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 September 30, 1998.
__ 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)
3420 Holland Road, Suite 107, Virginia Beach, Virginia 23452
(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 November 1, 1998: 5,512,114 shares
APPROVED FINANCIAL CORP.
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Page
Consolidated Balance Sheets as of
September 30, 1998 and December 31, 1997 1
Consolidated Statements of Income
for the nine months ended September 30, 1998 2
and 1997.
Consolidated Statements of Income
for the three months ended September 30, 1998 3
and 1997.
Consolidated Statements of Cash Flows for 4
the nine months ended September 30, 1998
and 1997.
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of
Results of Operations and Financial Condition 8
Item 3. Quantitative and Qualitative Disclosures About 24
Market Risk
Part II. OTHER INFORMATION
Item 1. Legal Proceedings 30
Item 2. Changes in Securities 30
Item 3. Defaults Upon Senior Securities 30
Item 4. Submission of Matters to a Vote of Security Holders 30
Item 5. Other Information 30
Item 6. Exhibits and Reports on Form 8-K 30
PART I . FINANCIAL INFORMATION
APPROVED FINANCIAL CORP.
CONSOLIDATED BALANCE SHEETS
As of September 30, 1998 and December 31, 1997
(Dollars in thousands, except share amounts)
1998 1997
---- ----
ASSETS (Unaudited)
Cash $ 14,926 $11,869
Mortgage loans, net 74,926 80,696
Real estate owned, net 1,969 2,367
Securities, available for sale 4,604 15,201
Premises and equipment, net 4,705 4,530
Goodwill, net 3,776 775
Income taxes receivable 1,527 -
Deferred tax asset 1,706 -
Other assets 4,755 2,687
------ -------
Total assets $ 112,894 $118,125
======= =======
LIABILITIES AND EQUITY
Liabilities:
Revolving warehouse lines of
credit $ 40,790 $ 52,488
Certificates of deposit 26,243 17,815
Federal Home Loan Bank advance 1,380 1,000
Mortgage loans payable 1,155 1,216
Promissory notes - related parties 6,744 6,684
Certificates of indebtedness 2,378 2,396
Loan proceeds payable 8,578 6,364
Accrued and other liabilities 3,677 2,837
Income taxes payable - 1,161
Deferred income tax liability - 1,109
------ ---------
Total liabilities 90,945 93,070
====== =========
Shareholders' equity:
Preferred stock - Series A, $10 par value;
noncumulative, voting:
Authorized 100 shares,
90 shares issued and outstanding 1 1
Preferred stock - Series B, $10 par value;
noncumulative, voting:
Authorized 50,000 shares,
none issued and outstanding - -
Common stock, par value - $1.00:
Authorized 40,000,000 shares,
Issued and outstanding 5,512,114
shares in 1998
and 5,395,408 in 1997 5,512 5,395
Accumulated other comprehensive income 974 6,854
Additional capital 552 0
Retained earnings 14,910 12,805
---------- ---------
Total equity 21,949 25,055
---------- ---------
Total liabilities and equity $ 112,894 $ 118,125
========= ==========
The accompanying notes are an integral part of the consolidated financial
statements.
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF INCOME
for the nine months ended September 30, 1998 and 1997
(Dollars in thousands, except share and per share amounts)
(Unaudited)
1998 1997
---- ----
Revenue:
Gain on sale of loans $ 25,593 $ 24,041
Interest income 7,559 7,845
Gain on sale of securities 996 2,796
Other fees and income 4,971 3,130
----------- -----------
39,119 37,812
----------- -----------
Expenses:
Compensation and related benefits 17,878 12,636
General and administrative 8,671 7,358
Loan production expenses 2,844 1,136
Interest expense 4,561 4,286
Provision for loan and foreclosed property
losses 1,556 1,133
----------- -----------
35,510 26,549
----------- -----------
Income before income taxes 3,609 11,263
Provision for income taxes 1,501 4,612
----------- -----------
Net income 2,108 6,651
Other comprehensive income, net of tax:
Unrealized gains on securities:
Unrealized holding loss arising during
period (5,879) (2,898)
----------- -----------
Comprehensive (loss)/income $ (3,771) $ 3,753
=========== ===========
Net income per share:
Basic $ 0.38 $ 1.26
=========== ===========
Diluted $ 0.38 $ 1.26
=========== ===========
Weighted average number of shares outstanding:
Basic 5,510,404 5,281,569
========= ==========
Diluted 5,513,744 5,288,719
========= ==========
The accompanying notes are an integral part of the consolidated financial
statements.
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF INCOME
for the three months ended September 30, 1998 and 1997 (Dollars in thousands,
except share and per share amounts) (Unaudited)
1998 1997
---- ----
Revenue:
Gain on sale of loans $ 7,060 $ 8,656
Interest income 2,305 2,949
Gain on sale of securities 996 2,796
Other fees and income 1,810 1,570
----------- -----------
12,171 15,971
----------- -----------
Expenses:
Compensation and related benefits 5,879 5,120
General and administrative 2,839 2,720
Loan production expense 976 415
Interest expense 1,477 1,428
Provision for loan and foreclosed property
losses 718 436
----------- -----------
11,889 10,119
----------- -----------
Income before income taxes 282 5,852
Provision for income taxes 121 2,416
----------- -----------
Net income 161 3,436
Other comprehensive income, net of tax:
Unrealized gains on securities:
Unrealized holding loss arising during
period (5,153) (2,683)
----------- -----------
Comprehensive (loss)/income $ (4,992) $ 753
=========== ===========
Net income per share:
Basic $ 0.03 $ 0.64
=========== ===========
Diluted $ 0.03 $ 0.63
=========== ===========
Weighted average number of shares outstanding:
Basic 5,512,114 5,392,930
=========== ===========
Diluted 5,512,114 5,414,264
=========== ===========
The accompanying notes are an integral part of the consolidated financial
statements.
