Securities and Exchange Commission
Washington, D.C. 20549
Form 10-Q
X Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Act of
- - --- 1934 for the quarterly period ended June 30, 2000.
Transition Report Pursuant to Section 13 or 15(d) of the Securities
- - --- Exchange Act of 1934.
Commission File Number 000-23775
Approved Financial Corp.
------------------------
(Exact Name of Registrant as Specified in its Charter)
Virginia 52-0792752
- - --------------------------------- ---------------------------------------
(State or Other Jurisdiction of (I.R.S. Employer Identification Number)
Incorporation or Organization)
1716 Corporate Landing Parkway, Virginia Beach, Virginia 23454
-------------------------------------------------------------------
(Address of Principal Executive Office) (Zip Code)
757-430-1400
-------------
(Registrant's Telephone Number, Including Area Code)
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 is
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No .
---- ----
The number of shares outstanding of the registrant's $1.00 par value common
stock, as of August 1, 2000: 5,482,114 shares
APPROVED FINANCIAL CORP.
INDEX
PART I. FINANCIAL INFORMATION Page
Item 1. Financial Statements
Consolidated Balance Sheets as of
June 30, 2000 and December 31, 1999 1
Consolidated Statements of Loss and Comprehensive
Loss for the three months ended June 30, 2000 2
and 1999.
Consolidated Statements of Loss and Comprehensive
Loss for the six months ended June 30, 2000
and 1999. 3
Consolidated Statements of Cash Flows for
the six months ended June 30, 2000
and 1999. 4
Notes to Consolidated Financial Statements 6
Consolidating Balance Sheet as of June 30, 2000 10
Consolidating Statement of Loss for the
three months ended June 30, 2000 11
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 12
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 29
Part II. OTHER INFORMATION
Item 1. Legal Proceedings 33
Item 2. Changes in Securities 33
Item 3. Defaults Upon Senior Securities 33
Item 4. Submission of Matters to a Vote of Security Holders 33
Item 5. Other Information 33
Item 6. Exhibits and Reports on Form 8-K 33
PART I . FINANCIAL INFORMATION
APPROVED FINANCIAL CORP.
CONSOLIDATED BALANCE SHEETS
June 30, 2000 and December 31, 1999
(Dollars in thousands, except per share amounts)
ASSETS (Unaudited) 1999
2000
----------- ---------
Cash $ 9,100 $10,656
Mortgage loans held for sale, net 37,053 66,771
Real estate owned, net 1,486 2,274
Investments 2,882 2,640
Income taxes receivable 1,265 5,644
Deferred tax asset 1,695 1,676
Premises and equipment, net 5,719 6,086
Goodwill, net 1,051 1,120
Other assets 1,404 1,733
--------- -----------
Total assets $61,655 $98,600
========= ===========
LIABILITIES AND EQUITY
Liabilities:
Revolving warehouse loan $ 121 $17,465
FHLB bank advances - 4,648
Mortgage notes payable 2,298 2,341
Notes payable-related parties 2,897 2,993
Certificates of indebtedness 2,000 2,087
Certificates of deposits 40,534 55,339
FDIC - insured money market account 1,676 -
Accrued and other liabilities 1,674 2,428
--------- -----------
Total liabilities 51,200 87,301
--------- -----------
Shareholders' equity:
Preferred stock series A, $10 par value; 1 1
Noncumulative, voting:
Authorized shares - 100
Issued and outstanding shares - 90
Common stock, par value - $1.00 5,482 5,482
Authorized shares - 40,000,000
Issued and outstanding shares - 5,482,114
Accumulated other comprehensive loss (22) (16)
Additional capital 552 552
Retained earnings 4,442 5,280
--------- -----------
Total equity 10,455 11,299
--------- -----------
Total liabilities and equity $61,655 $98,600
========= ===========
The accompanying notes are an integral part of the consolidated financial
statements.
1
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENT OF LOSS AND COMPREHENSIVE LOSS
for the three months ended June 30, 2000 and 1999
(In thousands, except per share amounts)
(Unaudited)
2000 1999
------ --------
Revenue:
Gain on sale of loans $ 2,502 $ 3,127
Interest income 1,317 1,943
Other fees and income 1,197 2,106
------ --------
5,016 7,176
------ --------
Expenses:
Compensation and related 3,089 4,559
General and administrative 1,534 2,512
Advertising expense 318 496
Loan production expense 274 472
Interest expense 959 1,212
Provision for loan and foreclosed property losses 92 43
------ --------
6,266 9,294
------ --------
Loss before income taxes (1,250) (2,118)
Benefit from income taxes (472) (808)
------ ---------
Net loss (778) (1,310)
Other comprehensive loss, net of tax:
Unrealized losses on securities:
Unrealized holding loss arising during period (6) (23)
------ --------
Comprehensive loss $ (784) $(1,333)
====== ========
Net loss per share:
Basic and Diluted $(0.14) $(0.24)
====== ========
Weighted average number of shares outstanding:
Basic and Diluted 5,482 5,482
====== ========
The accompanying notes are an integral part of the consolidated financial
statements.
2
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF LOSS AND COMPREHENSIVE LOSS
for the six months ended June 30, 2000 and 1999
(In thousands, except per share amounts)
(Unaudited)
2000 1999
------- -------
Revenue:
Gain on sale of loans $ 6,428 $ 7,523
Interest income 2,901 4,639
Other fees and income 2,399 4,398
------- -------
11,728 16,560
------- -------
Expenses:
Compensation and related 6,222 9,390
General and administrative 3,326 4,851
Advertising expense 655 859
Loan production expense 640 1,027
Interest expense 2,081 2,895
Provision for loan and foreclosed property losses 147 1,490
------- -------
13,071 20,512
------- -------
Loss before income taxes (1,343) (3,952)
Benefit from income taxes (505) (1,407)
------- -------
Net loss (838) (2,545)
Other comprehensive loss, net of tax:
Unrealized losses on securities:
Unrealized holding loss arising during period (6) (56)
------- -------
Comprehensive loss $ (844) $(2,601)
======= =======
Net loss per share:
Basic and Diluted $(0.15) $(0.46)
======= =======
Weighted average number of shares outstanding:
Basic and Diluted 5,482 5,482
======= =======
The accompanying notes are an integral part of the consolidated financial
statements.
3
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
for the six months ended June 30, 2000 and 1999
(In thousands)
(Unaudited)
2000 1999
--------- ---------
Operating activities
Net loss $ (838) $ (2,545)
Adjustments to reconcile net loss
to net cash provided by operating activities:
Depreciation of premises and equipment 382 442
Amortization of goodwill 69 235
Provision (recoveries) for loan losses (44) 1,080
Provision for losses on real estate owned 191 410
Loss on sale of ARM Portfolio shares - 8
Deferred tax expense (benefit) (19) 2,277
Gain on sale of loans (6,428) (7,523)
Proceeds from sale and prepayments of loans 159,037 154,139
Originations of loans held for sale, net (123,518) (106,899)
Changes in assets and liabilities:
Loan sale receivable 3 (2)
Other assets 328 1,308
Accrued and other liabilities (753) (618)
Income tax payable 4,379 (1,464)
Loan proceeds payable - (2,294)
--------- ----------
Net cash provided by operating activities 32,789 38,554
Cash flows from investing activities:
Purchase of securities - (125)
Sales of securities 115 -
Sales of ARM fund shares - 4,692
Purchase of premises and equipment (94) (1,112)
Sales of premises and equipment 75 1,328
Sales of real estate owned 1,361 1,172
Real estate owned capital improvements (93) (321)
Purchases of ARM fund shares (65) (3,566)
Purchases of FHLB stock (297) (146)
--------- ----------
Net cash provided by investing activities 1,002 1,922
4
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS, continued
for the six months ended June 30, 2000 and 1999
(In thousands)
(Unaudited)
2000 1999
-------- ----------
Cash flows from financing activities:
Borrowings - warehouse $ 29,111 $ 107,455
Repayments of borrowings - warehouse (46,454) (148,166)
Borrowings (repayments) of FHLB advances (4,648) 1,000
Principal payments on mortgage notes payable (43) (864)
Net increase (decrease) in:
Notes payable (96) 52
Certificates of indebtedness (88) (49)
Certificates of deposit (14,805) -
FDIC - insured money market account 1,676 298
-------- ----------
Net cash used in financing activities (35,347) (40,274)
-------- ----------
Net (decrease) increase in cash (1,556) 202
Cash at beginning of period 10,656 6,269
-------- ----------
Cash at end of period $ 9,100 $ 6,471
======== ==========
Supplemental cash flow information:
Cash paid for interest $ 1,964 $ 3,103
Supplemental non-cash information:
Loan balances transferred to real estate owned $ 838 $ 1,975
The accompanying notes are an integral part of the consolidated financial
statements.
