UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period ended July 31, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For transition period from __________ to __________
Commission File Number 001-14127
UNITED FINANCIAL MORTGAGE CORP.
------------------------------------------------------
(Exact name of Registrant as specified in its charter)
Illinois 36-3440533
------------------------------- ------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
815 Commerce Drive, Suite 100
Oak Brook, Illinois 60523
---------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number including area code: (630) 571-7222
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 was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes X No .
Indicate by check mark whether the Registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes No X .
Indicate the number of shares outstanding of each of the Issuer's class
of common stock as of the latest practicable date.
20,000,000 shares of Common Stock, no par value, were authorized, and
5,965,143 shares of Common Stock were issued and outstanding, as of
September 13, 2004.
UNITED FINANCIAL MORTGAGE CORP.
Form 10-Q Quarterly Report
Table of Contents
PART I
Page
Number
------
Item 1. Financial Statements 4
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 16
Item 3. Quantitative and Qualitative Disclosures About Market Risk 20
Item 4. Controls and Procedures 21
PART II
Item 1. Legal Proceedings 22
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 22
Item 3. Defaults Upon Senior Securities 22
Item 4. Submission of Matters to a Vote of Security Holders 22
Item 5. Other Information 22
Item 6. Exhibits and Reports on Form 8-K 22
Form 10-Q Signatures 23
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This document contains, and future oral and written statements may contain,
forward-looking statements within the meaning of such term in the Private
Securities Litigation Reform Act of 1995 with respect to our business,
financial condition, results of operations, plans, objectives and future
performance. Forward-looking statements, which may be based upon beliefs,
expectations and assumptions of our management and on information currently
available to management, are generally identifiable by the use of words
such as "believe," "expect," "anticipate," "plan," "intend," "estimate,"
"may," "will," "would," "could," "should" or other similar expressions.
Additionally, all statements in this document, including forward-looking
statements, speak only as of the date they are made, and we undertake no
obligation to update any statement in light of new information or future
events. Statements regarding the following subjects are forward-looking by
their nature:
* our business strategy, including acquisitions;
* statements regarding interest rates and yield spreads;
* our understanding of our competition;
* market trends;
* assumptions regarding our mortgage servicing rights; and
* projected sources and uses of funds from operations.
These forward-looking statements are subject to various risks and
uncertainties, including those related to:
* changes in demand for mortgage loans due to fluctuations in the real
estate market, interest rates or the market in which we sell our
mortgage loans;
* our access to funding sources and our ability to renew, replace or add
to our existing credit facilities on terms comparable to the current
terms;
* assumptions underlying the value of our mortgage servicing rights;
* the negative impact of economic slowdowns or recessions;
* management's ability to manage our growth and planned expansion;
* unexpected difficulties in integrating or operating newly acquired
businesses;
* the effect of the competitive pressures from other lenders or suppliers
of credit in our market;
* changes in government regulations that affect our business;
* our ability to expand origination volume while reducing overhead; and
* the impact of new state or federal legislation or court decisions
restricting the activities of lenders or suppliers of credit in our
market;
* our inability to manage the risks associated with the foregoing as well
as anticipated.
These risks and uncertainties should be considered in evaluating forward-
looking statements and undue reliance should not be placed on such
statements. Additional information concerning our company and its business,
including other factors that could materially affect our financial results,
is included in our filings with the Securities and Exchange Commission.
PART I
ITEM 1. FINANCIAL STATEMENTS
UNITED FINANCIAL MORTGAGE CORP.
Balance Sheets
(Dollars in thousands )
July 31, April 30,
2004 2004
----------- -----------
(Unaudited)
ASSETS
Cash and due from financial institutions $ - $ 10,968
Interest-bearing deposits in financial
institutions 11,132 1,933
----------- -----------
Total cash and cash equivalents 11,132 12,901
Restricted cash 1,517 1,388
Certificates of deposit 437 434
Loans held for sale 160,247 223,634
Mortgage servicing rights, net 18,273 16,438
Premises and equipment, net 1,178 1,185
Goodwill 575 575
Prepaid expenses and other assets 2,568 2,065
----------- -----------
Total assets $ 195,927 $ 258,620
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Warehouse lines of credit $ 155,617 $ 217,519
Accrued expenses and other liabilities 9,723 11,432
----------- -----------
Total liabilities 165,340 228,951
Shareholders' equity
Preferred stock, 5,000,000 authorized, no par
value, Series A redeemable shares, 63 issued
and outstanding at July 31, 2004 and April
30, 2004 (aggregate liquidation preference
of $315) 315 315
Common stock, no par value, 20,000,000 shares
authorized, 6,140,843 shares issued at July
31, 2004 and at April 30, 2004 18,687 18,687
Retained earnings 11,907 10,989
----------- -----------
30,909 29,991
Treasury stock, 176,700 shares at July 31,
2004 and at April 30, 2004, at cost (322) (322)
----------- -----------
Total shareholders' equity 30,587 29,669
----------- -----------
Total liabilities and shareholders' equity $ 195,927 $ 258,620
=========== ===========
See accompanying notes to the unaudited financial statements.
UNITED FINANCIAL MORTGAGE CORP.