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
for the nine months ended September 30, 1998 and 1997
(In thousands)
(Unaudited)
1998 1997
---------- -----------
Operating activities:
Net income $ 2,108 $ 6,651
Adjustments to reconcile net income to net cash
provided by (used in)
operating activities:
Depreciation of premises and equipment 515 348
Amortization of Goodwill 292 --
Provision for loan losses 1,657 1,043
Provision for losses on real estate owned (101) 201
Charge offs (1,637) (59)
(Gain) on sale of securities (994) (2,796)
Loss on sale of real estate owned 580 407
(Gain) on sale of loans (25,961) (24,041)
Proceeds from sales and prepayments of loans 368,015 346,067
Change in unearned loan fees 590 123
Change in deferred loan costs (318) --
Change in deferred hedging loss 91 --
Loans held for sale originations (340,435) (354,417)
Real estate owned capital improvements (234) --
Changes in assets and liabilities:
Loan sale receivable (3) --
Other assets (2,065) (155)
Accrued and other liabilities (1,786) 6,243
Income taxes payable (2,689) 2,077
Deferred income taxes 1,110 (850)
Loan proceeds payable 2,214 --
--------- ---------
Net cash provided by (used in) operating activities 949 (19,158)
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS, Continued
for the nine months ended September 30, 1998 and 1997
(In thousands)
(Unaudited)
1998 1997
------- --------
Investing activities:
Purchase of securities -- (2,522)
Sales of securities 3,919 3,729
Purchases of premises and equipment (733) (2,434)
Sales of premises and equipment 41 --
Sales of real estate owned 3,771 1,841
Recoveries on loans charged off 150 --
Purchases of ARM fund shares (2,035) --
Purchases of FHLB stock (96) --
--------- ---------
Net cash provided by investing activities 5,017 614
Financing activities:
Borrowings - warehouse 300,437 356,569
Repayments of borrowings - warehouse (312,135) (341,936)
Proceeds from FHLB advances 380 --
Proceeds from mortgage loans payable -- 800
Principal payments on mortgages payable (61) (42)
Net increase (decrease) in:
Notes payable - related parties 60 (135)
Certificates of indebtedness (18) 24
Certificates of deposit 8,428 8,408
Redemption of common stock warrants -- 332
--------- ---------
Net cash (used in) provided by financing activities (2,909) 24,020
--------- ---------
Net increase in cash 3,057 5,476
Cash at beginning of period 11,869 3,440
--------- ---------
Cash at the end of period $ 14,926 $ 8,916
========= =========
Supplemental cash flow information:
Cash paid for interest $ 5,068 $ 4,154
Cash paid for income taxes 3,080 2,536
Supplemental non-cash information:
Loan balances transferred to real estate owned $ 3,618 $ 3,119
Exchange of stock for acquisition of Armada
Residential Mortgage LLC 669 --
The accompanying notes are an integral part of the consolidated financial
statements.
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the three and nine months ended September 30, 1998 and 1997 (Unaudited)
Note 1. Organization and Summary of Significant Accounting Policies:
Organization: Approved Financial Corp., a Virginia corporation, and its
subsidiaries (collectively, "Approved", the "Company") engage 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. Approved has two wholly owned subsidiaries, Approved Residential
Mortgage, Inc. ("ARMI") and Approved Federal Savings Bank (the "Savings Bank").
During the nine month period ended September 30, 1998, ARMI originated loans
through its broker network in eleven states and originated loans on a direct
basis through its network of retail branch locations operated by its wholly
owned subsidiaries, Approved Federal Savings Bank and ARMI d/b/a Armada
Residential Mortgage. . The Company's retail offices also generate loans, which
are funded through other lenders with the Company acting in a broker capacity
("Brokered Loans"). Brokered Loans are normally loans that do not meet the
Company's underwriting guidelines. The Company and the Savings Bank, which is a
federally chartered savings bank, are located in Virginia Beach, Virginia. The
Savings bank has a wholly owned subsidiary operating as a title insurance
agency.
Principles of accounting and consolidation: The consolidated financial
statements of the Company include the accounts of Approved and its wholly owned
subsidiaries. All significant intercompany accounts and transactions have been
eliminated.
Note 2. Basis of Presentation:
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the interim periods are not necessarily
indicative of financial results for the full year. These unaudited consolidated
financial statements should be read in conjunction with the audited consolidated
financial statements and notes thereto included in the Company's Annual Report
on Form 10-K/A for the year ended December 31, 1997.
Note 3. New accounting pronouncements:
Effective January 1, 1998 the Company adopted SFAS No. 130, "Reporting
Comprehensive Income". The new statement requires that an enterprise (a)
classify items of other comprehensive income by their nature in a financial
statement and (b) display the accumulated balance of other comprehensive income
separately from retained earnings and additional capital in the equity section
of the statement of financial condition. The only item the Company has in
Comprehensive income for the three and nine months ended September 30, 1998 and
1997 is an unrealized holding gain or loss on securities, net of deferred taxes.
In June 1997, SFAS No. 131, "Disclosures about Segments of an Enterprise and
Related Information" was issued, effective for fiscal years beginning after
December 15, 1997. The new statement requires that a public business enterprise
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 resources and in
assessing performance. Generally, financial information is required to be
reported on the basis that it is used
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for the three and nine months ended September 30, 1998 and 1997 (Unaudited)
internally for evaluating segment performance and deciding how to allocate
resources to segments. This statement does not have any material impact on the
financial statements.
In June 1998, SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities" was issued, effective for fiscal year ends beginning after June 15,
1999. 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 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 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. The Company is currently
evaluating the effect this statement will have on the financial statements.
In October 1998, SFAS No. 134, "Accounting for Mortgage-Backed Securities
Retained After the Securitization of Mortgage Loans Held for Sale by a Mortgage
Banking Enterprise" was issued, effective for the first fiscal quarter beginning
after December 15, 1998. The new statement requires that after an entity that is
engaged in mortgage banking activities has securitized mortgage loans that are
held for sale, it must classify the resulting retained mortgage-backed
securities or other retained interests based on its ability and intent to sell
or hold those investments. Any retained mortgage-backed securities that are
committed for sale before or during the securitization process must be
classified as trading. This statement does not have any impact on the Company's
financial statements since the Company has never securitized loans.
Note 4. Acquisition:
Effective January 26, 1998, ARMI purchased substantially all of the assets of
Funding Center of Georgia, Inc. ("FCGA"), which is located in Atlanta. FCGA
generated loan volume of $37.7 million, from the acquisition date through
September 30, 1998, including brokered loans. All of the employees of FCGA have
become employees of ARMI, and the business is conducted under the assumed name
of "Funding Center of Georgia." The purchase price for FCGA's assets was
$3,300,000. ARMI paid $600,000 at closing, will pay $100,000 in 1998, $900,000
in 1999, $900,000 in 2000 and $800,000 in 2001, with interest at 6%. Payment
amounts of $800,000 each in 1999, 2000 and 2001 are subject to reduction in the
event of a failure to meet agreed-upon pre-tax profit targets each year. The two
principal owners of FCGA entered into three-year employment agreements with ARMI
to manage the operations of FCGA. This transaction was accounted for under the
purchase method of accounting. Net assets of $7,000 were acquired with an
associated intangible asset (goodwill) recorded in the amount of $3,293,000.
This goodwill will be amortized over 10 years.
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 nine month periods ended September 30, 1998 and 1997 and its
consolidated financial position at September 30, 1998 and December 31, 1997. The
discussion includes some forward-looking statements within the meaning of the
Private Securities Litigation Act of 1995 involving estimates, uncertainties and
management opinions. The Company's actual results could differ materially from
those anticipated in the forward-looking statements as a result of certain
factors. Those factors include, but are not limited to, changes in residential
real estate values, changes in industry competition, general economic
conditions, changes in interest rates, changes in the demand for non-conforming
mortgage loans, the Company's availability of funding sources for capital
liquidity, changes in loan prepayment speeds, delinquency and default rates,
changes in regulatory issues concerning mortgage companies or thrift
institutions, changes in GAAP accounting standards effecting the Company's
financial statements, any changes which influence all markets for profitable
sales of all types of mortgage loans, market forces affecting the price of the
Company's common stock and other risk factors as disclosed in the Company's Form
10/A and 10-K/A filed with the Securities and Exchange Commission. This
discussion should be reviewed in conjunction with the consolidated financial
statements and accompanying notes and other statistical information.
.
