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 MARCH 31, 1999.
__ 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
Incorporation or Organization) Identification Number)
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 May 1, 1999: 5,482,114 shares
APPROVED FINANCIAL CORP.
INDEX
PART I. FINANCIAL INFORMATION PAGE
Item 1. Financial Statements
Consolidated Balance Sheets as of
March 31, 1999 and December 31, 1998 2
Consolidated Statements of Income (Loss) and Comprehensive
Income (Loss) for the three months ended March 31,
1999 and 1998. 3
Consolidated Statements of Cash Flows for
the three months ended March 31, 1999
and 1998. 4
Notes to Consolidated Financial Statements 6
Consolidating Balance Sheet as of March 31, 1999 8
Consolidating Statements of Income for the
Three months ended March 31, 1999 9
Item 2. Management's Discussion and Analysis of
Results of Operations and Financial Condition 10
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 25
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 MARCH 31, 1999 AND DECEMBER 31, 1998
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
ASSETS (Unaudited) 1998
1999
------------ --------------
Cash $ 6,794 $ 6,269
Mortgage loans held for sale, net 71,127 105,044
Real estate owned, net 1,448 1,707
Investments 3,725 3,472
Income taxes receivable 2,798 2,023
Deferred tax asset 1,080 3,330
Premises and equipment, net 4,857 5,579
Goodwill, net 4,436 4,554
Other assets 3,803 4,140
------------ --------------
Total assets $ 100,068 $ 136,118
============ ==============
LIABILITIES AND EQUITY
Liabilities:
Revolving warehouse loan $ 38,584 $ 72,546
Mortgage payable 361 1,210
Notes payable-related parties 3,647 3,628
Certificate of indebtedness 2,424 2,414
Certificates of deposits 31,022 29,728
Loan proceeds payable 1,813 2,565
Accrued and other liabilities 4,218 4,760
------------ --------------
Total liabilities 82,069 116,851
------------ --------------
Shareholders' equity:
Preferred stock series A, $10 par value;
Noncumulative, voting: 1 1
Authorized shares - 100
Issued and outstanding shares - 90
Common stock $1.00 par value in 1999 and 1998: 5,482 5,482
Authorized shares - 40,000,000
Issued and outstanding shares -
5,482,114 in 1999 and 1998
Accumulated other comprehensive income (loss) (3) 30
Additional paid in capital 552 552
Retained earnings 11,967 13,202
------------ --------------
Total equity 17,999 19,267
------------ --------------
Total liabilities and equity $ 100,068 $ 136,118
============ ==============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL
STATEMENTS.
2
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF INCOME (LOSS) AND
COMPREHENSIVE INCOME (LOSS)
FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND 1998
(DOLLARS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)
1999 1998
------------- -------------
Revenue:
Gain on sale of loans $ 4,396 $ 9,754
Interest income 2,696 2,602
Other fees and income 2,290 1,482
------------- -------------
9,382 13,838
------------- -------------
Expenses:
Compensation and related benefits 4,830 6,019
General and administrative 2,868 3,013
Loan production expense 555 896
Interest expense 1,683 1,548
Provision for loan and foreclosed property 1,279 (111)
losses
------------- -------------
11,215 11,365
------------- -------------
Income/(loss) before income taxes (1,833) 2,473
Provision for (benefit from) income taxes (598) 1,038
------------- -------------
Net income/(loss) (1,235) 1,435
Other comprehensive income, net of tax:
Unrealized gains on securities:
Unrealized holding gain/(loss) arising during (33) 1,096
period
------------- -------------
Comprehensive income/(loss) $ (1,268) $ 2,531
============= =============
Net income/(loss) per share:
Basic and Diluted $ (0.23) $ 0.26
============= =============
Weighted average number of shares outstanding:
Basic 5,482 5,507
============= =============
Diluted 5,482 5,514
============= =============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL
STATEMENTS.
