a d/b/a of Brooke Credit Corporation) leases offices at 7400 College Boulevard, Overland Park, Kansas 66210 which serve as that company’s principal executive offices.
The properties from which operations are conducted are not materially important to us. Management believes that our current leased and owned facilities are in good repair and adequate for current and proposed operations. In management’s opinion, adequate insurance has been purchased for each of the above-referenced properties.
statements and related notes included elsewhere in this report and the information under “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
Based on net income available to common stockholders (basic) of ($1,299),$9,873, and $9,511 for the years ended December 31, 2007, 2006 and 2005, respectively. Net income available to common stockholders (basic) is equal to net income less preferred dividends of $2,894, $869 and $194 for the years ended December 31, 2007, 2006 and 2005, respectively.
Despite the associated disadvantages, we prefer to hold investments in small public companies, instead of private companies, for the purposes of promoting entrepreneurial behavior by managers, diversifying risk, increasing accountability and increasing liquidity. Based on the range of BCP and BRCR closing stock prices during the fourth quarter, we had unrealized portfolio gains in our shares of BCP and BRCR stock ranging from a low of approximately $29,000,000 to a high of approximately $57,000,000.
Brooke Capital Corporation. Brooke Capital, an 81% owned subsidiary, owns First Life America Corporation which issues life insurance policies primarily through independent insurance agents. Brooke Capital has agreed to acquire Delta Plus Holdings, Inc., the owner of Traders Insurance Company, which issues auto insurance policies through independent insurance agents. Brooke Capital also owns Brooke Investments, Inc. an independent insurance agency franchisor and Brooke Capital Advisors, a consultant to insurance agency borrowers.
Aleritas Capital Corp. (a d/b/a of Brooke Credit Corporation). Aleritas, a 62% owned subsidiary, is a finance company that lends to businesses that sell insurance and related services. Aleritas generates most of its revenues from interest income resulting from loans held on its balance sheet in the form of inventory loans held for sale and from gains on sale of loans when they are removed from its balance sheet. On March 14, 2008, a dividend of approximately 2,300,000 shares of Aleritas shares was declared payable to our shareholders. As a result, our ownership in Aleritas will be reduced to less than 50% and we do not expect to consolidate Aleritas results with our results in future accounting periods.
income and expenses (in thousands, except percentages and per share data) for the years ended December 31, 2007, 2006 and 2005, and the percentage change from year to year.
Payroll expenses, which include wages, salaries, payroll taxes and compensated absences expenses increased primarily as a result of acquiring Delta Plus, Brooke Savings Bank, and Brooke Capital. Payroll
expenses, as a percentage of total operating revenue, were approximately 17% in 2007, 17% in 2006 and 20% in 2005.
Other operating expenses increased at a faster rate than total operating revenues during 2007 when compared to the same period in 2006 partially as the result of increases in collateral preservation expenses (See Insurance Segment, below). Other operating expenses which include advertising, rent, travel, lodging and office supplies, also increased as the result of acquiring Delta Plus, Brooke Savings Bank and Brooke Capital. Other operating expenses, as a percentage of total operating revenue, were approximately 28% in 2007, 21% in 2006 and 18% in 2005.
Investments increased as the result of investments held by Brooke Savings Bank and Traders Insurance Company which were acquired during the first quarter of 2007.
Notes receivable include primarily loans made by Aleritas to franchisees and others. Notes receivable balances vary, sometimes significantly from period to period, as a result of our decision to temporarily retain more or fewer loans in our “held for sale” loan inventory based on the funds available to us. Notes receivable balances remained relatively the same from 2006 to 2007. A loan loss reserve has been established in 2007 totaling $1,655,000 which reduces the notes receivable balance. The loan loss reserve was established due to holding loans longer on the balance sheet than previously, and delinquencies are increasing as the loan portfolio grows and matures.
Customer receivables, notes receivables, interest earned not collected on notes and allowance for doubtful accounts are the items that comprise our accounts and notes receivable, net, as shown on our consolidated balance sheet.
Deferred charges includes primarily the fees associated with the issuance of long-term debt by Aleritas and the costs of acquiring life insurance by First Life America.
Accounts payable, which includes franchise payables, producer payables, payroll payables and other accrued expenses, increased partially from the continued expansion of our franchise operations, which increased the accrual for estimated commission expense due franchisees. Accounts payable also increased as the result of acquiring Delta Plus, Brooke Savings Bank and Brooke Capital.
Payable under participation agreements is the amount we owe to funding institutions that have purchased participating interests in loans pursuant to transactions that do not meet the true sale test of SFAS 140, “Accounting for Transfers and Services of Financial Assets and Extinguishments of Liabilities.” Payable under participation agreements increased because we sold more loans pursuant to transactions that did not meet the true sale test.
The premiums payable liability category is comprised primarily of amounts due to insurance companies for premiums that are billed and collected by our franchisees. Premiums payable increased primarily from the continued expansion of our franchise operations, including the acquisition of Delta Plus, which resulted in an increase of premiums billed and collected by our franchisees. Premiums payable also increase from temporary fluctuations in agent billed activity.
Debt decreased primarily as the result of elimination of the on-balance-sheet financing previously provided by Fifth Third Bank, which was modified and resulted in off-balance-sheet financing.
The following tables provide information regarding our Notes Receivable, Note Participations and asset-backed securities, and Notes Payable principal balances and the corresponding weighted interest rates as of the end of each quarter in 2007, 2006 and 2005 (excluding capitalized lease balances). Notes Receivable balances
include the loans originated by Aleritas to our franchisees and others, even though the notes may no longer be on our balance sheet. Note Participations and asset-backed securities are comprised of loan participation interests that we have sold to our funding institutions and securitization entities. The Note Participation balance includes participations sold that are classified as a true sale and those that are not classified as a true sale or payable under participation agreements. The asset-backed securities exclude the portion of the securitization pools that are retained by us of $58,769,000, $37,003,000 and $32,898,000 at December 31, 2007, 2006 and 2005, respectively. Notes Payable balances are comprised of borrowings to fund the loans that we have made to our franchisees and others and include primarily notes issued to sellers of agencies we have purchased, borrowings under our lines of credit and bank borrowings.
The Banking Segment includes the sale of banking services by Brooke Savings Bank through independent agents. The Brokerage Segment includes the brokering of hard-to-place property and casualty insurance policies and life insurance policies on a wholesale basis by CJD & Associates through independent agents. The Lending Segment includes the lending activities of Aleritas.
All insurance company and retail insurance agency activities currently conducted, or expected to be conducted, by Brooke Capital are discussed in the Insurance Segment. These activities include life insurance company activities (previously discussed in the Financial Services Segment), non-standard auto insurance company activities (previously discussed in the Brokerage Segment), and insurance agency franchise activities (previously discussed in the Franchise Segment).
Revenues, expenses, assets and liabilities that are not allocated to one of the four reportable segments are categorized as “Corporate.” Activities associated with Corporate include functions such as accounting, auditing, legal, human resources and investor relations. Activities associated with Corporate also include the operation of captive insurance companies that self-insure portions of the professional liability (errors and omissions) exposure of franchisee insurance agents and insurance agents employed by Brooke Capital and its affiliates and provide financial guaranty policies to Aleritas.
December 31, 2007, these types of accounts represented $7,900,000 of Brooke Savings Bank’s total deposits of $26,403,000.
Insurance Brokerage Insurance commission revenues, policy fee revenues, commission expense and payroll expense decreased in 2006 primarily as the result of the sale of the Texas All Risk General Agency, Inc. in November 2005. Brooke Brokerage, through its wholly owned subsidiary, CJD & Associates, L.L.C., conduct insurance brokerage activities at its Overland Park, Kansas and Omaha, Nebraska underwriting offices under the Davidson-Babcock trade name.
Profit sharing commissions, or Brooke Brokerage’s share of insurance company profits paid by insurance companies on policies written by non-exclusive insurance agents, decreased $39,000, or 10% to $370,000, in
2007 and decreased $555,000, or 56% to $409,000, in 2006. Profit sharing commissions decreased in 2006 primarily as the result of the sale of the Texas All Risk General Agency, Inc. Profit sharing commissions represented approximately 13% and 14%, respectively, of Brooke Brokerage’s insurance commissions for the years ended December 31, 2007 and 2006.
Commission expense represented approximately 40% and 39%, respectively, of Brooke Brokerage’s insurance commission revenue for the years ended December 31, 2007 and 2006. Policy fee income represented approximately 17% and 19%, respectively, of Brooke Brokerage’s insurance commissions for the years ended December 31, 2007 and 2006.
Brooke Franchise has merged into Brooke Capital and we expect all of the common stock of Delta Plus to be contributed to Brooke Capital in May 2008. Assuming this transaction closes as planned; the companies discussed in this segment will include Brooke Capital and its wholly-owned subsidiaries and will correspond to the following chart of Brooke Capital’s primary companies.
The following financial information relates to our Insurance Segment and includes the financial information of Brooke Capital and Delta Plus (in thousands, except percentages). Assets, liabilities, and equity amounts are as of December 31, 2007 and December 31, 2006.
Non-Standard Auto Insurance Company Premiums Non-standard auto insurance policy premiums are currently generated entirely through Delta Plus’ insurance company subsidiary, Traders Insurance Company. Because the direct sale of non-standard auto insurance policies by Delta Plus is not expected to disrupt Brooke Capital’s relationship with the third-party independent insurance companies that are critical to the success of its franchise activities, Delta Plus expects to expand its non-standard auto insurance activities. Insurance premiums revenues generated by Delta Plus totaled $11,551,000 during 2007. Comparatively, Delta Plus’ insurance premium revenues totaled $9,715,000 during 2006.
Life Insurance Company Premiums Life insurance policy premiums are currently generated entirely through First Life America. Because the direct sale of life insurance policies by First Life America is not expected to disrupt Brooke Capital’s relationship with the third-party independent insurance companies that are critical to the success of its franchise activities, First Life America expects to gradually expand its life insurance activities. Insurance premiums revenues generated by First Life America totaled $3,710,000 during 2007. Comparatively, First Life America’s insurance premium revenues totaled $3,677,000 during 2006.
Non-Standard Auto Insurance Company Expenses Loss and loss adjustment expenses incurred by Delta Plus totaled $7,322,000 during 2007. Comparatively, Delta Plus’ loss and loss adjustment expenses totaled $6,837,000 during 2006. General and administrative expenses incurred by Delta Plus totaled $6,653,000 during 2007. Comparatively, Delta Plus’ general and administrative expenses totaled $8,987,000 during 2006.
generated from the sale of a specific insurance policy written through a third-party insurance company. Brooke Capital primarily relies on the recruitment of additional franchisees to increase insurance commission revenues.
Retail insurance commissions have increased primarily as a result of Brooke Capital’s continued expansion of franchise operations. Brooke Capital also received commissions from the sale of investment securities that are not directly related to insurance sales. However, these revenues are not sufficient to be considered material and are, therefore, combined with insurance commission revenues.
Brooke Capital sometimes retains an additional share of franchisees’ commissions as payment for franchisee optional use of Brooke Capital’s service. However, all such payments are applied to service center expenses and not applied to commission expense. As of December 31, 2007 and 2006, Brooke Capital service centers totaled 10 and 20, respectively.
Profit sharing commissions, or Brooke Capital’s share of insurance company profits paid by insurance companies on policies written by franchisees, and other such performance compensation, decreased $303,000, or 5%, to $5,343,000 in 2007 and $607,000, or 12%, to $5,646,000 in 2006. Profit sharing commissions represented approximately 5%, 6% and 6%, respectively, of Brooke Capital’s insurance commissions for the years ended December 31, 2007, 2006 and 2005. Franchisees do not receive any share of Brooke Capitals’ profit sharing commissions although Brooke Capital typically pays annual advertising expenses for the benefit of franchisees in amounts no less than the amount of annual profit sharing received by Brooke Capital.
Net commission refund liability is our estimate of the amount of Brooke Capital’s share of retail commission refunds due to insurance companies resulting from future policy cancellations. As of December 31, 2007 and 2006, Brooke Capital recorded corresponding total commission refund liabilities of $481,000 and $535,000, respectively. Correspondingly, commission refund expense decreased in 2007 to reflect this lower estimate.
Revenues from initial franchise fees for basic services are recognized as soon as Brooke Capital delivers the basic services to the new franchisee, such as access to Brooke Capital’s information and access to the Brooke Capital’s brand name. Upon completion of this commitment, Brooke Capital has no continuing obligation to the franchisee with regards to basic services.