Results of Operations for the Three and Nine month Periods ended September 30,
1998 Compared to the Three and Nine Month Periods Ended September 30, 1997
Net Income
Net income for the three and nine months ended September 30, 1998 was $0.2
million and $2.1 million representing a decrease of $3.2 million and $4.6
million compared to net income of $3.4 million and $6.7 million for the three
and nine months ended September 30, 1997. On a per share basis (diluted), income
for the three and nine months ended September 30, 1998 was $0.03 and $0.38
compared to $0.63 and $1.26 for the three and nine months ended September 30,
1997. The per-share figures have been adjusted to reflect a 100% stock dividend
paid on common stock, of the Company on November 21, 1997.
Origination of Mortgage Loans
The following table shows the loan originations in dollars and units for the
Company's broker and retail units for the three and nine month periods ended
September 30, 1998 and 1997. The table excludes $23.5 million and $60.0 million
Brokered Loans generated by the Company's retail unit during the three and nine
month periods ended September 30, 1998.
(Dollars in thousands) Three Months Nine Months
Ended Sept. 30 Ended Sept. 30
1998 1997 1998 1997
---- ---- ---- ----
Dollar Volume of Loan
Originations:
Broker Referrals $ 56,224 $ 60,481 $161,307 $185,408
Retail 56,259 58,683 179,128 156,507
-------- -------- -------- --------
Total $112,483 $119,164 $340,435 $341,915
======== ======== ======== ========
Number of Loans Originated:
Broker Referrals 876 1,037 2,780 3,183
Retail 962 1,081 3,232 2,968
-------- -------- -------- --------
Total 1,838 2,118 6,012 6,151
======== ======== ======== ========
The decrease of 5.6 percent and 0.4 percent in dollar volume of loans originated
during the three and nine month periods ended September 30, 1998, respectively,
compared to the same periods in 1997 was due primarily to increased competition
in the non-conforming mortgage industry.
Loans originated through the Company's retail offices, excluding $23.5 million
and $60.0 million Brokered Loans, decreased 4.1 percent to $56.3 million and
increased 14.5 percent to $179.0 million during the three and nine month periods
ended September 30, 1998, compared to $58.7 million and $156.5 million during
the respective periods in 1997. The growth in retail origination for the nine
month period ended September 30, 1998, was due to an increase in retail office
locations from internal growth and due to the acquisition of FCGA. The decrease
in retail originations for the three-month period ended September 30, 1998, was
caused by increased competition in the non-conforming mortgage industry.
Brokered Loans generated by the retail division were $23.5 million and $60.0
million ,during the three and nine-month periods ended September 30, 1998.
Brokered loan volume created during the three and nine-month periods ended
September 30, 1997 was not material and therefore the dollar volumes were not
recorded. (See: Item 2-Other Income)
The volume of loans originated through referrals from the Company's network of
mortgage brokers decreased 7.0 percent to $56.2 million and decreased 13.0
percent to $161.3 million during the three and nine month periods ended
September 30, 1998, respectively, compared to $60.5 million and $185.4 million
during the three and nine month periods ended September 30, 1997. Contributing
to this decrease in volume from broker referrals is the refinance boom for
conforming mortgages created by the low interest rate environment, increased
competition in the non-conforming mortgage industry and the Company's
acquisition of FCGA, a former broker who referred loans to the Company.
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. Gains from the 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) recapture premiums and loan selling
costs.
Loan sales totaled $100.7 million and $331.9 million for the three and nine
months ended September 30, 1998, including the sale of approximately $2.3
million and $12.0 million of loans owned by the Company for more than 180 days
("Seasoned Loans") at a discount to par value, as compared to $108.3 million and
$306.9 million for the same periods in 1997. The Company sold $2.3 million of
Seasoned Loans at a 21% discount to par value in July 1998. Previously the
Company sold $9.6 million of Seasoned Loans at an 8% discount to par value in
June 1998.
Gain on the sale of loans was $7.1 million and $25.6 million for the three and
nine months ended September 30, 1998, which compares with $8.7 million and $24.0
million for the same periods in 1997. These gains exclude the sale of $2.3
million and $12.0 million of Seasoned Loans at a discount. The decrease for the
three-month period ended September 30, 1998, was the direct result of a decrease
in the weighted average premium paid by investors for the Company's loans. The
increase in the gain on sale of loans for the nine-month period ended September
30, 1998 increased primarily due to the increased dollar volume of loans sold.
Gain on the sale of mortgage loans represented 58.0% and 65.4% of total revenue
during the three and nine months ended September 30, 1998, compared to 54.2% and
63.6% of total revenue for the same periods in 1997.
The weighted-average premium realized by the Company on its loan sales decreased
to 5.29% and 5.73%, excluding the $2.3 million and $12.0 million sale of
Seasoned Loans, during the three and nine months ended September 30, 1998, from
6.33% and 6.45% for the same periods in 1997, respectively. The net premium
received on loan sales including the Seasoned Loan sales were 4.7% and 5.1% for
the three and nine months ended September 30, 1998, respectively.
The decrease in premium percentage was caused by changes in non-conforming
mortgage loan secondary market conditions. Concerns over a weakening
international financial system have given rise to a "flight to quality", which
has caused pricing spreads within the non-conforming mortgage backed
securitization marketplace to dramatically increase relative to the yields on
United States Treasury Securities, the benchmark from which they are often
priced. The Company has never used securitization as a form of financing,
however , this situation has caused deterioration in the valuation of
interest-only and residual assets created from securitization issued by other
lenders and has led to a lack of liquidity for several lenders that are
dependent on the securitization market. Consequently, these companies have
diverted to whole loan strategies to sell loans in order to generate current
cash flow. This strategic shift has resulted in excess supply and therefore
reduced premiums within the whole loan sale marketplace, which is the Company's
current outlet for loan sales. The weakening securitization market and excess
supply in the whole loan sale market has resulted in a lowering of premium
percentage paid by the Company's investors.
In addition, the 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 an increase in adjustable rate mortgage originations
during the first nine months of 1998 compared to the first nine months of 1997.
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 deferred and 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 nine months ended
September 30, 1998 was $2.1 million and $8.1 million, compared to $3.0 million
and $7.5 million for the same period in 1997. The decrease for the three months
ended September 30, 1998, is the result of a lower volume of retail loans sold
and a decrease in the average origination fee percentage. The increase for the
nine-month period ended September 30, 1998, is the result of the company selling
more loans generated by its retail division. The Company's retail loan sales
during the three and nine months ended September 30, 1998 comprised 51.0% and
51.7% of total loan sales, with average loan origination fee income earned of
4.3% and 4.9%. For the same period in 1997, the Company's retail loan sales were
51.3% and 45.7% of total loan sales with average origination fee income earned
of 5.3% and 5.3%. Fees associated with selling loans remained constant at
approximately 20 basis points of the dollar volume of loans sold for the three
and nine months ended September 30, 1998 and 1997.
The Company also defers recognition of the expense it incurs from payment of
fees mortgage brokers for services rendered on loan originations. These fees are
deferred and recognized over the lives of the related loans as an adjustment of
the loan's yield using the level-yield method. Deferred expenses pertaining to
loans held for sale is taken into income at the time of sale of the loan. The
Company ceased payment of fees to mortgage brokers for services rendered in
November 1998.
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 Savings Bank's deposit accounts and other borrowings.
