FRCCO First Republic Preferred Capital Corp. - Preferred Stock, Convertible (MM)

Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 27, 2008

Commission File Number: 000-33461

FIRST REPUBLIC PREFERRED CAPITAL CORPORATION

(Exact name of registrant as specified in its charter)

 

Nevada		91-1971389
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
111 Pine Street, 2nd Floor, San Francisco, California		94111
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (415) 392-1400

Securities registered pursuant to Section 12(b) of the Act:

7.25% Noncumulative Perpetual Series D Preferred Stock

Securities registered pursuant to Section 12(g) of the Act:

None

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes   x     No   ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer   ¨		Accelerated filer   ¨
Non-accelerated filer   x   (Do not check if a smaller reporting company)		Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes   ¨     No   x

The number of shares outstanding of the registrant’s common stock, par value $0.01 per share, as of August 1, 2008 was 30,538,277 shares.

 

 

 

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FIRST REPUBLIC PREFERRED CAPITAL CORPORATION

(A Wholly Owned Subsidiary of Merrill Lynch Bank & Trust Co., FSB)

TABLE OF CONTENTS

 

		PART I – FINANCIAL INFORMATION
Item 1.		Financial Statements (Unaudited):
		Balance Sheets at June 27, 2008 and December 28, 2007		3
		Statements of Income for the Three and Six Months Ended June 27, 2008 and June 30, 2007		4
		Statements of Changes in Stockholders’ Equity for the Six Months Ended June 27, 2008 and June 30, 2007		5
		Statements of Cash Flows for the Six Months Ended June 27, 2008 and June 30, 2007		6
		Notes to Financial Statements		7
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations		11
Item 3.		Quantitative and Qualitative Disclosures About Market Risk		15
Item 4.		Controls and Procedures		16
		PART II – OTHER INFORMATION
Item 1.		Legal Proceedings		17
Item 1A.		Risk Factors		17
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds		17
Item 3.		Defaults Upon Senior Securities		17
Item 4.		Submission of Matters to a Vote of Security Holders		17
Item 5.		Other Information		17
Item 6.		Exhibits		17
		SIGNATURES

 

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PART 1 - FINANCIAL INFORMATION

 

Item 1.

Financial Statements.

The following interim financial statements as of and for the three and six months ended June 27, 2008 are unaudited. However, the financial statements reflect all adjustments (which included only normal recurring adjustments) that are, in the opinion of management, necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods presented. (See Note 1 for discussion of a business combination with Merrill Lynch & Co. in September 2007.)

FIRST REPUBLIC PREFERRED CAPITAL CORPORATION

(A Wholly Owned Subsidiary of Merrill Lynch Bank & Trust Co., FSB)

BALANCE SHEETS

(Unaudited)

 

		June 27, 2008				December 28, 2007
ASSETS
Cash and cash equivalents		$	62,474,000			$	22,196,000
Single family mortgage loans			206,053,000				237,382,000
Multifamily mortgage loans			28,982,000				30,124,000
Total mortgage loans			235,035,000				267,506,000
Less: Allowance for loan losses			(481,000	)			(481,000	)
Mortgage loans, net			234,554,000				267,025,000
Accrued interest receivable			1,156,000				1,383,000
Prepaid expenses			19,000				58,000
Total Assets		$	298,203,000			$	290,662,000
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Dividends payable on preferred stock (Note 6)		$	3,919,000			$	—
Payable to First Republic (Note 3)			44,000				25,000
Other payables			111,000				69,000
Total liabilities			4,074,000				94,000
Stockholders’ equity (Notes 4 and 5):
Preferred stock, $0.01 par value per share; 10,000,000 shares authorized:
10.50% perpetual, exchangeable, noncumulative Series A preferred stock; $1,000 liquidation value per share; 55,000 shares authorized, issued and outstanding			55,000,000				55,000,000
7.25% perpetual, exchangeable, noncumulative Series D preferred stock; $25.00 liquidation value per share; 2,400,000 shares authorized, issued and outstanding			60,000,000				60,000,000
Common stock, $0.01 par value; 50,000,000 shares authorized, 30,538,277 shares issued and outstanding at June 27, 2008 and December 28, 2007			305,000				305,000
Additional paid-in capital			175,463,000				175,463,000
Retained earnings (dividends in excess of retained earnings)			3,361,000				(200,000	)
Total stockholders’ equity			294,129,000				290,568,000
Total Liabilities and Stockholders’ Equity		$	298,203,000			$	290,662,000

See accompanying notes to financial statements.

 

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FIRST REPUBLIC PREFERRED CAPITAL CORPORATION

(A Wholly Owned Subsidiary of Merrill Lynch Bank & Trust Co., FSB)

STATEMENTS OF INCOME

(Unaudited)

 

		Three Months Ended								Six Months Ended
		June 27, 2008					June 30, 2007			June 27, 2008					June 30, 2007
Interest income:
Interest on loans		$	3,785,000				$	4,659,000		$	8,162,000				$	9,523,000
Interest on interest-earning deposit with First Republic			337,000					280,000			622,000					404,000
Total interest income			4,122,000					4,939,000			8,784,000					9,927,000
Other income			—					58,000			—					58,000
Operating expense:
Advisory fees payable to First Republic (Note 3)			25,000					25,000			50,000					50,000
General and administrative			49,000					61,000			111,000					107,000
Total operating expense			74,000					86,000			161,000					157,000
Net income			4,048,000					4,911,000			8,623,000					9,828,000
Dividends on preferred stock (Note 6)			2,507,000					3,541,000			5,062,000					7,104,000
Net income available to common stockholders		$	1,541,000				$	1,370,000		$	3,561,000				$	2,724,000

See accompanying notes to financial statements.