5
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the six months ended June 30, 2000 and 1999
Note 1. Organization and Summary of Significant Accounting Policies:
Organization: Approved Financial Corp., a Virginia corporation ("Approved"), and
its subsidiaries (collectively, the "Company") operate primarily in the consumer
finance business of originating, servicing and selling mortgage loans secured
primarily by first and second liens on one-to-four family residential
properties. The Company sources mortgage loans through two origination channels;
a network of mortgage brokers who refer mortgage customers to the Company
("broker" or "wholesale") and an internal sales staff that originate mortgages
directly with borrowers ("retail" and "direct"). Approved has two wholly owned
subsidiaries through which it originates residential mortgages: Approved Federal
Savings Bank (the "Bank"), a federally chartered thrift institution with broker
operations in seven states and nine retail offices as of June 30, 2000; and
Approved Residential Mortgage, Inc. ("ARMI") with one retail location at June
30, 2000. Approved has a third wholly owned subsidiary, Approved Financial
Solutions ("AFS"), through which it offers other financial products such as Debt
Free Solutions, Mortgage Acceleration Program and insurance products to its
mortgage customers.
Principles of accounting and consolidation: The consolidated financial
statements of the Company include the accounts of Approved and its wholly-owned
subsidiaries. All significant inter-company accounts and transactions have been
eliminated.
Use of estimates: The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Cash and cash equivalents: Cash and cash equivalents consist of cash on deposit
at financial institutions and short-term investments that are considered cash
equivalents if they were purchased with an original maturity of three months or
less.
Loans held for sale: Loans, which are all held for sale, are carried at the
lower of aggregate cost or market value. Market value is determined by current
investor yield requirements.
Allowance for loan losses: The allowance for loan losses is maintained at a
level believed adequate by management to absorb probable losses in the loan
portfolio. Management's determination of the adequacy of the allowance is based
on an evaluation of the current loan portfolio characteristics including
criteria such as delinquency, default and foreclosure rates and trends, age of
the loans, credit grade of borrowers, loan to value ratios, current economic and
secondary market conditions, current and anticipated levels of loan volume, and
other relevant factors. The allowance is increased by provisions for loan
losses charged against income.
6
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the six months ended June 30, 2000 and 1999
Note 1. Organization and Summary of Significant Accounting Policies,
continued:
Loan losses are charged against the allowance when management believes it is
unlikely that the loan is collectable.
Origination fees: Net origination fees are recognized over the life of the loan
or upon the sale of the loan, if earlier.
Hedging: To offset the effects of interest rate fluctuations on the value of
its fixed rate mortgage loans held for sale, the Company in certain cases will
enter into Treasury security lock contracts, which function similarly to short
sales of U.S. Treasury securities. Gains or losses from these contracts are
deferred and recognized as an adjustment to gains on sale of loans when the
loans are sold or when the related hedge position is closed.
Real estate owned: Real estate owned is valued at the lower of cost or fair
market value, net of estimated disposal costs. Cost includes loan principal and
certain capitalized expenses. Any excess of cost over the estimated fair market
value at the time of acquisition is charged to the allowance for loan losses.
The estimated fair market value is reviewed periodically by management and any
write-downs are charged against current earnings using a valuation account which
has been netted against real estate owned in the financial statements. Income
from temporary rental of the properties is credited against the investment when
collected. Capital improvements are capitalized to the extent of net realizable
value. Additional carrying costs, including taxes, utilities and insurance, are
also capitalized to the property, to the extent of net realizable value.
Premises and equipment: Premises, leasehold improvements and equipment are
stated at cost less accumulated depreciation and amortization. The buildings
are depreciated using the straight line method over thirty years. Leasehold
improvements are amortized over the lesser of the terms of the lease or the
estimated useful lives of the improvements. Depreciation of equipment is
computed using the straight line method over the estimated useful lives of three
to five years. Expenditures for betterments and major renewals are capitalized
and ordinary maintenance and repairs are charged to operations as incurred.
Investments: The Company's investment in the stock of the Federal Home Loan Bank
("FHLB") of Atlanta is stated at cost.
All other investment securities, except the FHLB stock, are classified as
available-for-sale and reported at fair value, with unrealized gains and losses
excluded from earnings and reported as other comprehensive income in
shareholders' equity.
Realized gains and losses on sales of securities are computed using the specific
identification method.
7
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the six months ended June 30, 2000 and 1999
Note 1. Organization and Summary of Significant Accounting Policies,
continued:
Transfers of financial assets: The Company applies a financial-components
approach that focuses on control when accounting and reporting for transfers and
servicing of financial assets and extinguishments of liabilities. Under that
approach, after a transfer of financial assets, an entity recognizes the
financial and servicing assets it controls and the liabilities it has incurred,
derecognizes financial assets when control has been surrendered, and
derecognizes liabilities when extinguished. This approach provides consistent
standards for distinguishing transfers of financial assets that are sales from
transfers that are secured borrowings.
Income recognition: Gains on the sale of mortgage loans, representing the
difference between the sales price and the net carrying value of the loans, are
recognized when mortgage loans are sold and delivered to investors.
Interest on loans is credited to income based upon the principal amount
outstanding. Interest is accrued on loans until they become 31 days or more past
due.
Advertising costs: Advertising costs are expensed when incurred.
Income taxes: Taxes are provided on substantially all income and expense items
included in earnings, regardless of the period in which such items are
recognized for tax purposes. The Company uses an asset and liability approach
that requires the recognition of deferred tax assets and liabilities for the
estimated future tax consequences of events that have been recognized in the
Company's financial statements or tax returns. In estimating future tax
consequences, the Company generally considers all expected future events other
than enactments of changes in the tax laws or rates.
Earnings per share: The Company computes "basic earnings per share" by dividing
income available to common shareholders by the weighted-average number of common
shares outstanding for the period. "Diluted earnings per share" reflects the
effect of all potentially dilutive potential common shares such as stock options
and warrants and convertible securities.
Comprehensive income: The Company classifies items of other comprehensive income
(loss) by their nature in a financial statement and displays the accumulated
balance of other comprehensive income (loss) separately from retained earnings
and additional capital in the equity section of the consolidated balance sheets.
The only item the Company has in Comprehensive Income (Loss) for the three and
six month periods ended June 30, 2000 and 1999, is an unrealized holding loss on
securities, net of deferred taxes.
8
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the six months ended June 30, 2000 and 1999
Note 1. Organization and Summary of Significant Accounting Policies,
continued:
Segments: A public business enterprise is required to report financial and
descriptive information about its reportable operating segments. Operating
segments are components of an enterprise about which separate financial
information is available that is evaluated regularly by the chief operating
decision-maker in deciding how to allocate and in assessing performance.
Generally, financial information is required to be reported on the basis that it
is used internally for evaluating segment performance and deciding how to
allocate resources to segments. The Company has evaluated this requirement and
determined it operates in one segment.
New accounting pronouncements:
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" as
amended by SFAS 137, is effective for fiscal year ends beginning after June 15,
2000. This statement establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts (collectively referred to as derivatives), and for hedging
activities. It requires that entities recognize all derivatives as either
assets or liabilities in the financial statements and measure those instruments
at fair value. If certain conditions are met, a derivative may be specifically
designed as (a) a hedge of the exposure to changes in the fair value of a
recognized asset or liability or an unrecognized firm commitment, (b) a hedge of
the exposure to variable cash flows of a forecasted transaction, or (c) a hedge
of the foreign currency exposure of a net investment in a foreign operation, an
unrecognized firm commitment, an available-for-sale security, or a foreign-
currency-denominated forecasted transaction. This statement should not have any
material impact on the financial statements.
Securities and Exchange Commission Staff Accounting Bulletin 101 (SAB 101),
"Revenue Recognition in Financial Statements", as amended by SAB 101B, must be
adopted no later than the fourth calendar quarter of the year 2000. Adoption of
SAB101 is not expected to have any material impact on the recognition,
presentation, and disclosure of revenue.
Note 2. Transfer of Assets
On April 1, 2000 the Company, as part of its expense reduction initiatives,
transferred all assets of MOFC d/b/a ConsumerOne Financial ("ConsumerOne"), a
wholly owned subsidiary of Approved, to Approved Federal Savings Bank, also a
wholly owned subsidiary of Approved. The sole ConsumerOne retail office
operating in Michigan, now operates as a retail office of Approved Federal
Savings Bank. This transfer of assets eliminated the expense of maintaining
separate licenses for ConsumerOne.
9
Approved Financial Corp.