The total amount of initial fees paid by a franchisee is first allocated to basic services, and if the franchise is of an acquired and converted business, the excess of such fees over the amount allocated to basic services is allocated to buyer assistance plan services. The initial franchisee fee for basic services tends to be uniform among franchisees, and the total initial franchisee fees can be limited by competitive pressures. The decrease in initial franchise fees for buyer assistance plans is primarily attributable to an increase in the amount charged for initial franchise fees for basic services and the establishment of a cap, or maximum amount, on initial franchise fees for buyer assistance plans that are charged for each acquisition.
Seller and Borrower-Related Revenues Seller and borrower-related revenues typically are generated when an insurance agency is acquired by Brooke Capital for sale to a franchisee or when Brooke Capital assists an insurance business in securing a loan. Seller and borrower-related revenues include consulting fees paid directly by sellers and borrowers, gains on sale of businesses from deferred payments, gains on sale of businesses relating to company-owned stores, and gains on sale of businesses relating to inventory. All seller and borrower-related revenues are considered part of normal business operations and are classified on our income statement as operating revenue. Seller and borrower-related revenues increased $5,502,000, or 79%, to $12,489,000, in 2007 and decreased $1,020,000, or 15%, to $6,987,000, in 2006. The significant increase in seller and borrower-related revenues from 2006 to 2007 is primarily attributable to an increase in borrower consulting fees generated.
Consulting fees. Brooke Capital helps sellers prepare their insurance agency businesses for sale by developing business profiles, tabulating revenues, sharing its document library and general sale preparation. Brooke Capital also generates revenues from consulting with insurance agency borrowers and assisting them in securing loans. The scope of consulting engagements is largely determined by the size of the business being sold or the loan being originated. Consulting fees are typically based on the transaction value, are contingent upon closing of the transaction, and are paid at closing. Brooke Capital completes its consulting obligation at closing and is not required to perform any additional tasks for sellers or borrowers. Therefore, with no continuing obligation on the part of Brooke Capital, consulting fees paid directly by sellers or borrowers are immediately recognized as income by Brooke Capital. The significant increase in consulting fees from 2006 to 2007 is primarily attributable to an increase in borrower consulting fees generated by the Brooke Capital Advisors subsidiary of Brooke Capital.
Gains on Sale of Businesses - Company-owned Stores. If we expect to own and operate businesses for more than one year, we consider these businesses to be company-owned stores and treat such transactions under purchase accounting principles, including booking intangible assets and recognizing the related amortization expense. By contrast, businesses purchased for resale to our franchisees (usually within one year) are carried at cost as business inventory, without the booking of intangible assets. There were no gains on sale resulting from the sale of company-owned stores in 2007 or 2006.
Franchise Collateral Preservation (CPA) Expenses CPA activities are separated into two general categories. The first category of CPA activities consists primarily of support services provided by our Phillipsburg, Kansas campus personnel for all franchisees pursuant to a franchise agreement and the corresponding recurring expenses are paid from recurring franchise fees collected from franchisees (see above). The second category of CPA activities consists primarily of the extra monitoring and consulting with borrowers provided by national and regional personnel pursuant to collateral preservation agreements with lenders.
This discussion of company-owned stores is separated into five store types: (1) inventoried stores; (2) franchisor-developed stores; (3) managed stores; (4) pending stores; and (5) franchisee-developed stores.
Inventoried Stores The number of total businesses purchased into inventory in 2007, 2006 and 2005 was 19, 33 and 69, respectively. At December 31, 2007, 2006 and 2005, respectively, we held 6, 3 and 4 businesses in inventory with respective total balances, at the lower of cost or market, of $9,413,000, $2,333,000 and $5,058,000. Write down expense on inventoried stores, resulting from a decrease in the market values of inventoried businesses, for the years ended December 31, 2007, 2006 and 2005 totaled $300,000, $975,000 and $0, respectively. Revenues from the operation of inventoried stores for 2007 and 2006 totaled $1,636,000 and $941,000, respectively. Expenses incurred in the operation of inventoried stores for 2007 and 2006 totaled $1,677,000 and $499,000, respectively.
Pending Stores At December 31, 2007 and 2006, the total number of businesses under contract for sale and managed by us pending closing of a sale was 17 and 11, respectively. Revenues from the operation of pending stores for the years ended December 31, 2007 and 2006 totaled $160,000 and $934,000, respectively. Operating expenses incurred by pending stores for the years ended December 31, 2007 and 2006 totaled $263,000 and $344,000, respectively. Additionally, owner’s compensation expenses incurred by pending stores for the years ended December 31, 2007 and 2006 totaled $312,000 and $494,000, respectively.
Franchisor-Developed Stores At December 31, 2007 and 2006, the total number of businesses owned and under development by us was 10 and 14, respectively. Revenues from developed stores for the years ended December 31, 2007 and 2006 totaled $23,000 and $16,000, respectively. Operating expenses incurred by developed stores for the years ended December 31, 2007 and 2006 totaled $390,000 and $190,000, respectively.
Franchisee-Developed Stores At December 31, 2007 and 2006, the total number of start up business locations for which the development process was interrupted was 119 and 0, respectively. Revenues from franchisee-developed stores for the years ended December 31, 2007 and 2006 totaled $471,000 and $0, respectively. Operating expenses incurred by franchisee-developed stores for the years ended December 31, 2007 and 2006 totaled $716,000 and $0, respectively. Additionally, owners’ compensation expense incurred by franchisee-developed stores for the years ended December 31, 2007 and 2006 totaled $495,000 and $0, respectively.
We have improved our process for recruiting and identifying insurance agents whom we believe have the personal attributes required to be successful at starting an insurance agency business, and the length of the start up period is now about 8 months. The start up period is the length of time typically allowed for franchisees to demonstrate their ability to generate sufficient commission revenues to qualify for an insurance agency business loan based on historical revenues. As a result of reducing the length of the start up period, the number of franchisees for which start up periods are expiring in any given month has approximately doubled. For example, start up periods expire in the same month for franchisees that began an 18 month start up period in April 2006 and for franchisees that began an 8 month start up period in February 2007. It is our experience that start up success rates, (the percentage of franchisees that generate sufficient commission revenues during
Franchise Relocations Sophisticated software has been purchased to assist us in the on-going analysis of demographic data and location performance in order to improve its site selection process. When location facilities are determined to be unsuitable based on neighborhood demographic or local office characteristics (as opposed to when individual franchisees are unsuitable based on personal attributes), then facilities are closed and relocated to more suitable locations. At December 31, 2007, we have scheduled 31 facilities to close and relocate.
Same Store Sales Revenue generation, primarily commissions from insurance sales, is an important factor in franchise financial performance and revenue generation is carefully analyzed by Brooke Capital. Twenty-four months after initial conversion of an acquired business, Brooke Capital considers a franchise “seasoned” and the comparison of current to prior year revenues a more reliable indicator of franchise performance. Combined same store sales of seasoned converted franchises and start up franchises for years ended December 31, 2007 and 2006 decreased 2% and 2%, respectively. The median annual revenue growth rates of seasoned converted franchises and qualifying start up franchises for the years ended December 31, 2007 and 2006 were 7% and -1%. All same store calculations exclude profit sharing commissions. Same store calculations are based entirely on commissions allocated by Brooke Capital to franchisees’ monthly statements. Brooke Capital is unable to determine the impact, if any, on same store calculations resulting from commissions that franchisees receive but do not process through Brooke Capital as required by their franchise agreement.
Franchise Balances Brooke Capital categorizes the balances owed by franchisees as either statement balances or non-statement balances. Statement balances are generally short-term and non-statement balances are generally longer term. We believe the most accurate analysis of franchise balances occurs immediately after settlement of franchisees’ monthly statements and before any additional entries are recorded to their account. Therefore, the following discussion of franchise balances is as of the settlement date that follows the corresponding commission month.
Statement Balances Brooke Capital assists franchisees with short-term cash flow assistance by advancing commissions and granting temporary extensions of due dates for franchise statement balances owed by franchisees to Brooke Capital. Franchisees sometimes require short-term cash flow assistance because of cyclical fluctuations in commission receipts. Short-term cash flow assistance is also required when franchisees are required to pay Brooke Capital for insurance premiums due to insurance companies prior to receipt of the corresponding premiums from policyholders. The difference in these amounts has been identified as the “uncollected accounts balance” and this balance is calculated by identifying all charges to franchise statements for net premiums due insurance companies for which a corresponding deposit from policyholders into a premium trust account has not been recorded. Despite commission fluctuations and uncollected accounts balances, after initial conversion into its franchise system, Brooke Capital expects franchisees’ to regularly pay their statement balances. As such, Brooke Capital categorizes as “watch” those statement balances that have not been repaid in full at least once in the previous four months. The increase in watch statement balances is
partially attributable to financial stress resulting from less commission revenues from reduction of premium rates by insurance companies and increased expenses from higher interest rates.
The following table summarizes total statement balances, uncollected account balances and watch statement balances as of December, 2007 and December, 2006 (in thousands).
Non-statement Balances Separate from short-term statement balances, Brooke Capital also extends credit to franchisees for long-term producer development, including hiring and training new franchise employees, and for other reasons not related to monthly fluctuations of revenues. These longer term non-statement balances are not reflected in the short-term statement balances referenced above and totaled $9,798,000 and $9,115,000, respectively, as of December 2007 and 2006. During the years ended December 2007 and 2006, non-statement balances increased at a faster rate than commissions primarily as a result of the increasing use of our producer development program by an increasing number of start up and company developed franchises.
Brooke Capital’s experience indicates that producer failure is usually identified within three months of initiating a producer development program and producer failure significantly increases the likelihood of credit losses. Therefore, Brooke Capital categorizes as “watch” balances all balances for producers who are in the first three months of development. Watch non-statement balances totaled $0 and $10,000 as of December 2007 and 2006, respectively. The decrease in watch non-statement balances is attributable to the financing of more producer development expenses through lenders.
The following table summarizes the Allowance for Doubtful Accounts activity for December 31, 2007, 2006, and 2005 (in thousands). Additions to the allowance for doubtful accounts are charged to expense.
Lending interest rates are typically set by Aleritas, although competitive forces are important limiting factors when establishing rates. Aleritas funds its loan portfolio primarily through the sale of loan participation interests to other lenders, the sale of loans to qualified special-purpose entities in which the entities secure off-balance-sheet financing through the issuance of asset-backed securities or bank debt and on-balance-sheet funding from cash and short-term lines of credit.
The following discussions regarding loan balances, number of loans, number of obligors, interest rates and seasoning periods exclude related party loans made to Brooke Corporation and sister companies. As of December 31, 2007, loan balances in which Aleritas has retained interest and/or servicing rights, totaled approximately $678,246,000 compared to $483,278,000 as of December 31, 2006, a 40% increase. Of the loan balances as of December 31, 2007, $136,298,000 were on-balance sheet and $541,948,000 were off-balance sheet, compared to $164,153,000 on-balance sheet and $319,125,000 off-balance sheet as of December 31, 2006. On-balance sheet loans consist of (1) those loans held in inventory on the balance sheet, (2) those loans sold to participating lenders that do not qualify as true sales pursuant to the criteria established by SFAS 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” (“SFAS 140”), and (3) those loans sold to Aleritas’ warehouse entities that are bankruptcy-remote special purpose entities. Off-balance sheet loans consist of (1) those loans sold to participating lenders that qualify as true sales pursuant to the criteria established by SFAS 140, (2) those loans sold to qualifying special purpose securitization entities that qualify for a true sale pursuant to the criteria established by SFAS 140, and (3) those loans sold, on a revolving basis, to a $150 million warehouse facility which qualify for true sale treatment under SFAS 140.
As of December 31, 2007, loan balances were comprised of 1,313 loans with 843 obligors, resulting in an average balance per loan of approximately $517,000 and an average balance per obligor of approximately $805,000. As of December 31, 2006, loan balances were comprised of 1,156 loans with 750 obligors, resulting in an average balance per loan of $418,000 and average balance per obligor of $644,000.
As of December 31, 2007 and 2006, the weighted average seasoning period of the loans in Aleritas’ portfolio was 16 months and 14 months, respectively. As of December 31, 2007, the weighted average months to maturity or remaining term was 125 months, compared to 131 months as of December 31, 2006.