Interest income for the three and nine months ended September 30, 1998 was $2.3
million and $7.6 million compared with $2.9 million and $7.8 million for the
same period ended in 1997. The decrease in interest income for the three months
ended September 30, 1998 was primarily due to a lower weighted average coupon
associated with the balance of loans held for sale. The increase in interest
income for the nine month period ended September 30, 1998, compared to the same
period in 1997, was primarily due to a larger average balance of loans held for
sale.
Interest expense for the three and nine months ended September 30, 1998 was $1.5
million and $4.6 million compared with $1.4 million and $4.3 million for the
same period ended September 30, 1997. The increase in interest expense for the
nine month period ended September 30, 1998, was the direct result of an increase
in the average balance of interest bearing liabilities.
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 Savings 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 Savings Bank's deposits usually occur.
The following tables reflect the average yields earned and rate paid by the
Company during the nine months ended September 30, 1998 and 1997. 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.
Nine Months Ended Nine Months Ended
(In thousands) September 30, 1998 September 30, 1997
------------------ ------------------
Average Average
Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate
------- -------- ---- ------- -------- ----
Interest-earning assets:
Loans receivable (1) $ 78,549 $ 7,160 12.19% $ 69,786 $ 7,695 14.74%
Cash and other interest-
earning assets 7,686 399 6.94% 3,233 150 6.20%
--------- -------- ------- --------- ------ -----
86,235 7,559 11.72% 73,019 7,845 14.36%
----- ------ ----- ------- ------ -----
Non-interest-earning assets:
Allowance for loan losses (1,561) (1,345)
Investment in IMC 11,102 18,572
Premises and equipment, net 4,712 3,083
Other 16,914 6,560
------ ------
Total assets $ 117,402 $ 99,889
========= ======
Interest-bearing liabilities:
Revolving warehouse lines $54,011 2,843 7.04% $ 58,581 3,452 7.88%
FDIC-insured deposits 20,946 933 5.96% 3,049 123 5.39%
Other interest-bearing
liabilities 11,404 785 9.20% 10,221 711 9.30%
--------- ------- ------- ---------- -------- ------
86,361 4,561 7.06% 71,851 4,286 7.98%
-------- -------- ------- -------- -------- ------
Non-interest-bearing liabilities 4,594 3,498
---------- ---------
Total liabilities 90,955 75,349
Shareholders' equity 26,447 24,540
--------- -------
Total liabilities and equity $117,402 $ 99,889
========= =========
Average dollar difference between
interest-earning assets and
interest-bearing liabilities $ (126) $ 1,168
========= =========
Net interest income $2,998 $ 3,559
====== =====
Interest rate spread (2) 4.66% 6.39%
======= =======
Net annualized yield on average
interest-earning assets 4.65% 6.52%
======= =======
- --------------------------------------------------------------------------------
(1) Loans shown gross of allowance for loan losses and include non performing
loans, net of premiums/discounts.
(2) Average yield on total interest-earning
assets less average rate paid on total interest-bearing liabilities.
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 nine month period ending September 30,
1998 compared to the nine month period ended September 30, 1997 and for the nine
month period ending September 30, 1997 compared to
the nine month period endedSeptember 30, 1996. 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 $561,000 in interest income
for the nine months ended September 30, 1998 compared to the nine months ended
September 30, 1997 was the net result of a decrease in the average yield on
interest earning assets.
($ In Thousands)
Nine Months Ended Nine Months Ended
September 30, 1998 September 30, 1997
Compared to Compared to
Nine Months Ended Nine Months Ended
September 30,1997 September 30, 1996
Increase (Decrease)due to Increase (Decrease) due to
Volume Rate Total Volume Rate Total
------ ---- ----- ------ ---- -----
Interest-Earning Assets:
Loan Receivable $ 1,407 $(1,942) $ (535) $3,877 $ 528 $ 4,405
Cash and Other Interest-
Earning Assets 229 20 249 129 3 132
----- ----- ---- ---- ----- ------
1,636 (1,922) (286) 4,006 531 4,537
----- ------ ---- ----- ----- -----
Interest-Bearing Liabilities:
Revolving Warehouse Lines (257) (353) (610) 1,991 (230) 1,761
FDIC-Insured Deposits 796 14 810 117 2 119
Other Interest-
Bearing Assets 81 (6) 75 128 (5) 123
---- ---- ---- ----- ----- -----
620 (345) 275 2,236 (233) 2,003
---- ----- ---- ------ ----- -----
Net Interest Income $ 1,016 $ 1,577 $(561) $ 1,770 $ 764 $ 2,534
======= ======== ===== ======= ===== =======
OTHER INCOME
In addition to net interest income, and gain on the 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 document preparation fees, underwriting service fees,
prepayment penalties, and late charge fees for delinquent loan payments.
Brokered Loan fees were $1.1 million and $2.8 million for the three and nine
months ended September 30, 1998, compared to $0.3 million and $0.5 million for
the three and nine months ended September 30, 1997. For the three and nine
months ended September 30, 1998, other income totaled $1.8 million and $5.0
million compared to $1.5 million and $3.1 million for the same period in 1997.
The increase was primarily the result of the increase in Brokered Loan fees.
COMPREHENSIVE INCOME
The Company has comprehensive income (loss) in the form of unrealized holding
gain (loss) on securities held for sale. The shares of IMC Mortgage Company
common stock owned by the Company is the primary component of the Company's
security holdings (See Item 2 section "Assets"). For the three and nine months
ended September 30, 1998, comprehensive income (loss) was ($5.0) million and
($3.8) million compared to comprehensive income of $.8 million and $3.8 million
for the three and nine months ended September 30, 1997. The loss for the three
and nine months ended September 30, 1998 was related to a decrease in the market
price of IMC Mortgage Company common stock. The gain for the three and nine
month periods ended September 30, 1997 was related to an increase in the market
price of the IMC Mortgage Company common stock for the respective periods. The
Company owned approximately 900,000 shares of IMC Mortgage Company common stock
on September 30, 1998.
COMPENSATION AND RELATED EXPENSES
The largest component of expenses is compensation and related expenses, which
increased by $0.8 million and $5.2 million to $5.9 million and $17.9 million for
the three and nine months ended September 30, 1998, respectively, compared to
the same periods in 1997. The increases for the three and nine month periods
were directly attributable to an increase in the number of employees. For the
three months ended September 30, 1998 the Company had four additional retail
loan origination centers compared to the same period in 1997 which accounted for
the entire increase in compensation and related benefits expense during this
period. During the nine month period ended September 30, 1998, approximately 60%
of the increase was attributed to staffing needs for nine additional retail
origination offices compared to the same period in 1997. The remaining 40% of
the increase in compensation and related benefits expense for the nine-month
period ending September 30, 1998 was due to a higher number of employees in the
corporate headquarters during the first six months of 1998.. During the first
six months of 1998 the Company had an increase of 68.1% in corporate office
staff compared to the same period in 1997, with a corresponding increase in base
salaries and benefits of approximately $2.0 million. However, in July of 1998,
the Company initiated a plan to reduce the number of employees in the corporate
office. As of September 30, 1998, the home office staff had been reduced by 16%
compared to March 30, 1998.