 

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FIRST REPUBLIC PREFERRED CAPITAL CORPORATION

(A Wholly Owned Subsidiary of Merrill Lynch Bank & Trust Co., FSB)

STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(Unaudited)

 

		Preferred Stock				Common Stock			Additional Paid-in Capital			Retained Earnings (Dividends in Excess of Retained Earnings)				Total
Balance as of January 1, 2007		$	164,000,000			$	294,000		$	173,028,000		$	(200,000	)		$	337,122,000
Conversion of 7,000 shares of Series C preferred stock into common stock of First Republic			(7,000,000	)			—			—			—				(7,000,000	)
Issuance of 1,185,484 shares of common stock to First Republic			—				11,000			6,989,000			—				7,000,000
Net income			—				—			—			9,828,000				9,828,000
Dividends on preferred stock			—				—			—			(7,104,000	)			(7,104,000	)
Balance as of June 30, 2007		$	157,000,000			$	305,000		$	180,017,000		$	2,524,000			$	339,846,000
Balance as of December 28, 2007		$	115,000,000			$	305,000		$	175,463,000		$	(200,000	)		$	290,568,000
Net income			—				—			—			8,623,000				8,623,000
Dividends on preferred stock			—				—			—			(5,062,000	)			(5,062,000	)
Balance as of June 27, 2008		$	115,000,000			$	305,000		$	175,463,000		$	3,361,000			$	294,129,000

See accompanying notes to financial statements.

 

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FIRST REPUBLIC PREFERRED CAPITAL CORPORATION

(A Wholly Owned Subsidiary of Merrill Lynch Bank & Trust Co., FSB)

STATEMENTS OF CASH FLOWS

(Unaudited)

 

		Six Months Ended
		June 27, 2008				June 30, 2007
Operating activities:
Net income		$	8,623,000			$	9,828,000
Adjustments to reconcile net income to net cash provided by operating activities:
(Discount accretion) premium amortization on loans			(685,000	)			108,000
Decrease in accrued interest receivable			227,000				133,000
Decrease (increase) in prepaid expenses			39,000				(18,000	)
Increase in payable to First Republic			19,000				—
Increase (decrease) in other payables			42,000				(41,000	)
Net cash provided by operating activities			8,265,000				10,010,000
Investing activities:
Loans acquired from First Republic			—				(22,693,000	)
Principal payments on loans			33,156,000				42,446,000
Net cash provided by investing activities			33,156,000				19,753,000
Financing activities:
Dividends paid on preferred stock			(1,143,000	)			(7,104,000	)
Net cash used for financing activities			(1,143,000	)			(7,104,000	)
Increase in cash and cash equivalents			40,278,000				22,659,000
Cash and cash equivalents at beginning of year			22,196,000				12,813,000
Cash and cash equivalents at end of period		$	62,474,000			$	35,472,000
Supplemental disclosure of cash flow information:
Preferred stock dividends payable		$	3,919,000				—
Conversion of Series C preferred stock into common shares of First Republic			—			$	7,000,000

See accompanying notes to financial statements.

 

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FIRST REPUBLIC PREFERRED CAPITAL CORPORATION

(A Wholly Owned Subsidiary of Merrill Lynch Bank & Trust Co., FSB)

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

Note 1. Organization and Basis of Presentation

First Republic Preferred Capital Corporation (the “Company”) is a Nevada corporation formed in April 1999. The Company is a wholly owned subsidiary of Merrill Lynch Bank & Trust Co., FSB, a federal stock savings bank and a wholly owned subsidiary of Merrill Lynch & Co. Inc. (“Merrill Lynch & Co.”). The Company was formed for the purpose of raising capital for Merrill Lynch Bank & Trust Co., FSB (hereinafter referred to as the “Bank”). The Company’s principal business is acquiring, holding, financing and managing assets secured by real estate mortgages and other obligations secured by real property, as well as certain other qualifying real estate investment trust (“REIT”) assets (collectively, the “Mortgage Assets”). The Mortgage Assets presently held by the Company are loans secured by single family and multifamily real estate properties (“Mortgage Loans”) that were acquired from First Republic Bank (“First Republic”). The Company expects that all, or substantially all, of its Mortgage Assets will continue to be Mortgage Loans acquired from First Republic. The Company has elected to be taxed as a REIT and intends to make distributions to its stockholders such that the Company is relieved of substantially all income taxes relating to ordinary income under applicable tax regulations. Accordingly, no provision for income taxes is included in the accompanying financial statements.