Aleritas mitigates credit risk by retaining industry consultants and franchisors (“Collateral Preservation Providers”) to provide certain collateral preservation services, including assistance in the upfront analysis of a credit application, assistance with due diligence activities, assisting in ongoing surveillance of a borrower’s
As loan balances increased during 2006 and 2007, Aleritas correspondingly increased the number of Collateral Preservation Providers that it utilizes to help mitigate credit exposure and maintain credit quality. During the year ended December 31, 2007, Aleritas paid $5,750,000 in collateral preservation fees to Collateral Preservation Providers, including Brooke Capital, Brooke Brokerage’s subsidiary, CJD & Associates, L.L.C., Brooke Capital Advisors, Inc. (formerly First Life Brokerage, Inc.), all affiliates, and Marsh Berry & Company, a non-affiliate, compared to $4,263,000 paid for the year ended December 31, 2006. As of December 31, 2007, Collateral Preservation Providers in which Aleritas has contracted to purchase collateral preservation services included Brooke Capital, Brooke Brokerage Corporation’s subsidiary, CJD & Associates, LLC, and First Life Brokerage, Inc. (Brooke Capital Advisors, Inc. as of February 2007), all affiliates, and Marsh Berry & Company and Johnson Consulting Group, non-affiliates. In some cases, these affiliates may contract with unaffiliated third parties to assist them in providing collateral preservation services.
In a true sale, there are three components of the gain on sale of notes receivable: the gain associated with the over collateralization benefit, the gain associated with the ongoing servicing responsibilities, and the gain
The second component of the gain on sale of notes receivable is the gain on sale recorded associated with the interest-only strip receivable benefit based on a present value calculation of future expected cash flows of the interest spread on the underlying participation loans sold, net of prepayment and credit loss assumptions. The spread associated with loan participations increased from 2.24% in 2006 to 2.46% in 2007 since a greater proportion of loans sold as participations in 2007 were managing general agency and retail agency non-franchise loans. These loan types have a wider spread than retail agency franchise loans. The spread percentages above exclude the spread associated with related party loans sold. The increase in net gains from interest benefits during 2007 and 2006 was primarily the result of increased loans sold off-balance sheet in both years.
The third component of the gain on sale of notes receivable is the gain associated with the ongoing servicing responsibilities. When the sale of a loan participation is accounted for as a true sale, servicing responsibilities are retained for which Aleritas typically receives annual servicing fees ranging from 0.25% to 1.375% of the outstanding balance. A gain or loss is recognized immediately upon the sale of a loan participation based on whether the annual servicing fees are greater or less than the cost of servicing, which is estimated at 0.25% of the outstanding loan balance. The gain or loss associated with loan servicing is determined based on a present value calculation of future cash flows from servicing the underlying loans, net of servicing expenses and prepayment assumptions. The increase in net gains from loan servicing benefits for both 2007 and 2006 was primarily the result of more loans sold as true sale loan participations as a result of the growth of the loan portfolio. Additionally, the loan servicing fee was increased by 0.125% at the beginning of 2006.
qualifying special-purpose entities, it typically retains interest rights. The component of the gain on sale of notes receivable to qualifying special-purpose entities is the gain on sale recorded associated with the interest-only strip receivable and retained interest benefit, net of direct expenses. Unlike participation sales, in loans sold to qualifying special-purpose entities an unaffiliated third-party is the servicer and Aleritas is a secondary or sub-servicer. As such, no servicing asset or liability is recorded.
When Aleritas sells its loans to special-purpose entities in connection with securitizations, the net proceeds have historically approximated 75% to 85% of the loan balances sold to the special-purpose entity. Unlike participation sales, in securitizations an unaffiliated third-party is the servicer and Aleritas is a secondary or sub-servicer. No servicing asset or liability is recorded. The remaining amount is the retained interest (the over collateralization that is provided to enhance the credit of the asset-backed securities) or the interest-only strip receivable. The initial amount of this retained interest has historically ranged from approximately 15% to 25%, with the calculation varying depending on such factors as the type of loans being securitized (e.g. retail insurance agency - franchise, retail insurance agency - non franchise, funeral home), the relative size of principal balances of individual loans, state concentrations, borrower concentrations and portfolio seasoning. For example, in Aleritas’ securitization that closed in July of 2006, loans with balances totaling $65,433,000 were sold to a qualifying special-purpose entity. Net proceeds of $52,346,000 were received by Aleritas (see footnote 2 to our consolidated financial statements for the net proceeds associated with Aleritas’ other securitizations). With respect to loans sold as participations, the net proceeds received are generally 100% of the principal balance of the loans sold. In the event that Aleritas chooses to sell less than an entire loan to a participating lender, the net proceeds are generally 100% of the principal balance associated with the portion of the loan sold. Although when loans are sold pursuant to a true sale they are removed from the balance sheet, the fair value of the interest only strip receivable retained, the fair value of the difference between loans sold and securities issued to an investor (in the case of a securitization) and the fair value of cash reserves are recorded as the cash value of the reserve account.
During the fourth quarter of 2005, the discount rate assumption was changed from 8.50% to 11.00%. Several factors were considered when determining the discount rate. As a starting point for analyzing this assumption, a range of the risk-free rate was used to determine a base discount rate. This base discount rate was then adjusted for various risk characteristics associated with the sold loans.
The most significant impact from the sale of loan participations and asset-backed securities has been the removal of loans from Aleritas’ balance sheet that it continues to service. As of December 31, 2007 and December 31, 2006, the balances of those off-balance sheet assets totaled $541,948,000, or 80% of its portfolio, and $319,125,000, or 66% of its portfolio, respectively. These amounts exclude sales of related party
Loan Servicing Assets and Liabilities When Aleritas recognizes non-cash gains for the servicing benefits of loan participation sales, it books that amount as a loan servicing asset on its balance sheet. This amount is equal to Aleritas’ estimate of the present value of future cash flows resulting from the servicing spread. Aleritas recognizes such assets only
Loan Participations-Interest-Only Strip Receivable Asset To the extent that the difference between the rate paid by Aleritas to participating lenders and the rate received from its borrowers exceeds the maximum of 1.375% allocated to the servicing benefit, Aleritas recognizes a non-cash asset, called an “Interest-only strip receivable asset,” on its balance sheet. This amount is equal to Aleritas’ estimate of the present value of expected future cash flows resulting from this interest spread, net of credit loss (to the extent loans are sold to participating lenders with recourse to the Company) and prepayment assumptions. Components of the interest receivable asset as of December 31, 2007 were as follows (in thousands):
discount rates (11.00%) commensurate with the risks involved. The fair value of the cash reserves has been estimated at the cash value of the reserve account.
Additionally, Aleritas recognizes a non-cash gain from subordinate interest spread in the loans sold, in which Aleritas recognizes an interest-only strip receivable included within its securities balances. The amount of gain or loss recorded on the sale of notes receivable to qualifying special-purpose entities depends in part on the previous carrying amount of the financial assets involved in the transfer, allocated between the assets sold and the assets retained based on their relative fair value at the date of transfer. To initially obtain fair value of retained interest-only strip receivable resulting from the sale of notes receivable to qualifying special-purpose entities, quoted market prices are used, if available. However, quotes are generally not available for such retained residual assets. Therefore, Aleritas typically estimates fair value for these assets. The fair value of the interest-only strip receivables retained is based on the present value of future expected cash flows using management’s best estimates of key assumptions, credit losses (0.50% annually), prepayment speed (12.00% annually) and discount rates (11.00%) commensurate with the risks involved.
Although Aleritas does not provide recourse on the transferred notes and is not obligated to repay amounts due to investors and creditors of the qualifying special-purpose entities, its retained interest assets are subject to loss, in part or in full, in the event credit losses exceed initial and ongoing management assumptions used in the fair market value calculation. Additionally, a partial loss of retained assets could occur in the event actual prepayments exceed management’s initial and ongoing assumptions used in the fair market calculation.
Other Income The increase in other income during 2007 and 2006 was primarily attributable to increased prepayment income received on loans that prepaid prior to the scheduled maturity date.
Management anticipates that this interest expense will increase in the future because the off-balance sheet facility is nearing capacity and the on-balance sheet facility was renegotiated in 2007 to lower its interest rate, making it more economical to use.
borrower financial performance. Collateral preservation fees increased $2,015,000, or 85%, to $4,372,000 for the year ended December 31, 2007 from $2,357,000 for the year ended December 31, 2006. Additionally, other operating expenses increased due to a restricted stock grant expense of $2,174,000 for the year ended December 31, 2007.
Aleritas believes another important factor which has resulted in favorable credit performance for Aleritas, its participating lender and investors, is utilization of Collateral Preservation Providers to perform collateral
Financial information not allocated to a reportable segment and relating primarily to Brooke Corporation (parent only), The DB Group, Ltd. and DB Indemnity, Ltd. is as follows (in thousands, except percentages).
Shared Services Fees An internal allocation of legal, accounting, human resources, information technology and facilities management expenses is made to each of the four reportable segments based on our estimate of usage. These shared services fees totaled $5,190,000, $8,400,000 and $7,020,000, respectively, in 2007, 2006 and 2005, and are recorded as a reduction of other operating expenses. As a result of Aleritas and Brooke Capital becoming separate public companies during 2007, shared services fees are expected to be significantly less in 2008.
Other Operating Expenses Other operating expenses increased significantly in 2007 as a result of a $3,210,000 reduction in shared services fees, which are recorded as a reduction of other operating expenses, and our guaranty of franchise receivables balances to Brooke Capital when Brooke Franchise merged into Brooke Capital in November 2007.
The DB Group, Ltd. The DB Group insures a portion of the professional insurance agents’ liability exposure of Brooke Capital, its affiliated companies and its franchisees and had a policy in force on December 31, 2007 that provided $5,000,000 of excess professional liability coverage. In 2007 and 2006, respectively, DB Group recorded total revenues of $292,000 and $327,000 and total operating expenses of $96,000 and $112,000, resulting in income before income taxes of $196,000 and $215,000. Prior to January 1, 2006, DB Group results were recorded and discussed in the brokerage segment. DB Group has not established reserves for claims.
DB Indemnity, Ltd. DB Indemnity issues financial guarantee policies to Aleritas and had policies in force on December 31, 2007 covering principal loan balances totaling $257,041,000. In 2007 and 2006, respectively, DB Indemnity recorded total revenues of $1,471,000 and $934,000 and total operating expenses of $1,148,000 and $672,000, resulting in income before income taxes of $323,000 and $262,000. For the year ended December 31, 2007 and 2006, respectively, DB Indemnity incurred $826,000 and $260,000 in claims or loss expense. Based on information received from Aleritas, DB Indemnity’s IBNR reserve for claims was $600,000 and $350,000, respectively, on December 31, 2007 and 2006. If premium rates are established at
Future claims are expected to increase because some borrowers are experiencing financial stress, partially from a reduction of commission revenues resulting from reduction of premium rates by insurance companies. Aleritas has relied on Brooke Capital to assist in collateral preservation and the rehabilitation of problem borrowers. As Aleritas and Brooke Capital become increasingly independent of Brooke Corporation and each other, claims may also increase in the future if Brooke Capital does not continue the same level of assistance.
DB Indemnity issues financial guaranty policies exclusively for the benefit of Aleritas. As a result of the Aleritas merger, our ownership interest in Aleritas was significantly reduced but our interest in DB Indemnity was not correspondingly reduced. As such, we have changed the underwriting and pricing of DB Indemnity financial guarantee policies so that the minority shareholders of Aleritas do not receive extra benefits at the expense of our shareholders. Prior to the Aleritas merger, Aleritas primarily controlled policy underwriting by authorizing the issuance of policies on loans that complied with its internal loan policy. Subsequent to the Aleritas merger, we have assumed primary responsibility for policy underwriting and we now individually underwrite each policy. We have also increased premiums to help ensure that premium revenues are sufficient to pay claims expense.
Our cash and cash equivalents decreased a total of $16,045,000 from December 31, 2006 to December 31, 2007 primarily as a result of an increase in notes and account receivable along with increase in payments on debt. During 2007, net cash of $10,252,000 was provided by operating activities, which resulted primarily from a $16,147,000 decrease in notes receivables retained by our finance subsidiary prior to loan sale or securitization. Net cash of $10,675,000 was used in investing activities, which resulted primarily from our finance subsidiary’s investment in securities from securitizations. Net cash of $15,622,000 was used in financing activities, which resulted primarily from net payments on debt of $25,062,000.