GENERAL AND ADMINISTRATIVE EXPENSES
General and Administrative expenses for the three month period ended September
30, 1998, decreased by $0.1 million to $2.8 million compared to the three month
period ended September 30, 1997. The reduction is the result of the Company's
cost cutting procedures implemented during 1998. General and administrative
expenses for the nine month period ended September 30, 1998 increased by $1.3
million to $8.7 million, compared to the nine month period ended September 30,
1997. The Company had nine additional retail lending offices for the nine month
period ended September 30, 1998 compared to the same period in 1997.
LOAN PRODUCTION EXPENSE
The largest component of loan production expense is fees paid by the Company to
mortgage brokers for services rendered in the preparation of loan packages.
Other items that comprise loan production expenses are appraisals, credit
reports, leads research and telemarketing expenses. Loan production expenses for
the three and nine month periods ended September 30, 1998 were $1.0 million and
$2.8 million compared to $0.4 million and $1.1 million for the three and nine
months ended September 30, 1997. The increase was primarily the result of an
increase in services rendered fees. The Company is not paying services rendered
fees at the current time.
PROVISION FOR LOAN LOSSES
The Company added $.9 million and $1.7 million during the three and nine months
ended September 30, 1998 to the allowance for loan losses, compared to an
increase of $.6 million and $1.0 million for the three and nine month periods
ended September 30, 1997. The increase was caused by two Seasoned Loan sales, of
approximately $9.6 million, at 92% and $2.3 million, at 79%, of the carrying
value of the loans.
The following table presents the activity in the Company's allowance for loan
losses and selected loan loss data for the nine months ended September 30, 1998
and the year ended December 31, 1997
($ In thousands):
1998 1997
------------ -----------
Balance at beginning of period $1,687 $ 924
Provision charged to expense 1,657 1,534
Loans charged off (1,831) (953)
Recoveries of loans previously charged off 149 182
--------- -----------
Balance at end of period $ 1,662 $ 1,687
========= ===========
Loans receivable at period-end, gross
of allowance for losses $78,080 $ 83,512
Ratio of allowance for loan losses to gross
loans receivable at period-end 2.13% 2.02%
The decrease in dollar amount of the allowance for loan losses at September 30,
1998 compared to December 31, 1997 relates to the decrease in the balance of
gross mortgage loans held by the Company for the respective dates. All losses
("charge offs" or "write downs") and recoveries realized on the sale of
properties for which write downs were previously recorded at the time of
foreclosure, 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 current characteristics of the portfolio such as credit
quality, the weighted average coupon and the weighted average loan to value
ratio in the determination of an appropriate allowance. Other criteria such as
covenants associated with the Company's credit facilities, trends in the demand
for non-conforming mortgage loans in the secondary market 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.
PROVISION FOR FORECLOSED PROPERTY LOSSES
The Company decreased its provision for foreclosed property losses by $220,000
for the three months ended September 30, 1998, and increased its provision by
$101,000 for the nine month period ended September 30, 1998, compared to an
increase of $1,000 and $200,000 for the three and nine months ended
September 30, 1997.
Sales of real estate owned yielded net losses of $186,000 and $580,000 for the
three and nine months ended September 30, 1998 versus $55,000 and $407,000 for
the three and nine months ended September 30, 1997.
The following table presents the activity in the Company's allowance for
foreclosed property losses and selected real estate owned (REO) data for the
nine months ended September 30, 1998 and the year ended December 31, 1997
($ In thousands):
1998 1997
------ ------
Balance at beginning of period $ 671 $ 529
Provision charged to expense (101) 142
------- ------
Balance at end of period $ 570 $ 671
======== =======
Real estate owned at period-end, gross
of allowance for losses $ 2,539 $ 3,038
Ratio of allowance for REO losses
to gross real estate owned at period-end 22.45% 22.09%
Note: This reserve is in addition to the reserve for loan losses.
The Company maintains a reserve on its REO based upon management's assessment of
appraised values. The decrease in the provision for foreclosed property losses
relates to a decrease in the dollar amount of outstanding REO at September 30,
1998 when compared to December 31, 1997. While the Company's management believes
that its present allowance for foreclosed property losses is adequate, future
adjustments may be necessary.
INCOME TAXES
Income tax expense for the three and nine months ended September 30, 1998 was
$0.1 million and $1.5 million, resulting in an effective tax rate of 42.9% and
41.6%. By comparison, the Company had income tax expense of $2.4 million and
$4.6 million for an effective tax rate of 41.3% and 40.9% for the same periods
in 1997.
The effective tax rates differ from the statutory federal rates due primarily to
state income taxes and certain nondeductible expenses.
FINANCIAL CONDITION AT SEPTEMBER 30, 1998 COMPARED TO DECEMBER 31, 1997
ASSETS
The total assets of the Company were $112.9 million at September 30, 1998,
compared to total assets of $118.1 million at December 31, 1997.
Cash and cash equivalents were $14.9 million at September 30, 1998, representing
an increase of $3.0 million over cash and cash equivalents of $11.9 million at
December 31, 1997. The principal reason for the increase was the receipt of
proceeds from loan sales in the final week of September 1998. These proceeds
were used to fund new loans in the first week of October 1998.
Net mortgage loans receivable decreased by $5.8 million to $74.9 million at
September 30, 1998. The 7.2% decline was primarily the result of the Company's
sales and payoffs of loans being greater than loans originated during the first
nine months of 1998. The Company generally sells loans within sixty days after
origination.
Real estate owned ("REO") decreased by $0.4 million, from December 31, 1997 to
$2.0 million at September 30, 1998. The decrease was the result of increased
sales of REO properties. REO is carried net of a reserve for loss on foreclosed
property.
Securities available for sale consist primarily of shares of IMC Mortgage
Company ("IMC") owned by the Company and Saving's Bank Adjustable Rate Mortgage
Fund and FHLB stock owned by the Savings Bank. Following the conversion of the
Industry Mortgage L.P. into a public corporation in 1996, the Company received
shares of IMC common stock (NASDAQ: IMCC) in exchange for the partnership units
owned by the Company. The Company's investment in IMC is accounted for as an
available for sale security under SFAS No. 115 and is carried at the market
value. The market value of the IMC shares owned was $1.8 million at September
30, 1998 and $11.6 million at December 31, 1997.The decrease in securities
available for sale was primarily due to the sale of 92,500 shares of IMC stock
and a decline in the market price of IMC stock from $11.875 on December 31,1997,
to $1.969 per share on September 30, 1998.
Premises and equipment increased by $0.2 million, from December 31, 1997, to
$4.7 million at September 30, 1998. The primary reason for the increase was the
purchase of computers for a centralized telemarketing center located at the
Company's headquarters in Virginia Beach.
Goodwill increased $3.0 million, from December 31, 1997, to $3.8 million at
September 30, 1998. The increase is a result of the Company's purchase of the
Funding Center of Georgia, which resulted in goodwill of $3.3 million.
Income tax receivable increased by $1.5 million from December 31, 1997 to $1.5
million at September 30, 1998. The 1998 increase is the result of overpayment of
second quarter estimated tax payments.
The deferred tax asset was $1.7 million at September 30, 1998 compared to a
deferred tax liability of $1.1 million at December 31, 1997. The change was the
result of a decrease of $3.9 million in the deferred tax liability on securities
and a decrease of $1.1 million in the deferred tax asset. The deferred tax asset
decreased because the mark to market valuation of the Company's loans held for
sale portfolio decreased.