Statements of Income
(Dollars in thousands except per share data)
(Unaudited)
Three Months Ended July 31,
2004 2003
----------- -----------
Revenues
Gain on sale of loans, net $ 12,286 $ 19,819
Loan servicing income, net 783 222
Interest income 2,441 2,242
Other income 50 153
----------- -----------
Total revenues 15,560 22,436
Expenses
Salaries and commissions 9,829 15,801
Selling and administrative 3,112 2,291
Interest expense 1,011 1,270
Depreciation 77 92
----------- -----------
Total expenses 14,029 19,454
----------- -----------
Income before income taxes 1,531 2,982
Income taxes 613 1,193
----------- -----------
Net income $ 918 $ 1,789
=========== ===========
Basic earnings per common share $ .15 $ .46
=========== ===========
Diluted earnings per common share $ .15 $ .43
=========== ===========
See accompanying notes to the unaudited financial statements.
UNITED FINANCIAL MORTGAGE CORP.
Statements of Cash Flows
(Dollars in thousands)
(Unaudited)
Three Months Ended July 31,
2004 2003
----------- -----------
Cash flows from operating activities
Net income $ 918 $ 1,789
Adjustments to reconcile net income to net
cash from operating activities
Depreciation 77 92
Amortization of mortgage servicing rights 682 883
Impairment of mortgage servicing rights - (1,060)
Gain on sale of loans (12,286) (19,819)
Origination of mortgage loans held for sale (471,952) (1,018,312)
Proceeds from sale of mortgage loans held
for sale 545,108 994,058
Change in prepaid expenses and other assets (503) (135)
Change in accrued expenses and other
liabilities (1,709) 2,798
----------- -----------
Net cash from operating activities 60,335 (39,706)
Cash flows from investing activities
Acquisition of mortgage company net of
cash acquired - 154
Change in restricted cash (129) (34)
Net change in certificates of deposit (3) 2
Purchase of premises and equipment, net (70) (276)
----------- -----------
Net cash from investing activities (202) (154)
Cash flows from financing activities
Issuance of common stock - 14
Changes in warehouse lines of credit, net (61,902) 39,679
----------- -----------
Net cash from financing activities (61,902) 39,693
----------- -----------
Decrease in cash and cash equivalents (1,769) (167)
Cash and cash equivalents at beginning of period 12,901 8,709
----------- -----------
Cash and cash equivalents at end of period $ 11,132 $ 8,542
=========== ===========
See accompanying notes to the unaudited financial statements.
UNITED FINANCIAL MORTGAGE CORP.
Notes to the Unaudited Interim Financial Statements
NOTE 1 - BASIS OF PRESENTATION
United Financial Mortgage Corp. ("UFMC" or "the Company") is an Illinois
corporation organized to engage in the business of originating, selling and
servicing residential mortgages. Although the Company's mortgage banking
business has primarily focused on wholesale and retail residential mortgage
origination activities, the Company has expanded its business to include
mortgage servicing by retaining servicing rights on selected mortgage loans
that were originated by the Company. The Company's principal lines of
business are conducted in 36 states through its Wholesale Origination
Division, its Retail Origination Division and its Servicing Division. While
the Company's management monitors the revenue streams of the various
products and services, operations are managed and financial performance is
evaluated on a company-wide basis. Accordingly, all of the Company's
mortgage banking operations are considered by management to be aggregated in
one reportable operating segment. The Company is an approved mortgage loan
seller/servicer with the Federal Home Loan Mortgage Corporation and with the
Federal National Mortgage Association. In addition, the Company is an
approved mortgagee with the Government National Mortgage Association, the
Federal Housing Administration, and the Department of Veteran's Affairs.
The Company earns revenue both as an originator and as a servicer of
mortgage loans. The Company's primary source of revenue is the recognition
of gain on the sale of its mortgage loans. Additionally, it generates
revenue from origination fees and interest income earned on the mortgage
loans that the Company originates and the income it earns from servicing
mortgage loans. Expenses largely consist of: (i) commissions paid to loan
originators on closed mortgage loans; (ii) salaries and benefits paid
to employees other than loan originators; (iii) general selling and
administrative expenses such as occupancy costs and advertising costs; and
(iv) interest paid under the Company's warehouse credit facilities.
The accompanying financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America for
interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and notes required by accounting principles generally accepted
in the United States of America for complete financial statements and should
be read in conjunction with the Company's Annual Report on Form 10-KSB for
the fiscal year ended April 30, 2004. In the opinion of management, all
adjustments (consisting only of adjustments of a normal and recurring
nature) considered necessary for a fair presentation of the results of
operations have been included. Operating results for the three-month period
ended July 31, 2004 are not necessarily indicative of the results that might
be expected for the 12 months ending April 30, 2005. Unless otherwise
indicated, all dollar references are in thousands, except per share data.
Use of Estimates:
----------------
U.S. generally accepted accounting principles require management to make
estimates and assumptions in preparing financial statements that affect the
amounts reported and disclosed. These estimates and assumptions may change
in the future, and future results could differ from these estimates. Areas
involving the use of management's estimates and assumptions, which are
susceptible to change in the near term, include the valuation of loans held
for sale, mortgage servicing rights and derivatives.