Our cash and cash equivalents increased a total of $8,882,000 from December 31, 2005 to December 31, 2006. During 2006, net cash of $100,887,000 was used in operating activities, which resulted primarily from a $130,727,000 increase in notes receivables by our finance subsidiary prior to loan sale or securitization. Net cash of $25,002,000 was used in investing activities, which resulted primarily from a $13,312,000 purchase in July 2006 of subordinate investment interest in securitized loan pools. Net cash of $134,771,000 was provided by financing activities, which resulted primarily from an issuance of long term-debt.
Brooke Corporation We have transitioned from primarily holding wholly-owned, privately-held subsidiaries to primarily holding partially-owned, publicly-traded subsidiaries (Aleritas and Brooke Capital). Our future primary source of revenues will likely be the sale of stock in our public company subsidiaries because revenues from shared services fees, income tax sharing arrangements and dividends previously received from our private company subsidiaries will decrease significantly. As a result of “lock-up” provisions in the Aleritas and Brooke Capital merger agreements, we cannot sell shares of Brooke Capital until May 2008 and cannot sell shares of Aleritas until July 2008. Therefore, until the lock-up periods expire, Brooke Corporation may issue debt to pay corporate expenses and dividends. Disruption of the stock or credit markets may prohibit us from selling Aleritas or Brooke Capital stock or from issuing debt until stock is sold. After the lock periods expire, we believe that revenues from the sale of stock in our public company subsidiaries will be sufficient to offset decreases in other sources of revenues and that the combined sources of revenues will be sufficient to fund our normal operations and pay our corporate expenses, income taxes and dividends.
Brooke Capital Brooke Capital is listed on the American Stock Exchange and has responsibility for meeting its requirements for capital without our assistance. Brooke Capital plans to expand Delta Plus’ non-standard auto insurance company activities which may require additional capital. However, Brooke Capital does not intend to rely on additional equity capital investments from us and is exploring strategic alternatives, including soliciting capital investments from other investors and the sale of assets.
Our established accounting policies are summarized in footnotes 1 and 2 to our consolidated financial statements for the years ended December 31, 2007, 2006 and 2005. As part of our oversight responsibilities, we continually evaluate the propriety of our accounting methods as new events occur. We believe that our policies are applied in a manner that is intended to provide the user of our financial statements with a current, accurate and complete presentation of information in accordance with generally accepted accounting principles.
Reserve for Doubtful Accounts Our allowance for doubtful accounts is comprised primarily of allowance for estimated losses related to amounts owed to us by franchisees for short-term credit advances, which are recorded as monthly statement balances, and longer-term credit advances, which are recorded as non-statement balances. Losses from advances to franchisees are estimated by analyzing all advances recorded to franchise statements that had not been repaid within the previous four months; all advances recorded as non-statement balances for producers who are in the first three months of development, total franchise statement balances; total non-statement balances; historical loss rates; loss rate trends; potential for recoveries; and management’s experience. Loss rates will vary and significant growth in our franchise network could accelerate those variances. The effect of any such variances can be significant. The estimated allowance for doubtful accounts as of December 31, 2007 was $1,114,000. The estimated allowance was approximately 24% of the actual amount of losses from advances made to franchisees for the year ended December 31, 2007, approximately 6% of the actual total combined franchise statement and non-statement balances as of December 31, 2007, and approximately 12% of the actual combined advances recorded to franchise statements that had not been repaid during the year period ended December 31, 2007 and recorded as non-statement balances for producers in the first three months of development.
The Company has also established an allowance of $7,840,000 at December 31, 2007, for losses on property and casualty insurance policies issued by Traders Insurance Company.
These assumptions regarding discount rate, prepayment rate and credit loss are based on historical comparisons, management’s experience and the trends in actual and forecasted portfolio prepayment speeds, portfolio credit losses, risk-free interest rates and market interest rates. The accuracy of these assumptions is monitored and changes made as necessary. It is important to note that our loan portfolio experienced an annualized prepayment rate of 12.9% over the past twelve months. Management believes that this increase during 2007 is directly attributable to market conditions which are cyclical such as the softening insurance marketplace and the increasing interest rate environment. The prepayment assumption determined by management is an average annual rate over the life of our portfolio. Management believes that during the remaining term of this portfolio, several cycles are likely to occur which could increase or decrease actual prepayment rates; however, due to recent prepayment and interest rate trends, the prepayment rate assumption was increased from 10% to 12% annually in 2007’s fourth quarter. Shorter-term swings in prepayment rates typically occur because of cycles within a marketplace, such as a softening and hardening of the insurance marketplace, changes in the death care rate for funeral homes and changes in the variable interest rate loans from key index rate changes. Longer term increases in prepayment rates typically result from long-term deterioration of the marketplace or increased lending competition.
Subsequent to the initial calculation of the fair value of retained interest, we utilize a fair market methodology to determine the ongoing fair market value of the retained interest. Ongoing fair value is calculated using the then current outstanding principal of the transferred notes receivable and the outstanding balances due unaffiliated purchasers, which are reflective of credit losses and prepayments prior to the fair value recalculation. The rates of write down of the retained interest are based on the current interest revenue stream. This revenue stream is based on the loan balances at the date the impairment test is completed, which will include all prepayments on loans and any credit losses for those loans. However, due to the impairment of the collateral supporting certain loans an additional impairment loss of $4,739,000 was recorded which reduced the securities balance.
Provision for Credit Losses Our credit loss exposure is limited to on-balance sheet loans (other than loans sold to warehouse qualifying special-purpose entities which are classified as on-balance sheet) and the our retained interest in loans that are sold to qualifying special-purpose entities that have issued asset-backed securities or off-balance sheet bank debt. A credit loss assumption is inherent in the calculations of retained interest-only strip receivables resulting from loans that are sold. Historically, no reserve for credit losses had been made for on-balance sheet loans held in inventory for eventual sale for two reasons. First, these loans were typically held for six to nine months before being sold to investors and, therefore, had a short-term exposure to loss. Second, commissions received by Brooke Capital, are typically distributed to Aleritas for loan payments prior to distribution of commissions to the franchisee borrower and most other creditors.
Amortization and Useful Lives We acquire insurance agencies and other businesses that we intend to hold for more than one year. We record these acquisitions as Amortizable intangible assets. Accounting for Amortizable intangible assets, and the subsequent tests for impairment are summarized in footnote 1(g) to our consolidated financial statements for the years ended December 31, 2007 and 2006. The rates of amortization of Amortizable intangible assets are based on our estimate of the useful lives of the renewal rights of customer and insurance contracts purchased. We estimate the useful lives of these assets based on historical renewal rights information, management’s experience, industry standards, and trends in actual and forecasted commission payout rates. The rates of amortization are calculated on an accelerated method (150% declining balance) based on a 15-year life. As of December 31, 2007, we tested Amortizable intangible assets for impairment and the resulting analysis indicated that our assumptions were historically accurate and that the useful lives of these assets exceeded the amortization rate. The Amortizable intangible assets have a relatively stable life and unless unforeseen circumstances occur, the life is not expected to change in the foreseeable future. Because of the relatively large remaining asset balance, changes in our estimates could significantly impact our results.
remaining asset balance, changes in our estimates that significantly shorten the estimated maturity dates could significantly impact our results.
As part of our ongoing operations, we make loans to franchisees and others to fund purchases or start ups of insurance agencies or funeral homes or ongoing working capital needs. We engage in the sale of loan participation interests in individual loans to banks and finance companies and the securitization of pools of insurance agency loans. These typically meet the requirements of true sales as outlined in FAS 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities.” The sale of loan participations and loan securitizations has resulted in the removal of a significant amount of loans from our balance sheet. The loan sales enable us to:
Even when loans are removed from the balance sheet, however, some risk is retained with respect to those loans that are sold with recourse and the over-collateralized portion of securitized loan pools. See “Retained Securities” and “Loans Sold with Recourse,” below. Credit losses associated with recourse notes, retained interest held in securities and retained servicing obligations in excess of management’s assumptions could materially and adversely affect our operations and financial condition. Although credit performance has historically been favorable for us, our participating lenders and our asset-backed security investors, the level of credit losses and payment delinquencies increased during 2007 due, in part, to increasing interest rates and a softening insurance premium insurance market. We expect increased levels of delinquencies, defaults and credit losses as the full impact of these market conditions are felt by the Company’s borrowers.
The following table reports for each of the six securitizations in which we have been involved during fiscal years 2003, 2004, 2005 and 2006: (1) the amount of loans sold to a qualifying special purpose entity,
(2) the amount of asset-backed securities issued as a part of the securitization, (3) the amount of servicing income received by the Company for the year ended December 31, 2006, (4) the fair value of the difference between loans sold and securities issued to accredited investors and the fair value of the interest receivable retained recorded as a security for the period ended December 31, 2006, (5) the portion of the security comprised of retained interest, and (6) the portion of the security comprised of retained equity in the special purchase entity.
To the extent that the difference between the rate paid by Aleritas to participating lenders and investors and the rate received by Aleritas from borrowers exceeds the maximum of 1.375% allocated to the servicing benefit, Aleritas recognizes a non-cash asset, called an “Interest Receivable Asset,” on its balance sheet. This amount is equal to our estimate of the present value of future cash flows resulting from this interest spread. With respect to sale of loan participations, our right to interest income is not subordinate to the purchaser’s interests and we share interest income with purchasers on a pro rata basis. Although not subordinate to the purchaser’s interests, our retained interest is subject to credit and prepayment risks on the transferred assets. On loan participations sold with recourse, our retained interest is subject to credit risk on the transferred assets.
In connection with the recognition of non-cash gains for the interest benefits of asset-backed securities sales, the present value of future cash flows was recorded as an interest receivable asset and included on the balance sheet as part of the investment securities balance. Components of the interest receivable asset as of December 31, 2007 were as follows (in thousands):
We annually evaluate and measure the retained interest and servicing assets for potential impairment. Impairment testing involves comparing our current discounted value of future interest and servicing revenue with our carrying value for the retained interest and servicing assets. If the new discounted revenue stream is less than the value on the books, further analysis is performed to determine if an “other than temporary” impairment has occurred. If an “other than temporary” impairment has occurred, we write the asset to the new discounted revenue stream.
Subsequent to the initial calculation of the fair value of retained interest, BCC utilizes a fair market methodology to determine the ongoing fair market value of the retained interest. Ongoing fair value is
calculated using the then current outstanding principal of the transferred notes receivable and the outstanding balances due unaffiliated purchasers, which are reflective of credit losses and prepayments prior to the fair value recalculation. The rates of write down of the retained interest are based on the current interest revenue stream. This revenue stream is based on the loan balances at the date the impairment test is completed, which will include all prepayments on loans and any credit losses for those loans. However, due to the impairment of the collateral supporting certain loans an additional impairment loss of $4,739,000 was recorded which reduced the securities balance.
Loans Sold with Recourse The business and real estate loans on our balance sheet at December 31, 2007 and 2006, $130,000 and $2,247,000, respectively, were sold to various participating lenders with recourse to Aleritas. Such recourse is limited to the amount of actual principal and interest loss incurred and any such loss is not due for payment to the participating lender until such time as all collateral is liquidated, all actions against the borrower are completed and all liquidation proceeds applied. However, participating lenders may be entitled to periodic advances from Aleritas against liquidation proceeds in the amount of regular loan payments. At December 31, 2007, all such recourse loans: a) had no balances more than 60 days past due; b) had adequate collateral; and c) were not in default.
One of our goals is to fund an increasing number of originated loans through our warehouse lines of credit, leading up to the time of loan securitizations. To do so, our debt is expected to increase. The increase in our debt may cause our network of participating lenders to become uncomfortable and, as a result, we may not be able to sell participation interests in loans we originate on terms acceptable to us or at all. Such result would have a material adverse effect on our operations and prospects for growth. Accordingly, we are cautiously monitoring our increased debt totals resulting from warehouse funding activities and the comfort of the network of participating lenders and will modify our method of funding practices as needed to maintain a
significant network of purchasers of loans. We are considering alternative warehouse structures to reduce our debt. However, no assurances can be made that we will find an acceptable alternative.
the absence of any downgrading or withdrawal of ratings given to securities previously issued in our securitizations.
A general decline in economic activity in the United States or in one of the states or geographic regions in which we operate, such as California, Texas, the Southwest, the Midwest or the Southeast, could also affect our results and financial condition.