First Republic owned 100% of the Company’s outstanding shares until September 2007 when Merrill Lynch & Co. acquired all of the outstanding shares of First Republic’s common stock. First Republic became a division of the Bank, and the Bank became the controlling shareholder of the Company. The acquisition of First Republic was accounted for under the purchase method of accounting. The portion of the purchase price of First Republic allocable to the Company has been “pushed down” and allocated to the Company’s assets and liabilities based on their estimated fair values. Push down accounting changed the basis of the Company’s assets and liabilities compared with periods prior to the change of control. Therefore, a vertical black line appears on the Statement of Income to distinguish between the Company’s results of operations prior to the change of control and after the change of control. As a result of the merger, the Company changed its fiscal quarter end from the last calendar day to the last Friday of the third month in the quarter.

At June 27, 2008, the Company has issued 30,538,277 shares of common stock, par value $0.01 per share. The Bank owns all of the common stock. Earnings per share data is not presented, as the Company’s common stock is not publicly traded.

These interim financial statements are intended to be read in conjunction with the Company’s 2007 Annual Report on Form 10-K for the year ended December 28, 2007 (the “2007 Annual Report”), Financial Statements and Notes thereto. Interim results should not be considered indicative of results to be expected for the full year.

The results of operations of the Company and the Bank are subject to various risks, including business, economic, legal and regulatory conditions and factors. Additional information is included in Item 1A, “Risk Factors,” in the 2007 Annual Report on Form 10-K filed with the Securities and Exchange Commission (the “SEC”) on March 27, 2008.

Note 2. Summary of Significant Accounting Policies

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and disclosure of contingent assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses.

 

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Mortgage Loans

The Company has acquired all Mortgage Loans from First Republic at a price equal to First Republic’s carrying value. Mortgage Loans are carried at the principal amount outstanding, net of purchase discounts and premiums. Discounts or premiums on Mortgage Loans are accreted or amortized as yield adjustments over the contractual lives of the loans using methods that approximate the interest method. The unaccreted discount or unamortized premium on a loan sold or paid in full is recognized in income at the time of sale or payoff.

The Company recognizes interest income, net of servicing fees paid to First Republic, in the month earned. The Company places a loan on nonaccrual status, and interest income is not recorded on the loan, when the loan becomes more than 90 days delinquent, except for a single family loan that is well secured and in the process of collection, or at such earlier times as management determines that the ultimate collection of all contractually due principal or interest is unlikely. When a loan is placed on nonaccrual status, interest income may be recorded when cash is received if the Company’s recorded investment in such loan is deemed collectible. When, in management’s judgment, the borrower’s ability to make periodic interest and principal payments resumes, the loan is returned to accrual status. The Company classifies a loan as impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement.

Allowance for Loan Losses

The Company maintains an allowance for loan losses that can be reasonably anticipated based upon specific conditions at the time. The Company considers a number of factors, including the Company’s and First Republic’s past loss experience, First Republic’s underwriting policies, the amount of past due and nonperforming loans, legal requirements, recommendations or requirements of regulatory authorities, current economic conditions and other factors. If the Company were to determine that an additional provision is required, the Company would provide for loan losses by charging current income.

Other Real Estate Owned

Real estate acquired through foreclosure is recorded at the lower of cost or fair value, less estimated costs to sell such real estate. The Company records costs related to holding real estate as expenses when incurred. The Company has not owned any real estate since inception.

Statement of Cash Flows

For the purpose of reporting cash flows, cash and cash equivalents include cash and an interest-earning deposit with First Republic. As a REIT making sufficient dividend distributions, the Company paid no income taxes for the six months ended June 27, 2008 or June 30, 2007.

 

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Note 3. Related Party Transactions

The Company’s related party transactions include the acquisition of Mortgage Loans from First Republic, loan servicing fees paid to First Republic and advisory fees paid to First Republic. The following table presents the Company’s related party transactions for the three and six months ended June 27, 2008 and June 30, 2007:

 

		Three Months Ended						Six Months Ended
		June 27, 2008			June 30, 2007			June 27, 2008			June 30, 2007
Mortgage Loans acquired from First Republic:
Principal		$	—		$	—		$	—		$	22,666,000
Premium			—			—			—			27,000
Total Mortgage Loans acquired		$	—		$	—		$	—		$	22,693,000
Loan servicing fee expense		$	152,000		$	196,000		$	314,000		$	399,000
Advisory fee expense		$	25,000		$	25,000		$	50,000		$	50,000

Since inception, the Company has acquired all Mortgage Loans from First Republic at a price equal to First Republic’s carrying value of the loans.

First Republic retains loan servicing fees on the Company’s Mortgage Loans under a loan purchase and servicing agreement pursuant to which First Republic performs, among other things, servicing of loans held by the Company in accordance with normal industry practice. In its capacity as servicer, First Republic receives Mortgage Loan payments on behalf of the Company and holds the payments in custodial accounts at First Republic. The loan purchase and servicing agreement is renewable on an annual basis. Pursuant to the agreement, First Republic charges an annual servicing fee of 25 basis points of the gross average outstanding principal balances of Mortgage Loans that First Republic services. The Company records these loan servicing fees as a reduction of interest income.

