CFNB California First Leasing Corporation (QX)

Item 1(a). Reports to Stockholders

Semi-Annual Financial Report

December 31, 2022

California First Leasing Corporation, (OTCQX: CFNB, “CalFirstLease” or the “Company”), headquartered in Newport Beach, California, registered as an internally managed non-diversified closed-end investment company under the Investment Company Act of 1940, as amended (the “1940 Act”) in February 2022. The Company continues its lease business while using equity and other investments to maximize current income and generate capital appreciation.

An investment in the Company’s common stock involves certain risks, including the risk of loss. The shares of common stock are not deposits or obligations of, or guaranteed by any federal or other government agency. A registration statement dated July 20, 2022 (the “Registration Statement”) containing additional information about the Company has been filed with the Securities and Exchange Commission (the “SEC”). Investors should carefully consider the Company’s objectives and risks detailed in the Registration Statement that may adversely affect the Company’s shareholders’ equity and stock price and may make an investment in the Company not appropriate for all investors.

Statements made in this report that are not strictly historical in nature constitute “forward-looking statements.” Forward-looking statements involve management judgment and assumptions, risks and uncertainties and include, but are not limited to, beliefs regarding investments in equity securities, swings in stock prices and the potential for significant volatility in reported net earnings, changes in the lease portfolio, the impact of external events on business activities, estimates of expected tax rates applicable to future periods, impact of changes in interest rates and equity and fixed income markets.  Such forward-looking statements involve known and unknown risks and uncertainties and factors that could cause actual results to differ materially include political, economic, competitive, market, regulatory and other risks. Consequently, if management assumptions prove to be incorrect or such risks or uncertainties materialize, the Company’s actual results could differ materially from the results forecast in the forward-looking statements.  All forward-looking statements are qualified in their entirety by this cautionary statement, and the Company undertakes no obligation to revise or update this information to reflect events or circumstances arising after the date hereof (January 30, 2023).

CONTENTS

Overview

For the six months ended December 31, 2022, net earnings decreased 68% to $3.4 million. This included a gain on equity securities of $12.8 million, a return of 10.0% for the three months ended December 31, 2022 that offset a loss on equity securities of $12.0 million reported for the first three months of fiscal 2023. The return on the equity portfolio for the six-month period of 1.9% compared to the return on the S&P 500^®TR Index  of 2.4% for the same period.  The Company’s overall return based on the change in net asset value of 3.0% for the first half of fiscal 2023 benefitted from increased interest income related to higher interest rates and higher short-term investment balances, an 18% increase in lease income and 12% decline in operating expenses.

During the first six months of fiscal 2023, the Company did not declare or pay any dividends as in years past, but it did successfully complete a tender offer to repurchase 580,683 shares, or 5.6% of CalFirstLease’s common stock outstanding. The repurchase of shares below book value contributed to a 1.5% increase to net book value per share at December 31, 2022.

Investment Operations

The Company focuses on investing in fair or under-valued public companies that we expect to generate excess cash flow that can be reinvested into the business at attractive rates of return to continue substantial growth or be returned to shareholders via share repurchases or dividends. A high percentage of the equity portfolio generally is invested in U.S. large capitalization equities. From time to time, the Company may retain a significant amount of funds in short-term liquid investments in order to take advantage of investment or lease opportunities as they arise. The Company does not specialize in any specific industry, but may hold large positions in certain sectors that it believes offer the opportunity for long-term returns but may underperform in certain market environments.

U.S. equities made robust gains during the three months ended December 31, 2022, with the S&P 500 up 7.6% following the 4.9% decline during the September quarter, although technology and small-cap dominated NASDAQ was down slightly. While inflationary pressures persist, the latest consumer price index (CPI) data shows that inflation has slowed, GDP is stronger than earlier estimates and unemployment remains low. The Fed’s last rate hike of 50 basis points in December signaled support for improving conditions.

The equity securities portfolio at December 31, 2022 consisted of common stock holdings in 30 public companies, all with readily available stock prices, compared to 34 public companies at June 30, 2022. Although the Company owns shares in 30 businesses, about 38% of the equity portfolio is invested in our top 5 holdings that amount to 27% of net assets. That is due to in most part to the strong performance of those investments since we purchased shares. The distribution of the Company’s equity securities across four segments at December 31, 2022 and the comparative gains or losses by group is summarized below:

After declining into a net loss position during the September 2022 quarter, by the end of December 2022 the Company’s equity securities had swung back into positive territory and produced a 1.9% return for the first six months of fiscal 2023, compared to a 2.4% all-in return on the benchmark S&P 500^®TR Index for the comparable period. CFNB’s six-month results include a 10.0% return on the equity portfolio for the 3 months ended December 31, 2022 compared to a 7.6% return on the S&P 500^®TR Index.