3
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND 1998
(IN THOUSANDS)
(UNAUDITED)
1999 1998
-------------- -------------
Operating activities
Net income/(loss) $ (1,235) $ 1,435
Adjustments to reconcile net income/(loss)
to net cash provided by operating activities:
Depreciation of premises and equipment 194 180
Amortization of goodwill 119 88
Provision for loan losses 1,364 17
Provision for losses on real estate owned (85) (128)
Loss on sale of securities 2
Loss on sale of real estate owned 168 178
(Gain) on sale of loans (4,396) (9,754)
Proceeds from sale and prepayments of loans 87,379 133,367
Originations - Loans held for sale (50,760) (116,256)
Changes in assets and liabilities:
Loan sale receivable (344)
(5,756)
Other assets 680 (393)
Accrued and other liabilities 767 (1,732)
Income tax payable (775) (342)
Deferred tax asset 2,272 541
Loan proceeds payable (2,062) -
-------------- -------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 33,288 1,445
Cash flows from investing activities:
Purchase of securities (125) -
Sales of ARM fund shares 3,500 -
Purchase of premises and equipment (742) (390)
Sales of premises and equipment 1,270 13
Sales of real estate owned 730 1,181
Real estate owned capital improvements (227) (67)
Recoveries on loans charged off 4 23
Purchases of ARM fund shares (3,539) (51)
Purchases of FHLB stock (146) (96)
-------------- -------------
NET CASH PROVIDED BY INVESTING ACTIVITIES 725 613
APPROVED FINANCIAL CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
FOR THE THREE MONTHS ENDED MARCH 31, 1999, AND 1998
(IN THOUSANDS)
(Unaudited)
1999 1998
-------------- -------------
Cash flows from financing activities:
Borrowings - warehouse $ 56,043 $ 98,257
Repayments of borrowings - warehouse (90,005) (100,952)
Proceeds from FHLB advances - 380
Principal payments on mortgages payable (849) (20)
Net increase (decrease) in:
Notes payable 19 (73)
Certificates of indebtedness 10 (83)
Certificates of deposit 1,294 799
-------------- -------------
NET CASH USED BY FINANCING ACTIVITIES (33,488) (1,692)
-------------- -------------
NET INCREASE IN CASH 525 366
CASH AT BEGINNING OF PERIOD 6,269 11,869
-------------- -------------
CASH AT END OF PERIOD $ 6,794 $ 12,235
============== =============
Supplemental cash flow information:
Cash paid for interest $ 1,796 $ 1,553
Cash paid for income taxes - 834
Supplemental non-cash information:
Loan balances transferred to real estate owned $ 260 $ 736
Exchange of stock for acquisition of Armada
Residential
Mortgage LLC - 677
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE CONSOLIDATED FINANCIAL
STATEMENTS.
APPROVED FINANCIAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE MONTHS ENDED MARCH 31, 1999, AND 1998
NOTE 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
ORGANIZATION: Approved Financial Corp., a Virginia corporation ("Approved"), and
its subsidiaries (collectively, the "Company") operate in a single operating
segment in the consumer finance business of originating, servicing and selling
home equity loans secured primarily by first and second liens on one-to-four
family residential properties. Approved has three wholly-owned subsidiaries,
Approved Residential Mortgage, Inc. ("ARMI") which had broker operations in five
states and five retail locations at March 31, 1999, Approved Federal Savings
Bank (the "Savings Bank") which is a federally chartered thrift institution that
had broker operations in six states and ten retail offices and MOFC d/b/a
ConsumerOne Financial ("ConsumerOne"), which had one retail office in Michigan
on March 31, 1999. 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 for the year ended December 31, 1998.
NOTE 3. NEW ACCOUNTING PRONOUNCEMENTS:
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 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. 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. SALE OF BUILDING:
The Company sold the administrative and executive office building located at
3386 Holland Road, Virginia Beach, Virginia. The sales price was $1,081,250
which resulted in a break even transaction for the Company. The Company had a
mortgage note payable on this property in the amount of $751,674 at the time of
sale. The closing date for this transaction was March 26, 1999. The Company also
entered into a lease agreement with the purchaser to lease back 15,574 square
feet of the premises for an initial term commencing from the closing date to
September 30, 1999, with the option to renew the lease for three additional one
month terms. The lease payment will be $15,000 per month.
NOTE 5. PURCHASE OF LAND:
The Company purchased 7.77 acres of land for a new administrative and executive
office building from the City of Virginia Beach Development Authority on March
11, 1999. The purchase price of the land was approximately $642,000.
APPROVED FINANCIAL CORP.
CONSOLIDATING BALANCE SHEET
MARCH 31, 1999
($ IN THOUSANDS)
MOFC,
APPROVED INC.
APPROVED APPROVED FEDERAL D/B/A
ASSETS FINANCIAL RESIDENTIAL SAVINGS GLOBAL CONSUMER ONE
CONSOLIDATED ELIMINATIONS CORP. MORTGAGE BANK TITLE FINANCIAL
----------- ---------- ---------- ---------- --------- -------- -----------
Cash $ 6,794 $ 5,812 $ 563 342 $ 45 $ 32
Mortgage loans held 71,127 3,469 30,044 33,106 - 4,508
for sale, net
Real estate owned, net 1,448 334 1,114 - - -
Investments 3,725 (9,397) 9,555 - 3,567 - -
Income taxes 2,798 (4,741) 7,539 - - - -
receivable
Deferred tax asset 1,080 (1,166) - 2,246 - - -
Premises and 4,857 3,074 851 204 - 728
equipment, net
Goodwill, net 4,436 1,219 - 113 - 3,104
Due from affiliates - (2,723) 1,716 (239) 587 - 658
Other Assets 3,803 1,332 1,290 641 11 529
-------- ---------- ---------- --------- -------- -------- ---------
Total Assets $ 100,068 $ (18,027) $ 34,050 $ 35,869 $ 38,560 $ 56 $ 9,559
======== ========== ========== ========= ======== ======== =========
LIABILITIES AND EQUITY
Liabilities:
Revolving warehouse $ 38,584 $ 5,386 $ 28,087 $ - - $ 5,111
loan
Deferred tax liability - (1,166) 1,149 - 17 - -
Mortgage payable 361 361 - - - -
Notes payable-related 3,647 3,647 - - - -
parties
Certificates of 2,424 2,424 - - - -
indebtedness
Certificates of 31,022 - - 31,022 - -
deposits
Loan proceeds payable 1,813 - 504 1,309 - -
Due to affiliates - (2,721) 317 6 833 3 1,562
Accrued and other 4,218 2,767 558 130 18 745
liabilities
Income taxes payable - (4,741) - 4,741 - - -
-------- ---------- ---------- --------- -------- -------- ---------
Total Liabilities 82,069 (8,629) 16,051 33,896 33,311 21 7,418
-------- ---------- ---------- --------- -------- -------- ---------
Shareholder's equity:
Preferred stock-series A 1 1 - - - -
Common stock 5,482 (299) 5,482 250 32 16 1
Unrealized gain on (3) 15 (3) - (15) - -
securities
Additional paid in 552 (6,837) 552 491 3,056 - 3,290
capital
Retained earnings 11,967 (2,277) 11,967 1,232 2,176 19 (1,150)
-------- ----------- ---------- --------- -------- -------- ---------
Total Equity 17,999 (9,398) 17,999 1,973 5,249 35 2,141
-------- ----------- ---------- --------- -------- -------- ---------
Total liabilities
and equity $ 100,068 $ (18,027) $ 34,050 $ 35,869 $ 38,560 $ 56 $ 9,559
========= =========== ========== ========= ======== ======== =========
APPROVED FINANCIAL CORP.