Consolidating Balance Sheet
June 30, 2000
(dollars in thousands)
Approved Approved Approved Approved
Financial Residential Federal Financial
ASSETS Consolidated Eliminations Corp. Mortgage Savings Bank Solutions
-------------------------------------------------------------------------------------------------
Cash $ 9,100 $ 0 $ 5,172 $ 232 $ 3,625 $ 71
Mortgage loans held for 37,053 0 9,056 54 27,943 0
sale, net
Real estate owned, net 1,486 0 215 1,271 0 0
Investments 2,882 (5,399) 5,524 0 2,757 0
Income taxes receivable 1,265 (2,711) 3,964 0 0 12
Deferred tax asset 1,695 0 222 239 1,234 0
Premises and equipment, net 5,719 0 4,762 101 856 0
Goodwill, net 1,051 0 469 0 582 0
Due from affiliates 0 (27,046) 7,464 37 19,482 63
Other assets 1,404 0 721 95 586 2
-------------------------------------------------------------------------------------------------
Total assets $61,655 $(35,156) $37,569 $ 2,029 $57,065 $148
=================================================================================================
LIABILITIES AND EQUITY
Liabilities:
Revolving warehouse loan $ 121 $ 0 $ 121 $ 0 $ 0 $ 0
FHLB bank advances 0 0 0 0 0 0
Mortgage payable 2,298 0 2,298 0 0 0
Notes payable-related 2,897 0 2,897 0 0 0
parties
Certificates of 2,000 0 2,000 0 0 0
indebtedness
Certificates of deposits 40,534 0 0 0 40,534 0
FDIC - insured money market 1,676 0 0 0 1,676 0
Due to affiliates 0 (27,046) 19,129 2,580 5,216 121
Loan proceeds payable 0 0 0 0 0 0
Accrued and other 1,674 0 669 330 675 0
liabilities
Income taxes payable 0 (2,711) 0 2,711 0 0
-------------------------------------------------------------------------------------------------
Total liabilities 51,200 (29,757) 27,114 5,621 48,101 121
-------------------------------------------------------------------------------------------------
Shareholder's equity:
Preferred stock-series A 1 0 1 0 0 0
Common stock 5,482 (299) 5,482 250 33 16
Unrealized loss on securities (22) 30 (22) 0 (30) 0
Additional paid in capital 552 (6,838) 552 493 6,345 0
Retained earnings (deficit) 4,442 1,708 4,442 (4,335) 2,616 11
-------------------------------------------------------------------------------------------------
Total equity 10,455 (5,399) 10,455 (3,592) 8,964 27
-------------------------------------------------------------------------------------------------
Total liabilities and $61,655 $(35,156) $37,569 $ 2,029 $57,065 $148
equity
=================================================================================================
10
Approved Financial Corp.
Consolidating Statement of Income (Loss)
For the six months ended June 30, 2000
(dollars in thousands)
Approved Approved Approved Approved
Financial Residential Federal Financial
Consolidated Eliminations Corp. Mortgage Savings Bank Solutions
--------------------------------------------------------------------------------------------------------
Revenue:
Gain on sale of loans $ 6,428 0 $ (465) $ 436 $ 6,457 $ 0
Interest income 2,901 0 373 (588) 3,115 1
Other fees and income 2,399 0 3 297 2,013 86
------------------------------------------------------------------------------------------------------
11,728 0 (89) 145 11,585 87
Expenses:
Compensation and $ 6,222 0 $ 1,711 $ 324 $ 4,102 85
related
General and 3,326 0 270 138 2,909 9
administrative
Advertising expense 655 0 (19) 36 638 0
Loan production expense 640 0 (52) 186 506 0
Interest expense 2,081 0 544 0 1,537 0
Provision for loan/REO 147 0 336 (241) 52 0
losses
------------------------------------------------------------------------------------------------------
13,071 0 2,790 443 9,744 94
Income (loss) before income (1,343) 0 (2,879) (298) 1,841 (7)
taxes
Provision for income taxes (505) 0 (1,103) (115) 716 (3)
------------------------------------------------------------------------------------------------------
Net income (loss) $ (838) 0 $(1,776) $(183) $ 1,125 $(4)
======================================================================================================
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
General
The following commentary discusses major components of the Company's business
and presents an overview of the Company's consolidated results of operations for
the three and six month periods ended June 30, 2000 and 1999 and its
consolidated financial position at June 30, 2000 and December 31, 1999. The
discussion includes some forward-looking statements involving estimates and
uncertainties. The Company's actual results could differ materially from those
anticipated in the forward-looking statements as a result of certain factors
such as reduced demand for the Company's loan products, competitive forces,
availability of adequate capital funding, loan delinquency, default and loss
rates, general economic environment, market forces affecting the value of the
loans originated by the Company and the price of the Company's common stock.
This discussion should be reviewed in conjunction with the consolidated
financial statements and accompanying notes and other statistical information
presented in the Company's 1999 audited financial statements.
Results of Operations for the three and six months ended June 30, 2000 compared
to the three and six months ended June 30, 1999.
Net Loss
The Company's net loss decreased by 41% and 67% for the three and six months
ended June 30, 2000 was $0.8 million and $0.8 million compared to a net loss of
$1.3 and $2.5 million for the three and six month periods ended June 30, 1999.
On a per share basis, the net loss for the three and six month periods ended
June 30, 2000 was $0.14 and $0.15 compared to a net loss of $0.24 and $0.46 for
the three and six month periods ended June 30, 1999.
12
Origination of Mortgage Loans
The following table shows the loan originations in dollars and units for the
Company's broker and retail divisions for the three and six months ended June
30, 2000 and 1999. During the second quarter of 1999, the Company initiated in-
house funding of conforming and government mortgages originated by the retail
division. Additionally, the retail branches originate mortgages that are funded
through other lenders ("Brokered loans"). Brokered loans consist primarily of
non-conforming mortgages that do not meet the Company's underwriting criteria
and conforming loans.
Three Months Six Months
(dollars in thousands) Ended Ended
June 30, June 30,
2000 1999 2000 1999
-------------------------- ---------------------------
Dollar Volume of Loans Originated:
Broker $29,840 $31,585 $69,984 $57,310
Retail - funded through other lenders 13,317 42,352 26,974 88,856
Retail - funded in-house non-conforming 12,702 17,065 30,994 42,100
Retail - funded in-house conforming and government 11,998 7,451 22,524 7,451
-------------------------- ---------------------------
Total $67,857 $98,453 $150,476 $195,717
========================== ===========================
Number of Loans Originated:
Broker 420 519 960 927
Retail - funded through other lenders 208 497 386 1,042
Retail - funded in-house non-conforming 199 268 459 645
Retail - funded in-house conforming and government 123 79 215 79
-------------------------- ---------------------------
Total 950 1,363 2,020 2,693
========================== ===========================
The dollar volume of loans, originated during the three and six months ended
June 30, 2000, decreased 54.9% and 49.7% when compared to the same period in
1999. The decrease was primarily the result of increased pricing competition in
the non-conforming mortgage area and a decrease in the number of retail loan
origination centers from 16 at June 30, 1999 to 10 at June 30, 2000.
The 37.5% decrease in retail loan origination centers resulted in a 43.1% and
41.8% decrease in the Company's retail loan volume for the three and six month
periods ending June 30, 2000 when compared to the same period in 1999. Brokered
loans generated by the retail division were $13.3 and $27.0 million during the
three and six month periods ended June 30, 2000 which was a 68.6% and 69.6%
decrease compared to $42.4 and $88.9 million during the same period in 1999.
The decrease was the result of a company initiative to close more in-house
loans.
The volume of loans originated through broker referrals from the Company's
network of mortgage brokers increased 22.1% to $70.0 million for the six month
period ended June 30, 2000, compared to $57.3 million for the six month period
ended June 30, 1999. The increase was the result of a decrease in the number of
non-conforming mortgage lenders using broker referrals. The decrease for the
three months ended June 30, 2000 was primarily the result of increased pricing
competition in the non-conforming mortgage area. Average fees paid to mortgage
brokers for the three and six month periods ended June 30, 2000 were 43 basis
points compared to 37 and 31 basis points for the three and six months
ended June 30, 1999.
13
Gain on Sale of Loans
The largest component of the Company's net income is gain on sale of loans.
There is an active secondary market for most types of mortgage loans originated
by the Company. The majority of the loans originated by the Company are sold to
other financial institutions. The Company receives cash at the time loans are
sold. The loans are sold service-released on a non-recourse basis, except for
normal representations and warranties, which is consistent with industry
practices. By selling loans in the secondary mortgage market, the Company is
able to obtain funds that may be used for additional lending and investment
purposes. Gain on sale of loans is comprised of several components, as follows:
(a) the difference between the sales price and the net carrying value of the
loan; plus (b) loan origination fee income collected at loan closing and
deferred until the loan is sold; less (c) loan sale recapture premiums and loan
selling costs.
Non-conforming loan sales totaled $42.4 and $126.6 million for the three and six
month periods ended June 30, 2000, compared to $55.1 and $136.9 million for the
same period in 1999.
Conforming and government loan sales were $12.8 million and $23.5 million for
the three and six month periods ended June 30, 2000, compared to $5.5 million
and $5.5 million for the three and six month periods ended June 30, 1999. The
Company began originating conforming loans in May 1999.
The combined gain on the sale of loans was $2.5 and $6.4 million for the three
and six month periods ended June 30, 2000, which compares with $3.2 and $7.5
million for the same period in 1999. The decrease for the three and six month
periods ended June 30, 2000, was primarily the result of fewer loans being sold
when compared to the same period ended June 30, 1999. Gain on the sale of
mortgage loans represented 49.9% and 54.8% of total revenue for the three and
six months ended June 30, 2000, compared to 43.6% and 45.4% of total revenue for
the same period in 1999. This was primarily a result of the Company's initiative
to decrease Brokered loans, revenues from which are reported in other income,
and to increase the percentage of retail loan originations funded in-house,
revenues from which are reported in gain on sale of loans.
The weighted-average premium, realized by the Company on its non-conforming loan
sales was 3.13% and 2.92%, during the three and six month periods ended June 30,
2000, compared to 3.07% and 3.14% for the same period in 1999. The weighted-
average premium realized by the Company on its conforming and government loans
sales was 1.33% and 1.15% during the three and six month periods ended June 30,
2000, compared to 2.01% for the three and six month periods ended June 30, 1999.