The equity portfolio’s recent performance relative to the broader market reflects better performance by energy, large-cap and value stocks, while growth and technology stocks continued to lag.  Energy remains the Company’s largest sector and this overweight, dominated by Exxon Mobil at 23% of the equity portfolio at December 31, made the group the top contributor to the Company’s results for the second quarter and six months of fiscal 2023.  The runner up contribution came from the health plan sector comprised of Cigna and United Health, followed by financial services led by Goldman Sachs. The greatest detractors to performance were telecom companies Verizon and AT&T, internet platforms Alphabet and Meta, as well as semiconductor companies, though the latter group did recover somewhat during the December quarter.

During the first six months of fiscal 2023, the Company invested $20.8 million in 7 existing holdings and 6 new positions. It also sold 10 positions for $9.3 million, realizing a net loss of $2.0 million. Following the sale of 9 positions during the first quarter, including AT&T, the Company did not make any sizable shifts to the equity portfolio during the second quarter other than to sell Warner Bros Discovery.

Interest and Dividend Income  

A key component of the Company’s strategy is to generate current income through dividends in addition to the opportunity to realize investment returns from appreciation in stock values. Of the 30 stock positions held at December 31, 2022, 21 pay a dividend and account for 85% of the fair value of equity securities at December 31, 2022. In addition, following aggressive Federal Reserve actions to raise interest rates since March 2022, income from money market balances are a more meaningful contributor to income.  The following table presents the Company’s average balances and yields earned on investments for the periods shown:

Total dividend and interest income for the six months ending December 31, 2022 increased 22% to $2.48 million as interest income jumped significantly on an 88% increase in average interest-earning balances and 282 basis point increase in average yield earned to 2.89%. This offset a 12% decline in dividend income related to an 22% decline in average equity balances to $144 million, notwithstanding a 17-basis point increase in average dividend yield to 2.47%.

Lease Operations

Lease bookings of $6.9 million for the first six months of fiscal 2023 were up from $5.2 million for the first six months of fiscal 2022. Lease originations in fiscal 2023 have been minimal, leaving the backlog of approved lease commitments of $5.9 million at December 31, 2022, down from $8.0 million at June 30, 2022.  Transactions in process of $250,000 at December 31, 2022 are down from $2.7 million at June 30, 2022.

Finance and loan income of $730,000 for the first six months of fiscal 2023 was down 42% due to a 39.3% decrease in average balances to $20.8 million and a 35-basis point decrease in the average yield to 7.02%.   The following table presents the Company’s average lease and loan balances, income and related yields earned on an annualized basis.

Other Lease Income – In December 2022, the Company recovered $906,200 on a lease-related claim filed in 2015 and recognized the recovery as part of other lease income in the period. An increase in operating lease income also contributed to a 130% increase in other lease income during the first six months of fiscal 2023.

Operating Expenses

The Company’s operating expenses for the six months ended December 31, 2022 decreased by 12.1% to $1.4 million compared to $1.5 million the year before.  The decrease in fiscal 2023 included the continued release of reserves for credit losses along with a 16.2% decline in compensation and benefit costs despite absorbing the requirements related to registering with the SEC as an investment company.

Income Taxes

The Company’s effective income tax rate varies between periods due to changes in the mix of pre-tax earnings, the magnitude of gains or losses from equity securities included in earnings, and underlying income tax rates applicable in various taxing jurisdictions. For the first six months ending December 31, 2022, the tax provision of $842,000 included a provision accrued at an effective tax rate of 18.2% on pretax earnings of $3.40 million excluding the equity securities gain, and a provision accrued at 27.0% on the net equity security gain of $830,876. The effective tax rate reflects the benefit the Company receives from the dividends received exclusion. The equity gain for the first six months of fiscal 2023 included net realized taxable losses of $2.0 million on the sale of equity securities in the period, and unrealized gains of $2.83 million.

The components of earnings and taxes are summarized as follows:

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

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

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

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