An adverse change in economic activity could reduce the ability of individuals and small businesses - the key customers for our franchisees - to purchase insurance and other financial services. In such event, the revenue growth rate of our franchisees could flatten or decline, in turn reducing our revenues and hurting our franchisees’ ability to make timely interest and principal payments on their loans.
We have audited the accompanying consolidated balance sheets of BROOKE CORPORATION AND SUBSIDIARIES (Brooke Corporation) as of December 31, 2007 and 2006, and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2007. We also have audited Brooke Corporation’s internal control over financial reporting as of December 31, 2007 based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Brooke Corporation’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on these consolidated financial statements and an opinion on the Company’s internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinion.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatement. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Brooke Corporation (the “Company”) was incorporated under the laws of the State of Kansas in January 1986. The Company’s registered office is located in Overland Park, Kansas. At December 31, 2007, Brooke Holdings, Inc. owned 42.84% of the Company’s outstanding common stock. The Company is primarily a holding company that owns directly, or indirectly through a wholly owned subsidiary, 100% of the stock and ownership interests of all of its subsidiaries, except for Brooke Capital Corporation and Brooke Credit Corporation. The Company’s primary business operations are conducted by its subsidiaries and include franchising, franchise and insurance related lending, insurance brokerage and loan brokerage.
Although the Company has multiple subsidiaries, the Company’s business operations are typically performed by one of four operating subsidiaries: Brooke Capital Corporation, Brooke Credit Corporation, Brooke Bancshares, Inc. and Brooke Brokerage Corporation. Each operates independently from the other four operating subsidiaries, and from the Company, to perform its specific business purpose. The Company provides accounting, administrative and legal support to its four operating subsidiaries for which it receives administrative fees. Company revenues are typically limited to dividends and administrative fees from these operating subsidiaries.
Brooke Bancshares, Inc. (formerly named Brooke Brokerage Corporation), is a wholly-owned Kansas corporation which on January 8, 2007 acquired all of the issued and outstanding stock of Generations Bank (now Brooke Savings Bank), a federal savings bank for a purchase price of $10.1 million in cash. The Bank conducts its operations providing banking products and services through contracted bank agents who leverage existing relationships with Brooke Capital Corporation franchisees through its network and with other independent agents.
Brooke Brokerage Corporation (formerly named Brooke Bancshares, Inc.) is a wholly-owned Kansas corporation and serves as the parent holding company of the subsidiaries involved in the brokerage segment. It is the direct owner of 100% of the ownership interests of CJD & Associates, L.L.C. Although Brooke Brokerage Corporation is categorized as an operating subsidiary, all of its operations are conducted through CJD & Associates, L.L.C., a licensed insurance agency that sells hard-to-place and niche insurance on a wholesale basis, under the trade name of Davidson-Babcock. During 2006 CJD brokered loans for general insurance agencies, funeral homes and other small businesses. Beginning on December 8, 2006, Brooke Capital Advisors, Inc. began operating a managing general agency loan brokerage and consulting business, with CJD & Associates, L.L.C. ceasing to offer such services to new customers on that date.
DB Indemnity, Ltd. was incorporated under the laws of Bermuda and is licensed as a Class 1 insurer under the Insurance Act 1978 of Bermuda and related regulations for the purpose of self-insuring financial guaranty policies to Brooke Credit Corporation and its participating lenders. Prior to 2006, DB Indemnity, Ltd. self-insured a portion of the professional insurance agents’ liability exposure of Brooke Capital Corporation, its affiliated companies and its franchisees.
As part of the process of securitizing Brooke Credit Corporation’s loan portfolio, limited liability companies are organized in Delaware as bankruptcy-remote qualifying special purpose entities. To the extent required by the securitization process, separate financial statements are prepared for each securitization subsidiary.
Brooke Acceptance Company 2007-1, LLC was formed during March 2007 and is a wholly-owned subsidiary of Brooke Warehouse Funding, LLC. Brooke Warehouse Funding, LLC is a wholly-owned subsidiary of Brooke Credit Corporation. Brooke Acceptance Company 2007-1, LLC was the purchaser of loan participation interests from Brooke Warehouse Funding, LLC in connection with an off balance sheet financing facility with Fifth Third Bank that closed on March 30, 2007. Brooke Warehouse Funding, LLC was the true sale purchaser of Brooke Credit Corporation loans. Brooke Master Trust, LLC, a Delaware bankruptcy remote special purpose limited liability company organized on September 18, 2007, is a wholly owned subsidiary of Brooke Warehouse Funding, LLC and replaced Brooke Acceptance Company 2007-1, LLC, which was dissolved, as borrower upon the closing of a master trust credit facility with Fountain Square Commercial Funding Corporation. The financial information of Brooke Warehouse Funding, LLC is consolidated with the Company’s financial information while Brooke Master Trust, LLC’s financial information is not consolidated.
Delta Plus Holdings, Inc. was acquired on March 30, 2007. Delta Plus Holdings, Inc. is a holding company based in Missouri with one direct subsidiary, Traders Insurance Connection, Inc. Traders Insurance Connection, Inc. has two direct subsidiaries, Traders Insurance Company and Professional Claims, Inc. Christopher Joseph & Company was a direct subsidiary of Delta Plus Holdings, Inc., but the assets were sold to Brooke Franchise Corporation on March 30, 2007, immediately after Brooke Corporation’s acquisition of Delta Plus Holdings, Inc. to be franchised as Brooke franchise offices. Traders Insurance Company is a Missouri domiciled property and casualty insurance company writing non-standard private passenger auto liability and physical damage business in Arkansas, Missouri, Kansas, Oklahoma and New Mexico. Traders Insurance Company’s products are marketed through independent agents, as well as through Christopher Joseph & Company, and, after the acquisition, through Brooke franchisees. Traders Insurance Connection, Inc. provides professional management services to clients, sales management, underwriting and servicing of personal lines insurance products. Traders Insurance Connection, Inc. also provides business planning, personnel consulting, general marketing, financial management and maintenance of accounting records for affiliates. Professional Claims, Inc. operates as an independent claims adjusting company for Traders Insurance Connection, Inc. and other unrelated insurance companies, providing for the investigation and adjusting of
Brooke Credit Corporations’s credit loss exposure is limited to on-balance sheet loans (other than loans sold to warehouse special purpose entities which are classified as on-balance sheet) and the retained interest in loans which have been sold to qualifying special purpose entities that have issued asset-backed securities or off-balance sheet bank debt. A credit loss assumption is inherent in the calculations of retained interest-only
The following schedule entitled “Valuation and Qualifying Accounts” summarizes the Allowance for Doubtful Accounts activity for the periods ended December 31, 2007, 2006 and 2005. Additions to the allowance for doubtful accounts are charged to expense.
The Company does not accrue interest on loans that are 90 days or more delinquent and payments received on all such loans are applied to principal. Loans and accounts receivables are written off when management determines that collection is unlikely. This determination is made based on management’s experience and evaluation of the debtor’s circumstances.
from amounts due to the Company from insurance carriers. The Company has estimated and accrued a liability for commission refunds of $570,000 and $645,000 at December 31, 2007 and 2006, respectively.
Impairment Losses. Although the Company does not provide recourse on its transferred notes and is not obligated to repay amounts due to investors and creditors of the qualifying special purpose entities, its retained assets are subject to loss, in part or in full, including in the event credit losses exceed initial and ongoing management assumptions used in the fair market value calculation. Additionally, a partial loss of retained assets could occur in the event actual prepayments exceed management’s initial and ongoing assumptions used in the fair market calculation.
On an ongoing basis, the Company determines the ongoing fair market value of the retained interest using the current outstanding principal of the transferred notes receivable and the outstanding balances due to unaffiliated purchasers, which are reflective of credit losses and prepayments prior to the fair value recalculation. Additionally, the Company performs an ongoing analysis of key assumptions used in the fair market value calculation to ensure that such assumptions remain viable, based on current and historical prepayments and credit loss treads, within similar asset types. Management may adjust the key assumptions based on current and historical trends, which may result in an immediate reduction or impairment loss in the fair market value of retained interest.
Total initial franchise fees for BAP services typically vary based on a percentage of the acquired business’s revenues because the time and expertise required of the Company to perform BAP services generally varies with acquisition size. However, the time and expertise required of the Company to provide basic services and the value to franchisees of those basic services, remains the same for all franchisees (even to start up or de novo franchisees), therefore the amount of total initial franchise fees allocated to basic services does not vary. Accordingly, total initial franchise fees are first allocated to initial franchise fees for basic services in the amount typically charged to start up franchisees and the remainder of the total initial franchise fees is allocated to BAP services. Although substantially all of the BAP services are performed prior to closing, the Company does not record revenues from initial franchise fees until the actual payment of fees at closing.
The Company sometimes acquires businesses that it plans to own and operate as part of its business. If it later decides to sell such businesses for a price greater than their carrying value, it then recognizes a gain. When the business is sold, the Company has no continuing obligations and, therefore, revenues from gains on sale of businesses resulting from agency sales are recognized immediately at the time of sale.
Included in other assets are the unamortized costs of renewal rights (rights to renewal commissions received from insurance policies) purchased by the Company and through subsidiaries (Brooke Life and Health, Inc., The American Agency, Inc. and CJD & Associates, L.L.C.) for businesses the Company plans to own and operate for more than one year. The balance is being amortized over a 15-year period using an accelerated 150% declining balance switching to straight-line method. The rates of amortization of Amortizable Intangible Assets are based on management’s estimate of the useful lives of the renewal rights of customer and insurance contracts purchased. Amortization was $454,000, $297,000 and $478,000 for the years ended December 31, 2007, 2006 and 2005, respectively.
Goodwill represents the amount by which the cost of an acquisition exceeded the fair values of net assets in excess of the fair values of liabilities acquired by the Company in transactions accounted for using the purchase method of accounting. The Company periodically reviews goodwill to determine whether there have been any events or circumstances to indicate that the recorded amounts are not recoverable from projected undiscounted net operating cash flows. If the projected undiscounted net operating cash flows are less than the carrying amount, a loss would be recognized to reduce the carrying amount to fair value. During 2007, the Company’s goodwill has been determined to be unimpaired.
Net income tax expense is the tax calculated for the year based on the Company’s effective tax rate plus the change in deferred income taxes during the year. Deferred tax liabilities were recorded in 2007 and 2006 to recognize the future tax consequences of temporary differences between financial reporting amounts and the tax basis of existing assets and liabilities based on currently enacted tax laws and tax rates in effect for the years in which the differences are expected to reverse.
The amount of assets included in the “Investment in Businesses” category is the total of purchase prices paid, or market prices if lower, for business assets, primarily renewal rights, that Brooke Capital Corporation acquires to hold in inventory for sale to its franchisees. Renewal rights associated with businesses that the Company plans to own and operate for less than one year are considered inventory and are not amortized (see footnote 1(g)) because the residual values of those assets are expected to be the same at the time of sale to franchisees as at the time of acquisition by the Company. Typically, the Company acquires and sells the business assets simultaneously. If the assets are not sold simultaneously, then the Company operates the business until sold and records the income and expense associated with the business. The amount of income and expenses associated with inventoried businesses is not considered material by the Company. The number of businesses purchased for this purpose for the years ended December 31, 2007 and 2006 was 19 and 33, respectively. Correspondingly, the number of businesses sold from inventory for the year ended December 31, 2007 and 2006 was 16 and 34, respectively. At December 31, 2007 and 2006, the “Investment in Businesses” inventory consisted of 6 businesses and 3 businesses, respectively, with fair market values totaling $9,413,000 and $2,333,000, respectively.
Deferred charges include loan fees paid in 2004, 2005 and 2007 to establish and increase a line of credit with DZ BANK AG Deutsche Zentral-Genossenschaftsbank. Associated costs totaled $1,741,000, of which $696,000 was paid in 2004 to establish the line of credit and $300,000 was paid in 2005 to increase the line of credit and $745,000 was paid in 2007 to further increase the line of credit. Also included in deferred charges are costs associated with fees paid to establish lines of credit with Fifth Third Bank and Home Federal Savings and Loan Association of Nebraska in 2006. These costs totaled $423,000 and $168,000, respectively, and were paid in 2006. These costs are amortized over the period ending at the maturity date of the respective line of credit. Additional deferred charges include $4,839,000 in fees paid in association with the $45,000,000 subordinated debt issuance that occurred in November 2006. These costs are amortized over the period ending at the maturity date of the subordinated debt. Net of amortization, the balance of all such amounts was $5,354,000 and $5,884,000 at December 31, 2007 and 2006, respectively.