Other assets increased by $2.1 million, from December 31, 1997, to $4.8 million
at September 30, 1998. The 1998 increase was the result of two factors. The
Company sold 92,500 shares of IMC Mortgage Company stock resulting in proceeds
of $1.0 million. As of September 30, 1998 the Company had not received the cash,
proceeds from the sale, therefore, a receivable was booked. Also there was an
increase of $0.7 million in prepaid expenses.
LIABILITIES
Outstanding balances for the Company's revolving warehouse lines of credit
decreased by $11.7 million, from December 31, 1997, to $40.8 million at
September 30, 1998. The 22.3% decrease in 1998 was primarily attributable to the
decrease in net mortgage loans held for sale and the increase in certificates of
deposit issued by the Savings Bank.
The Company draws on its revolving warehouse lines of credit as needed to fund
loan production. As of September 30, 1998, the Company had issued checks to fund
loans totaling $8.6 million which had not cleared the Company's checking account
and for which the Company had not drawn funds from its warehouse lines. These
checks cleared the Company's bank accounts in the first few business days of
October 1998 and most were funded with cash on hand or by funds from warehouse
lines of credit.
The Savings Bank's deposits totaled $26.2 million at September 30, 1998,
compared to $17.8 million at December 31, 1997. The Savings Bank increased its
deposits in 1998 in order to fund loans. Of the certificate accounts as of
September 30, 1998, a total of $4.9 million was scheduled to mature in the next
twelve-months.
The Savings Bank increased its borrowings from the Federal Home Loan Bank
("FHLB") to $1.4 million at September 30, 1998, from $0.4 million at December
31, 1997. The Savings Bank held $145,800 of FHLB stock at September 30, 1998.
Management expects to utilize FHLB advances as the Savings Bank builds a
portfolio of loans.
Promissory notes and certificates of indebtedness totaled $9.1 million at
September 30, 1998, compared to $9.1 million at December 31, 1997. The Company
has utilized promissory notes and certificates of indebtedness to help fund its
operations. These borrowings are subordinated to the Company's warehouse lines
of credit, and are The promissory notes are loans from insiders (shareholders,
directors and employees) issued for terms of one to five years and with interest
rates between 8.00% and 10.25%. The certificates of indebtedness are uninsured
deposits authorized for Virginia financial institutions holding an industrial
loan association charter. The Company is not currently soliciting new promissory
notes or certificates of indebtedness.
Accrued and other liabilities increased by $0.8 million to $3.7 million at
September 30, 1998. This category includes accounts payable, accrued interest
payable, deferred income, accrued bonuses, and other payables. The increase was
the result of a payable being established in connection with the acquisition of
the Funding Center of Georgia. The acquisition payable was $2.6 million at
September 30, 1998.
SHAREHOLDERS' EQUITY
Total shareholders' equity at September 30, 1998 was $21.9 million, compared to
$25.1 million at December 31, 1997. The $3.2 million decrease in 1998 was
primarily due to a decrease of $5.9 million in accumulated other comprehensive
income, related to a decrease in the market value of the shares of IMC Mortgage
Company owned by the Company. This was offset by an increase in common stock and
additional paid in capital of $0.7 million related to the purchase of the
remaining 17% interest in Armada Residential Mortgage, L. L. C., and $0.5
million in net income.
LIQUIDITY AND CAPITAL RESOURCES
The Company's operations require access to short and long-term sources of
capital. The Company receives cash from the sale of loans through whole loan
sales, loan origination fees, processing and underwriting fees, net interest
income, and borrowings under its warehouse facilities and other debt 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 received cash from operating activities
of $.9 million for the nine months ended September 30, 1998. The Company used
cash from operating activities of $19.2 million for the nine months ended
September 30, 1997. The net cash provided from operating activities during the
nine month period ended September 30, 1998 resulted because the Company's sales
and payoffs being greater than originated loans. The net cash used from
operating activities is primarily used to fund mortgage loan originations.
The Company finances its operating cash requirements primarily through warehouse
and other credit facilities, and the issuance of other debt. For the nine months
ended September 30, 1998, the Company used cash from financing activities of
$2.9 million, compared to positive cash received from financing activities of
$24.0 million for the nine months ended September 30, 1997. During the first
nine months of 1998, the Company's repayments on its warehouse line of credit
exceeded borrowings because loan sales exceeded loan originations.
The Company had cash and cash equivalents of $14.9 million at September 30,
1998. The Company has sufficient cash resources to fund its operations at
current levels through the end of 1998.. However, loan origination volume is
expected to continue to grow in future periods, and management anticipates that
it will need additional capital to fund this growth and to continue its
expansion. New debt financing, equity financing, and lines of credit will be
evaluated with consideration for maximizing shareholder value. However, the
company has no commitments for additional bank borrowings or additional debt or
equity financing and there can be no assurance that the Company will be
successful in consummating any such financing transaction in the future on terms
the Company would consider to be favorable. Management expects that the recent
changes throughout the mortgage industry will challenge the Company and other
lenders in their attempt to raise new capital.(See: Item 2 -Gain on Sale of
Loans)
The Company's outstanding borrowings from all sources plus loan proceeds payable
represented 77.3% of total assets at September 30, 1998, compared to 74.5% of
total assets at December 31, 1997.
Warehouse and Other Credit Facilities. The Company has a $100.0 million
warehouse line of credit from a syndicate of commercial banks. The syndicate is
led by Chase Bank of Texas. Other banks in the syndicate are BankBoston,
National City Bank, Comerica Bank and Compass Bank. The line is secured by loans
originated by the Company and bears interest at a rate of 1.5% over the
one-month LIBOR rate. The line expires on December 31, 1999 and is subject to
renewal. The Company may receive warehouse credit advances of 98% of the
original principal balances on pledged mortgage loans for a maximum period of
180 days after origination. As of September 30, 1998, $32.6 million was
outstanding under this facility.
The Company also has a $25.0 million Seasoned Loan line of credit from a
commercial bank syndicate. This line is secured by loans originated by the
Company. The Seasoned Loan line of credit bears interest at a rate of 2.5% over
the one-month LIBOR rate, and the Company may receive credit advances of 90% of
the current principal balances on pledged mortgage loans. As of September 30,
1998, $8.3 million was outstanding under this facility.
Whole Loan Sale Program. The Company's primary source of funding is the sale of
its loans in the secondary market. The market value of the Company's loans is
dependent on a number of factors, including but not limited to the credit
quality of the loans, prepayment penalties attached to the loans, performance of
loans previously sold by the Company, general economic conditions, market
interest rates, secondary market conditions for whole loan sales and
governmental regulations. Adverse changes in these conditions may affect the
Company's ability to sell loans in the secondary market for acceptable prices.
The ability to sell loans in the secondary market is essential to the
continuation of the Company's loan origination operations. (see: Item 2-Gain on
Sale of Loans)
Other Capital Resources. The Savings Bank's deposits totaled $26.2 million at
September 30, 1998, compared to $17.8 million at December 31, 1997. The Savings
Bank increased its deposits in order to fund loans. The Savings Bank currently
utilizes funds from the deposits and a line of credit with the FHLB of Atlanta
to fund first lien and junior lien mortgage loans.