The Company pays advisory fees to First Republic under an advisory agreement pursuant to which First Republic administers the day-to-day operations of the Company. First Republic is responsible for: (i) monitoring the credit quality of the Mortgage Assets held by the Company; (ii) advising the Company with respect to the reinvestment of income from, and principal payments on, the Mortgage Assets, and with respect to the acquisition, management, financing and disposition of the Mortgage Assets; (iii) monitoring the Company’s compliance with the requirements necessary to qualify as a REIT and (iv) performing financial reporting and internal control duties required for all public companies. The advisory agreement is renewable on an annual basis. The advisory fees were $100,000 per annum for 2008 and 2007, payable in equal quarterly installments. The Company had advisory fees payable to First Republic of $25,000 at June 27, 2008 and at December 28, 2007.

At June 27, 2008 and at December 28, 2007, the Bank owned 25,410 shares of the Company’s Series A Preferred Shares, with a liquidation preference value of $25.4 million. For the first six months of 2008 and 2007, neither the Bank nor First Republic purchased any of the Company’s outstanding Series A Preferred Shares. The Company had dividends payable to the Bank of $1,319,000 at June 27, 2008.

Note 4. Preferred Stock

At June 27, 2008, the Company was authorized to issue 10,000,000 shares of preferred stock, of which 2,455,000 shares were outstanding. The Company has issued and outstanding shares for each of the following series of preferred stock, par value $0.01 per share at June 27, 2008 and December 28, 2007:

 

		June 27, 2008			December 28, 2007
Series A — 55,000 shares authorized, issued and outstanding		$	55,000,000		$	55,000,000
Series D — 2,400,000 shares authorized, issued and outstanding			60,000,000			60,000,000
Total preferred stock		$	115,000,000		$	115,000,000

In June 1999, the Company issued 55,000 Series A Preferred Shares. The Company’s proceeds from this issuance were $55 million; First Republic paid all expenses of the offering, including underwriting commissions and discounts. The Series A Preferred Shares are not redeemable prior to June 1, 2009. Holders of the Series A Preferred Shares are entitled to receive, if authorized and declared by the Board of Directors of the Company, noncumulative dividends at a rate of 10.5% per annum, or $105 per annum per share. Dividends on the Series A Preferred Shares, if authorized and declared, are payable semiannually in arrears on June 30 and December 30 of each year.

 

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In June 2001, the Company issued 7,000 Series C Preferred Shares. In June 2007, the holder of the Series C Preferred Shares elected to exercise the right to convert all of the shares into common stock of First Republic. The conversion was pursuant to the terms set forth in the certificate of designations governing the Series C Preferred Shares. The former holder of the Series C Preferred Shares has no further rights arising out of the ownership of such shares.

In January 2002, the Company issued 1,680,000 Series B Preferred Shares. On November 19, 2007 (the “Redemption Date”), the Company redeemed the Series B Preferred Shares at a total redemption price of $42.5 million, which represented $25.00 per share plus accrued and unpaid dividends to the Redemption Date at a rate of $10.296 per share of all the issued and outstanding Series B Preferred Shares.

In June 2003, the Company issued 2,400,000 Series D Preferred Shares. The Company’s proceeds from this issuance were $60 million; First Republic paid all expenses of the offering, including underwriting commissions and discounts. The Series D Preferred Shares are redeemable at the option of the Company. Holders of the Series D Preferred Shares are entitled to receive, if authorized and declared by the Board of Directors of the Company, noncumulative dividends at a rate of 7.25% per annum, or $1.8125 per annum per share. Dividends on the Series D Preferred Shares, if authorized and declared, are payable quarterly in arrears on March 30, June 30, September 30, and December 30 of each year.

Upon the occurrence of an adverse change in relevant tax laws, the Company will have the right to redeem its preferred shares, in whole (but not in part). The liquidation preference for the Series A Preferred Shares is $1,000 per share plus the semiannual dividend thereon accrued through the date of redemption for the dividend period in which the redemption occurs. The liquidation preference for the Series D Preferred Shares is $25 per share plus the quarterly dividend thereon accrued through the date of redemption for the dividend period in which the redemption occurs.

The Company’s preferred shares will be exchanged into preferred shares of the Bank upon the occurrence of certain events. The exchange rate for the Series A Preferred Shares is 1:1. The exchange rate for the Series D Preferred Shares is 1:1/40. Except under certain limited circumstances, the holders of the Company’s preferred shares have no voting rights.

Note 5. Common Stock

At June 27, 2008, the Company was authorized to issue 50,000,000 shares of common stock with a par value of $0.01 per share, of which 30,538,277 shares were outstanding and owned by the Bank. The Company issued no common stock in the first three and six months of 2008. In June 2007, the Company issued 1,185,484 shares of common stock to First Republic in connection with the conversion of the Company’s Series C Preferred Shares.

The holder of common stock is entitled to receive dividends if and when authorized and declared by the Board of Directors out of funds legally available therefore after all preferred dividends have been paid for the full year.

Note 6. Dividends on Preferred Stock and Common Stock

The following table presents the dividends on preferred stock for the three and six months ended June 27, 2008 and June 30, 2007. The Company paid dividends on the Series D Preferred Shares for the three months ended March 28, 2008. The Company accrued dividends on the Series D Preferred Shares for the three months ended June 27, 2008 and on the Series A Preferred Shares for the six months ended June 27, 2008 and expects to pay these dividends on June 30, 2008.