Cash and Cash Equivalents:
-------------------------
Cash and cash equivalents include both non-interest-bearing and interest-
bearing deposits with other financial institutions with original maturities
of three months or less.
Restricted Cash
---------------
The Company has elected to maintain cash balances with its warehouse banks
to facilitate borrowings under the terms of its warehouse credit facilities
and the gross amount of these cash balances is presented in the financial
statements as restricted cash.
Loans Held for Sale and Related Derivatives
-------------------------------------------
Loans held for sale include deferred origination fees and costs and are
stated at the lower of cost or market value in the aggregate. The market
value of mortgage loans held for sale is based on market prices and yields
at period end in normal market outlets used by the Company.
The Company enters into derivatives that include forward contracts to
deliver loans and mortgage-backed securities. Forward contracts are used to
manage interest rate risk on loans held for sale and the pipeline of loans
in process. The loans held for sale are generally sold pursuant to forward
contracts. Under Statement of Financial Accounting Standards No. 133,
Accounting for Derivative Instruments and Hedging Activities, (SFAS 133),
forward contracts are carried at fair value, while the change in fair value
of loans held for sale will be recorded to offset the value of forward
contracts designated as effective hedges. The fair value of derivatives is
included with the balance of loans held for sale. Changes in the fair value
of derivatives and the offsetting change in fair value of hedged loans held
for sale is included in gain on sale of loans in the statements of income.
The pipeline of loans in process includes commitments to make loans at
specific interest rates (rate lock commitments). At the time of interest
rate lock commitment, no gain or loss is recognized. Subsequent changes in
fair value are recorded in earnings. Fair value is determined based on the
effect that change in market interest rates subsequent to the commitment
date have on the value of the related loan. The fair value of rate lock
commitments adjusted for estimated fallout, is included with loans held for
sale, and changes in fair value are included in the net gain on sale of
loans.
The Securities and Exchange Commission ("SEC") has issued Staff Accounting
Bulletin (SAB) No. 105, "Application of Accounting Principles to Loan
Commitments." SAB 105 states that future cash flows from servicing rights
and other internally-developed intangible assets cannot be included in the
determination of fair value of rate lock commitment derivatives. The SAB
also discusses disclosure requirements for rate lock commitment derivatives
and is required to be applied to rate lock commitments entered into
after March 31, 2004. At April 30, 2004 this SAB did not have a material
effect on the financial statements, as servicing rights and other
internally-developed intangible assets are not included in the value of the
Company's rate lock commitments.
Mortgage Servicing Rights, Net
------------------------------
The Company originates mortgage loans for sale to the secondary market and
sells the loans on either a servicing retained or servicing released basis.
Servicing rights are recognized as assets for the allocated value of
retained servicing rights on loans sold. The capitalized cost of loan
servicing rights is amortized in proportion to and over the period of
estimated net future servicing revenue. The expected period of the
estimated net servicing income is based, in part, on the expected prepayment
of the underlying mortgages.
Mortgage servicing rights are periodically evaluated for impairment.
Impairment represents the excess of amortized cost over its estimated fair
value. Impairment is evaluated based upon the fair value of the assets,
using groupings of the underlying loans as to interest rates and then,
secondarily, as to geographic, loan type and term characteristics. Fair
value is determined using prices for similar assets with similar
characteristics, when available, or based upon discounted cash flows using
market-based assumptions. Any impairment of a grouping is reported as a
valuation allowance. The impairment charges reversed during the three month
period ended July 31, 2003 was a result of this process and the change in
market values during that period.
Impact of Interest Rate Fluctuations
------------------------------------
Interest rate fluctuations generally have a direct impact on a mortgage
banking institution's financial performance. Significant increases in
interest rates may make it more difficult for potential borrowers to
purchase residential property and to qualify for mortgage loans as well
as potentially reduce the number of borrowers who may seek to refinance
their current loans. As a result, the volume and related income from loan
originations may be reduced. Significant increases in interest rates will
also generally increase the value of the Company's servicing portfolio as a
result of slower than anticipated prepayment activity.
Significant decreases in interest rates may enable more potential borrowers
to qualify for a mortgage loan, resulting in higher income related to the
loan originations. However, significant decreases in interest rates may
result in higher than anticipated loan prepayment activity and therefore
reduce the value of the loan servicing portfolio.
Income and Expense Recognition
------------------------------
The Company sells loans on both a servicing retained and servicing-released
basis. Gain or loss is recognized upon delivery of the loans to the
purchaser. The gain or loss is equal to the difference between the sales
price and the carrying amounts of the loans sold. Loan revenue is
recognized into gain on sale at the time of sale and consists of various
items including commitment fees, underwriting fees, and other charges that
the customer pays to the Company. Certain direct loan origination costs for
loans held for sale are deferred until the related loans are sold.
Salaries and commissions related to the origination of loans held for sale
and other corporate purposes are disclosed as a separate line item on the
statements of income.
Interest on loans held for sale is credited to income as earned, and
interest on warehouse lines of credit is charged to expense as incurred.