SAVINGS 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 Office of
Thrift Supervision ("OTS") require thrift associations and/or savings banks to
maintain liquid assets at certain levels. At present, the required ratio of
liquid assets to withdrawal savings and borrowings due in one year or less is
5.0%. Penalties are assessed for noncompliance. During 1997 and the first nine
month of 1998, the Savings Bank maintained liquidity in excess of the required
amount, and management anticipates that it will continue to do so.
SAVINGS BANK REGULATORY CAPITAL
At September 30, 1998, the Savings Bank's book value under generally accepted
accounting principles ("GAAP") was $4.6 million. OTS Regulations require that
savings institutions maintain the following capital levels: (1) tangible capital
of at least 1.5% of total adjusted assets, (2) core capital of 4.0% of total
adjusted assets, and (3) overall risk-based capital of 8.0% of total
risk-weighted assets. As of September 30, 1998, the Savings Bank satisfied all
of the regulatory capital requirements, as shown in the following table
reconciling the Savings Bank's GAAP capital to regulatory capital:
Tangible Core Risk-Based
($ In thousands) Capital Capital Capital
------- ------- -------
GAAP capital $ 4,596 $ 4,596 $4,596
Add:unrealized loss on securities 6 6 6
Nonallowable asset: goodwill (120) (120) (120)
Additional capital item:general allowance - - 236
-------- --------- --------
Regulatory capital - computed 4,482 4,482 4,718
Minimum capital requirement 578 1,541 1,955
--------------------------- ------- ------- -------
Excess regulatory capital $ 3,904 $ 2,941 $ 2,763
========= ======= =======
Ratios:
Regulatory capital - computed 11.64% 11.64% 19.31%
Minimum capital requirement 1.50% 4.00% 8.00%
-------- ------ -------
Excess regulatory capital 10.14% 7.64% 11.31%
========= ======= =======
The Company is not aware of any other trends, events or uncertainties which will
have or that are likely to have a material effect on the Company's or the
Savings 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.
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. 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. From time to time, the
Company will attempt to offset the effects of interest rate fluctuations on the
value of its fixed rate mortgage loans held for sale by entering into Treasury
security lock contracts, which function similar to short sales of U.S. Treasury
securities. However, the Company does not find this cost effective in most
instances, since the majority of the loans are sold within a sixty-day period.
The Company did not have any treasury security contracts at September 30, 1998.
IMPACT OF INFLATION,DEFLATION 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 or deflation.
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 changes in the general levels prices. Interest
rates do not necessarily move in the same direction or with the same magnitude
as the prices of goods and services. Inflation or deflation affects the Company
most significantly in the area of loan originations, the value of loan
collateral 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 or deflation
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 Savings 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 or deflation and changes in interest rates. (Also see
"Interest Rate").
YEAR 2000 ISSUES
COMPLIANCE
The Year 2000 issue relates to the way computer systems and programs define and
handle calendar issues. Non-compliant systems could fail or make miscalculations
due to interpretations of dates that fall past the millennium. For example, the
year value "00" could be interpreted to mean the year "1900", rather than
"2000". Other systems not normally thought of as computer related may also
contain embedded hardware or software that may contain a date or time element.
Approved Financial, similar to other financial service institutions, is
sensitive and subject to the potential impacts of the Year 2000 issue.
Approved Financial initiated a Year 2000 project in late 1997 under the
direction of a project leader, supervised by the Company's Board of Directors.
Management has placed a high priority on Year 2000 issues, in recognition of the
business risk inherent in non-compliance. The project is proceeding ahead of
schedule, with expected completion by the end of first quarter 1999.
PROJECT
The Approved Financial Year 2000 project generally follows suggested OTS and
FFIEC guidelines. The scope of the project includes: ensuring the compliance of
all systems and applications of significance, operating systems and hardware on
the Company's LAN and PC platforms; addressing issues related to other systems
not normally thought of as computer related, and addressing the compliance of
key business partners.
There are five (5) phases of the project: Awareness, Assessment, Renovation,
Validation and Implementation. During the Assessment phase, the Company
determined to concentrate physical upgrades to those computers representing
"current" technologies. Older units may still be used in non-critical
applications, but would be phased out and replaced before the Year 2000. The
Assessment phase also identified several systems that are classified as
"mission-critical" and represent the Company's core business of mortgage
lending. Project efforts have focused on getting these systems to Year 2000
compliance levels.
Approved Financial has no internally generated programmed software to correct,
as substantially all of the software utilized by the Company is purchased or
licensed from external providers. The Company is currently completing the
Renovation phase of the project. Virtually all "mission-critical" applications
and hardware have been upgraded to Year 2000 compliance release levels.
In addition, the Company has contracted for a new Human Resources and Payroll
system, which is certified by the vendor as being Year 2000 compliant.
Installation of these systems is scheduled for fourth quarter 1998, with full
integration expected by the end of the first quarter 1999. All PC equipment
located at corporate headquarters, including hardware BIOS, and software, have
been upgraded to Year 2000 compliance release levels.
The final portion of the Renovation phase consists of field upgrades of systems
and software located in our branch offices, with an expected completion date of
December 31, 1998. Branch renovations are estimated at 75% complete.
The Company has initiated formal communications with significant outside vendors
and business partners to determine the extent to which the Company is vulnerable
to those third parties' failure to remedy their own Year 2000 issues. Approved
Financial is requesting that third party vendors represent their products and
services to be Year 2000 compliant and that they have a program to test for that
compliance.
The majority of the Company's mission-critical systems are already certified by
their respective vendors as being Year 2000 compliant. Certified compliant
systems include mortgage loan origination and processing, closing, servicing,
secondary marketing, and accounting systems. All named systems are installed at
current release levels. One system used for Indirect Lending is not compliant.
However, the vendor has scheduled replacement with a compliant version by the
end of the first quarter 1999.
The majority of the Company's non-computer-related systems and equipment are
currently Year 2000 compliant, based primarily upon verbal and written
communication with vendors. Compilation of written documentation regarding this
compliance is virtually complete.
Validation of internal mission-critical applications has begun upon those
applications certified by their vendors as being fully Year 2000 compliant.
Validations of several of the Company's mission-critical systems have been
completed. Approved Financial expects to meet the FFIEC milestone of having
"internal testing of mission-critical systems substantially complete" by
December 31, 1998.
COSTS
The total cost associated with required modifications and testing to become Year
2000 compliant has been budgeted at $200,000, and is not considered material to
the Company's financial position. Costs are expensed as incurred in the current
period. This estimate does not include Approved Financial's potential share of
Year 2000 costs that may be incurred by partnerships or ventures in which the
company may participate but is not the operator. The total amount of the project
expended through September 30, 1998 is $48,000, of which the bulk is for
upgrades of systems and software at corporate headquarters and branch offices.
RISKS
The failure to correct a material Year 2000 problem could result in interruption
in, or failure of, certain normal business activities or operations. Such
failures could materially and adversely affect the company's results of
operations, liquidity and financial condition.
The company's Year 2000 project has resulted in a significantly reduced level of
uncertainty about the company's mission-critical systems and software. The
company believes that the completion of the Year 2000 project as scheduled will
vastly reduce the possibility of significant interruptions of normal business
operations.