CONSOLIDATING STATEMENT OF INCOME/(LOSS)
FOR THE THREE MONTHS ENDING MARCH 31, 1999
($ IN THOUSANDS)
MOFC,
APPROVED INC.
APPROVED APPROVED FEDERAL D/B/A
FINANCIAL RESIDENTIAL SAVINGS GLOBAL CONSUMER ONE
CONSOLIDATED ELIMINATIONS CORP. MORTGAGE BANK TITLE FINANCIAL
------------ ----------- ---------- ---------- --------- --------- ---------
REVENUE:
Gain on sale of loans $ 4,397 $ 372 $ 3,028 $ 570 $ - $ 427
Interest income 2,696 252 1,390 902 - 152
Other fees and income 2,290 (27) 1,560 424 12 321
------------ ----------- ---------- ---------- --------- --------- ---------
9,382 - 597 5,978 1,896 12 900
EXPENSES:
Compensation and $ 4,830 1,267 2,551 $ 635 - 377
related
General and 2,868 904 1,148 378 3 435
administrative
Loan production 555 (2) 361 127 - 69
expense
Interest expense 1,683 281 910 435 - 57
Provision for
loan/REO losses 1,279 (423) 1,680 30 - (8)
------------ ------------ ---------- ---------- --------- --------- ---------
11,216 2,027 6,650 1,606 3 930
Income before income taxes (1,833) - (1,430) (672) 290 9 (30)
Provision for income taxes (598) (711) - 110 3 -
----------- ------------- ---------- ---------- --------- --------- ---------
Net Income/(Loss) $ (1,235) - $ (719) $ (672) $ 180 $ 6 $ (30)
=========== ============= =========== ========== ========= ========= =========
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 month periods ended March 31, 1999 and 1998 and its consolidated
financial position at March 31, 1999 and December 31, 1998. 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 loans, competitive forces, limits on available funds, loan
delinquency, default on loss rates, general economic environment, market forces
affecting the price of the Company's common stock, and other risks as disclosed
in the Company's filing on Form 10K for the year ended December 31, 1998. This
discussion should be reviewed in conjunction with the consolidated financial
statements and accompanying notes and other statistical information presented in
the Company's 1998 audited financial statements.
RESULTS OF OPERATIONS FOR THE THREE MONTH PERIOD ENDED MARCH 31, 1999 COMPARED
TO THE THREE MONTH PERIOD ENDED MARCH 31, 1998.
NET INCOME
The Company's net loss for three month period ended March 31, 1999 was ($1.2)
million compared to net income of $1.4 million for the three month period ended
March 31, 1998. On a per share basis (diluted), income (loss) for the three
months ended March 31, 1999 was $(0.23) compared to $0.26 for three months ended
March 31, 1998.
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 months ended March 31, 1999
and 1998. The table includes $46.5 million of loans generated by the Company's
retail division that were funded through other lenders ("Brokered Loans") during
the first quarter of 1999 and $15.5 million for the same period in 1998.
Three Months Three Months
Ended Ended
(dollars in millions) March 31, 1999 March 31, 1998
----------------- ------------------
Dollar Volume of Loans Originated:
Broker $ 27.5 $ 49.3
Retail - funded through other lenders 46.5 15.5
Retail - funded in-house 23.2 59.5
----------------- ------------------
Total $ 97.2 $ 124.3
================= ==================
Number of Loans Originated:
Broker 429 905
Retail - funded through other lenders 545 156
Retail - funded in-house 356 1,122
----------------- ------------------
Total 1,330 2,183
================= ==================
The decrease of 21.8% in dollar volume of loans, originated during the three
months ended March 31, 1999, compared to the same period in 1998 was due
primarily to increased competition in the non-conforming mortgage industry.
Loans originated through the Company's retail offices, decreased 7.1% to $69.7
million, compared to $75.0 million during the same period in 1998. The decrease
was primarily the result of a net decrease of four retail loan origination
centers during the three months ended March 31, 1999 as compared to the same
period in 1998.