Stock-Based Compensation
------------------------
Employee compensation expense under stock options is reported using the
intrinsic value method. No stock-based compensation cost is reflected in
net income, as all options granted had an exercise price equal to or greater
than the market price of the underlying common stock at date of grant. The
following table illustrates the effect on net income for common shareholders
and earnings per share for the three months ended July 31, 2004 and 2003 if
expense were measured using the fair value recognition provisions of FASB
Statement No. 123, Accounting for Stock-Based Compensation.
2004 2003
-------- --------
Net income, as reported $ 918 $ 1,789
Deduct: Stock-based compensation expense
determined under fair value based method 37 27
-------- --------
Pro forma net income $ 881 $ 1,816
======== ========
Basic earnings per common share as reported $ .15 $ .46
Pro forma basic common earnings per share $ .14 $ .45
Diluted earnings per common share as reported $ .15 $ .43
Pro forma diluted earnings per common share $ .14 $ .43
Reclassifications
-----------------
Certain prior period amounts have been reclassified to conform to the
current presentation.
NOTE 2 - MORTGAGE LOANS SERVICED AND LOANS HELD FOR SALE
The Company sells mortgage loans to secondary market investors
("Investor(s)"). These loans can be sold in one of two ways, servicing
released or servicing retained. If a loan is sold servicing released, the
Company has sold all the rights to the loan and the associated servicing
rights. If a loan is sold servicing retained, the Company has sold the loan
and kept the servicing rights, and thus the Company is responsible for
collecting monthly principal and interest payments and performing certain
escrow services for the Investor. The Investor, in turn, pays an annual
fee for these services. The Company performs these servicing activities
through what is referred to as a sub-servicer arrangement. The sub-servicer
collects the monthly principal and interest payments and performs the escrow
services for the Investor on behalf of the Company. The Company pays the
sub-servicer a fee for these services. Servicing revenue is reported net of
sub-servicer fees. At July 31, 2004 and April 30, 2004, the Company had the
following loans held for sale.
July 31, 2004 April 30, 2004
------------- --------------
Loans held for sale $ 160,247 $ 223,634
Less: Allowance to adjust loans not
assigned to forward contracts to
lower of cost or market - -
--------- ---------
Loans held for sale, net $ 160,247 $ 223,634
========= =========
The Company's servicing portfolio for third parties was approximately $1.5
billion and $1.4 billion at July 31, 2004 and April 30, 2004, respectively.
These loans are owned by third parties and are not included in the assets
of the Company. The Company's servicing portfolio for outside parties was
as follows:
July 31, 2004 April 30, 2004
------------- --------------
Mortgage loan portfolios serviced for:
FHLMC $1,071,715 $ 989,526
FNMA 403,905 410,498
IHDA 930 933
--------- ---------
$1,476,550 $1,400,957
========= =========
The escrow funds are transferred to the sub-servicer and are not carried on
the Company's balance sheet. At July 31, 2004 and April 30, 2004, the sub-
servicer maintained escrow balances of approximately $7.7 million and
$6.5 million, respectively, for loans in our portfolio. The value of the
servicing rights is however included in the assets of the Company under the
category of mortgage servicing rights, net.
Activity related to capitalized mortgage servicing rights and the related
valuation allowance for the three months ended July 31, 2004 and the year
ended April 30, 2004 is summarized as follows:
July 31, 2004 April 30, 2004
------------- --------------
Servicing rights:
Beginning of year $ 16,438 $ 5,964
Additions 2,517 13,164
Amortized (682) (2,690)
--------- ---------
Balance at end of year $ 18,273 $ 16,438
========= =========
Valuation Allowance:
Beginning of year $ - $ (1,229)
Provision - -
Valuation Allowance Reversal - 1,229
--------- ---------
Balance at end of year $ - $ -
========= =========
The Company analyzes the mortgage servicing rights for impairment on
a quarterly basis. The provision and reversal of the impairment charges
incurred during the year ended April 30, 2004 were a result of this process.
$1,060 of this reversal is reflected in gain on sale of loans, net in the
statement of income for the three months ended July 31, 2003.
The Company receives a third party valuation of its capitalized servicing
rights portfolio on a quarterly basis. The valuation of the portfolio
reported by a contracted third party at July 31 and April 30, 2004 was
approximately $18.9 million and $18.1 million, respectively.
The following are the critical assumptions used by the third party to
estimate the fair value:
July 31, 2004 April 30, 2004
------------- --------------
Servicing cost per loan $ 46.00 $ 40.98
Weighted average discount rates 9.1% 9.8%
Weighted average prepayment rates 12.3% 13.0%
NOTE 3 - WAREHOUSE LINES OF CREDIT
The Company funds mortgage loan activity using various warehouse lines of
credit that are secured by the mortgage loans funded by the lines. On
August 1, 2003, the Company combined several of its warehouse agreements
into one syndicated facility ("the Syndication") reducing its total number
of credit lines to four. The Syndication also provides for a working
capital line of credit that is secured by the Company's mortgage loan
servicing rights. There have been no borrowings under this provision since
inception.
The table below reflects the amounts outstanding on these lines as if the
Syndication was in place for all periods presented. As it has historically,
the Company expects to renew or extend its expiring credit facilities at
levels appropriate for then current operations.
