SEC Company Response from MICROFINANCIAL INC (CIK 0000827230) — Oct 12, 2005
MICROFINANCIAL INC (CIK 0000827230)
Date: Oct. 12, 2005 · CIK: 0000827230 · Accession: 0000908662-05-000260
AI Filing Summary & Sentiment
File numbers found in text: 001-14771
Referenced dates: September 13, 2005
Letter
VIA EDGAR / ORIGINAL BY FEDERAL EXPRESS United States Securities and Exchange Commission Division of Corporation Finance MicroFinancial Incorporated Form 10-K for Fiscal Year Ended December 31, 2004 Filed March 30, 2005 File No. 001-14771
Re:
Dear Ms. Jackson:
Attached please find responses to the questions and comments you had outlined in your Comment Letter dated September 13, 2005. To facilitate your review process, I have replicated the questions you provided in your letter (in italics) and have included the response to the question just below it.
In accordance with your request, Company Management acknowledges that:
•
The Company is responsible for the adequacy and accuracy of the disclosure in the filing;
•
Staff comments or changes to disclosure in response to staff comments do not foreclose the Commission from taking any action with respect to the filing; and
•
The Company may not assert staff comments as a defense in any proceeding initiated by the Commission or any person under the federal securities laws of the United States.
Critical Accounting Policies – Revenue Recognition, page 15
1.
Please explain to us your policy for measuring the residual value of the equipment that you lease under direct financing leases.
•
Tell us how you determine the fair value of the leased equipment at the end of the lease term.
Our standard lease contract provides for a fair market value purchase option at the end of the lease term. At the end of the contractual lease term, the lessee may do one of the following: a) return the leased equipment, b) purchase the leased equipment at the fair market value, or c) continue to lease the equipment via a monthly renewal
option which allows the lessee to continue to pay for the use of the equipment on a month to month basis. This month to month renewal is the default option to the extent the lessee does not notify the Company of its intent to do otherwise at the end of lease term. The residual values are estimated at the inception of the lease contract and are based upon industry data and our own experience regarding the end of term options mentioned above, as well as, from defaults or other dispositions of the leased equipment. The booked residual amount is estimated at lease inception and is generally 10% of the original lease stream. This value approximates our historical performance given the options outlined above. We then, at least annually, review these values for impairment. Since any impairment would result in a write down of the residual value during the lease term, this ensures that the fair value assessment at the end of lease term is still valid.
•
Tell us if you consider the cash flows expected to be received after the lease term during which you continue to bill the lessee on a month-to-month basis in your determination of the residual value of the leased asset.
As mentioned previously, our leases include renewal options whereby the lease contract provides for a month to month renewal of the contract to the extent the lessee selects this option at the end of lease term or otherwise fails to select one of the other end of lease options. Our historical experience relating to the expected cash flows to be received after the lease term is a consideration in the determination of the residual value of the leased asset.
•
Tell us how often you evaluate the residual value of leased assets for impairment.
Management performs reviews of the estimated residual values at least annually, and any impairment, if other than temporary, is recognized in the current period. The company will also perform an additional review of the values at any time when management deems a significant market event has occurred which could affect the values.
2.
We note in your disclosure that if a lessee continues to rent equipment after the lease term expires, you record an investment in rental contracts at the estimated residual value. Please confirm to us that you record these new month-to-month leases as operating leases in accordance with SFAS 13. Furthermore, please provide us with sample journal entries to describe how you record the termination of the prior financing lease and the inception of the new operating lease.
If a lessee continues to rent their equipment after the initial lease term has expired, the remaining net investment is removed from the accounts, and the account is recorded at its residual value, which in accordance with SFAS 13 paragraph 17 (f) (as amended) is the lower of its original cost, fair value, or present carrying amount, and the resulting difference, if any, is charged to income for the period. In accordance with SFAS 13 we record the new month to month contract as an operating lease. The contract is depreciated over a term of the lesser of 12 months or the actual
renewal period. The new operating lease is recorded net of accumulated depreciation on the balance sheet. Rents are reported as income over the lease term as they become receivable according to the provisions of the lease, which is on a straight line, month to month basis.
Example Entry to Terminate Direct Finance Lease and Record Operating Lease
At the end of lease term, the estimated residual value is credited and the new asset, investment in rental contracts, is established.
Investment in rental contracts
140.95
•
Estimated residual value
(140.95)
Results of Operations
Depreciation and Amortization, page 18
3.
Please tell us and revise future filings to more clearly explain your accounting policy for recording and depreciating rental equipment under operating leases. For example, explain why you record some equipment at estimated residual value and other equipment at acquisition cost. In addition, tell us how you determined depreciation periods of 12 months and 36 months.