The volume of loans originated through referrals from the Company's network of
mortgage brokers decreased 44.2% to $27.5 million for the three months ended
March 31, 1999, compared to $49.3 million for the three months March 31, 1998.
Contributing to this decrease in volume from broker referrals is the refinance
boom for conforming mortgages created by the low interest rate environment and
increased competition in the non-conforming mortgage industry.
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 $81.8 million for the three months ended March 31, 1999,
compared to $114.6 million for the same period in 1998. The decrease was caused
primarily by the decrease in loan origination volume. Also, loan sales were
lower than anticipated. While the Company has an inventory of loans held for
sale, the recent imbalance in the supply and demand for whole loan sales of
mortgage loans produced an adverse pricing environment for whole loan sales. In
the opinion of management, it was not prudent to sell certain loans during the
first quarter at prices that they thought did not reasonably reflect the value
of certain loans.
Gain on the sale of loans was $4.4 million for the three months ended March 31,
1999, which compares with $9.8 million for the same period in 1998. The decrease
for the three months ended March 31, 1999, was the direct result of a decrease
in the weighted-average premium paid by investors for the Company's loans and a
lower volume of loans sold. Gain on the sale of mortgage loans represented 46.9%
of total revenue during the three months ended March 31, 1999, compared to 70.5%
of total revenue for the same period in 1998.
The weighted-average premium realized by the Company on its loan sales decreased
to 3.19%, during the three months ended March 31, 1999, from 6.16% for the same
period in 1998. The decrease in premium percentage was caused by material
changes in the secondary market conditions for non-conforming mortgage loans.
The Company has never used securitization as a loan sale strategy. However, the
whole-loan sale marketplace was impacted by changes that affected companies who
previously used securitizations to sell loans. Excessive competition during 1997
and 1998 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. The increased prepayment
speeds experienced in the industry were greater than the assumptions previously
used by many securitization issuers and led to an impairment of Asset values for
several companies in the industry. Additionally, in September 1998, 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 reported material losses, experienced reductions in liquidity sources
and diverted to whole loan sale strategies in order to generate cash. This shift
caused excess supply in the whole-loan marketplace, which led to lower premiums
on whole-loan sales.
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 a lower interest rate market. 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 months ended March 31, 1999
was $1.9 million, compared to $3.0 million in the three months March 31, 1998.
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 retail loan sales
during the three months ended March 31, 1999 comprised 51.6% of total loan
sales, with average loan origination fee income earned of 4.5%. For the same
period in 1998, the Company's retail loan sales were 58.4% of total loan sales
with average origination fee income earned of 4.5%. Fees associated with selling
loans were approximately 20 and 25 basis points of the dollar volume of loans
sold for the three months ended March 31, 1999 and 1998, respectively.
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
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. The remaining
balance of expenses associated with fees paid to brokers are 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 Savings Bank's deposit accounts and other borrowings.
Interest income for the three months ended March 31, 1999 was $2.7 million
compared with $2.6 million for the same period ended in 1998. The increase in
interest income for the three months ended March 31, 1999 was primarily due to a
larger average balance of loans held for sale.
Interest expense for the three months ended March 31, 1999 was $1.7 million
compared with $1.5 million for the three months ended March 31, 1998. The
increase in interest expense for the three months ended March 31, 1999, 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 rates paid by the
Company during the three months ended March 31, 1999 and 1998. 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) March 31, 1999 March 31, 1998
------------------------------------ -----------------------------------
Average Average Average Average
Balance Interest Yield/Rate Balance Interest Yield/Rate
---------- -------- ----------- --------- -------- ----------
Interest-earning assets:
Loans receivable (1) $ 96,006 $ 2,585 10.77% $ 79,378 $2,487 12.53%
Cash and other interest-
Earning assets 9,758 111 4.55 7,612 115 6.04
---------- -------- ----------- -------- ---------- ---------
105,764 2,696 10.20 86,990 2,602 11.96
-------- ----------- -------- ----------
Non-interest-earning assets:
Allowance for loan losses (2,839) (1,629)
Investment in IMC 162 12,012
Premises and equipment, net 5,626 4,636
Other 14,021 17,926
---------- ---------
Total assets $ 122,734 $119,935
========== =========
Interest-bearing liabilities:
Revolving warehouse lines $ 60,617 1,065 7.03 $ 54,350 1,003 7.38
FDIC - insured deposits 30,926 434 5.61 18,979 285 6.00
Other interest-bearing 7,692 184 9.57 11,270 260 9.23
Liabilities ---------- -------- ---------- --------- --------- ----------
99,235 1,683 6.78 84,599 1,548 7.31
-------- ---------- --------- ----------
Non-interest-bearing liabilities 4,971 8,963
---------- ---------
Total liabilities 104,206 93,562
Shareholders' equity 18,528 26,373
---------- ---------
Total liabilities and equity $ 122,734 $119,935
========== =========
Average dollar difference between $ 6,529 $ 2,391
Interest-earning assets and
interest-
Bearing liabilities
========== =========
Net interest income $ $
$1,013 $1,054
======== ========
Interest rate spread (2) 3.42% 4.65%
=========== ==========
Net annualized yield on average 3.83% 4.85%
Interest-earning assets
=========== ==========
(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.