Commissions and other costs of acquiring life insurance, which vary with, and are primarily related to, the production of new business have been deferred to the extent recoverable from future policy revenues and gross profits. The acquisition costs are being amortized over the premium paying period of the related policies using assumptions consistent with those used in computing policy reserves. Net of amortization, the balance was $5,406,000 and $5,210,000 at December 31, 2007 and 2006, respectively.
Commissions and other costs of acquiring property and casualty insurance, which vary with, and are primarily related to, the production of new business, have been deferred to the extent recoverable from future policy revenues and gross profits. The acquisition costs are being amortized over the premium paying period of the related policies using assumptions consistent with those used in computing policy reserves. Net of amortization, the balance was $550,000 at December 31, 2007.
In September 2006, the Company issued to an accredited institutional investor in a private placement transaction 20,000 shares of its newly designated 13% Perpetual Convertible Preferred Stock Series 2006, par
In September 2006, in conjunction with the sale of the 2006 convertible preferred stock, the Company issued warrants to purchase 235,294 shares of the Company’s common stock at an exercise price per share of $24.00, subject to anti-dilution adjustments. These warrants were exercisable immediately and expire September 2010.
Basic net income per share is calculated by dividing net income, less preferred stock dividends declared in the period (whether or not paid) and the dividends accumulated for the period on cumulative preferred stock (whether or not earned), by the average number of shares of the Company’s common stock outstanding. Diluted net income per share is calculated by including the probable conversion of preferred stock to common stock, and then dividing net income, less preferred stock dividends declared on non-convertible stock during the period (whether or not paid) and the dividends accumulated for the period on non-convertible cumulative preferred stock (whether or not earned), by the adjusted average number of shares of the Company’s common stock outstanding. The dilutive calculation of earnings per share can be anti-dilutive if the dividends paid on preferred stock are greater than the common stock earnings per share. If this occurs, these shares are eliminated for the calculation. Total preferred stock dividends declared during the years ended December 31, 2007, 2006 and 2005 were $2,894,000, $869,000 and $194,000, respectively.
*The convertible preferred stock is anti-dilutive at December 31, 2007. These shares are excluded from the dilution calculation and included as preferred stock dividend.
As part of its initial services to franchisees, the Company sometimes assists franchisees with the conversion of acquired businesses into its franchise system pursuant to a buyers assistance plan (BAP). Substantially all of the BAP services (inspection reports, operations analysis and marketing plan development) are typically provided by the Company before franchise acquisition.
The consolidated financial statements include the accounts of the Company and its subsidiaries, except for the following qualifying special purpose entities: Brooke Acceptance Company, LLC, Brooke Captive Credit Company 2003, LLC, Brooke Capital Company, LLC, Brooke Securitization Company 2004A, LLC, Brooke Securitization Company V, LLC, Brooke Securitization 2006-1, LLC and Brooke Master Trust, LLC. These qualifying special purpose entities were formed for the sole purpose of acquiring loans in connection with the securitization of agency loans. Each is treated as its own separate and distinct entity. Qualifying special purpose entities are specifically excluded from consolidation under FIN 46(R), “Consolidation of Variable Interest Entities.”
The Company owns controlling interest in Brooke Capital Corporation and Brooke Credit Corporation. Accordingly, the results of operations and balance sheets accounts at December 31, 2007 are included in the Company’s consolidated financial statements.
On January 8, 2007, the Company completed the acquisition of Generations Bank. The Company assigned its rights and obligations under the Agreement to its wholly owned subsidiary, Brooke Bancshares, Inc. (formerly Brooke Brokerage Corporation), prior to closing. Accordingly, the Bank’s balance sheet accounts at December 31, 2007 and results of operations since January 8, 2007 are included in the Company’s consolidated financial statements.
The net notes receivable included as part of the “Accounts and Notes Receivable, Net” asset category are available for sale and are carried at the lower of cost or market. Based on management’s experience, the carrying value approximates the fair value. Any changes in the net notes receivable balances are classified as an operating activity.
The Company expenses the costs of advertising as they are incurred. Total advertising and marketing expenses for the years ended December 31, 2007, 2006 and 2005 was $14,950,000, $13,224,000 and $10,306,000, respectively.
Cash payments are made monthly to First National Bank of Phillipsburg as trustee for the Industrial Revenue Bonds. These funds are held by the trustee for payment of semi-annual interest and principal payments to bond holders on January 1st and July 1st. The amount of cash held at First National Bank of Phillipsburg at December 31, 2007 and 2006 was $73,000 and $71,000, respectively.
The Company holds insurance commissions for the special purpose entities Brooke Acceptance Company LLC, Brooke Captive Credit Company 2003, LLC, Brooke Securitization Company 2004A, LLC, Brooke Capital Company, LLC, Brooke Securitization Company V, LLC and Brooke Securitization Company 2006-1 for the purpose of making future loan payments, and the use of these funds is restricted until the next monthly loan payment is made. The amount of commissions held at December 31, 2007 and 2006 was $171,000 and $615,000, respectively.
The Company holds amounts in escrow in a cash account for certain borrowers for the purpose of paying debt service, property taxes and/or property insurance typically paid during the first year of the loan financing. The amount of escrowed cash held at December 31, 2007 and 2006 was $210,000 and $564,000, respectively.
When the Company sells notes receivable to qualifying special purpose entities that qualify as true-sales under SFAS 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” (“SFAS 140”), a gain on sale is recognized when the note receivables are sold. When the Company sells notes receivable to qualifying special purpose entities, it typically retains the interest rights. The component of the gain on sale of notes receivable to qualifying special purpose entities is the gain on sale recorded associated with the interest-only strip receivable and retained interest benefit as described below, net of direct expenses. Unlike participation sales, for loans sold to qualifying special purpose entities an unaffiliated third party is the servicer and the Company acts as a secondary or sub-servicer. As such, no servicing asset or liability is recorded.
When the Company sells notes receivable to qualifying special purpose entities, it retains an interest-only strip receivable or retained interest. The carrying values of the interest-only strip receivable in loans sold to qualifying special purpose entities were $28,144,000 and $12,094,000 at December 31, 2007 and December 31, 2006, respectively. The amount of gain or loss recorded on the sale of notes receivable to qualifying special purpose entities depends in part on the previous carrying amount of the financial assets involved in the transfer, allocated between the assets sold and the assets retained based on their relative fair value at the date of transfer. To initially obtain fair value of the retained interest-only strip receivable resulting from the sale of notes receivable to qualifying special purpose entities, quoted market prices are used if available. However, quotes are generally not available for such retained residual assets. Therefore, the Company typically estimates fair value for these assets. The fair value of the interest-only strip receivables retained is based on the present value of future expected cash flows using management’s best estimates of key assumptions, credit losses (0.50% annually), prepayment speed (12.00% annually at December 31, 2007, and 10.00% annually at December 31, 2006) and discount rates (11.00%) commensurate with the risks involved. The amount of unrealized gain (loss) on the retained residual assets was ($89,000), $89,000 and $575,000 at December 31, 2007, 2006 and 2005 respectively. The interest-only strip receivables have varying dates of maturity ranging from the fourth quarter of 2015 to the second quarter of 2021.
When the Company sells notes receivable to qualifying special purpose entities, it retains an over-collateralization interests in loans sold and cash reserves. The carrying values of retained over-collateralization interests were $58,769,000 and $37,003,000 at December 31, 2007 and December 31, 2006, respectively. The carrying values of cash reserves were $850,000 and $1,223,000 at December 31, 2007 and December 31, 2006, respectively. The fair value of the over-collateralization interest in the loans sold to qualifying special purpose entities that have issued asset-backed securities has been estimated at the par value (carrying value) of the underlying loans less the asset-backed securities sold. The fair value of the over-collateralization interest in the loans sold to qualifying special purpose entities that have secured bank debt, is based on the present value of future expected cash flows using management’s best estimates of key assumptions, credit losses (0.50% annually), prepayment speed (12.00% annually at December 31, 2007, and 10.00% annually at December 31, 2006) and discount rates (11.00%) commensurate with the risks involved. The cash reserves do not represent
credit enhancement reserves for benefit of the asset-backed security holders and creditors of the qualifying special purpose entities. These reserves are for the benefit of the third party trustee and servicer and if not used for excessive trustee and servicer expenses, the funds will be returned to the Company once the last note receivable held by the qualifying special purpose entity has matured. If excessive expenses are incurred by the trustee and servicer the Company will expense the reduction of the cash reserve. No excessive expenses have been incurred by the trustees and servicers to date. Therefore, the fair value of the cash reserves has been estimated at the cash value of the reserve account.
The notes receivable sold in April 2003, November 2003, June 2004, March 2005, December 2005 and July 2006 involved the issuance of asset-backed securities by the following qualifying special purpose entities: Brooke Acceptance Company, LLC; Brooke Captive Credit Company 2003, LLC; Brooke Securitization Company 2004A, LLC; Brooke Capital Company, LLC; Brooke Securitization Company V, LLC; and Brooke Securitization Company 2006-1, LLC, respectively. In September 2006, Brooke Warehouse Funding, LLC entered into a receivables financing agreement with Fifth Third Bank which was classified as secured borrowings. However, in March 2007, Brooke Warehouse’s Fifth Third facility was paid off and replaced with a new off balance sheet facility through Brooke Warehouse Funding, LLC’s wholly-owned qualifying special purpose entity, Brooke Acceptance Company 2007-1, LLC. Therefore, the loans sold in March 2007 to Brooke Warehouse Funding, LLC, the Company’s special purpose entity, involved the incurrence of debt owed to Fifth Third Bank by Brooke Acceptance Company 2007-1, LLC, a wholly-owned qualifying special purpose entity subsidiary of the Brooke Warehouse Funding, LLC. Loans sold to Brooke Warehouse Funding, LLC are participated to Brooke Acceptance Company 2007-1, LLC which are then pledged to Fifth Third Bank for the off balance sheet debt. The purchase of loans by Brooke Warehouse Funding, LLC, the participation of those loans to Brooke Acceptance Company 2007-1, LLC and the pledge to Fifth Third Bank occurred simultaneously. In December 2007 Brooke Acceptance Company 2007-1, LLC was replaced by Brooke Master Trust, LLC. Loans now sold to Brooke Warehouse Funding, LLC are participated to Brooke Master Trust, LLC which are then pledged to Fifth Third Bank for the off-balance sheet debt.
Cash flows associated with the Company’s retained assets in the transferred assets are subordinate to cash flow distributions to the trustee over the transferred assets, servicer of the transferred loans, collateral preservation providers of the transferred loans, investors and creditors of the qualifying special purpose entities. Actual prepayments and credit losses will impact the amount and frequency of cash flow distributions to the Company from its retained assets. Although the Company expects to receive a certain level of cash flows over the life of the sold financial assets and the term of the asset-backed securities and senior debt
secured by the qualifying special purpose entities, the Company will not receive full return of its retained assets until all obligations of the qualifying special purpose entities with respect to underlying loans are met.
Footnote 2 also contains a table summarizing the principal balances of loans managed by the Company. Included within the table are delinquency and net credit loss trends of managed receivables at December 31, 2007 and December 31, 2006.
Trading securities are those securities that may be purchased and held principally for the purpose of selling in the near term. Such securities are carried at fair value with unrealized gains or losses included in earnings. Realized gains or losses, determined on the basis of the cost of specific securities sold, are included in earnings. Unrealized losses for securities classified as held to maturity and available for sale judged to be other than temporary are charged to operations. As of December 31, 2007 and December 31, 2006, all investment securities within the Company’s portfolio were classified as available-for-sale.
The Company has established an allowance of $7,840,000 at December 31, 2007, for losses on property and casualty insurance policies issued by Traders Insurance Company. Reserves of $600,000 and $350,000 at December 31, 2007 and 2006, respectively, were established for claims on financial guaranty policies issued by DB Indemnity, Ltd. on loans originated by the Company’s finance subsidiary.