The Company’s accounting policy for recording and depreciating rental equipment under operating leases depends upon the source of the rental contract. Certain rental contracts (operating lease treatment) are originated as a result of the renewal provisions of the lease agreement described above. These contracts are recorded at the lower of the fair value of the equipment or the net book value as described above and depreciated over a term of 12 months. This term represents our estimate of the expected life of a previously leased piece of equipment and is based upon our historical experience. In the event the contract terminates prior to the end of the 12 month period, the remaining net book value is expensed as an impairment charge.
The Company also offers a financial product where the customer may acquire a new piece of equipment and sign a Rental Agreement which allows a renter to terminate the contract at any time by returning the equipment and providing the company with 30 days notice. Unlike the rental contracts that are originated as a result of automatic lease term renewals, these contracts are recorded at acquisition cost and an average contract life of 36 months is assigned to these schedules. This term is an estimate of the expected term under which the renter will continue to make payments and is based upon our historical experience. In the event that the contract terminates prior to the end of the 36 month period, the remaining net book value is expensed as an impairment charge. In accordance with SFAS 13, under an operating lease, the leased property should be depreciated following the lessor’s normal depreciation policy.
Our normal policy is to depreciate computer hardware and software over a period of 36 months. The rental contracts that we have originated or acquired through portfolio purchases have been various products such as Point of Sale, Credit Authorization and Medical Equipment, which are primarily comprised of computer hardware and software components, therefore a life of 36 months was assigned.
The Company will revise future filings to make these policies clearer.
4.
Please tell us how you determined the estimated life of service contracts to be 84 months. Tell us whether this represents the contractual term of your monitoring agreements.
In a typical service contract, a homeowner will purchase a home security system and simultaneously sign a contract with the security dealer for the monitoring of that system for a monthly fee. The security dealer will then sell the rights to that monthly payment to us for an upfront payment. We perform all of the processing, billing, collection and administrative work on these transactions. The service contract is recorded at cost. The estimated life of 84 months for service contracts is based upon the standard expected life of such contracts in the security monitoring industry and corresponds to the average outstanding period for a mortgage. This makes sense in that homeowners generally tend to keep the service for as long as they own the home. This estimated life has also proven to be accurate based upon our own historical performance of various monitoring portfolios. In the event the contract terminates prior to the 84 month term, the remaining net book value is expensed as an impairment charge at that time. This term differs from the contractual term in that the Service contracts we employ are not a firm term document, but rather are cancelable by the homeowner on a month to month basis but include a graduated early termination fee (which is designed to recover our costs in the event the cancellation takes place within the first four years).
Financial Statements
Note C – Net Investment in Leases, page F-14
5.
Please tell us and in future filings revise to include a complete description of your accounting policy for the allowance for credit losses. Describe your systematic analysis and procedural discipline, required by FRR-28, for determining the amount of your allowance for losses. Specifically discuss the following:
•
Explain how you develop each element of the allowance
•
Explain which loans, leases, and contracts are evaluated individually and which are evaluated as a group.
•
Explain how you determine the loss factors you apply to your graded loans to develop a general allowance
•
Explain how you consider any recourse provisions in determining each element of your allowance
We operate primarily through our wholly-owned subsidiaries, Leasecomm Corporation and TimePayment Corp. LLC. We lease and rent equipment and provide other financing services in amounts generally ranging from $500 to $15,000 and an average lease term of 44 months. Leasecomm historically financed contracts with an average amount financed of approximately $1,900, while the average amount financed by TimePayment is approximately $7,200. Given the nature of the “microticket” market and the individual size of each transaction, the business does not warrant the creation of a formal credit review committee to review individual transactions. Rather, we developed a sophisticated, risk-adjusted pricing model and have automated the credit scoring, approval and collection processes.
We believe that with the proper risk-adjusted pricing model, we can grant credit to a wide range of applicants provided we have priced appropriately for the associated risk inherent in the transaction. As a result of approving a wide range of credits, we experience a relatively high level of delinquency and write-offs in our portfolio. During periods where we are making credit decisions and funding new transactions, it is important for us to periodically review the credit scoring and approval process to ensure that the automated system is making appropriate credit decisions. Given the nature of the “microticket” market and the individual size of each transaction, the business does not warrant evaluating transactions individually for the purpose of developing and determining the adequacy of the allowance for credit losses. As such, transactions in our portfolio are not re-graded subsequent to the initial extension of credit, nor is the reserve allocated to specific transactions. Rather, in accordance with SFAS 114 paragraph 12, we view the impaired contracts to have common characteristics and maintain a general allowance against our entire portfolio utilizing historical statistics for recovery and timing of recovery as the basis for the amount.