The Company has never used securitization as a loan sale strategy. However, the
whole-loan sale marketplace for non-conforming mortgage loans was impacted by
changes that affected companies who previously used this loan sale strategy.
Excessive competition during 1998 and 1999 and a coinciding reduction in
interest rates in general caused an increase in the prepayment speeds for non-
conforming loans. The valuation method applied to interest-only and residual
assets ("Assets"), the capitalized assets created from securitization, include
an assumption for average prepayment speed in order to determine the average
life of a loan pool and an assumption for loan losses. The increased prepayment
speeds as well as the magnitude of loan losses experienced in the industry were
greater than the assumptions previously used by many securitization issuers and
resulted in an impairment or write down of Asset values for several companies in
the industry. Additionally, in September of 1998, due to the Russian crisis, and
again in the fourth quarter of 1999, due to Y2K concerns, a flight to quality
among fixed income investors negatively impacted the pricing spreads for
mortgage-backed securitizations compared to earlier periods and negatively
impacted the associated economics to the issuers. Consequently, many of these
companies have experienced terminal liquidity problems. and others have diverted
to whole loan sale strategies in order to generate cash. This shift has
materially decreased the demand for and increased the supply of non-conforming
mortgage loans in the secondary marketplace, which resulted in significantly
lower premiums on non-conforming whole-loan mortgage sales beginning in the
fourth quarter of 1998 and continuing throughout the second quarter 2000 when
compared to earlier periods.
14
Furthermore, the loan sale premium percentage has decreased due to a decrease in
the Weighted Average Coupon ("WAC") on the Company's loan originations, which
was primarily the result of a shift in the Company's origination profile to a
higher credit grade customer. These premiums do not include loan origination
fees collected by the Company at the time the loans are closed, which are
included in the computation of gain on sale when the loans are sold.
The Company defers recognizing income from the loan origination fees it receives
at the time a loan is closed. These fees are recognized over the lives of the
related loans as an adjustment of the loan's yield using the level-yield method.
Deferred income pertaining to loans held for sale is taken into income at the
time of sale of the loan. Origination fee income is primarily derived from the
Company's retail lending division. Origination fee income included in the gain
on sale of loans for the three and six month periods ended June 30, 2000 was
$1.1 and $2.8 million, compared to $1.4 and $3.3 million for the three and six
month periods ended June 30, 1999. The decrease is the result of a decrease in
the volume of loans sold, which were generated by the Company's retail division.
The Company's non-conforming retail loan sales for the three and six month
periods ended June 30, 2000 comprised 35.3% and 33.9% of total non-conforming
loan sales, with average loan origination fee income earned of 4.50% and 4.85%.
For the three and six months ended June 30, 1999, the Company's non-conforming
retail loan sales were 50.1% and 51.0% of total non-conforming loan sales with
average origination fee income of 4.44% and 4.50%. Average origination fee
income from conforming and government loans was 3.09% and 3.12% for the three
and six months ended June 30, 2000 compared to 2.54% for the three and six
months ended June 30, 1999. Fees associated with selling loans were
approximately 12 and 20 basis points for the three and six months ended June 30,
2000 compared to six and 12 basis points for the three and six months ended June
30, 1999.
The Company also defers recognition of the expense it incurs, from the payment
of fees to mortgage brokers, for services rendered on loan originations. These
costs are deferred and recognized over the lives of the related loans as an
adjustment of the loan's yield using the level-yield method. The remaining
balance of expenses associated with fees paid to brokers is recognized when the
loan is sold.
Interest Income and Expense
The Company's net interest income is dependent on the difference, or "spread",
between the interest income it receives from its loans and its cost of funds,
consisting principally of the interest expense paid on the warehouse lines of
credit, the Bank's deposit accounts and other borrowings.
Interest income for the three and six months ended June 30, 2000 was $1.3 and
$2.9 million compared with $1.9 and $4.6 million for the same period ended in
1999. The decrease in interest income for the three and six months ended June
30, 2000 was due to a lower average balance of loans held for sale.
Interest expense for the three and six months ended June 30, 2000 was $0.9 and
$2.1 million compared with $1.2 and $2.9 million for the three and six months
ended June 30, 1999. The decrease in interest expense for the three and six
months ended June 30, 2000, was the direct result of a decrease in the average
balance of interest-bearing liabilities.
15
Changes in the average yield received on the Company's loan portfolio may not
coincide with changes in interest rates the Company must pay on its revolving
warehouse loans, the Bank's FDIC-insured deposits, and other borrowings. As a
result, in times of rising interest rates, decreases in the difference between
the yield received on loans and other investments and the rate paid on
borrowings and the Bank's deposits usually occur.
16
The following tables reflect the average yields earned and rates paid by the
Company during the six month periods ended June 30, 2000 and 1999. In computing
the average yields and rates, the accretion of loan fees is considered an
adjustment to yield. Information is based on average month-end balances during
the indicated periods.
(In thousands) June 30, 2000 June 30, 1999
------------------------------------------------------------------------------
Average Average Average Average
Balance Interest Yield/Rate Balance Interest Yield/Rate
------------------------------------------------------------------------------
Interest-earning assets:
Loan receivable (1) $46,820 $2,548 10.88% $ 83,181 $4,433 10.66%
Cash and other interest- 14,400 353 4.90 8,578 206 4.80
------- ------ ------ -------- ------ ------
earning assets
61,220 2,901 9.48% 91,759 4,639 10.11%
------ ------ ------ ------
Non-interest-earning assets:
Allowance for loan losses (1,315) (3,178)
Investment in IMC 0 114
Premises and equipment, net 5,934 5,271
Other 10,424 13,732
------- --------
Total assets $76,263 $107,698
======= ========
Interest-bearing liabilities:
Revolving warehouse lines $ 6,113 212 6.94% $ 47,301 1,676 7.09%
FDIC - insured deposits 48,449 1,439 5.94 30,716 861 5.61
Other interest-bearing 8,596 430 10.01 7,557 358 9.47
liabilities
------- ------- ------- -------- ------ ------
63,158 2,081 6.59% 85,574 2,895 6.77%
------ ----- ------ -----
Non-interest-bearing liabilities 2,160 4,451
------- --------
Total liabilities 65,318 90,025
Shareholders' equity 10,945 17,673
------- --------
Total liabilities and equity $76,263 $107,698
======= ========
Average dollar difference between
Interest-earning assets and
interest-bearing liabilities $(1,938) $ 6,185
======= ========
Net interest income $ 820 $1,744
====== ======
Interest rate spread (2) 2.89% 3.34%
===== =====
Net annualized yield on average
Interest-earning assets 2.68% 3.80%
===== =====
(1) Loans shown gross of allowance for loan losses, net of premiums/discounts.
(2) Average yield on total interest-earning assets less average rate paid on
total interest-bearing liabilities.
17
The following table shows the change in net interest income, which can be
attributed to rate (change in rate multiplied by old volume) and volume (change
in volume multiplied by old rate) for the six months ended June 30, 2000
compared to the six months ended June 30, 1999, and for the six months ended
June 30, 1999, compared to the six months ended June 30, 1998. The changes in
net interest income due to both volume and rate changes have been allocated to
volume and rate in proportion to the relationship of absolute dollar amounts of
the change of each. The table demonstrates that the decrease of $0.9 million in
net interest income for the six months ended June 30, 2000 compared to the six
months ended June 30, 1999 was primarily the result of a decrease in the average
balance on interest-earning assets.
($ In thousands)
2000 Versus 1999 1999 Versus 1998
Increase (Decrease) due to: Increase (Decrease) due to:
Volume Rate Total Volume Rate Total
--------- ------------ --------- --------- --------- -------
Interest-earning assets:
Loans receivable $(1,980) $ 94 $(1,886) $ 226 $ (824) $(598)
Cash and other interest- 143 4 147 199 (216) (17)
earning assets -------- ------- -------- ------- ------- -------
(1,837) 98 (1,739) 425 (1,040) (615)
-------- ------ -------- ------ ------- -------
Interest-bearing liabilities:
Revolving warehouse lines (1,429) (35) (1,464) (279) (23) (302)
FDIC-insured deposits 524 53 577 310 (34) 276
Other interest- 51 21 72 (180) 17 (163)
bearing liabilities -------- ------ -------- ------ ------- ------
(854) 39 (815) (149) 40 (189)
-------- ------ -------- ------- ------- -------
Net interest income (expense) $ (983) $ 59 $ (924) $ 574 $(1,000) $(426)
======= ====== ======= ======= ======= ======
Other Income
In addition to net interest income (expense), and gain on sale of loans, the
Company derives income from origination fees earned on Brokered loans generated
by the Company's retail offices and other fees earned on the loans funded by the
Company such as underwriting service fees, prepayment penalties, and late charge
fees for delinquent loan payments. Revenues associated with the financial
products marketed by Approved Financial Solutions, while not material during the
first six months of 2000, are also recorded in other income. For the three and
six month periods ended June 30, 2000, other income totaled $1.2 and $2.4
million compared to $2.1 and $4.4 million for the same period in 1999. The
decrease was primarily the result of the decrease in brokered loan fees which
was the result of a decrease in brokered loan volume. Brokered loan fees were
$0.7 and $1.4 million for the three and six month period ended June 30, 2000,
compared to $1.7 and $3.2 million for the three and six months ended June 30,
1999.