July 31, April 30,
2004 2004
-------- --------
$110 million mortgage warehouse syndication led
by a commercial bank; interest at the 30-day
LIBOR plus a factor based on the profiles of the
underlying loans; expires September 30, 2004;
interest rate was 2.81% at July 31, 2004, weighted
average interest rate for the year was 2.54%. $ 54,102 $ 100,099
$150 million mortgage warehouse credit facility
at a commercial bank; interest rate at the 30-
day LIBOR plus a rate depending on the type of
loan funded; expires August 25, 2005; weighted
average interest rate was 2.81% at period end. 91,007 90,285
$2.6 million mortgage warehouse credit facility
at a commercial bank; interest rate is fixed at
prime at the time of each advance; expires
October 31, 2004; weighted average interest rate
was 4.24% at period end. 1,259 1,264
$35 million mortgage warehouse credit facility
at a commercial entity; interest is a margin
based on underlying collateral over the one-
month LIBOR; expires August 31, 2005; interest
rate was 2.42% at July 31, 2004. 9,249 25,871
-------- --------
$ 155,617 $ 217,519
======== ========
The warehouse lines of credit contain certain restrictive covenants that
require the Company to maintain certain minimum net worth levels and maximum
indebtedness to adjusted net worth ratios as defined in the respective
agreements. The Company was in compliance or had obtained necessary waivers
with all material aspects of these covenants as of July 31, 2004 and April
30, 2004.
NOTE 4 - EARNINGS PER SHARE
The following summarizes the computation of basic and diluted earnings per
share:
Three Months
Ended July 31,
-----------------------
2004 2003
---------- ----------
Basic earnings per common share
Net income for common shareholders $ 918 $ 1,789
========== ==========
Weighted average shares outstanding 5,964,143 3,918,529
---------- ----------
Basic earnings per share $ .15 $ .46
========== ==========
Diluted earnings per common share
Net income for common shareholders $ 918 $ 1,789
========== ==========
Weighted average shares outstanding 5,964,143 3,918,529
Diluted effect of assumed exercise of
stock options 141,515 204,667
---------- ----------
Diluted average shares outstanding 6,105,658 4,123,196
========== ==========
Diluted earnings per common share $ .15 $ .43
========== ==========
For the three months ended July 31, 2004, warrants to purchase 142,745
shares of common stock at a price of $8.00 per share were outstanding but
not included in the calculation of the diluted earnings per share because
the warrant price was greater than the average market price of the common
stock and, therefore, anti-dilutive. Additionally, for three months ended
July 31, 2004, options to purchase 176,500 shares of common stock at prices
ranging from $6.50 to $6.70 were outstanding but were not included in the
calculation of diluted earnings per share because the option exercise price
was greater than the average market price of the common stock and was,
therefore, anti-dilutive.
NOTE 5 - STOCK OPTIONS
There were no options granted or exercised during the three months ended
July 31, 2004 and 1,000 shares forfeited in the same period. In the three
months ended July 31, 2003, 5,700 options were exercised at a weighted
average price of $2.44 and 3,250 stock options forfeited. Total stock
options outstanding were 432,100 and 404,850 at July 31, 2004 and 2003,
respectively, with exercise prices ranging between $1.10 and $6.70 per share
and $1.10 and $6.50 per share, respectively.
NOTE 6 - DERIVATIVES
Derivatives such as forward contracts and rate lock commitments are used
in the ordinary course of business. Forward contracts represent future
commitments to deliver securities and whole loans at a specified price and
date and are used to manage interest rate risk on loan commitments and loans
held for sale. Rate lock commitments are commitments to fund loans at a
specific rate. The derivatives involve the underlying items, such as
interest rates, and are designed to transfer risk. Substantially all of
these instruments expire within 90 days from the date of issuance. Notional
amounts are amounts on which calculations and payments are based, but which
do not represent credit exposure, as credit exposure is limited to the
amounts required to be received or paid. The approximate notional amounts,
fair values, and carrying amounts of these derivatives are as follows at
July 31, 2004 and 2003:
2004 2003
---------- ----------
Forward contracts
Notional amount $ 134,835 $ 294,314
Fair value (1,560) 12,273
Carrying amount (1,560) 12,273
Rate lock commitments
Notional amount $ 126,726 $ 87,832
Fair value 895 (3,683)
Carrying amount 895 (3,683)
Forward contracts also contain an element of risk in the event that the
counterparties may be unable to meet the terms of such agreements. In the
event the parties to all delivery commitments were unable to fulfill their
obligations, the Company would not incur any significant additional cost by
replacing the positions at current market rates. The Company minimizes its
risk of exposure by limiting the counterparties to those major banks and
financial institutions that meet established credit and capital guidelines.
Management does not expect any counterparty to default on their obligations
and therefore, does not expect to incur any cost due to counterparty
default.
The Company is exposed to interest rate risk on loans held for sale and rate
lock commitments. As market interest rates increase or decrease, the fair
value of loans held for sale and rate lock commitments will decline or
increase. To offset this interest rate risk, the Company enters into
derivatives such as forward contracts to sell loans. The fair value of
these forward contracts will change as market interest rates change, and the
change in the value of these instruments is expected to largely, though not
entirely, offset the change in fair value of loans held for sale and rate
lock commitments. The objective of this activity is to minimize the
exposure to losses on rate lock commitments and loans held for sale due to
market interest rate fluctuations. The net effect of derivatives on
earnings will depend on the effectiveness of hedging and risk management
activities and a variety of other factors, including market interest rate
volatility, the amount of rate lock commitments that close, the ability to
fill the forward contracts before expiration, and the time period required
to close and sell loans.