 

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		Three Months Ended						Six Months Ended
		June 27, 2008			June 30, 2007			June 27, 2008			June 30, 2007
Series A Preferred Shares		$	1,443,000		$	1,443,000		$	2,887,000		$	2,887,000
Series B Preferred Shares			—			932,000			—			1,864,000
Series C Preferred Shares			—			78,000			—			178,000
Series D Preferred Shares			1,064,000			1,088,000			2,175,000			2,175,000
Total		$	2,507,000		$	3,541,000		$	5,062,000		$	7,104,000

Dividends on the Company’s preferred shares are payable if, when and as authorized by the Company’s Board of Directors. If the Board of Directors does not authorize a dividend on any series of preferred shares for any respective dividend period, holders of each series of preferred shares will not be entitled to be paid that dividend later or to recover any unpaid dividend whether or not funds are, or subsequently become, available. The Board of Directors, in its business judgment, may determine that it would be in the best interest of the Company to pay less than the full amount of the stated dividend on each series of preferred shares for any dividend period. However, to remain qualified as a REIT, the Company must distribute annually at least 90% of its “REIT taxable income” (excluding deductions for any dividends paid and any net capital gains) to stockholders, and, generally, the Company cannot pay dividends on common stock for periods in which less than full dividends are paid on each series of preferred shares.

The Company expects to pay the holders of common stock an amount of dividends that when aggregated with the dividends paid to holders of the preferred shares is not less than 90% of the Company’s “REIT taxable income” (excluding deductions for any dividends paid and any net capital gains) in order to remain qualified as a REIT. The Company did not declare dividends on its common stock during the three and six months ended June 27, 2008 or June 30, 2007.

Note 7. Concentration of Credit Risk

At June 27, 2008, approximately 80% of Mortgage Loans were secured by real estate properties located primarily in California. Future economic, political or other developments in California could adversely affect the value of the Mortgage Loans. See “Financial Condition - Significant Concentration of Credit Risk” under “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Introduction

This discussion summarizes the significant factors affecting the financial condition of the Company as of June 27, 2008 and results of operations for the three and six months ended June 27, 2008. This discussion is provided to increase the understanding of, and should be read in conjunction with, the unaudited interim financial statements, accompanying notes and tables included in this Quarterly Report on Form 10-Q and in the 2007 Annual Report.

Information Regarding Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended. These statements reflect management’s current views and assumptions and are subject to known and unknown risks, uncertainties and other factors that may cause actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. Forward-looking statements include, but are not limited to, statements regarding the following:

 

•

business strategy;

 

•

estimates regarding capital requirements and the need for additional financing; and

 

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•

plans, objectives, expectations and intentions contained in this report that are not historical facts.

Forward-looking statements often include words such as “may,” “would,” “should,” “could,” “expect,” “anticipate,” “believe,” “estimate,” “plan,” “target,” “project,” “predict,” “intend,” “potential,” “continue,” or similar expressions. Statements that contain these words should be read carefully because they discuss future expectations, contain projections of future results of operation or financial condition or state other forward-looking information. There may be events in the future, however, that cannot be accurately predicted or controlled and that may cause actual results to differ materially from the expectations described in the forward-looking statements. The reader is cautioned that all forward-looking statements involve risks and uncertainties, and actual results may differ materially from those discussed as a result of various factors, including, but not limited to, competitive pressure in the mortgage lending industry; changes in the interest rate environment that reduce margins; general economic conditions, either nationally or regionally, that are less favorable than expected, resulting in, among other things, a deterioration in credit quality and an increase in the provision for loan losses; changes in the regulatory environment; changes in business conditions, particularly in San Francisco and Los Angeles counties and the New York area and in the home mortgage lending industry; and changes in the securities markets. Other risks, uncertainties and factors are discussed elsewhere in this report, in other Company filings with the SEC (including in Item 1A, “Risk Factors,” in the 2007 Annual Report and in materials incorporated therein by reference.

Throughout this document, the “Company,” “we,” “our” or “us” refers to First Republic Preferred Capital Corporation, “First Republic” refers to First Republic Bank, and the “Bank” refers to Merrill Lynch Bank & Trust Co., FSB.

Critical Accounting Policies and Estimates

The Company’s discussion and analysis of its financial condition and results of operation are based upon its financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and the disclosures for contingent assets and liabilities. On an ongoing basis, the Company evaluates its estimates, including those related to allowance for loan losses, credit risks, estimated loan lives, interest rate risk, contingencies and litigation. The Company bases its estimates on historical experience and other assumptions it believes are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of its assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

The Company considers accounting for allowance for loan losses to be a critical accounting policy because it is a complex process involving difficult and subjective judgments, assumptions and estimates. The allowance for loan losses is an estimate that can change under different assumptions and conditions. The Company estimates credit losses resulting from the inability of borrowers to make required payments. If the financial condition of borrowers were to deteriorate, resulting in an impairment of their ability to make payments, or the value of collateral securing Mortgage Loans were to decline, an increase in the allowance may be required by charging current income. A significant decline in the credit quality of the Company’s loan portfolio could have a material adverse affect on the Company’s financial condition and results of operations.