18
Comprehensive Loss
For the three and six months ended June 30, 2000 the Company had other
comprehensive losses of $6,000 and $6,000 in the form of unrealized holding
losses on an Asset Management Fund investement. For the three and six month
periods ended June 30, 1999, the Company had other comprehensive losses of
$23,000 and $56,000 million in the form of unrealized holding losses on
securities held for sale. This loss related to a decrease in the market price of
IMC Mortgage Company common stock.
Compensation and Related Expenses
The largest component of expenses is compensation and related expenses, which
decreased by $1.5 and $3.2 million to $3.1 and $6.2 million for the three and
six month periods ended June 30, 2000 from 1999. The decrease was directly
attributable to a decrease in the number of employees and lower commissions
expense caused by the decrease in loan volume. For the three and six month
periods ended June 30, 2000, salary expense decreased by $1.0 million and $1.9
million when compared to the same periods ended 1999. Also the payroll and
related benefits decreased by $0.2 million and $0.7 million for the three and
six month periods ended June 30, 2000 when compared to the same periods in 1999.
The decrease was caused by a lower average number of employees, which was
attributed to the Companies cost cutting initiative. For the three and six
month period ended June 30, 2000, the average full time equivalent employee
count was 249 and 266 compared to 427 and 470 for the three and six month
periods ended June 30, 1999. For the three and six month periods ended June 30,
2000 the commissions to loan officers decreased by $0.3 million and $0.6 million
when compared to the same periods ended June 30, 1999. The decrease was
primarily due to lower loan volume.
General and Administrative Expenses
General and administrative expenses are comprised of various expenses such as
rent, postage, printing, general insurance, travel & entertainment, telephone,
utilities, depreciation, professional fees and other miscellaneous expenses.
General and administrative expenses for the three and six month periods ended
June 30, 2000 decreased by $1.0 and $1.5 million to $1.5 and $3.3 million,
compared to the three and six month periods ended June 30, 1999. The decrease
was the result of a reduction in retail loan origination offices, a decline in
the Company employee count, and the Company's cost cutting initiative.
Loan Production Expense
Loan production expenses are comprised of expenses for appraisals, credit
reports, and payment of fees to mortgage brokers, for services rendered on loan
originations, and verification of mortgages. Loan production expenses for the
three and six month periods ended June 30, 2000 were $0.3 and $0.6 million
compared to $0.5 and $1.0 million for the three and six month periods ended June
30, 1999. The decrease was primarily the result of decreases in appraisal and
credit report expenses, which resulted from lower loan volume. The Company also
eliminated payments to outside consultants for research of customer leads due to
the creation of the centralized advertising and marketing departments. The
expenses for those leads were classified in loan production expenses for the
three and six month periods ended June 30, 1999.
19
Advertising Expense
The Company has a centralized telemarketing and advertising department in
Virginia Beach, Virginia. Advertising expenses are comprised of newspaper
advertising, yellow page advertising, postage & printing associated with
mailers, the purchase of telemarketing lists, and marketing supplies for trade
shows. Advertising expenses for the three and six month periods ended June 30,
2000 were $0.3 and $0.7 million compared to $0.5 and $0.9 million for the three
and six month periods ended June 30, 1999. The decrease was the result of the
reduction in retail loan origination offices.
Provision for Loan Losses
The following table presents the activity in the Company's allowance for loan
losses and selected loan loss data for the six months ended June 30, 2000 and
the year ended December 31, 1999:
(In thousands)
2000 1999
-------- --------
Balance at beginning of year $ 1,382 $ 2,590
Provision (benefit) charged to expense (44) 2,042
Loans charged off (431) (3,286)
Recoveries of loans previously charged off 439 36
-------- --------
Balance at end of period $ 1,346 $ 1,382
======== ========
Loans receivable at the end of period, gross $38,844 $69,054
of allowance for losses
Ratio of allowance for loan losses to gross 3.47% 2.00%
loans receivable at the end of period
The Company decreased its provision for loan losses by $0.05 for the three month
period ended June 30, 2000 and decreased $0.04 during the six months ended June
30, 2000 to the allowance for loan losses, compared to a decrease of $0.3
million for the three month period ended June 30, 1999 and the Company had an
addition to the provision of $1.1 million, during the six months ended June 30,
1999. For the three and six month period ended June 30, 2000, there was a
decrease in the provision because there was a $41.1 and $44.5 million decrease
in loans receivable and the composition of loans held for sale remained
unchanged. For the six months ended June 30, 1999, there was a large increase
in the provision as a result of changes in the secondary market environment for
whole loan sales which changed the composition of loans held for sale. All
losses ("charge offs" or "write downs") and recoveries realized on loans
previously charged off, are accounted for in the allowance for loan losses.
The allowance is established at a level that management considers adequate
relative to the composition of the current portfolio of loans held for sale.
Management considers characteristics of the Company's current loan portfolio
such as credit quality, the weighted average coupon, the weighted average loan
to value ratio, the age of the loan portfolio and the portfolio's delinquency
status in the determination of an appropriate allowance. Other criteria such as
covenants associated with the Company's credit facilities, trends in the demand
for and pricing for loans sold in the secondary market for non-conforming
mortgages and general economic conditions, including interest rates, are also
considered when establishing the allowance. Adjustments to the reserve for loan
losses may be made in future periods due to changes in the factors mentioned
above and any additional factors that may effect anticipated loss levels in the
future.
20
Provision for Foreclosed Property Losses
The Company increased its provision for foreclosed property losses by $0.1 and
$0.2 million for the three and six months ended June 30, 2000, compared to an
increase of $0.3 and $0.2 million for the three and six months ended June 30,
1999.
Sales of real estate owned yielded net losses of $208,000 and $452,000 for the
three and six months ended June 30, 2000 versus $77,000 and $245,000 for the
three and six months ended June 30, 1999.
The following table presents the activity in the Company's allowance for
foreclosed property losses and selected real estate owned data for the six
months ended June 30, 2000 and for the year ended December 1999:
(In thousands)
2000 1999
------ ------
Balance at beginning of year $ 718 $ 503
Provision charged to expense 191 863
Loss on sale of foreclosures (452) (648)
------ ------
Balance at end of period $ 457 $ 718
====== ======
Real estate owned at the end of period, gross $1,943 $2,992
of allowance for losses
Ratio of allowance for foreclosed property losses 23.52% 24.00%
to gross real estate owned at the end of period
The Company maintains a reserve on its real estate owned ("REO") based upon
management's assessment of appraised values at the time of foreclosure. The
increase in the provision for foreclosed property losses relates to losses on
real estate owned sales for the three and six month periods ended June 30, 2000
and 1999. While the Company's management believes that its present allowance for
foreclosed property losses is adequate, future adjustments may be necessary.
21
Financial Condition at June 30, 2000 and December 31, 1999
Assets
The total assets of the Company were $61.7 million at June 30, 2000 compared to
total assets of $98.6 million at December 31, 1999.
Cash and cash equivalents decreased by $1.6 million to $9.1 million at June 30,
2000, from $10.7 million at December 31, 1999. The Company paid down its credit
line in order to reduce interest expense.
Net mortgage loans receivable decreased by $29.7 million to $37.1 million at
June 30, 2000. The 44.5% decrease in 2000 is primarily due to the Company
selling more loans than were originated in-house during the first six months of
2000. The Company generally sells loans within sixty days of origination.
Real estate owned ("REO") decreased by $0.8 million to $1.5 million at June 30,
2000. The 34.7% decrease in REO resulted from the sale of $1.8 million in REO
properties and additions of $0.8 million to REO during the six months ended June
30, 2000.
Investments increased by $0.2 million to $2.9 million at June 30, 2000.
Investments consist primarily of an Asset Management Fund, Inc. Adjustable Rate
Mortgage Portfolio and FHLB stock owned by the Bank. The 9.2% increase in
investments in the first six months of 2000 is primarily due to the purchase of
shares of FHLB stock.
Premises and equipment decreased by $0.4 million to $5.7 million at June 30,
2000. The decrease is due to the depreciation of these assets for the first six
months of 2000.
Goodwill (net) decreased by $0.07 million to $1.1 million at June 30, 2000. The
decrease is due to the amortization of the intangible asset for the first six
months of 2000.
Income tax receivable decreased by $4.4 million to $1.7 million at June 30,
2000. The 77.6% decrease represents the receipt of a refund due on federal
taxes based upon actual tax return filing.
The deferred tax asset increased by $0.02 million to $1.7 million at June 30,
2000. The increase related to changes in timing differences of the deferred tax
asset.
Other assets decreased by $0.3 million to $1.4 million at June 30, 2000. Other
assets consist of accrued interest receivable, prepaid assets, brokered loan
fees receivable, deposits, and various other assets. The majority of the
decrease was in accrued interest receivable, which was due to a lower average
loans held for sale at June 30, 2000.