The Company has granted stock options to employees of the Company pursuant to its 2001 Compensatory Stock Option Plan, which terminated, except with respect to options then outstanding on April 27, 2006. The Company adopted SFAS 123R, “Share-Based Payment,” on January 1, 2006. The Company’s net income for the year ended December 31, 2006 was reduced by $38,000 and its income per fully diluted share remained at $0.76. The Company’s net income would have been reduced to $9,641,000 and $6,493,000 for the years ended December 31, 2005 and 2004, respectively, with the Company’s income per fully diluted share being reduced to $0.86 and $0.63 at December 31, 2005 and 2004, respectively, if the compensation cost for the stock options had been determined based on the fair value at the date of grant pursuant to the provisions of SFAS 123R, “Share-Based Payment.” The Company made the following assumptions when calculating the fair
When the Company sells notes receivable to a participating bank, it retains an interest-only strip receivable. The amount of gain or loss recorded on the sale of notes receivable to a participating bank depends in part on the previous carrying amount of the financial assets involved in the transfer, allocated between the assets sold and the interest-only strip receivable based on its relative fair value at the date of transfer. To obtain fair values, the Company estimates fair value based on the present value of future expected cash flows using management’s best estimates of the key assumptions (credit losses, prepayment speeds, and discount rates) commensurate with the risks involved.
The amortized cost and fair value of fixed maturities at December 31, 2007, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities because certain borrowers may have the right to call or prepay obligations.
be worse than expected or have more of an impact on the issuer than anticipated, (3) the risk that fraudulent information could be provided to the Company’s investment professionals who determine the fair value estimates and other-than-temporary impairments, and (4) the risk that new information obtained by the Company or changes in other facts and circumstances lead the Company to change its intent to hold the security to maturity or until it recovers in value. Any of these situations could result in a charge to income in a future period.
The warrant obligation consisted of the detachable warrants for Brooke Credit Corporation common stock issued in connection with Brooke Credit Corporation’s debt offering during the fourth quarter of 2006. The detachable noteholder warrants are within the scope of SFAS 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity”. SFAS 150 requires issuers to classify as liabilities (or assets under certain circumstances) free-standing financial instruments which, at inception, require or may require an issuer to settle an obligation by transferring assets.
In conjunction with the construction of an advertising/marketing center in Phillipsburg, Kansas the Company now retains large quantities of marketing materials that franchisees use to promote their businesses. These marketing supplies may be held in inventory for a period of up to 12 months before delivery to franchisees.
Interest expense on deposits totaled approximately $502,000 for the year ended December 31, 2007
The Company has a corresponding liability for interest payable to participating lenders in the amounts of $1,609,000 and $903,000 at December 31, 2007 and 2006, respectively.
Loan participations and loan securitizations represent the transfer of notes receivable, by sale, to “participating” lenders or asset-backed security investors. The Company receives consideration from the transfer of notes receivable, through retained interest and servicing assets. These transfers are accounted for by the criteria established by SFAS 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.”
Of the notes receivable sold, at December 31, 2007 and 2006, $538,963,000 and $319,125,000, respectively, were accounted for as sales because the transfers meet the criteria established by SFAS 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.”
and securities issued to accredited investors (or the retained equity) and the fair value of cash reserves were recorded on the Company’s books as a security with balances of $1,054,000 and $2,307,000, respectively, on December 31, 2007 and 2006. At December 31, 2007, this security is comprised of retained interest-only strip receivables totaling $80,000, retained equity in the special purpose entity totaling $849,000 and cash reserves totaling $125,000.
In November 2003, Brooke Credit Corporation sold $23,526,000 of loans to qualifying special purpose entity Brooke Captive Credit Company 2003, LLC. This sale represents a loan securitization for which an interest receivable was retained. Of the loans sold, $18,500,000 of asset-backed securities were issued to accredited investors by Brooke Captive Credit Company 2003, LLC. Brooke Credit Corporation received servicing income of $4,000, $8,000 and $12,000, respectively, from the primary servicer for the years ended December 31, 2007, 2006 and 2005. The fair value of the interest-only strip receivable retained, the fair value of the difference between loans sold and securities issued to accredited investors (or the retained equity) and the fair value of cash reserves were recorded on the Company’s books as a security with balances of $1,263,000 and $3,511,000, respectively, on December 31, 2007 and 2006. At December 31, 2007, this security is comprised of retained interest-only strip receivables totaling $108,000, retained equity in the special purpose entity totaling $1,030,000 and cash reserves totaling $125,000.
In March 2005, the Company sold $40,993,000 of loans to qualifying special purpose entity Brooke Capital Company, LLC. This sale represents a loan securitization in which an interest receivable was retained. Of the loans sold, $32,000,000 of asset-backed securities were issued to accredited investors by Brooke Capital Company, LLC. Brooke Credit Corporation received servicing income of $30,000, $36,000 and 32,000, respectively, from the primary servicer for the years ending December 31, 2007, 2006 and 2005. The fair value of the interest-only strip receivable retained, the fair value of the difference between loans sold and securities issued to accredited investors (or the retained equity) and the fair value of cash reserves were recorded on the Company’s books as a security with balances of $5,902,000 and $9,339,000, respectively on December 31, 2007 and 2006. At December 31, 2007, this security is comprised of retained interest-only strip receivables totaling $1,810,000, retained equity in the special purpose entity totaling $3,967,000 and cash reserves totaling $125,000.
In December 2005, the Company sold $64,111,000 of loans to qualifying special purpose entity Brooke Securitization Company V, LLC. The sale represents a loan securitization in which an interest receivable was retained. Of the loans sold, $51,500,000 of asset-backed securities were issued to accredited investors by Brooke Securitization Company V, LLC. Brooke Credit Corporation received servicing income of $45,000, $61,000 and $6,000, respectively, from the primary servicer for the years ending December 31, 2007, 2006 and 2005. The fair value of the interest-only strip receivable retained, the fair value of the difference between loans sold and securities issued to accredited investors (or the retained equity) and the fair value of cash reserves were recorded on the Company’s books as a security with a balance of $9,285,000 and $14,891,000, respectively, on December 31, 2007 and 2006. At December 31, 2007, this security is comprised of retained
interest-only strip receivables totaling $2,995,000, retained equity in the special purpose entity totaling $6,115,000 and cash reserves totaling $175,000.
At December 31, 2007 and December 31, 2006, the fair value of retained interest-only strip receivables recorded by the Company was $35,893,000 and $16,591,000, respectively. Of the totals at December 31, 2007,
At December 31, 2007 and December 31, 2006, the value of the servicing asset recorded by the Company was $6,025,000 and $4,512,000, respectively.
At December 31, 2007, key economic assumptions used in measuring the retained interest-only strip receivables and servicing assets when loans were sold during the year were as follows (rates per annum):
During the fourth quarter of 2007, the prepayment speed assumption was changed from 10.00% to 12.00%.
The above adverse changes for prepayment speed and discount rate are calculated on the Company’s retained interest-only strip receivables and servicing assets on loans sold totaling $538,963,000. The above adverse changes for expected credit losses are calculated on the Company’s retained interest-only strip receivables in loans sold to qualifying special-purpose entities.
Loans 60 days or more past due are based on end of period loan balances.
Net credit losses are based on total loans outstanding. The net credit losses are net of recoveries, including recoveries from the proceeds of financial guaranty policies.
Loans on balance sheet exclude reserve for credit loss of $1,655,000 and $0 at December 31, 2007 and 2006.
Net credit losses for loans in the off-balance sheet warehouse facility are accounted for through the valuation of the retained securities.
Seller notes payable are typically the deferred portion of purchase prices paid by the Company to acquire insurance agencies for resale by the Company to franchisees. Seller notes payable are secured by a collateral interest in the insurance policy renewal rights purchased by the Company. Sellers typically agree that their security interests are subordinate to Brooke Credit’s security interests in the renewal rights of the agency, which also collateralize the loans made by Brooke Credit to franchisees. The renewal rights associated with the collateral interests of seller notes payable had estimated annual commissions of $47,457,000 and $39,369,000 at December 31, 2007 and 2006, respectively.
None of the Amortizable Intangible Assets described in footnote 1(g) and none of the Acquisitions and Divestitures described in footnote 11 were financed with seller note payables at December 31, 2007. Three notes payable to banks for Company debt require the Company to maintain minimum financial ratios or net worth and restrict dividend payments from Brooke Credit Corporation to the Company.
The note payable to Fifth Third Bank contains the following covenants: maintain a minimum stockholders’ equity of $40,000,000 and maintain positive net income for the trailing four quarters in Brooke Credit Corporation. The Company is also subject to certain minimum stockholders’ equity requirements. The Fifth
Third Bank warehouse facility also places restrictions on certain other warehouse line indebtedness to a maximum of $85,000,000.
In addition, the Company has agreed to certain restrictions applicable to it and certain of its subsidiaries regarding, among other things, (1) investment in other affiliates; (2) payment of any dividends or distributions, (3) incurrence of additional debt, (4) pledging of certain assets (5) reorganization and merger, and (6) disposition of assets.
The miscellaneous adjustment above includes the taxes of Brooke Capital Corporation which files a separate tax return.
Credit risk is limited by emphasizing investment grade securities and by diversifying the investment portfolio among various investment instruments. The Company maintains cash balances at several banks. Certain cash balances exceed the maximum insurance protection of $100,000 provided by the Federal Deposit Insurance Corporation. At December 31, 2007, the Company had account balances of $10,663,000 that exceeded the insurance limit of the Federal Deposit Insurance Corporation.
Brooke Credit, through its qualifying special-purpose entities subsidiaries, had $145,438,000 in off-balance sheet debt outstanding to one financial institution, equaling 47% of the total assets then sold through qualifying special-purpose entities. Brooke Credit had an additional $8,967,000 of on-balance sheet debt outstanding to this financial institution. Brooke Credit also had sold asset-backed securities totaling $58,153,000 to one financial institution, equaling 19% of the total assets then sold through qualifying special-purpose entities. Brooke Credit Corporation had sold participation interests in loans totaling $104,678,000 to two financial institutions, equaling 36% of the participation interests then sold.
As of December 31, 2007, approximately 60% of Brooke Savings Bank’s loan accounts and approximately 33% of its loan volume and current business activity is with customers located within the states of Missouri and Kansas.
Approximately 27% of Brooke Credit Corporations loans (both on and off-balance sheet) were located in Florida.
Loans to the four largest obligors comprised 13% of Brooke Credit Corporations total loan portfolio excluding related party loans.
The Company had three reportable segments in 2006 and 2005 and has four reportable segments in 2007. For the year ended December 31, 2007 the segments consisted of its Insurance Services Business, its Brokerage Business, its Lending Services Business and its Banking Services Business. For the year ended December 31, 2006 the segments consisted of its Franchise Services Business, its Brokerage Business and its Lending Services Business.
The Insurance Services Business segment includes the sale of insurance, financial and credit services on a retail basis through franchisees. Activities associated with the Insurance Services Business also include real estate ownership and corporate real estate management through Brooke Investments, Inc. and operations of Brooke Capital Corporation and Delta Plus Holdings, Inc. The Brokerage Business segment includes the sale of hard-to-place and niche insurance policies on a wholesale basis, operations of a small life insurance company, the brokerage of loans for general insurance agencies, funeral homes and other small businesses. The Lending Services Business segment includes the solicitation, underwriting, origination, sale and servicing of loans. The Banking Services Business segment sells banking products and services primarily through independent insurance and other agents. Revenues, expenses, assets and liabilities that are not allocated to one of the four reportable segments are categorized as “Corporate.” Activities associated with Corporate include functions such as accounting, auditing, legal, human resources and investor relations. Activities associated with Corporate also include the operation of captive insurance companies that self-insure portions of the professional insurance agents’ liability exposure of Brooke Capital Corporation, its affiliated companies and its franchisees and provide financial guaranty policies to Brooke Credit Corporation and its participating lenders. Activities associated with Corporate in 2006 also include the operations of First American Capital Corporation and real estate ownership and corporate real estate management through Brooke Investments, Inc.
The segments’ accounting policies are the same as those described in the summary of significant accounting policies. The Company assesses administrative fees to each business segment for legal, corporate and administrative services. Administrative fees for Insurance Services, Lending Services, Brokerage Business and Banking Services for the year ended December 31, 2007 totaled $2,850,000, $2,250,000, $60,000 and $30,000 respectively. Shared services for the three segments existing during the years ended December 31, 2006 and 2005 totaled $4,800,000, $1,800,000, $1,800,000 and $5,100,000, $1,800,000, $120,000, respectively. Administrative fees are reported as an expense for the individual business segment and reported as “other operating expenses” in the reconciliation of the segment totals to the related consolidated totals. Unallocated corporate-level expenses are reported in the reconciliation of the segment totals to the related consolidated totals as “other operating expenses.”