Results of Operations

Overview

Net income was $4,048,000 and $8,623,000 for the three and six months ended June 27, 2008, compared with $4,911,000 and $9,828,000 for the same periods in 2007. The decrease was primarily due to a decrease in interest income resulting from lower average loan balances. The ratio of earnings to fixed charges was 1.61x and 1.70x for the three and six months ended June 27, 2008 and 1.39x and 1.38x for the same periods in 2007. Dividend payments were 100% of fixed charges.

 

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Total Interest Income

Total interest income decreased in the three and six months ended June 27, 2008 compared with the same periods in 2007 due to lower average loan balances, partially offset by higher loan yields. The following table presents the average balances and yields on the Company’s interest-earning assets for the periods indicated:

 

		Three Months Ended
		June 27, 2008									June 30, 2007
($ in thousands)		Average Balance			Interest Income			Yield			Average Balance			Interest Income			Yield
Loans		$	240,681		$	3,785		6.31	%		$	314,350		$	4,659		5.92	%
Short-term investments			54,221			337		2.49				26,408			280		4.20
Total interest-earning assets		$	294,902		$	4,122		5.61	%		$	340,758		$	4,939		5.79	%
		Six Months Ended
		June 27, 2008									June 30, 2007
($ in thousands)		Average Balance			Interest Income			Yield			Average Balance			Interest Income			Yield
Loans		$	249,015		$	8,162		6.57	%		$	320,033		$	9,523		5.95	%
Short-term investments			44,163			622		2.82				19,338			404		4.16
Total interest-earning assets		$	293,178		$	8,784		6.01	%		$	339,371		$	9,927		5.85	%

Interest income on Mortgage Loans decreased $874,000, or 19%, in the second quarter of 2008 compared with the same period in 2007 due to lower average balances as cash was accumulated in anticipation of the possible redemption of the Series D Preferred Shares. Beginning in the fourth quarter of 2007, interest income on mortgage loans included discount accretion related to the valuation of loans for purchase accounting, which increased the average yield on loans. The net discount accretion was $273,000 and $685,000 for the three and six months ended June 27, 2008 compared with the net premium amortization of $(62,000) and $(108,000) for the same periods in 2007. The total net unaccreted purchase accounting discount was $8.9 million at June 27, 2008. The weighted average net coupon rate on Mortgage Loans was 5.38% at June 27, 2008, 6.12% at December 28, 2007 and 6.02% at June 30, 2007. See “Quantitative and Qualitative Disclosures about Market Risks.”

Included in interest income on Mortgage Loans is a reduction for loan servicing fees that First Republic retains. The annual servicing fee is 25 basis points on the gross average outstanding principal balance of the Mortgage Loans that First Republic services. Loan servicing fees were $152,000 and $314,000 for the three and six months ended June 27, 2008 and $196,000 and $399,000 for the same periods in 2007.

Interest income on short-term investments increased in the three and six months ended June 27, 2008, compared with the same periods in 2007, due to higher average investment balances, partially offset by lower rates. The average yields on short-term investments for the three and six months ended June 27, 2008 decreased to 2.49% and 2.82% respectively, compared with 4.20% and 4.16% for the same periods in 2007.

Operating Expense

The Company incurs advisory fee expenses payable to First Republic pursuant to an advisory agreement with First Republic for services that First Republic renders on the Company’s behalf. Advisory fees were $100,000 per annum for 2008 and 2007, or $25,000 per quarter.

General and administrative expenses were $49,000 and $111,000 for the three and six months ended June 27, 2008, compared with $61,000 and $107,000 for the same periods in 2007. These expenses consisted primarily of audit fees, directors’ fees, regulatory costs and other stockholder costs.

 

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Financial Condition

Short-term Investments on Deposit with First Republic

At June 27, 2008 and December 28, 2007, short-term investments consisted entirely of a money market account held at First Republic.

Mortgage Loans

The loan portfolio at June 27, 2008 and December 28, 2007 consisted of both single family and multifamily mortgage loans acquired from First Republic. The Company anticipates that in the future it will continue to acquire all of its loans from First Republic.

The Company has purchased from First Republic single family loans with a period of interest only payments. Underwriting standards for all such loans have required a high level of borrower net worth, substantial post-loan liquidity, excellent FICO scores and significant down payments. At June 27, 2008, approximately $131 million of loans, or 61% of the Company’s single family loan portfolio, allowed interest only payments for varying periods. These interest only loans had an average loan-to-value (“LTV”) ratio at June 27, 2008 of approximately 56%, based on appraised value at the time of origination. None of the Company’s interest only home loans had an LTV ratio at origination of more than 80%.

Nonaccrual Loans and Allowance for Loan Losses

A loan is placed on nonaccrual status when any installment of principal or interest is over 90 days past due, except for any single family loan that is well secured and in the process of collection or when the Company determines that the ultimate collection of all contractually due principal or interest is unlikely. The Company classifies a loan as impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan purchase and servicing agreement.