Due to the general uncertainty inherent in the Year 2000 problem, resulting in
part from the uncertainty of the Year 2000 readiness of third-party suppliers,
the company is unable to determine at this time whether the consequences of Year
2000 failures will have a material impact on the company's results of
operations, liquidity or financial condition.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ASSET/LIABILITY MANAGEMENT
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 Savings 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 program in an attempt to limit its exposure to interest rate
risk in addition to generating cash revenues. The Company sold approximately 88%
of the total loans originated during the year ended December 31, 1997. At
September 30, 1998, the Company had sold approximately 81% of loans originated
during the first nine months of 1998. Also, approximately 56% of the unsold 1998
loans were originated in September and had not been sent to any investors for
sale. The Company expects to sell the majority of its loan originations within a
twelve month period from the date the loans are funded by the Company. 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 September 30, 1998, 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. The Company's one-year gap was a negative 26.91%
of total assets at September 30, 1998, as illustrated in the following table:
Asset and liability management strategies impact the one year maturity "gap,"
which is the difference between interest-earning assets and interest-bearing
liabilities maturing or repricing in one year or less. The Company's one-year
gap was a negative 26.91% of total assets at September 30, 1998, as follows:
($ In thousands)
One Year Three to More Than
Total or Less Two Years Four Years Four Years
----- ------- --------- ---------- ----------
Interest-earning assets:
Loans receivable (1) $ 76,588 $ 13,525 $ 1,164 $ 2,792 $ 59,108
Cash and other interest-
earning assets 17,764 17,764 - - -
--------- -------- -------- -------- -------
94,352 $ 31,289 $ 1,164 $ 2,792 $ 59,108
======== ======== ======== ========
Non-interest-earning assets:
Allowance for loan losses (1,662)
Investment in IMC 1,775
Premises and equipment, net 4,705
Other 13,724
------
Total assets $112,894
========
Interest-bearing liabilities:
Revolving warehouse lines $ 40,790 $ 40,790 $ - $ - $ -
FDIC-insured deposits 26,243 15,626 6,849 2,578 1,190
Other interest-
bearing liabilities 11,657 5,252 1,635 1,833 2,937
--------- ---------- -------- --------- ----------
78,690 $ 61,668 $ 8,484 $ 4,411 $ 4,127
========= ========= ========= ==========
Non-interest-bearing liabilities 12,255
------
Total liabilities 90,945
Shareholders' equity 21,949
------
Total liabilities and equity $112,894
========
Maturity/repricing gap $ (30,379) $ (7,320) $ (1,619) $ 54,981
========= ======= ======== ========
Cumulative gap $ (30,379) $(37,699) $(39,318) $ 15,663
========= ========= ========= ==========
As percent of total assets - 26.91% - 33.39% - 34.83% 13.87%
======== ======== ========= ===========
As percent of total interest earning assets - 32.20% -39.96% -41.67% 16.60%
======== ======== ======== ===========
Ratio of Cumulative Interest Earning Assets to
Cumulative Interest Earning Liabilities .51x .46x .47x 1.20x
======= ======= ======== ==========
- -------------
(1) Loans shown gross of allowance for loan losses, net of premiums/discounts.
The Company originates fixed-rate, fixed-term mortgage loans for sale in the
secondary market. While most of these loans are expected to be sold within sixty
days of origination, for purposes of the gap table the loans are shown based on
their contractual scheduled maturities. As of September 30, 1998, 70.9% 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, 81.6% of which reprice within one year of September 30, 1998.
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.
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.
Fluctuating interest rates 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.
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 Savings 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 Savings Bank is building a portfolio of loans to be held for net interest
income. The sale of fixed rate products is intended to protect the Savings 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
Savings Bank's portfolio, which is influenced by the level of market interest
rates and the Savings Bank's asset/liability management strategy. As with other
investments, the Savings 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.
Asset Quality
The following table summarizes all of the Company's delinquent loans at
September 30, 1998 and December 31, 1997:
($ in thousands) September 30, 1998 December 31, 1997
----------------------- --------------------
Delinquent 31 to 60 days $ 1,382 $ 866
Delinquent 61 to 90 days 581 1,124
Delinquent 91 to 120 days 339 970
Delinquent 121 days or more 1,888 1,567
------- -------
Total delinquent loans (1) $ 4,190 $ 4,527
======= =======
Total loans receivable
outstanding, gross of
the allowance for loan
losses (1) $78,080 $83,512
======= =======
Delinquent loans as a
percentage of total loans
outstanding:
Delinquent 31 to 60 days 1.77% 1.05%
Delinquent 61 to 90 days 0.74 1.36
Delinquent 91 to 120 days 0.43 1.19
Delinquent 121 days or more 2.42 1.90
------- -------
Total delinquent loans as a
percentage of total
loans outstanding 5.36% 5.50%
======= =======
- -------------
(1) Includes loans in foreclosure and in bankruptcy, but excludes real estate
owned.
Loans delinquent 31 days or more as a percentage of total loans outstanding
decreased to 5.36% at September 30, 1998 from 5.50% at December 31, 1997
primarily as a result of an decrease in the dollar amount of loans delinquent
60-91 days and a decrease in the dollar amount of total loans outstanding. The
dollar amount of loans delinquent 31-60 days increased from $866 thousand at
December 31, 1997 to $1.4 million on September 30, 1998. The dollar amount of
total loans outstanding decreased because the companies sales of loans and loan
run off were greater than loans originated during the nine month period ended
September 30, 1998.
Most of the Company's loans are collectively evaluated for impairment. The
Company's impaired loans are nonaccrual loans, as generally loans are placed on
nonaccrual status on the earlier of the date that principal or interest amounts
are 60 days or more past due (90 days or more in the case of loans held by the
Savings Bank) or the date that collection of such amounts is judged uncertain
based on an evaluation of the net realizable value of the collateral and the
financial strength of the borrower. Nonaccrual loans were $2.8 million and $4.1
million at September 30, 1998 and 1997, respectively. The amount of interest
that would have been recorded had these loans not been placed on nonaccrual
status was approximately $127,000 and $106,000 for the nine months ended
September 30, 1998 and 1997, respectively. The amount of interest income on the
nonaccrual loans, that was included in net income for the nine months ended
September 30, 1998 was $65,700. The data for interest income on nonaccrual
loans, that was included in net income for the nine months ended September 30,
1997 was not available.
At September 30, 1998 and December 31, 1997 the recorded investment in loans for
which impairment has been determined in accordance with SFAS 114 totaled $2.2
million and $2.5 million, respectively. The average recorded investment in
impaired loans for the nine months ended September 30, 1998 and the year ended
December 31, 1997 was approximately $2.4 million and $1.6 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 nonaccrual
loans, interest receipts for impaired loans are recognized as interest income or
are applied to principal when the ultimate collectibility of principal is in
doubt. Due to the homogenous nature and the collateral securing these loans,
there is no corresponding valuation allowance.
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 three (3)
months ending September 30, 1998.
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: /s/ ALLEN D. WYKLE
-----------------------------------
Allen D. Wykle,
Chairman, President, and Chief
Executive Officer
By: /s/ Eric S. Yeakel
-----------------------------------
Eric S. Yeakel,
Its Treasurer and Chief Financial
Officer