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 three months ended March 31, 1999,
compared to the three months ended March 31, 1998, and for the three months
ended March 31, 1998, compared to the three months ended March 31, 1997. 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 $41,000 in net interest income for the three months ended March 31, 1999
compared to the three months ended March 31, 1998 was primarily the result of a
decrease in the average yield on interest-earning assets.
($ IN THOUSANDS)
1999 Versus 1998 1998 Versus 1997
Increase (Decrease) due to: Increase (Decrease) due to:
Volume Rate Total Volume Rate Total
---------- --------- --------- --------- -------- ---------
Interest-earning assets:
Loans receivable $ 298 $(200) $ 98 $ 504 $ 74 $ 578
Cash and other interest-
earning assets (32) 28 (4) 67 7 74
---------- --------- --------- --------- -------- ---------
266 (172) 94 571 81 652
---------- --------- --------- --------- -------- ---------
Interest-bearing
liabilities:
Revolving warehouse lines 106 (44) 62 26 (102) (76)
FDIC-insured deposits 166 (17) 149 259 2 261
Other interest-
Bearing liabilities (86) 10 (76) (7) 33 26
---------- --------- --------- --------- -------- ---------
186 (51) 135 278 (67) 211
---------- --------- --------- --------- -------- ---------
Net interest income $ 80 $(121) $(41) 293 148 441
(expense)
========== ========= ========= ========= ======== =========
OTHER INCOME
In addition to net interest income (expense), 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. Also, 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 are
classified as other income. Other income for the three months ended March 31,
1999 was $2.3 million compared with $1.5 million for the same period ended in
1998. The increase in other income for the three months ended March 31, 1999 was
primarily due to an increase in brokered loan fee income. Brokered Loan fees
were $1.8 million for the three months ended March 31, 1999, compared to $0.7
million for the three months ended March 31, 1998.
COMPREHENSIVE INCOME
The Company has other comprehensive income (loss) in the form of unrealized
holding gains (losses) on securities held for sale. For the three months ended
March 31, 1999, other comprehensive loss was $0.03 million compared to other
comprehensive income of $1.1 million for the three months ended March 31, 1998.
The loss for the three months ended March 31, 1999 was related to a decrease in
the market price of IMC Mortgage Company common stock. The gain for the three
months ended March 31, 1998, was related to an increase in the market price of
IMC Mortgage Company common stock. The Company owned 435,634 shares of IMC
Mortgage Company common stock on March 31, 1999.
COMPENSATION AND RELATED EXPENSES
The largest component of expenses is compensation and related benefits expense,
which decreased by $1.2 million to $4.8 million for the three month period ended
March 31, 1999 compared to the same period in 1998. The 20% decrease was
directly attributable to a decrease in the number of employees. During the three
months ended March 31, 1999 the company had 441 full time equivalent employees
compared to 605 full time equivalent employees during the three month period
ended March 31, 1998. The reduction in employees was part of the Company's cost
reduction initiative.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses for the three months ended March 31, 1999
decreased by $0.1 million to $2.9 million, compared to the three month period
ended March 31, 1998. This decrease is attributed to the reduction of retail
lending offices during the three months ended March 31, 1999. For the three
months ended March 31, 1999 the Company had 16 full service retail branches
opened for three months and another 7 full services branches which were closed
in February 1999. For the three months ended March 31, 1998, the Company had 20
full service retail branches opened for three months and another two full
service offices that opened in February 1998.
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.
Average fees paid to mortgage brokers declined to .49% during the first quarter
of 1999 compared to .93% for the same period in 1998. Other items that comprise
loan production expenses are appraisals, credit reports, leads research and
telemarketing expenses. Loan production expenses for the three months ended
March 31, 1999 were $0.6 million compared to $0.9 million for the three months
ended March 31, 1998. The decrease was primarily the result of a decrease in
services rendered fees paid to mortgage brokers.
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 three months ended March 31,1999 and
the year ended December 31, 1998:
(IN THOUSANDS)
1999 1998
---------------- --------------
Balance at beginning of year $ 2,590 $ 1,687
Provision charged to expense 1,364 3,064
Acquisition of MOFC, Inc. 0 49
Loans charged off (315) (2,372)
Recoveries of loans previously charged off 4 162
---------------- --------------
Balance at end of period $ 3,643 $ 2,590
================ ==============
Loans receivable at period-end, gross
of allowance for losses $ 74,769 $ 107,634
Ratio of allowance for loan losses to gross
loans receivable at period-end 4.87% 2.41%
The Company added $1.4 million during the three months ended March 31, 1999 to
the allowance for loan losses, compared to $0.02 million for the three months
ended March 31, 1998. The increase was primarily the result of the composition
of loans held for sale and the recent secondary market environment for whole
loan sales. 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 current characteristics of the 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
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 provision for foreclosed property losses decreased by $85,000 for the three
months ended March 31, 1999, compared to a decrease of $127,000 for the three
months ended March 31, 1998.
Sales of real estate owned yielded net losses of $168,000 for the three months
ended March 31, 1999 versus $178,000 for the three months ended March 31, 1998.