At June 27, 2008 and December 28, 2007, there were no nonaccrual loans, impaired loans, loans that were troubled debt restructurings or accruing loans that were contractually past due more than 90 days. The following table presents information with respect to the Company’s allowance for loan losses:

 

		For the Six Months Ended								For the Year Ended December 28, 2007
		June 27, 2008				June 30, 2007
Allowance for loan losses:
Balance, beginning of period		$	481,000			$	481,000			$	481,000
Provision charged to expense			—				—				—
Chargeoffs			—				—				—
Recoveries			—				—				—
Balance, end of period		$	481,000			$	481,000			$	481,000
Average Mortgage Loans for the period		$	249,015,000			$	320,033,000			$	304,270,000
Total Mortgage Loans at end of period		$	235,035,000			$	303,355,000			$	267,506,000
Ratio of allowance for loan losses to total loans			0.20	%			0.16	%			0.18	%

 

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Significant Concentration of Credit Risk

Concentration of credit risk generally arises with respect to the loan portfolio when a number of borrowers engage in similar business activities or activities in the same geographical region. Concentration of credit risk indicates the relative sensitivity of the Company’s performance to both positive and negative developments affecting a particular industry. The balance sheet exposure to geographic concentrations directly affects the credit risk of the Company’s Mortgage Loans. The following table presents an analysis of Mortgage Loans at June 27, 2008 by major geographic location:

 

		San Francisco Bay Area				New York /New England				Los Angeles County				San Diego County				Other California Areas				Other				Las Vegas, Nevada				Total
($ in thousands)																														Amount				%
Single family		$	115,765			$	26,148			$	20,126			$	7,605			$	16,726			$	18,340			$	1,343			$	206,053			88	%
Multifamily			22,368				865				2,524				619				2,606				—				—				28,982			12
Total		$	138,133			$	27,013			$	22,650			$	8,224			$	19,332			$	18,340			$	1,343			$	235,035			100	%
Percent by location			59	%			11	%			10	%			3	%			8	%			8	%			1	%			100	%

At June 27, 2008, approximately 80% of Mortgage Loans were secured by properties located in California. The weighted average loan to value ratio on Mortgage Loans was approximately 54%, based upon the appraised values of the properties at the time the loans were originated.

Liquidity and Capital Resources

The Company’s principal liquidity needs are to pay dividends and to fund the acquisition of additional Mortgage Assets as borrowers repay Mortgage Loans. The Company intends to fund the acquisition of additional Mortgage Loans with the proceeds from principal repayments on Mortgage Loans. Proceeds from interest payments will be reinvested until used for the payment of operating expenses and dividends. The Company does not anticipate that it will have any other material capital expenditures. The cash generated from interest and principal payments on Mortgage Assets is expected to provide sufficient funds for operating requirements and dividend payments in accordance with the requirements to be taxed as a REIT for the foreseeable future.

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk.

Interest Rate Risk Management

The Company services fixed-rate dividend obligations to preferred stockholders and operating expenses by the collection of interest income from Mortgage Loans. To meet dividend payments, the Company maintains an average interest-earning asset balance of approximately two times the liquidation preference of its outstanding preferred shares. The Company’s earnings to fixed charges ratio was 1.61x for the second quarter of 2008, compared with 1.39x for the second quarter of 2007 and 1.43x for the year 2007.

Beginning mid-2004, interest rates moved up from 40-year historical lows through September 2007 when interest rates began to fall. The yield on total interest-earning assets dropped 18 basis points to 5.61% for the second quarter of 2008 compared with the second quarter of 2007 primarily due to the increase in the lower-yielding short-term investment portfolio, offset by discount accretion related to the Bank’s acquisition of the Company. The yield on loans increased 39 basis points; however, excluding the net discount accretion in the second quarter of 2008 and the net premium amortization in the second quarter of 2007, the yield would have decreased by approximately 17 basis points. The loan portfolio mix in terms of interest rate type at June 27, 2008 was similar to that at June 30, 2007. ARMs were 76% of Mortgage Loans at June 27, 2008 and 77% at June 30, 2007. However, the weighted average net coupon rate for ARMs at June 27, 2008 decreased 84 basis points from a year ago, compared with a 10 basis point increase in the weighted average net coupon rate for intermediate fixed rate loans and 1 basis point decrease for fixed rate loans. The weighted average remaining maturity of Mortgage Loans was 21.8 years at June 27, 2008 and 22.8 years at June 30, 2007.

For ARMs, the timing of changes in the average yield depends on the underlying interest rate index, the timing of changes in the index and the frequency of adjustments to the loan rate. For ARMs, the decrease in the weighted average net coupon rate of 84 basis points was due to the drop in short-term rates. The average interest rate reset period for ARMs was 2 months at June 27, 2008. The decrease in the yield on ARM loans was mitigated by a significant volume of ARM loans indexed to COFI. COFI is a lagging index that tends to respond more slowly to changes in the general interest rate environment than a market rate index. At June 27, 2008, ARM loans indexed to COFI were 83% of total ARMs and 63% of Mortgage Loans, compared with 76% of total ARMs and 58% of Mortgage Loans at June 30, 2007.