22
Liabilities
Outstanding balances for the Company's revolving warehouse loans decreased by
$17.3 million to $0.1 million at June 30, 2000. The 99.3% decrease in the first
six months of 2000 was primarily attributable to the decrease in loans
receivable.
The Bank's deposits totaled $40.5 million at June 30, 2000 compared to $55.3
million at December 31, 1999. Of the certificate accounts on hand as of June 30,
2000, a total of $32.4 million was scheduled to mature in the twelve-month
period ending June 30, 2001.
During the three and six month periods ended June 30, 2000, the Company received
$1.6 million in money market deposits through an arrangement with a local NYSE
member broker/dealer. There were no money market deposits for the three and six
month periods ended June 30, 1999.
As of December 31, 1999, the Bank borrowed $4.6 million from the Federal Home
Loan Bank (FHLB) to fund loan production. There were no borrowings at June 30,
2000.
Promissory notes and certificates of indebtedness totaled $4.9 million at June
30, 2000 compared to $5.1 million at December 31, 1999. The 3.6% decrease is
primarily due to the redemption of maturing promissory notes and certificates.
In the first six months of 2000 and for the year of 1999, the Company was not
soliciting new promissory notes or certificates of indebtedness. The Company has
utilized promissory notes and certificates of indebtedness, which are
subordinated to the Company's warehouse lines of credit, to help fund its
operations since 1984. Promissory notes outstanding carry terms of one to five
years and interest rates between 8.00% and 10.25%, with a weighted-average rate
of 9.77% at June 30, 2000. Certificates of indebtedness are uninsured deposits
authorized for financial institutions like the Company, which have Virginia
industrial loan association charters. The certificates of indebtedness carry
terms of one to five years and interest rates between 6.75% and 10.00%, with a
weighted-average rate of 8.97% at June 30, 2000.
Mortgage loans payable totaled $2.3 million at June 30, 2000 compared to $2.3
million at December 31, 1999. There was a minimal decrease in mortgage loans
payable due to the normal principal reduction with payments made on the note
payable.
Accrued and other liabilities decreased by $0.8 million to $1.7 million at June
30, 2000. This category includes accounts payable, accrued interest payable,
deferred income, accrued bonuses, and other payables. The 31.0% decrease is the
result of various payments of year end accrued expenses.
Shareholders' Equity
Total shareholders' equity at June 30, 2000 was $10.5 million compared to $11.3
million at December 31, 1999. The $0.8 million decrease in 2000 was due to the
$0.8 million loss for the six months ended June 30, 2000.
23
Liquidity and Capital Resources
The Company's operations require access to short and long-term sources of cash.
The Company's primary sources of cash flow result from the sale of loans through
whole loan sales, loan origination fees, processing, underwriting and other fees
associated with loan origination and servicing, revenues generated by Approved
Financial Solutions, net interest income, and borrowings under its warehouse
facilities, certificates of indebtedness issued by Approved Financial Corp. and
certificates of deposit issued by the Bank to meet its working capital needs.
The Company's primary operating cash requirements include the funding of
mortgage loan originations pending their sale, operating expenses, income taxes
and capital expenditures.
Adequate credit facilities and other sources of funding, including the ability
to sell loans in the secondary market, are essential to the Company's ability to
continue to originate loans. The Company has historically operated, and expects
to operate in the future on a negative cash flow basis from operations due to
the fact that origination's normally exceed loan sales. However, for the six
months ended June 30, 2000, the Company was provided cash from operating
activities of $32.8 million, due to the fact that the Company sold a greater
volume of loans than it funded during the period. The net cash provided by
operating activities was primarily used to fund mortgage loan originations. For
the six months ended June 30, 1999 the Company was provided cash from operating
activities of $38.5 million.
The Company finances its operating cash requirements primarily through warehouse
and other credit facilities, and the issuance of other debt. For the six months
ended June 30, 2000, the Company paid down debt from financing activities of
$35.3 million, due to the fact that the Company had repayments of debt in excess
of borrowings, which was the result of loan sales exceeding loan origination's.
For the six months ended June 30, 1999 the Company paid down debt from financing
activities of $40.3 million.
The Company's borrowings (revolving warehouse loans, FDIC-insured deposits,
mortgage loans on Company office buildings, FHLB advances, subordinated debt and
loan proceeds payable) were 80.1% of assets at June 30, 2000 compared to 86.1%
at December 31, 1999.
Whole Loan Sale Program
The Company's most important source of liquidity and capital resources is the
ability to profitably sell conforming and non-conforming loans in the secondary
market. The market value of the loans funded by the Company is dependent on a
number of factors, including but not limited to loan delinquency and default
rates, the original term and current age of the loan, the interest rate and loan
to value ratio, whether or not the loan has a prepayment penalty, the credit
grade of the loan, the credit score of the borrower, the geographic location of
the real estate, the type of property and lien position, the supply and demand
for conforming and non-conforming loans in the secondary market, general
economic and market conditions, market interest rates and governmental
regulations. Adverse changes in these conditions may affect the Company's
ability to sell mortgages in the secondary market for acceptable prices, which
is essential to the continuation of the Company's mortgage origination
operations.
Bank Sources of Capital
The Bank's deposits totaled $40.5 million at June 30, 2000, compared to $55.3
million at December 31, 1999. The Bank currently utilizes funds from deposits
and a $15 million line of credit with the FHLB of Atlanta to fund first lien and
junior lien mortgage loans. The Company plans to increase the use of credit
facilities and funding opportunities available to the Bank.
24
Warehouse and Other Credit Facilities
In addition to the $15 million line of credit with the FHLB of Atlanta, the
Company has available funding from warehouse facilities with other
non-affiliated financial institutions.
On July 21, 2000, the Company obtained a $40.0 million line of credit from
BankUnited. The credit line can be used for prime and sub-prime mortgage loans
and is secured by loans originated by the Company. The line bears interest at a
rate of 2.00% and 2.75% over the one-month LIBOR rate for prime and sub-prime
loans respectively. The Company may receive warehouse credit advances of 98%,
97%, and 90% for prime, sub-prime, and high LTV loans (loans with LTV's greater
than 90%), respectively, of the collateral value amount on pledged mortgage
loans for a period of 90 days after origination. If a loan has not been
purchased by an investor within 90 days of origination, the interest rate on the
loan increases to 3.75% over the one-month LIBOR and the Company has an
additional 30 days to sell the loan or purchase the loan back from the
warehouse. The aged loan sublimit is $2.0 million. As of June 30, 2000 there
were no borrowings outstanding under this facility. The line of credit is
scheduled to expire on July 21, 2001. The line of credit is subject to financial
covenants for a current ratio, tangible net worth and a leverage ratio. As of
June 30, 2000 the Company is in compliance with all financial covenants.
On November 10, 1999, the Company obtained a $20.0 million sub-prime line of
credit from Regions Bank. The line is secured by loans originated by the Company
and bears interest at a rate of 3.25% over the one-month LIBOR rate. The
Company may receive warehouse credit advances of 100% of the net loan value
amount on pledged mortgage loans for a period of 90 days after origination. As
of June 30, 2000 there were no borrowings outstanding under this facility. The
line of credit is scheduled to expire on November 10, 2001. The line of credit
is subject to financial covenants for a current ratio, tangible net worth and a
leverage ratio. As of June 30, 2000 the Company is in compliance with all
financial covenants.
On November 10, 1999, the Company obtained a $20.0 million conforming loan line
of credit from Regions Bank. The line is secured by loans originated by the
Company and bears interest ranging from 2.25% to 2.75% over the one-month LIBOR
rate based upon the monthly advance levels. The Company may receive warehouse
credit advances of 100% of the net loan value amount on pledged mortgage loans
for a period of 90 days after origination. As of June 30, 2000 there were no
borrowings outstanding under this facility. The line of credit is scheduled to
expire on November 10, 2001. The line of credit is subject to financial
covenants for a current ratio, tangible net worth and a leverage ratio. As of
June 30, 2000 the Company is in compliance with all financial covenants.
Effective on December 8, 1999, the Company obtained an amendment to their
warehouse line of credit agreement with Chase Bank of Texas. Since the
utilization of the credit line was very low in 1999, the amendment reduced the
size of the warehouse facility to $15.0 million, and all bank syndicate members
other than Chase were released from the commitment. The line is secured by
loans originated by the Company and bears interest at a rate of 1.75% over the
one-month LIBOR rate. The Company may receive warehouse credit advances of 95%
of the original principal balances on pledged mortgage loans for a maximum
period of 180 days after origination. This line expired on June 7, 2000 and will
not be renewed.
Other Capital Resources
Promissory notes and certificates of indebtedness have been a source of capital
for the Company since current management acquired the Company in 1984.
Promissory notes and certificates of indebtedness totaled $4.9 million at June
30, 2000 compared to $5.1 million at December 31, 1999. These borrowings are
subordinated to the Company's warehouse lines of credit.