We have adopted a consistent, systematic procedure for establishing and maintaining an appropriate reserve for credit losses for the microticket transactions by reserving, on a monthly basis an amount that is equal to or greater than 50% of the 90-day delinquency balance. In order to support the premise that 50% of the 90-day delinquency balances are an appropriate level of reserve, we review, on a static pool basis, the collection experience on various months of originations. In addition we also review, on a static pool basis, the recoveries made on written off accounts. The results of these static pool analyses reflect our actual collection experiences given the fact that the company obtains additional recourse in many instances in the form of personal guaranties from the borrowers, as well as, in some instances, limited recourse from the Dealer. This review is conducted on a quarterly basis by the Chief Financial Officer. This historical experience provides the basis of the analysis to determine the adequacy of the reserves.
The Company will revise future filings to make this policy clearer.
6.
Specifically tell us how you determined your allowance for credit losses as of December 31, 2004 of $15 million to be sufficient to cover losses inherent in your portfolio given the fact that your net charge-offs during each of the last three years were in excess of $65 million.
The sufficiency of the allowance for credit losses of $15.0 million was determined based upon the policy as outlined above under the previous questions. Based upon the size of the remaining portfolio, delinquency levels, the static pool analysis, and the seasoning of the portfolio as of December 31, 2004, $15.0 million was deemed to be an appropriate reserve by management. It is also important to note that although the absolute dollar value of the reserve has changed, that the reserve at year end 2004 represented 28.04% of outstanding lease receivables. In December of 2003, the reserve represented 28.3% of receivables, and in December of 2002, the reserve represented 25.6% of outstanding lease receivables. In addition, the portfolio is significantly more seasoned now than in previous periods (its average age is older) given the fact that the Company was forced to stop funding virtually all new business from September 2002 through June of 2004 as outlined in the 2004 10-K filing. This seasoning factor should result in a lower default rate since lessees have been paying longer on their contracts. Accordingly, prior year historical charge off levels, when measured on an absolute dollar basis, are not indicative of our current portfolio requirements.
Our projections of probable net credit losses are inherently uncertain, and as a result we cannot predict with certainty the amount of such losses. Changes in economic conditions, the risk characteristics and composition of the portfolio, bankruptcy laws, and other factors could impact our actual and projected net credit losses and the relat
Show Raw Text
CORRESP
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filename1.htm
October 12, 2005
VIA EDGAR / ORIGINAL BY FEDERAL EXPRESS
Ms. Angela Jackson
Senior Accountant
United States Securities and Exchange Commission
Division of Corporation Finance
Washington D.C. 20549
Re:
MicroFinancial Incorporated
Form 10-K for Fiscal Year Ended December 31, 2004
Filed March 30, 2005
File No. 001-14771
Dear Ms. Jackson:
Attached please find responses to the questions and comments you had outlined in your Comment Letter dated September 13, 2005. To facilitate your review process, I have replicated the questions you provided in your letter (in italics) and have included the response to the question just below it.
In accordance with your request, Company Management acknowledges that:
•
The Company is responsible for the adequacy and accuracy of the disclosure in the filing;
•
Staff comments or changes to disclosure in response to staff comments do not foreclose the Commission from taking any action with respect to the filing; and
•
The Company may not assert staff comments as a defense in any proceeding initiated by the Commission or any person under the federal securities laws of the United States.
Critical Accounting Policies – Revenue Recognition, page 15
1.
Please explain to us your policy for measuring the residual value of the equipment that you lease under direct financing leases.
•
Tell us how you determine the fair value of the leased equipment at the end of the lease term.
Our standard lease contract provides for a fair market value purchase option at the end of the lease term. At the end of the contractual lease term, the lessee may do one of the following: a) return the leased equipment, b) purchase the leased equipment at the fair market value, or c) continue to lease the equipment via a monthly renewal
option which allows the lessee to continue to pay for the use of the equipment on a month to month basis. This month to month renewal is the default option to the extent the lessee does not notify the Company of its intent to do otherwise at the end of lease term. The residual values are estimated at the inception of the lease contract and are based upon industry data and our own experience regarding the end of term options mentioned above, as well as, from defaults or other dispositions of the leased equipment. The booked residual amount is estimated at lease inception and is generally 10% of the original lease stream. This value approximates our historical performance given the options outlined above. We then, at least annually, review these values for impairment. Since any impairment would result in a write down of the residual value during the lease term, this ensures that the
fair value assessment at the end of lease term is still valid.