Robert D. Orr, Chairman of the Board, and Leland G. Orr, Chief Executive Officer, own a controlling interest in Brooke Holdings, Inc. which owned 42.84% of the Company’s common stock at December 31, 2007.
During 2007, BCC entered into a $271,000 agency acquisition loan with a borrower advised by Post Rock Advisors. Shawn T. Lowry, a principal of Post Rock Advisors, is Michael S. Lowry’s brother. The borrower paid Post Rock Advisors a fee of 5% of the agency purchase price which was paid with loan proceeds.
Anita F. Larson, Chairman and Chief Operating Officer of Brooke Credit Corporation, is married to John Arensberg, a partner in Arensberg Insurance of Overland Park, Kansas. Arensberg Insurance is a franchisee of Brooke Capital Corporation pursuant to a standard form franchise agreement, and utilizes the administrative and processing services of Brooke Capital Corporation’s service center employees pursuant to a standard form service center agreement. Brooke Capital Corporation receives in excess of $135,000 in fees from the franchisee in connection with each of these agreements.
In December 2007, Brooke Holdings, Inc. purchased a participation from Brooke Capital Advisors in the amount of $12,382,000, of which a portion has subsequently been sold. Brooke Holdings, Inc. is controlled by Robert D. Orr and Leland G. Orr, who owned 73.65% and 21.72%, respectively, of its outstanding shares of stock as of February 29, 2008. The interest rate on the participation is variable, at 4.50% over the printed rate as published in the Wall Street Journal, and annual principal payments are scheduled with a final payment of $8,154,000 due in December 2011. The underlying loan is secured by the stock of First Life, TIC, and Brooke Capital Advisors. In addition, the Company owes Brooke Holdings, Inc. $1,668,000 as of December 31, 2007.
In July 2002, the Company acquired 100% of the outstanding ownership interests of CJD & Associates, L.L.C. for an initial purchase price of $2,025,000. Additional payments of the purchase price in the amount of $3,283,000 were made since the initial purchase through December 31, 2007
In November 2005, CJD & Associates, L.L.C. transferred all of its interest in the outstanding shares of Texas All Risk General Agency, Inc. and T.A.R. Holding Co., Inc. to Brooke Franchise Corporation. The consideration for this transfer was $2,054,000, which represented the book value on November 30, 2005. Therefore, CJD & Associates, L.L.C. did not record a gain on this transfer. Brooke Franchise Corporation immediately sold 100% of the outstanding shares of Texas All Risk General Agency, Inc. and T.A.R. Holding Co., Inc. to an unrelated party. The sale price was $3,450,000. The gain on sale of $1,396,000 was recognized by Brooke Franchise Corporation. Brooke Franchise paid consulting fees to CJD & Associates, L.L.C. in the amount of $1,396,000 in connection with the transaction.
In December 2005, CJD & Associates, L.L.C., a wholly owned subsidiary of the Company, sold DB Indemnity, Ltd. and The DB Group, Ltd. to Brooke Investments, Inc., another wholly owned subsidiary of the Company. DB Indemnity, Ltd. was sold for $2,152,000 and The DB Group, Ltd. was sold for $1,070,000. Effective January 1, 2007 DB Indemnity, Ltd. and DB Group, Ltd. were transferred to Brooke Brokerage (formerly Brooke Bancshares, Inc.) a wholly-owned subsidiary of the Company.
Company, resulting in the Company being the survivor. The transaction was accounted for in accordance with the guidance under Statement of Financial Accounting Standards (SFAS) No. 141, “Business Combinations,” issued by the Financial Accounting Standards Board. Prior to the merger, Brooke Corporation owned 100% of Brooke Franchise and 53% of the Company. As a result of the closing of the merger, Brooke Corporation owned approximately 81% of the Company’s common stock.
As part of the consideration under the 2006 Stock Purchase Agreement, Brooke Capital Advisors, a subsidiary of Brooke Capital Corporation, and CJD & Associates, L.L.C. (“CJD”), Brooke Corporation’s brokerage subsidiary, entered into an agreement by which, as of that date, Brooke Capital Advisors began transacting all new managing general agent loan brokerage business (formerly operated by CJD). CJD operated such a business prior to Closing and, as part of the Brokerage Agreement, agreed not to engage in any new managing general agent loan brokerage business. Pursuant to the terms of the 2006 Stock Purchase Agreement, Brooke Corporation agreed to contribute funds to Brooke Capital Corporation as additional consideration, to the extent the pretax profits of Brooke Capital Advisors did not meet a three-year $6 million pretax profit goal in accordance with an agreed upon schedule set forth in the 2007 Stock Purchase Agreement. Brooke Capital Advisors reported pretax income of approximately $7,773,000 and $1,084,000 during 2007 and 2006, respectively.
On January 8, 2007, the Company completed the acquisition of Generations Bank, a federal savings bank, by purchasing for $10.1 million in cash all of the issued and outstanding capital stock of the Bank from Kansas City Life Insurance Company pursuant to a Stock Purchase Agreement dated January 23, 2006. The Company assigned its rights and obligations under the Agreement to its wholly owned subsidiary, Brooke Bancshares, Inc. (formerly Brooke Brokerage Corporation), prior to closing. Accordingly, the Bank’s results of operations since January 8, 2007 are included in these consolidated financial statements.
On September 28, 2007, Brooke Capital acquired 60 insurance agency locations from entities associated with Chicago-based J and P Holdings Inc. The agencies currently sell auto insurance under the trade names of Lone Star Auto, Insurance Xpress, Car Insurance Store, Hallberg Insurance Agency and Hallberg Xpress in Colorado, Illinois, Kansas, Missouri and Texas. The acquired agencies will be converted into Brooke franchises or merged into existing Brooke franchise locations. At December 31, 2007, 36 of the acquired agencies had been sold.
The Company adopted SFAS 123R, “Share-Based Payment,” on January 1, 2006. The fair value of the options granted for the years ended December 31, 2007 and 2006 is estimated on the date of grant using the
In connection with its acquisitions of Brooke Savings Bank and Delta Plus Holdings, Inc., the Company recorded goodwill of approximately $3,022,000 which is not being amortized but, rather, evaluated periodically
DB Indemnity, Ltd. is required by its license to maintain statutory capital and surplus greater than a minimum amount determined as the greater of $120,000, a percentage of outstanding losses or a given fraction of net written premiums. At December 31, 2007, the Company was required to maintain a statutory capital and surplus of $487,000. Actual statutory capital and surplus was $2,737,000 and $2,410,000 at December 31, 2007, and 2006, respectively. Of the actual statutory capital $120,000 and $120,000 is fully paid up share capital, and, accordingly, all of the retained earnings and contributed surplus were available for payment of dividends to shareholders.
The DB Group, Ltd. is required by its license to maintain statutory capital and surplus greater than a minimum amount determined as the greater of $1,000,000, a percentage of outstanding losses or a given fraction of net written premiums. At December 31, 2007, the Company was required to maintain a statutory capital and surplus of $1,000,000. Actual statutory capital and surplus was $1,473,000 and $1,263,000 at December 31, 2007, and 2006, respectively. Of the actual statutory capital $1,102,000 and $1,102,000 is fully paid up share capital and contributed surplus, and, accordingly, all of the retained earnings were available for payment of dividends to shareholders.
Traders Insurance Company is a Missouri domiciled property-casualty insurance company and prepares its statutory-basis financial statements in accordance with statutory accounting practices (“SAP”) prescribed or permitted by the Missouri Insurance Department (“MID”).
For statutory purposes, bonds are generally recorded at amortized cost pursuant to the NAIC instructions. For GAAP, such securities are reported at fair value or amortized cost depending on their designation as to trading, available-for-sale or held-to-maturity.
The MID imposes on insurance enterprises minimum risk-based capital (“RBC”) requirements that were developed by the NAIC. Enterprises below specific trigger points or ratios are classified within certain levels, each of which requires specified corrective action. Management believes Traders Insurance Company meets the RBC requirements.
In connection with the January 18, 2008 transaction with Bank of the West (see Note 20), the Bank committed to operating within the parameters of a revised three-year business plan which reflects the transaction and will continue to submit quarterly business variance plan reports to the OTS through the first quarter of 2010. The Bank also committed to maintaining a minimum Tier 1 (Core) Capital Ratio of 6.5% (which is higher than the 5% level necessary to be considered well-capitalized under prompt corrective action provisions).
The Bank’s management believes that with respect to the current regulations, the Bank will continue to meet its minimum capital requirements in the foreseeable future. However, events beyond the control of the Bank, such as increased interest rates or a downturn in the economy in areas where the Bank has most of its loans, could adversely affect future earnings and, consequently, the ability of the Bank to meet its future minimum capital requirements.
Pursuant to the terms of the agreement with Optimum Re, First Life generally pays no reinsurance premiums on first year individual business. However, SFAS No. 113, “Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts,” requires the unpaid premium to be recognized as a first year expense and amortized over the estimated life of the reinsurance policies. First Life records this unpaid premium as “reinsurance premiums payable” in the accompanying balance sheet and as “reinsurance premiums ceded” in the accompanying income statement. At December 31, 2007 and 2006, respectively, the unpaid reinsurance premiums net of amortization totaled $8,000 and $11,000. To the extent that the reinsurance companies are unable to fulfill their obligations under the reinsurance agreements, First Life remains primarily liable for the entire amount at risk.
Ceded reinsurance agreements provide Traders Insurance Company with increased capacity to write larger risk and maintain its exposure to loss within its capital resources. Effective June 1, 2007 and 2006, Traders Insurance Company entered into Automobile Quota Share Reinsurance Agreements with one reinsurance company whereby it cedes 30% of written premium for both years.
At December 31, 2007, there were no outstanding commitments to sell mortgage loans. As discussed in Note 20, the Bank was committed to purchasing almost $7.5 million in loans from Bank of the West and did, in fact, consummate that transaction on January 18, 2008.
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements.” This Statement amends ARB 51 to establish accounting and reporting standards for the
noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. Minority interests will be recharacterized as noncontrolling interests and classified as a component of equity. This Statement is effective for the Company beginning on January 1, 2009. It is not expected that adoption of this Statement will have a material impact on the operating results or financial condition of the Company.
On March 7, 2008, Brooke Credit Corporation entered into a credit agreement with First State Bank, a banking corporation organized under the laws of the State of Nebraska (the “Bank”), as lead lender, along with a number of participating banks for the advancement of a $52.5 million secured term loan, (the “Credit Agreement”). The Credit Agreement was initially advanced for $41 million. The remainder of the facility is expected to be advanced by the end of March 2008. The Parties also entered into a Security Agreement and Pledge Agreement which gave the Bank a security interest covering substantially all of Brooke Credit’s assets including Brooke Credit’s rights to receive any payments from a majority of Brooke Credit’s subsidiaries, and further assigned to Bank Brooke Credit’s membership in two of Brooke Credit’s subsidiaries and a cash collateral account to be funded over an 18 month period following the closing. This provides the Bank the right to receive any payments related to certain of Brooke Credit’s bank and other depository accounts.
The Credit Agreement contains representation and warranties, additional affirmative and negative covenants, and events of default customary for loans of this type. The Loan is subject to acceleration upon an event of default.
The funds of this Agreement were used, in part, to repurchase certain notes from Falcon Mezzanine Partners II, LP, FMP II Co-Investment, LLC, and JZ Equity Partners PLC (“Purchasers”) pursuant to a repurchase agreement filed on Brooke Credit Corporations Form 8-K, as amended by Form 8-KA, on February 14 and 15, 2008, respectively.
Brooke Credit will use its commercially reasonable best efforts to register the shares underlying the related warrants of the Purchasers as soon as practicable; and
On March 14, 2008, a dividend of approximately 2,300,000 shares of Aleritas shares was declared payable to the Company’s shareholders. As a result, the Company’s ownership in Aleritas will be reduced to less than 50% and we do not expect to consolidate Aleritas results with the Company’s results in future accounting periods.
The earnings per share is based on the weighted average number of shares outstanding at the end of each quarter. This affected the weighted average shares outstanding for the year which affects the annual earnings per share reported on the consolidated statement of operations.
In June 2007 the Company had a secondary offering that issued an additional 1,500,000 shares of common stock.