25
The Company had cash and cash equivalents of $9.1 million at June 30, 2000. The
Company has sufficient resources to fund its current operations. Alternative
sources for future liquidity and capital resource needs may include the issuance
of debt or equity securities, increase in Saving Bank deposits and new lines of
credit. Each alternative source of liquidity and capital resources will be
evaluated with consideration for maximizing shareholder value, regulatory
requirements, the terms and covenants associated with the alternative capital
source. Management expects that the Company and the industry will continue to
be challenged by a limited availability of capital, a reduction in premiums
received on non-conforming mortgage loans sold in the secondary market compared
to premiums realized in recent years, new competition and a rise in loan
delinquency and the associated loss rates.
Bank Regulatory Liquidity
Liquidity is the ability to meet present and future financial obligations,
either through the acquisition of additional liabilities or from the sale or
maturity of existing assets, with minimal loss. Regulations of the OTS require
thrift associations and/or banks to maintain liquid assets at certain levels.
At present, the required ratio of liquid assets to and borrowings, which can be
withdrawn and are due in one year or less is 4.0%. Penalties are assessed for
noncompliance. In 1999 and the first six months of 2000, the Bank maintained
liquidity in excess of the required amount, and management anticipates that it
will continue to do so.
Bank Regulatory Capital
At June 30, 2000, the Bank's book value under generally accepted accounting
principles ("GAAP") was $9.0 million. OTS Regulations require that institutions
maintain the following capital levels: (1) tangible capital of at least 1.5% of
total adjusted assets, (2) core capital of 4.0% of total adjusted assets, and
(3) overall risk-based capital of 8.0% of total risk-weighted assets. As of
June 30, 2000, the Bank satisfied all of the regulatory capital requirements, as
shown in the following table reconciling the Bank's GAAP capital to regulatory
capital:
Tangible Core Risk-Based
(In thousands) Capital Capital Capital
GAAP capital $8,965 $8,965 $8,965
Add: unrealized loss on securities 19 19 19
Nonallowable asset: goodwill (582) (582) (582)
Additional capital item: general allowance - - 381
-------------------------------------
Regulatory capital - computed 8,402 8,402 8,783
Minimum capital requirement 848 2,260 3,167
-------------------------------------
Excess regulatory capital $7,554 $6,142 $5,616
=====================================
Ratios:
Regulatory capital - computed 14.87% 14.87% 22.18%
Minimum capital requirement 1.50% 4.00% 8.00%
-------------------------------------
Excess regulatory capital 13.37% 10.87% 14.18%
=====================================
Management believes that the Bank can remain in compliance with its capital
requirements.
The Company is not aware of any other trends, events or uncertainties other than
those discussed in this document which will have or that are likely to have a
material effect on the Company's or the Bank's liquidity, capital resources or
operations. The Company is not aware of any current recommendations by
regulatory authorities, which if they were implemented would have such an
effect.
26
Hedging Activities
The Company originates mortgage loans for sale as whole loans. The Company
mitigates its interest rate exposure by selling most of the loans within sixty
days of origination. However, the Company may choose to hold certain loans for
a longer period prior to sale in order to increase net interest income.
Currently loans held for investment by the Bank are primarily composed of
adjustable rate mortgages in order to minimize the Bank's interest rate risk
exposure. However, excluding the Bank's loans held for investment the majority
of loans held by the Company beyond the normal sixty-day holding period are
fixed rate instruments. Since most of the Company's borrowings have variable
interest rates, the Company has exposure to interest rate risk. For example, if
market interest rates were to rise between the time the Company originates the
loans and the time the loans are sold, the original interest rate spread on the
loans narrows, resulting in a loss in value of the loans. To offset the effects
of interest rate fluctuations on the value of its fixed rate mortgage loans held
for sale, the Company in certain cases, may enter into Treasury security lock
contracts, which function similar to short sales of U.S. Treasury securities. If
the value of an interest rate hedge position decreases in value, offsetting an
increase in the value of the hedged loans, the Company, upon settlement with its
counter-party, will pay the hedge loss in cash and realize the corresponding
increase in the value of the loans. Conversely, if the value of a hedge
position increases, offsetting a decrease in the value of the hedged loans, the
Company will receive the hedge gain in cash at settlement. The Company's
management believes that its current hedging strategy using Treasury rate lock
contracts is an effective way to manage interest rate risk on fixed rate loans
prior to sale. The Company may in the future enter into similar transactions
with government and quasi-government agency securities in relation to its
origination and sale of conforming mortgage loans or similar forward loan sale
commitments concerning non-conforming mortgages. Prior to entering into any
type of hedge transaction or forward loan sale commitment, the Company performs
an analysis of the loan associated with the transaction or commitment taking
into account such factors as credit quality of the loans, interest rate and term
of the loans, as well as current economic market trends, in order to determine
the appropriate structure and/or size of a hedge transaction or loan sale
commitment that will to limit the Company's exposure to interest rate risk. The
Company had no hedge contracts or forward commitments outstanding at June 30,
2000. The Company has not entered into any hedge contracts since the fourth
quarter of 1997. That commitment expired during the first quarter of 1998.
New Accounting Standards
As amended, SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities" is effective for fiscal years beginning after June 15, 2000. This
statement establishes the accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts, (collectively referred to as derivatives) and for hedging activities.
It requires that entities recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. If certain conditions are met, a derivative may be specifically
designated as (a) a hedge of the exposure to changes in the fair value of
recognized asset or liability or an unrecognized firm commitment, (b) a hedge of
the exposure to variable cash flows of a forecasted transaction, or (c) a hedge
of the foreign currency exposure of a net investment in a foreign operation, an
unrecognized firm commitment, an available-for-sale security, or foreign-
currency-denominated forecasted transaction. This statement should not have any
material impact on the financial statements.
27
Impact of Inflation and Changing Prices
The consolidated financial statements and related data presented in this
document have been prepared in accordance with generally accepted accounting
principles, which require the measurement of the financial position and
operating results of the Company in terms of historical dollars, without
considering changes in the relative purchasing power of money over time due to
inflation.
Virtually all of the assets of the Company are monetary in nature. As a result,
interest rates have a more significant impact on a financial institution's
performance than the effects of general levels of inflation. Interest rates do
not necessarily move in the same direction or with the same magnitude as the
prices of goods and services. Inflation affects the Company most significantly
in the area of loan originations and can have a substantial effect on interest
rates. Interest rates normally increase during periods of high inflation and
decrease during periods of low inflation.
Because the Company sells a significant portion of the loans it originates,
inflation and interest rates have a diminished effect on the Company's results
of operations. The Bank is expected to continue to build its portfolio of loans
held for investment, and this portfolio will be more sensitive to the effects of
inflation and changes in interest rates.
Profitability may be directly affected by the level and fluctuation of interest
rates, which affect the Company's ability to earn a spread between interest
received on its loans and the costs of its borrowings. The profitability of the
Company is likely to be adversely affected during any period of unexpected or
rapid changes in interest rates. A substantial and sustained increase in
interest rates could adversely affect the ability of the Company to originate
and purchase loans and affect the mix of first and junior lien mortgage loan
products. Generally, first mortgage production increases relative to junior lien
mortgage production in response to low interest rates and junior lien mortgage
loan production increases relative to first mortgage loan production during
periods of high interest rates. A significant decline in interest rates could
decrease the size of the Company's future loan servicing portfolio by increasing
the level of loan prepayments and it may also affect the net interest income
earned by the Company resulting from the difference between the yield to the
Company on loans held pending sales and the interest paid by the Company for
funds borrowed under the Company's warehouse facilities. Additionally, while the
Company has no plans to adopt a securitization loan sale strategy at this time,
if it were to do so in the future , then to the extent servicing rights and
interest-only and residual classes of certificates are capitalized on the
Company's books from future loan sales through securitization, higher than
anticipated rates of loan prepayments or losses could require the Company to
write down the value of such servicing rights and interest-only and residual
certificates, adversely affecting earnings. Conversely, lower than anticipated
rates of loan prepayments or lower losses could allow the Company to increase
the value of interest-only and residual certificates, which could have a
favorable effect on the Company's results of operations and financial condition.
28
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risk Management - Asset/Liability Management
The Company's primary market risk exposure is interest rate risk. Fluctuations
in interest rates will impact both the level of interest income and interest
expense and the market value of the Company's interest-earning assets and
interest-bearing liabilities.
Management strives to manage the maturity or repricing match between assets and
liabilities. The degree to which the Company is "mismatched" in its maturities
is a primary measure of interest rate risk. In periods of stable interest
rates, net interest income can be increased by financing higher yielding long-
term mortgage loan assets with lower cost short-term Bank deposits and
borrowings. Although such a strategy may increase profits in the short run, it
increases the risk of exposure to rising interest rates and can result in
funding costs rising faster than asset yields. The Company attempts to limit
its interest rate risk by selling a majority of the fixed rate mortgage loans
that it originates.
Contractual principal repayments of loans do not necessarily reflect the actual
term of the Company's loan portfolio. The average lives of mortgage loans are
substantially less than their contractual terms because of loan prepayments and
because of enforcement of due-on-sale clauses, which gives the Company the right
to declare a loan immediately due and payable in the event, among other things,
the borrower sells the real property subject to the mortgage and the loan is not
repaid. In addition, certain borrowers increase their equity in the security
property by making payments in excess of those required under the terms of the
mortgage.