•
Tell us if you consider the cash flows expected to be received after the lease term during which you continue to bill the lessee on a month-to-month basis in your determination of the residual value of the leased asset.
As mentioned previously, our leases include renewal options whereby the lease contract provides for a month to month renewal of the contract to the extent the lessee selects this option at the end of lease term or otherwise fails to select one of the other end of lease options. Our historical experience relating to the expected cash flows to be received after the lease term is a consideration in the determination of the residual value of the leased asset.
•
Tell us how often you evaluate the residual value of leased assets for impairment.
Management performs reviews of the estimated residual values at least annually, and any impairment, if other than temporary, is recognized in the current period. The company will also perform an additional review of the values at any time when management deems a significant market event has occurred which could affect the values.
2.
We note in your disclosure that if a lessee continues to rent equipment after the lease term expires, you record an investment in rental contracts at the estimated residual value. Please confirm to us that you record these new month-to-month leases as operating leases in accordance with SFAS 13. Furthermore, please provide us with sample journal entries to describe how you record the termination of the prior financing lease and the inception of the new operating lease.
If a lessee continues to rent their equipment after the initial lease term has expired, the remaining net investment is removed from the accounts, and the account is recorded at its residual value, which in accordance with SFAS 13 paragraph 17 (f) (as amended) is the lower of its original cost, fair value, or present carrying amount, and the resulting difference, if any, is charged to income for the period. In accordance with SFAS 13 we record the new month to month contract as an operating lease. The contract is depreciated over a term of the lesser of 12 months or the actual
renewal period. The new operating lease is recorded net of accumulated depreciation on the balance sheet. Rents are reported as income over the lease term as they become receivable according to the provisions of the lease, which is on a straight line, month to month basis.
Example Entry to Terminate Direct Finance Lease and Record Operating Lease
At the end of lease term, the estimated residual value is credited and the new asset, investment in rental contracts, is established.
Investment in rental contracts
140.95
•
Estimated residual value
(140.95)
Results of Operations
Depreciation and Amortization, page 18
3.
Please tell us and revise future filings to more clearly explain your accounting policy for recording and depreciating rental equipment under operating leases. For example, explain why you record some equipment at estimated residual value and other equipment at acquisition cost. In addition, tell us how you determined depreciation periods of 12 months and 36 months.
The Company’s accounting policy for recording and depreciating rental equipment under operating leases depends upon the source of the rental contract. Certain rental contracts (operating lease treatment) are originated as a result of the renewal provisions of the lease agreement described above. These contracts are recorded at the lower of the fair value of the equipment or the net book value as described above and depreciated over a term of 12 months. This term represents our estimate of the expected life of a previously leased piece of equipment and is based upon our historical experience. In the event the contract terminates prior to the end of the 12 month period, the remaining net book value is expensed as an impairment charge.
The Company also offers a financial product where the customer may acquire a new piece of equipment and sign a Rental Agreement which allows a renter to terminate the contract at any time by returning the equipment and providing the company with 30 days notice. Unlike the rental contracts that are originated as a result of automatic lease term renewals, these contracts are recorded at acquisition cost and an average contract life of 36 months is assigned to these schedules. This term is an estimate of the expected term under which the renter will continue to make payments and is based upon our historical experience. In the event that the contract terminates prior to the end of the 36 month period, the remaining net book value is expensed as an impairment charge. In accordance with SFAS 13, under an operating lease, the leased property should be depreciated following the lessor’s
normal depreciation policy.
Our normal policy is to depreciate computer hardware and software over a period of 36 months. The rental contracts that we have originated or acquired through portfolio purchases have been various products such as Point of Sale, Credit Authorization and Medical Equipment, which are primarily comprised of computer hardware and software components, therefore a life of 36 months was assigned.
The Company will revise future filings to make these policies clearer.
4.
Please tell us how you determined the estimated life of service contracts to be 84 months. Tell us whether this represents the contractual term of your monitoring agreements.
In a typical service contract, a homeowner will purchase a home security system and simultaneously sign a contract with the security dealer for the monitoring of that system for a monthly fee. The security dealer will then sell the rights to that monthly payment to us for an upfront payment. We perform all of the processing, billing, collection and administrative work on these transactions. The service contract is recorded at cost. The estimated life of 84 months for service contracts is based upon the standard expected life of such contracts in the security monitoring industry and corresponds to the average outstanding period for a mortgage. This makes sense in that homeowners generally tend to keep the service for as long as they own the home. This estimated life has also proven to be accurate based upon our own historical performance of various monitoring portfolios. In the event the
contract terminates prior to the 84 month term, the remaining net book value is expensed as an impairment charge at that time. This term differs from the contractual term in that the Service contracts we employ are not a firm term document, but rather are cancelable by the homeowner on a month to month basis but include a graduated early termination fee (which is designed to recover our costs in the event the cancellation takes place within the first four years).