The following table presents the activity in the Company's allowance for
foreclosed property losses and selected real estate owned data for the three
months ended March 31, 1999 and the year ended December 31, 1998:
(IN THOUSANDS)
Three Months Year Ended
Ended December 31,
March 31,1999 1998
---------------- --------------
Balance at beginning of year $ 503 $ 671
Provision (reducing) expense (85) (168)
---------------- --------------
Balance at end of period $ 418 $ 503
================ ==============
Real estate owned at period-end, gross
of allowance for losses $ 1,867 $ 2,211
Ratio of allowance for foreclosed property losses
to gross real estate owned at period-end 22.39% 22.75%
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
decrease in the provision for foreclosed property losses relates to a decrease
in the dollar amount of outstanding REO at March 31, 1999 when compared to March
31, 1998. While the Company's management believes that its present allowance for
foreclosed property losses is adequate, future adjustments may be necessary.
FINANCIAL CONDITION AT MARCH 31, 1999 AND DECEMBER 31, 1998
ASSETS
The total assets of the Company were $100.1 million at March 31, 1999, compared
to total assets of $136.1 million at December 31, 1998. The decrease was
primarily due to a decrease in net mortgage loans receivable.
Cash and cash equivalents increased by $.5 million to $6.8 million at March 31,
1999, from $6.3 million at December 31, 1998. The principal reason for the
increase for the period ending March 31, 1999 was the receipt of proceeds from
loan sales in the final week of March 1999. These proceeds were used to fund new
loans in the first week of April 1999.
Net mortgage loans receivable decreased by $33.9 million to $71.1 million at
March 31, 1999. The 32.3% decrease in 1999 is primarily due to the Company
selling more loans than were originated in-house during the first quarter of
1999.
Real estate owned ("REO") decreased by $0.3 million to $1.4 million at March 31,
1999. The 15.2% decrease in REO resulted from the sale of $0.9 million in REO
properties an addition of $0.6 million to REO during the three months ended
March 31, 1999.
Investments consist primarily of an Adjustable Rate Mortgage Fund and FHLB stock
owned by the Savings Bank. The increase in investments was primarily due to the
purchase of additional FHLB stock during the three months ending March 31, 1999.
Premises and equipment decreased by $0.7 million to $4.9 million at March 31,
1999. The primary reason for the 1999 decrease was the sale of one of the
Company's headquarters buildings for $1.1 million. This decrease was offset by
the $0.6 million acquisition of 7.77 acres of land that is designated for the
Company's new administrative and executive headquarters.
Goodwill (net) decreased by $0.1 million to $4.4 million at March 31, 1999. The
1999 decrease is due to amortization of the intangible asset.
The income tax receivable increased by $0.8 million to $2.8 million at March 31,
1999. The 38.3% increase can be attributed to the Company's before tax net loss
of $1.8 million for the first quarter 1999.
The deferred tax asset decreased by $2.3 million to $1.1 million at March 31,
1999. The change was the result of a combination of a reduction of the state tax
rate from 8.75% in 1998 to 7.00% in 1999 and the elimination of unearned loan
fees (FAS 91) as a timing difference in the calculation of the Company's tax
provision.
Other assets decreased by $0.3 million to $3.8 million at March 31, 1999. Other
assets consist of accrued interest receivable, prepaid assets, broker fees
receivable, deposits, and various other assets. The decrease was primarily the
result of a decrease in accrued interest receivable of $0.3 million, which was
due to a lower average balance of loans held for sale.
LIABILITIES
Outstanding balances for the Company's revolving warehouse lines of credit
decreased by $34.0 million to $38.6 million at March 31, 1999. The 46.8%
decrease in 1999 was primarily attributable to the decrease in loans receivable.
The Company draws on its revolving warehouse lines of credit as needed to fund
loan production. As of March 31, 1999, the Company had issued loan funding
checks totaling $1.3 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 April 1999 and most were funded with cash on hand or new warehouse line
draws.
The Savings Bank's deposits totaled $31.0 million at March 31, 1999, compared to
$29.7 million at December 31, 1998. The Savings Bank increased its deposits in
the first quarter 1999 in order to fund loans. Of the certificate accounts as of
March 31, 1999, a total of $15.3 million was scheduled to mature in the
twelve-month period ending March 31, 2000.
Promissory notes and certificates of indebtedness totaled $6.1 million at March
31, 1999, compared to $6.0 million at December 31, 1998. 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. 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 9.49%
at March 31, 1999. Certificates of indebtedness are uninsured deposits
authorized for financial institutions chartered as a Virginia industrial loan
association. 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
9.46% at March 31, 1999. The promissory notes and certificates of indebtedness
with terms exceeding twelve months as of March 31, 1999 totaled $5.2 million.
Mortgage loans payable decreased by $.8 million to $.3 million at March 31,
1999. The decline is due to the sale of one of the Company's headquarters
buildings which the Company was carrying a mortgage note payable of $.8 million.
Accrued and other liabilities decreased by $0.5 million to $4.2 million at March
31, 1999. This category includes accounts payable, accrued interest payable,
deferred income, accrued bonuses, and other payables. The decrease in the first
quarter 1999 is primarily attributable to payment of year end accrued payables.