 

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For intermediate fixed and fixed rate loans, the balance outstanding at June 27, 2008 was $57.1 million, or 24% of total Mortgage Loans, compared with $70.9 million at June 30, 2007, or 23% of total Mortgage Loans. The weighted average net coupon rate for intermediate fixed rate loans was 5.43% at June 27, 2008, up from 5.33% at June 30, 2007. The weighted average net coupon rate for fixed rate loans was 5.67% at June 27, 2008 and 5.68% at June 30, 2007.

The following table presents an analysis of Mortgage Loans at June 27, 2008 by interest rate type:

 

($ in thousands)		Balance			Net Coupon  (1)   (2)			Months to Next Reset  (1)		% of Total Loans
ARM loans:
COFI		$	148,311		5.30	%		1		63	%
CMT			20,080		5.88			6		9
LIBOR			9,504		4.46			2		4
Total ARMs			177,895		5.32			2		76
Intermediate fixed:
12 months to 36 months			9,367		5.19			22		4
37 months to 60 months			10,638		5.58			47		5
Greater than 60 months			2,450		5.63			74		1
Total intermediate fixed			22,455		5.43			40		10
Total adjustable rate loans			200,350		5.33			6		86
Fixed rate loans			34,685		5.67					14
Total loans		$	235,035		5.38	%				100	%

 

(1)	Weighted average net coupon rate.

(2)	Net of servicing fees retained by First Republic.

The following table presents maturities or interest rate adjustments based upon the contractual maturities or adjustment dates as of June 27, 2008:

 

($ in thousands)		6 Months or Less				>6 to 12 Months				>1 to 3 Years				>3 to 5 Years				>5 Years				Not Rate Sensitive				Total
Cash and investments		$	62,474			$	—			$	—			$	—			$	—			$	—			$	62,474
Loans, net			172,958				15,469				21,220				13,060				11,847				—				234,554
Other assets			—				—				—				—				—				1,175				1,175
Total assets		$	235,432			$	15,469			$	21,220			$	13,060			$	11,847			$	1,175			$	298,203
Other liabilities		$	—			$	—			$	—			$	—			$	—			$	4,074			$	4,074
Stockholders’ equity			—				—				—				—				—				294,129				294,129
Total liabilities and equity		$	—			$	—			$	—			$	—			$	—			$	298,203			$	298,203
Repricing gap — positive (negative)		$	235,432			$	15,469			$	21,220			$	13,060			$	11,847			$	(297,028	)
Cumulative repricing gap:
Dollar amount		$	235,432			$	250,901			$	272,121			$	285,181			$	297,028
Percent of total assets			79.0	%			84.1	%			91.3	%			95.6	%			99.6	%

The Company has not engaged in business activities related to foreign currency transactions or commodity-based instruments and has not made any investments in equity securities subject to price fluctuations.

 

Item 4.

Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

As required by SEC rules, the Company carried out an evaluation of the effectiveness of the design and operation of its “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) under the Securities Exchange Act as of the end of the period covered by this report. The Company’s management, including the

 

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Company’s chief executive officer and chief financial officer, supervised and participated in the evaluation. Based on that evaluation, the chief executive officer and the chief financial officer concluded that the Company’s disclosure controls and procedures, as of June 27, 2008, were effective.

Changes in Internal Control Over Financial Reporting

There were no significant changes in the Company’s internal control over financial reporting during the quarter ended June 27, 2008 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II - OTHER INFORMATION

 

Item 1.

Legal Proceedings.

The Company is not currently involved in nor, to its knowledge, currently threatened with any material legal proceedings.

 

Item 1A.

Risk Factors.

There are risks, many beyond the Company’s control, which could cause the Company’s results to differ significantly from management’s expectations. Some of these factors are described in the Company’s Annual Report on Form 10-K for the year ended December 28, 2007. Any factor described in the Company’s 2007 Form 10-K or in this report could, by itself or together with one or more other factors, adversely affect the Company’s business, results of operations and/or financial condition. There may be other factors not described in the Company’s 2007 Form 10-K or in this Quarterly Report on Form 10-Q that could cause results to differ from the Company’s expectations.

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds.

None.

 

Item 3.

Defaults Upon Senior Securities.

Not applicable.

 

Item 4.

Submission of Matters to a Vote of Security Holders.

None.

 

Item 5.

Other Information.

None.

 

Item 6.

Exhibits.

 

12		Statement of computation of ratios of earnings to fixed charges.
31.1		Certification pursuant to 15 U.S.C. 7m(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2		Certification pursuant to 15 U.S.C. 7m(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1		Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2		Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

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SIGNATURES

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

FIRST REPUBLIC PREFERRED CAPITAL CORPORATION

 

Date: August 8, 2008						By:		/s/ JAMES J. BAUMBERGER
								James J. Baumberger
								President and Director
								(Principal Executive Officer)
Date: August 8, 2008						By:		/s/ WILLIS H. NEWTON, JR.
								Willis H. Newton, Jr.
								Vice President,
								Chief Financial Officer,
								Treasurer and Director
								(Principal Financial Officer)

 

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INDEX TO EXHIBITS

 

Exhibit Number		Exhibit Title
12		Statement of computation of ratios of earnings to fixed charges.
31.1		Certification pursuant to 15 U.S.C. 7m(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2		Certification pursuant to 15 U.S.C. 7m(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1		Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2		Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.