The majority of the loans originated by the Company are sold through the
Company's loan sale strategies in an attempt to limit its exposure to interest
rate risk in addition to generating cash revenues. The Company sold, during 1999
and the first six months of 2000 approximately 97.3% of the total loans
originated and funded in-house during the year ended December 31, 1999. The
Company expects to sell the majority of its loan originations during the same
twelve-month period in which they are funded by the Company in future periods.
Also, the Company sold, during the first six months in 2000, approximately 93.0%
of loans originated and funded in-house during the period beginning January 1,
2000 and ending May 31, 2000. As a result, loans are held on average for less
than 12 months in the Company's portfolio of Loans Held for Sale. The "gap
position", defined as the difference between interest-earning assets and
interest-bearing liabilities maturing or repricing in one year or less, was
negative at June 30, 2000, as anticipated, and is expected to remain negative in
future periods. The Company has no quantitative target range for past gap
positions, nor any anticipated ranges for future periods due to the fact that
the Company sells the majority of its loans within a twelve month period while
the gap position is a static illustration of the contractual repayment schedule
for loans.
29
The Company's one-year gap was a negative 17.00% of total assets at June 30,
2000, as illustrated in the following table:
One Year Two Three to More Than
Description Total Or Less Years Four Years Four Years
Interest earning assets:
Loans receivable (1) $38,399 $ 13,853 $ 1,197 $ 2,838 $20,511
Cash and other 11,268 11,268
interest-earning assets
------- -------- -------- -------- -------
49,667 $ 25,121 $ 1,197 $ 2,838 $20,511
======== ======== ======== =======
Allowance for loan losses (1,346)
Investment in IMC 0
Premises and equipment, net 5,719
Other 7,615
-------
Total assets $61,655
=======
Interest-bearing liabilities:
Revolving warehouse lines $ 121 121
FDIC - insured deposits 40,534 32,416 5,147 2,971
FDIC - insured money market account 1,676 1,676
Other interest-bearing 7,353 1,391 495 1,749 3,718
liabilities ------- -------- --------- --------- --------
49,684 $ 35,604 $ 5,642 $ 4,720 $ 3,718
======== ======== ======== =======
Non-interest-bearing liabilities 1,516
-------
Total liabilities 51,200
Shareholders' equity 10,455
-------
Total liabilities and equity $61,655
=======
Maturity/repricing gap $(10,483) $ (4,445) $ (1,882) $16,793
======== ======== ======== =======
Cumulative gap $(10,483) $(14,928) $(16,810) $ (17)
======== ======== ======== =======
As percent of total assets (17.00)% (24.21)% (27.26)% (0.03)%
Ratio of cumulative interest 0.71 0.64 0.63 1.00
earning
Assets to cumulative interest
earning
liabilities
=============================================================================================================
(1) Loans shown gross of allowance for loan losses, net of premiums/discounts.
30
Interest Rate Risk
The principal quantitative disclosure of the Company's market risks is the gap
table on page 30. The gap table shows that the Company's one-year gap was a
negative 17.00% of total assets at June 30, 2000. The Company originates fixed-
rate, fixed-term mortgage loans for sale in the secondary market. While most of
these loans are sold within a month or two of origination, for purposes of the
gap table the loans are shown based on their contractual scheduled maturities.
As of June 30, 2000, 53.4% of the principal on the loans was expected to be
received more than four years from that date. However, the Company's activities
are financed with short-term loans and credit lines, 71.7% of which reprice
within one year of June 30, 2000. The Company attempts to limit its interest
rate risk by selling a majority of the fixed rate loans that it originates. If
the Company's ability to sell such fixed-rate, fixed-term mortgage loans on a
timely basis were to be limited, the Company could be subject to substantial
interest rate risk.
Profitability may be directly affected by the levels of, and fluctuations in
interest rates, which affect the Company's ability to earn a spread between
interest received on its loans and the costs of borrowings. The profitability of
the Company is likely to be adversely affected during any period of unexpected
or rapid changes in interest rates. For example, a substantial or sustained
increase in interest rates could adversely affect the ability of the Company to
purchase and originate loans and would reduce the value of loans held for sale.
A significant decline in interest rates could decrease the size of the Company's
loan servicing portfolio by increasing the level of loan prepayments.
Additionally, to the extent mortgage loan servicing rights in future periods
have been capitalized on the books of the Company, higher than anticipated rates
of loan prepayments or losses could require the Company to write down the value
of these assets, adversely affecting earnings.
In an environment of stable interest rates, the Company's gains on the sale of
mortgage loans would generally be limited to those gains resulting from the
yield differential between mortgage loan interest rates and rates required by
secondary market purchasers. A loss from the sale of a loan may occur if
interest rates increase between the time the Company establishes the interest
rate on a loan and the time the loan is sold. Fluctuating interest rates also
may affect the net interest income earned by the Company, resulting from the
difference between the yield to the Company on loans held pending sale and the
interest paid by the Company for funds borrowed, including the Company's
warehouse facilities and the Bank's FHLB advances and FDIC-insured customer
deposits. Because of the uncertainty of future loan origination volume and the
future level of interest rates, there can be no assurance that the Company will
realize gains on the sale of financial assets in future periods.
The Bank is building a portfolio of loans to be held for net interest income.
The sale of fixed rate product is intended to protect the Bank from precipitous
changes in the general level of interest rates. The valuation of adjustable rate
mortgage loans is not as directly dependent on the level of interest rates as is
the value of fixed rate loans. Decisions to hold or sell adjustable rate
mortgage loans are based on the need for such loans in the Bank's portfolio,
which is influenced by the level of market interest rates and the Bank's
asset/liability management strategy. As with other investments, the Bank
regularly monitors the appropriateness of the level of adjustable rate mortgage
loans in its portfolio and may decide from time to time to sell such loans and
reinvest the proceeds in other adjustable rate investments.
31
Asset Quality
The following table summarizes all of the Company's delinquent loans at June 30,
2000 and December 31, 1999:
(in thousands)
2000 1999
------- -------
Delinquent 31 to 60 days $ 1,217 $ 864
Delinquent 61 to 90 days 554 264
Delinquent 91 to 120 days 328 513
Delinquent 121 days or more 1,566 1,466
------- -------
Total delinquent loans (1) $ 3,665 $ 3,106
======= =======
Total loans receivable outstanding, gross $38,844 $69,054
======= =======
Delinquent loans as a percentage of
Total loans outstanding:
Delinquent 31 to 60 days 3.13% 1.25%
Delinquent 61 to 90 days 1.43 0.39
Delinquent 91 to 120 days .84 0.74
Delinquent 121 days or more 4.03 2.12
------- -------
Total delinquent loans as a percentage
of total loans outstanding 9.43% 4.50%
======= =======
_____________
(1) Includes loans in foreclosure proceedings and delinquent loans to borrowers
in bankruptcy proceedings, but excludes real estate owned.
Interest on most loans is accrued until they become 31 days or more past due.
Interest on loans held for investment by the Bank is accrued until the loans
become 90 days or more past due. Non-accrual loans were $2.4 million and $2.2
million at June 30, 2000 and December 31, 1999 respectively. The amount of
additional interest that would have been recorded had the loans not been placed
on non-accrual status was approximately $24,000 and $235,000 for the six months
ended June 30, 2000 and the year ended December 31, 1999, respectively. The
amount of interest income on the non-accrual loans, that was included in net
income for the six months ended June 30, 2000 and the twelve months ended
December 31, 1999 was $43,000 and $109,000, respectively.
Loans delinquent 31 days or more as a percentage of total loans outstanding
increased to 9.43% at June 30, 2000 from 4.50% at December 31, 1999. The
increase resulted primarily from a management conversion in the collections
department.
At June 30, 2000 and December 31, 1999 the recorded investment in loans for
which impairment has been determined in accordance with SFAS 114 totaled $1.9
million and $2.0 million, respectively. The average recorded investment in
impaired loans for the six months ended June 30, 2000 and the year ended
December 31, 1999 was approximately $2.0 million and $3.5 million respectively.
SFAS 118 allows a creditor to use existing methods for recognizing interest
income on an impaired loan. Consistent with the Company's method for non-accrual
loans, interest receipts for impaired loans are recognized as interest income or
are applied to principal when the principal is in doubt of being collected. Due
to the homogenous nature and the collateral securing these loans, there is no
corresponding valuation allowance.
32
PART II. OTHER INFORMATION
Item 1. Legal Proceedings - The Company is party to various legal proceedings
arising out of the ordinary course of its business. Management believes that
none of these actions, individual or in the aggregate will have a material
adverse effect on the results of operations or financial condition of the
Company.
Item 2. Changes in Securities - None
Item 3. Defaults Upon Senior Securities - None
Item 4. Submission of Matters to a Vote of Security Holders - None
Item 5. Other Information - None
Item 6. Exhibits and Reports on Form 8-K -
(a) Exhibits:
27 Financial Data Schedule
(b) Reports on Form 8-K:
No reports on Form 8-K have been filed during the six (6) months
ending June 30, 2000.
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: ______________________ APPROVED FINANCIAL CORP.
By: ________________________________
Allen D. Wykle,
Chairman, President, and
Chief Executive Officer
By: ________________________________
Eric S. Yeakel,
Its Treasurer and Chief Financial
Officer
33