SHAREHOLDERS' EQUITY
Total shareholders' equity at March 31, 1999 was $18.0 million compared to $19.3
million at December 31, 1998. The $1.3 million decrease in the first quarter
1999 was due to the $1.3 million loss for the first quarter of 1999.
LIQUIDITY AND CAPITAL RESOURCES
The Company's operations require access to short- and long-term sources of cash.
The Company uses cash flow 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 has historically operated, and expects
to operate in the future on a negative cash flow basis from operations due to
the fact that originations normally exceed loan sales. For the three months
ended March 31, 1999 and 1998, the Company was provided cash from operating
activities of $33.2 million and $1.4 million, respectively. The net cash used
from operating activities was 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 three
months ended March 31, 1999 and 1998, the Company used cash from financing
activities of $33.5 million and $1.7 million, respectively.
The Company's borrowings (revolving warehouse loans, FDIC-insured deposits,
mortgage loans on Company office buildings, FHLB advances, subordinated debt and
loan proceeds payable) at March 31, 1999 were 77.8%, compared to 82.3% of assets
at December 31, 1998.
WAREHOUSE AND OTHER CREDIT FACILITIES
On December 10, 1997, the Company obtained a $100.0 million warehouse line of
credit from a commercial bank syndicate. The syndicate's lead bank is 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
March 31, 1999, $26.8 million was outstanding under this facility.
Also on December 10, 1997, the Company obtained a $25.0 million seasoned loan
line of credit from certain members of the 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. There is not a time limit as to the number of days from
origination for the loans pledged to secure this line of credit. As of March 31,
1999, $11.8 million was outstanding under this facility.
WHOLE LOAN SALE PROGRAM
The Company's most important capital resource for generating cash to fund new
loans and for making payments on its warehouse facilities has been its ability
to sell its loans in the secondary market. The market value of the Company's
loans is dependent on a number of factors, including loan delinquency rates, the
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, general economic and market conditions, market interest
rates 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.
OTHER CAPITAL RESOURCES
The Savings Bank's deposits totaled $31.0 million at March 31, 1999, compared to
$29.7 million at December 31, 1998. 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.
The Company has utilized promissory notes and certificates of indebtedness to
help funds its operations. Promissory notes and certificates of indebtedness
totaled $6.1 million at March 31, 1999, compared to $6.0 million at December 31,
1998. These borrowings are subordinated to the Company's warehouse lines of
credit.
The Company had cash and cash equivalents of $6.8 million at March 31, 1999. The
Company has sufficient cash resources to fund its operations at current levels.
New debt financing, equity financing, and lines of credit will be evaluated with
consideration for maximizing shareholder value. Management expects that the
Company and the industry will be challenged by continued competition and rising
delinquencies.
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 OTS require
thrift associations and/or savings banks to maintain liquid assets at certain
levels. At present, the required ratio of liquid assets to savings and
borrowings, which can be withdrawn and are due in one year or less is 4.0%.
Penalties are assessed for noncompliance. In 1998 and in the first quarter of
1999, 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 March 31, 1999, the Savings Bank's book value under generally accepted
accounting principles ("GAAP") was $5.2 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 March 31, 1999, 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 $ 5,249 $ 5,249 $ 5,249
Add: unrealized loss on securities 9 9 9
Nonallowable asset: goodwill (113) (113) (113)
Additional capital item: general allowance - - 306
----------------- ---------------- --------------
Regulatory capital - computed 5,145 5,145 5,451
Minimum capital requirement 577 1,539 2,352
----------------- ---------------- --------------
Excess regulatory capital $ 4,568 $ 3,606 $ 3,099
================= ================ ==============
Ratios:
Regulatory capital - computed 13.37% 13.37% 17.50%
Minimum capital requirement 1.50 4.00 8.00
================= ================ ==============
Excess regulatory capital 11.87% 9.37% 9.50%
================= ================ ==============
Management believes that the Savings 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 the section concerning Gain on Sale of loans on page 11 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. 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 similar to short sales of U.S. Treasury securities.
Prior to entering into a hedge transaction, the Company performs an analysis of
its loans, taking into account such factors as interest rates and maturities, to
determine the proportion of contracts to sell so that the risk value of the
loans will be most effectively hedged. The Company had no hedge contracts
outstanding at March 31, 1999.
If the value of a hedge decreases, 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 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.
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.
The Company intends to sell a significant portion of the loans it originates
therefore, inflation and interest rates should have a diminishing effect on the
Company's results of operations. However, 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 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 portfolio by increasing the level
of loan prepayments and it therefore 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, to the
extent servicing rights and interest-only and residual assets are capitalized on
the Company's books in the future from 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 assets, if created in the future which
could have a favorable effect on the Company's results of operations and
financial condition.
YEAR 2000 ISSUES
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, similar to other financial service institutions, is sensitive and
subject to the potential impact of the Year 2000 issue.
Approved 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 on schedule, with expected
completion by the end of third quarter 1999.
PROJECT. The Approved 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 of
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 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.
The Company contracted for a new Human Resource and Payroll system, which is
certified by the vendor as being Year 2000 compliant. Installation of these
systems occurred in the fourth quarter 1998. 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, which was substantially complete as
of December 31, 1998.
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
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 to being Year 2000 compliant. Certified compliant
systems include mortgage loan origination and processing, closing, servicing,
secondary marketing, and account systems. All named systems are installed at
current release levels.