Certain forward contracts are designated as fair value hedges of loans held
for sale. Accordingly, these forward contracts and the hedged loans held
for sale are carried at fair value in offsetting amounts. At July 31, 2004
and 2003, loans held for sale with a notional amount of approximately $51.9
million and $160.2 million, respectively, were designated as a part of the
fair value hedge. The fair value of these loans approximated $52.7 million
and $150.2 million as of July 31, 2004 and 2003, respectively. The remaining
forward contracts and rate lock commitments are not designated as hedges and
are carried at fair value. The net gain or loss on all derivative activity
is included as a component of gain on sale of loans, net. The following
table reflects the net gain or loss recorded on all derivative activity, the
portion of this net gain or loss attributable to the ineffective portion
of fair value hedges, and the portion of gain or loss attributable to
derivatives that are not included in fair value hedges for the three months
ended July, 2004 and 2003:
2004 2003
---------- ----------
Net gain/(loss) recognized in earnings $ 203 $ (1,385)
Ineffective portion of hedge - -
---------- ----------
Gain/(loss) from derivatives excluded from hedges $ 203 $ (1,385)
========== ==========
NOTE 7 - SUBSEQUENT EVENTS
On August 31, 2004, the Company acquired the operations of Vision Mortgage
Group, Inc. (VMG). VMG's operations consist of retail mortgage banking
activities primarily in the Rockford, Illinois and Tacoma, Washington areas.
VMG employs 58 full-time employees and operates six branches in Illinois and
Washington. The acquisition of these offices strengthens the Company's
position in the northwestern United States as well as northwest Illinois and
increases the Company's overall position in retail originations. The
purchase price for the acquisition is based on the August 31, 2004 equity of
VMG plus an earnout of approximately $788 thousand payable 25% at closing
and annually thereafter upon the realization of certain earnings targets.
If those targets are not met, the payments decrease and conversely, if they
are exceeded, the purchase price payments are adjusted upward. As the final
August 31, 2004 VMG financial statements were not yet available, total
purchase price and thus purchase accounting have not been established. In
accordance with the acquisition agreement, the Company has paid $388
thousand to date related to this acquisition. Pro forma information has not
been provided as the results of the operations of VMG in total are not
material to the overall net income of the Company.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
General
The following discussion and analysis presents our financial condition at
July 31, 2004 and the results of operations for the three months ended July
31, 2004 and 2003. You should read the following discussion together with
our financial statements and the related notes elsewhere in this quarterly
report. In addition to the historical information provided below, we have
made certain estimates and forward-looking statements that involve risks and
uncertainties. Our actual results could differ materially from those
anticipated or implied by these estimates and forward-looking statements as
a result of certain factors, including those discussed in the CAUTIONARY
NOTE REGARDING FORWARD LOOKING STATEMENTS on page 3 of this quarterly
report.
We are an Illinois corporation organized to engage in the business of
originating, selling and servicing residential mortgages. Although our
mortgage banking business has primarily focused on wholesale and retail
residential mortgage origination activities, the Company has expanded its
business to include mortgage servicing by retaining servicing rights on
selected mortgage loans that we originated. Our principal lines of business
are conducted in 36 states through our Wholesale Origination Division, our
Retail Origination Division and our Servicing Division. During the three
months ended July 31, 2004, we originated approximately $472.0 million in
loans for resale.
Since we organized in 1986, we have focused on growing our origination
volume by building a retail and wholesale origination network through
internal growth and selective acquisitions. On August 31, 2004, we acquired
Vision Mortgage Group, Inc. ("VMG"). Vision is now a mortgage banking
division that operates six branches in and around Rockford, Illinois and
Tacoma, Washington. On May 6, 2003 we acquired Portland Mortgage Company
("PMC"). PMC is now a mortgage banking division that operates five branches
in Oregon and southwest Washington.
We earn revenue both as an originator and as a servicer of mortgage loans.
Our primary source of revenue is the recognition of gain on the sale of its
mortgage loans. Additionally, we generate revenue from origination fees and
interest income earned on the mortgage loans that we originate and the
income we earn from servicing mortgage loans. Expenses largely consist of:
(i) commissions paid to loan originators on closed mortgage loans; (ii)
salaries and benefits paid to employees other than loan originators;
(iii) general selling and administrative expenses such as occupancy costs;
and (iv) interest paid under our warehouse credit facilities.
Results of Operations
Three Months Ended July 31, 2004 and 2003
Revenue
Gain on sale of loans decreased to $12.3 million for the three months ended
July 31, 2004 from $19.8 million for the three months ended July 31, 2003.
This decrease was attributable to the decrease in loan originations from
$1.0 billion in the same period in 2003 to $472 million in the same period
in 2004. The decrease in volume is reflective of the generally higher
interest rate environment that has prevailed since the end of July, 2003.