Financial Statements
Note C – Net Investment in Leases, page F-14
5.
Please tell us and in future filings revise to include a complete description of your accounting policy for the allowance for credit losses. Describe your systematic analysis and procedural discipline, required by FRR-28, for determining the amount of your allowance for losses. Specifically discuss the following:
•
Explain how you develop each element of the allowance
•
Explain which loans, leases, and contracts are evaluated individually and which are evaluated as a group.
•
Explain how you determine the loss factors you apply to your graded loans to develop a general allowance
•
Explain how you consider any recourse provisions in determining each element of your allowance
We operate primarily through our wholly-owned subsidiaries, Leasecomm Corporation and TimePayment Corp. LLC. We lease and rent equipment and provide other financing services in amounts generally ranging from $500 to $15,000 and an average lease term of 44 months. Leasecomm historically financed contracts with an average amount financed of approximately $1,900, while the average amount financed by TimePayment is approximately $7,200. Given the nature of the “microticket” market and the individual size of each transaction, the business does not warrant the creation of a formal credit review committee to review individual transactions. Rather, we developed a sophisticated, risk-adjusted pricing model and have automated the credit scoring, approval and collection processes.
We believe that with the proper risk-adjusted pricing model, we can grant credit to a wide range of applicants provided we have priced appropriately for the associated risk inherent in the transaction. As a result of approving a wide range of credits, we experience a relatively high level of delinquency and write-offs in our portfolio. During periods where we are making credit decisions and funding new transactions, it is important for us to periodically review the credit scoring and approval process to ensure that the automated system is making appropriate credit decisions. Given the nature of the “microticket” market and the individual size of each transaction, the business does not warrant evaluating transactions individually for the purpose of developing and determining the adequacy of the allowance for credit losses. As such, transactions in our portfolio are not re-graded
subsequent to the initial extension of credit, nor is the reserve allocated to specific transactions. Rather, in accordance with SFAS 114 paragraph 12, we view the impaired contracts to have common characteristics and maintain a general allowance against our entire portfolio utilizing historical statistics for recovery and timing of recovery as the basis for the amount.
We have adopted a consistent, systematic procedure for establishing and maintaining an appropriate reserve for credit losses for the microticket transactions by reserving, on a monthly basis an amount that is equal to or greater than 50% of the 90-day delinquency balance. In order to support the premise that 50% of the 90-day delinquency balances are an appropriate level of reserve, we review, on a static pool basis, the collection experience on various months of originations. In addition we also review, on a static pool basis, the recoveries made on written off accounts. The results of these static pool analyses reflect our actual collection experiences given the fact that the company obtains additional recourse in many instances in the form of personal guaranties from the borrowers, as well as, in some instances, limited recourse from the Dealer. This review is conducted on a quarterly
basis by the Chief Financial Officer. This historical experience provides the basis of the analysis to determine the adequacy of the reserves.
The Company will revise future filings to make this policy clearer.
6.
Specifically tell us how you determined your allowance for credit losses as of December 31, 2004 of $15 million to be sufficient to cover losses inherent in your portfolio given the fact that your net charge-offs during each of the last three years were in excess of $65 million.
The sufficiency of the allowance for credit losses of $15.0 million was determined based upon the policy as outlined above under the previous questions. Based upon the size of the remaining portfolio, delinquency levels, the static pool analysis, and the seasoning of the portfolio as of December 31, 2004, $15.0 million was deemed to be an appropriate reserve by management. It is also important to note that although the absolute dollar value of the reserve has changed, that the reserve at year end 2004 represented 28.04% of outstanding lease receivables. In December of 2003, the reserve represented 28.3% of receivables, and in December of 2002, the reserve represented 25.6% of outstanding lease receivables. In addition, the portfolio is significantly more seasoned now than in previous periods (its average age is older) given the fact that the Company was forced to stop funding virtually
all new business from September 2002 through June of 2004 as outlined in the 2004 10-K filing. This seasoning factor should result in a lower default rate since lessees have been paying longer on their contracts. Accordingly, prior year historical charge off levels, when measured on an absolute dollar basis, are not indicative of our current portfolio requirements.
Our projections of probable net credit losses are inherently uncertain, and as a result we cannot predict with certainty the amount of such losses. Changes in economic conditions, the risk characteristics and composition of the portfolio, bankruptcy laws, and other factors could impact our actual and projected net credit losses and the relat