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 has met the FFIEC milestone of having "internal
testing of mission-critical systems substantially complete" by the end of the
first quarter 1999.
Although the critical systems are expected to be compliant well before December
31, 1999, the Company is developing a contingency plan to address the possible
failure of critical systems. This plan will address the Company's strategy in
dealing with an unlikely event such as a system not performing as expected, or
if there is non-compliance by a major third party provider. The Company expects
to complete its contingency plan by the end of the third quarter of 1999.
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.
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 position.
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
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 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 strategies in an attempt to limit its exposure to interest
rate risk in addition to generating cash revenues. The Company sold, during 1998
and the first three months in 1999, approximately 90.4% of the total loans
originated and funded in-house during the year ended December 31,1998. Also, the
Company sold, during the first three months in 1999, approximately 85% of loans
originated and funded in-house during January and February 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.
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 March 31, 1999, 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 20.92% of total assets at March 31,
1999, 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) $ 74,769 $ 23,681 $ 1,046 $ 2,504 $ 47,538
Cash and other
Interest-earning assets 10,326 10,326
----------- ---------- ---------- ----------- -----------
Interest-earning assets 85,095 34,007 1,046 2,504 47,538
Allowance for loan losses (3,643)
Investment in IMC 68
Premises and equipment, net 4,857
Other 13,691
-----------
Total assets $ 100,068
===========
Interest-bearing liabilities:
Revolving warehouse lines $38,584 38,584
FDIC - insured deposits 31,022 15,259 8,536 4,852 2,375
Other interest-bearing
Liabilities 6,910 1,101 1,898 2,613 1,298
----------- ---------- ---------- ----------- -----------
76,516 54,944 10,434 7,465 3,673
========== ========== =========== ===========
Non-interest-bearing liabilities 5,553
Total liabilities 82,069
Shareholders' equity 17,999
-----------
Total liabilities and equity $ 100,068
===========
Maturity/repricing gap $ (20,937) $ (9,388) $(4,961) $43,865
========= ========== =========== ===========
Cumulative gap $ (20,937) (30,325) $(35,286) $ 8,579
========== ========== =========== ===========
As percent of total assets (20.92)% (30.30)% (35.26)% 8.57%
========== ========== =========== ===========
Ratio of cumulative interest earning
Assets to cumulative interest earning
Liabilities .62x .54x .52x 1.11x
========== ========== =========== ===========
(1) Loans shown gross of allowance for loan losses, net of premiums/discounts.
INTEREST RATE RISK
The principal quantitative disclosure of the Company's market risks are the gap
table on page 26. The gap table shows that the Company's one-year gap was a
negative 20.9% of total assets at March 31, 1999. 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 March 31, 1999, 63.6% 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, 71.8%
of which reprice within one year of March 31, 1999. 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 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 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 product 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 March
31, 1999 and December 31, 1998:
(IN THOUSANDS)
March 31, December 31,
1999 1998
-------------- -------------
Delinquent 31 to 60 days $ 1,705 $ 697
Delinquent 61 to 90 days 994 1,115
Delinquent 91 to 120 days 370 1,460
Delinquent 121 days or more 3,145 2,658
-------------- -------------
Total delinquent loans (1) $ 6,214 $ 5,930
============== =============
Total loans receivable outstanding, gross of the
allowance for loan losses (1) $ 75,972 $ 109,500
============== =============
Delinquent loans as a percentage of total loans
outstanding:
Delinquent 31 to 60 days 2.24% .64%
Delinquent 61 to 90 days 1.31 1.02
Delinquent 91 to 120 days .49 1.33
Delinquent 121 days or more 4.14 2.43
-------------- -------------
Total delinquent loans as a percentage
of total loans outstanding 8.18% 5.42%
============== =============
- -------------
(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 Savings Bank is accrued until the
loans become 90 days or more past due. Nonaccrual loans were $6.2 million and
$5.9 million at March 31, 1999 and December 31, 1998, respectively. The amount
of additional interest that would have been recorded had the loans not been
placed on non-accrual status was approximately $343,000 and $212,000 for the
three months ended March 31, 1999 and for the year ended December 31, 1998,
respectively. The amount of interest income on the nonaccrual loans, that was
included in net income for the three months ended March 31, 1999 was $26,000.
The data for interest income on nonaccrual loans, that was included in net
income for the three months ended March 31, 1998 was not available.
Loans delinquent 31 days or more as a percentage of total loans outstanding
increased to 8.18% at March 31, 1999 from 5.42% at December 31, 1998. The
increase was primarily a result of an increase in the dollar amount of loans
delinquent 31-60 days and a decrease in the dollar amount of total loans
outstanding. The dollar amount of total loans outstanding decreased because the
amount of loans sold or prepaid was greater than the amount of loans originated
during the three month period ended March 31, 1999.
At March 31, 1999 and December 31, 1998 the recorded investment in loans for
which impairment has been determined in accordance with SFAS 114 totaled $3.5
million and $4.1 million, respectively. The average recorded investment in
impaired loans for the three months ended March 31, 1999 and the year ended
December 31, 1998 was approximately $4.3 million and $2.6 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 March 31, 1999.
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