For the three months ended July 31, 2004, the originations were 63%
refinances, 33% purchases and 4% other. For the three months ended July 31,
2003 the origination were 84% refinances, 15% purchases and 1% other. Gains
from each individual sale in the three months ended July 31, 2003 were
higher than in the corresponding period in 2004 as a result of the prolonged
falling interest rates to 30 year record lows we experienced in the first
six months of calendar 2003. The competitive environment for the business
remaining in the current interest rate environment has caused individual
mortgage loan sales to be lower margin sales.
Loan servicing income increased by 253%, or $.5 million, as a result of the
additions made to the mortgage loan servicing portfolio throughout 2003 and
2004. The aggregate unpaid principal balance of the mortgage loans in the
mortgage loan servicing portfolio increased 60% from $939 million at July
31, 2003 to $1.5 billion at July 31, 2004. Growth in the portfolio is
expected to continue as long as interest rates remain in the general range
prevalent during the last year.
Interest income increased 9%, or $.2 million, from $2.2 million for the
three months ended July 31, 2003 to $2.4 million for the three months ended
July 31, 2004. This increase was attributable to an increase in the average
coupon rate of the loans that were originated in the quarter ended July 31,
2004 as well as the length of time the loans were held prior to sale.
Higher interest rate loans tend to be less interest rate sensitive and thus
become a higher percentage of the volume when rates trend upward and the
higher credit quality customers leave the refinance market.
Expenses
Salary and commissions expenses decreased 38% from $15.8 million for the
three months ended July 31, 2003 to $9.8 million for the three months ended
July 31, 2004. The decrease was primarily volume related as the commission
component of the expenses both in the retail and wholesale origination
divisions has a direct correlation to loan origination volume.
Selling and administrative expenses increased 36% from $2.3 million for the
period ended July 31, 2003 to $3.1 million for the period ended July 31,
2004. The increase from period to period is due to the expansion of the
sales efforts including opening additional offices, especially in the
eastern United States. Expansion costs consist primarily of office rental
and insurance expenses. Additionally, the Company increased its lead
generation purchases for its retail segment substantially and used outside
information technology resources to enhance the automation and connectivity
of our new offices and acquisitions.
Interest expense decreased $.3 million, or 20%, from $1.3 million for the
three months ended July 31, 2003 to $1.0 million for the three months ended
July 31, 2004. This decrease was the result of a decrease in the average
balance of the warehouse lines of credit in the respective periods. In
addition, in May, 2004 we negotiated a rate improvement on certain products
we originate and warehouse with one of our lenders. We expect similar
negotiations to occur as the warehouse facilities renew in the second
quarter. Further, our treasury management program initiated in our fourth
quarter ended April 30, 2004 has taken available cash balances and applied
them to the outstanding borrowings on one of our facilities, which has had a
favorable impact on interest expense.
Income taxes decreased from $1.2 million for the three months ended July 31,
2003 to $.6 million for the three months ended July 31, 2004. This decrease
in taxes was the result of the decrease in taxable income for the same
periods. Our effective tax rate remained consistent at 40% for both
periods.
Financial Condition
Total assets decreased $62.7 million or 24% from $258.6 million at April 30,
2004 to $195.9 million at July 31, 2004. The decrease primarily relates to
the $63.4 million or 28% decrease in loans held for sale. The decrease in
loans held for sale resulted from a decrease in originations in the three
months ended July 31, 2004 compared to the three months ended April 30, 2004
from $698.9 million to $472.0 million, a decline of 32% generally resulting
from an increase in mortgage lending rates between periods. Mortgage loan
servicing rights increased from $16.4 million at April 30, 2004 to $18.3
million at July 31, 2004 an 11% increase. This increase is as a result of
our continued plan to increase our servicing rights portfolio while interest
rates continue to be relatively low from a historical perspective. Prepaid
expenses and other assets increased $.5 million primarily as a result of the
timing of annual premiums for certain insurance and annual maintenance
payments for our information technologies systems.
Total liabilities decreased $63.6 million or 28% from $229.3 million at
April 30, 2004 to $165.3 million at July 31, 2004. The decrease is
primarily attributable to the decrease of $61.9 million or 28% decrease in
warehouse lines of credit from April 30, 2004 to July 31, 2004. This
decrease relates directly to our decrease in originations discussed above as
our borrowing under the lines of credit our collateralized by our loans held
for sale and we do not maintain other borrowings.
Total equity increased from $29.7 to $30.6 million or $.9 million as a
result of the retention of $.9 million of the Company's earnings over the
same period.
Liquidity and Capital Resources
Our sources of cash flow include proceeds from the sale of mortgage loans,
interest income and fees from originations, servicing fees and borrowings.
We sell our mortgage loans held for sale continuously to generate cash for
operations. Our uses of cash in the short term include the funding of
mortgage loan purchases and originations and the retention of mortgage
servicing rights, payment of interest, repayment of amounts borrowed
pursuant to warehouse lines of credit, operating and administrative
expenses, income taxes and capital expenditures.
We maintain cash balances in excess of the insurance limits provided by
the Federal Deposit Insurance Corporation. We monitor the financial
institutions where these balances are held to limit the risk on the
uninsured portions of those balances. Additionally, we have adopted and are
completing implementation of a policy to maintain cash balances at
institutions which are involved in the warehouse lines of credit and apply
excess cash against outstanding warehouse balances between reporting periods
to limit our cash deposit exposure and reduce interest expense.
For the three months ended July 31, 2004 and 2003, net cash from operating
activities was $60.3 million and $(39.7) million, respectively. Net cash
from operating activities is impacted primarily by the origination of and
proceeds from the sale of mortgage loans held for sale and the change in
prepaid expenses, and other assets, accrued expenses and other current
liabilities. Cash proceeds from the sale of mortgage loans held for sale
varies on whether we have sold or retained servicing rights. As noted
previously, the sale of servicing rights generates an immediate cash premium
while the retention of servicing rights increases the intangible mortgage
servicing rights asset and generates less immediate cash. For the three
months ended July 31, 2004 and 2003, we originated $472.0 million and $1.0
billion in loans held for sale, respectively, and received proceeds of
$545.1 million and $994.1 million on sales of loans, respectively. During
2004, we have continued to pursue our strategy of retaining servicing rights
on certain mortgage loans that we originate. Such retention has resulted in
some reduction in short term cash flow available to us. We have employed
capital to finance the retention of servicing rights. However, the
retention of servicing rights creates an asset on our balance sheet and
creates a future cash flow stream in the form of servicing income.
Net cash from investing activities decreased $48 thousand from the three
months ended July 31, 2003 to the same period in 2004. This decrease
relates to increases in our restricted cash balances and the impact of the
PMC acquisition on the three months ended July, 31, 2003 offset by fewer
additions to premises and equipment in the three months ended July 31, 2004.
The increase in restricted cash balances is a result of the August 1, 2003
change to our lending agreements which consolidated three lines of credit to
one under which we elect to hold compensating balances in order to fund our
originations at the note amount.
Cash flow from financing activities for the three months ended July 31, 2004
and 2003 was $(61.9) million and $39.7 million, respectively. This cash
flow primarily relates to increases in and decreases in our warehouse lines
of credit as a result of originations volume.
The net cash flow from operating, financing and investing activities was
$(1.8) million for the three months ended July 31, 2004 and $(.2) million
for the three months ended July 31, 2003.
Cash flow requirements depend on the level and timing of our activities in
loan origination in relation to the timing of the sale of such loans. In
addition, we require cash flow for the payment of operating expenses,
interest expense and capital expenditures. Currently, our primary sources
of funding are borrowings under warehouse lines of credit, proceeds from the
sale of loans and internally generated funds.
Liquidity refers to the ability or the financial flexibility to manage
future cash flows and fund operations on a timely and cost-effective
basis. We fund our business, in part, through the use of warehouse lines of
credit. Outstanding borrowings pursuant to the warehouse lines of credit
totaled $155.6 million and $217.5 million at July 31, 2004 and April 30,
2004, respectively. The interest rates on the warehouse lines of credit
vary and resulted in a weighted average rate of 2.7% and 2.6% at July 31,
2004 and April 30, 2004, respectively. We have one facility expiring in
September 30, 2004 which we are currently in the process of renewing and do
not anticipate will have an impact on our future ability to fund loans. Our
renewal of our second facility in August, 2004 resulted in a $150 million
line at more favorable terms to us. Additionally, we have a warehouse line
for commercial loan production with another bank for $2.6 million.
Borrowings under this line are at the prime rate at the time of the draw,
and the facility expires in October of 2004. We have entered into another
facility with an investor which allows us to warehouse up to $35 million in
loans which will be sold to them at a rate which is margin based on the
underlying collateral over the one-month LIBOR. This facility expires
August 31, 2005. While we intend to renew these facilities at their
respective expirations, if we cannot successfully maintain our existing
credit facilities or replace them with comparable financing sources, we
may be required to curtail our loan origination activities, which would
have a material adverse effect on our financial condition and results
of operations. Because our credit facilities are short-term lending
commitments, the lenders may respond to market conditions which may favor an
alternative investment strategy for them, making it more difficult for us to
secure continued financing.
Additionally, our warehouse credit facilities contain extensive restrictions
and covenants that, among other things, require us to satisfy specified
financial tests. If we fail to meet or satisfy any of these covenants, we
would be in default under these agreements and our lenders could elect to
declare all amounts outstanding under the agreements to be immediately due
and payable, enforce their interests against collateral pledged under such
agreements and restrict our ability to make additional borrowings. These
agreements also contain cross-default provisions, so that if a default
occurs under any one agreement, the lenders under our other agreements could
also declare a default.
Seasonality
The mortgage banking industry is generally subject to seasonal trends.
These trends reflect the general national pattern of sales and resales of
homes, although refinancings tend to be less seasonal and more closely
related to changes in mortgage interest rates. Sales and resales of homes
typically peak during the spring and summer seasons and decline to
lower levels from mid-November through February. In addition, mortgage
delinquency rates typically rise temporarily in the winter months. The
mortgage loan servicing business is generally not subject to seasonal
trends.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Qualitative Information About Market Risk. The principal objectives of our
interest rate risk management are to evaluate the interest rate risk
included in balance sheet accounts, to determine the level of risk
appropriate given our business strategy, operating environment, capital and
liquidity requirements and performance objectives and to manage the risk
consistent with our policy. Through this management, we seek to reduce the
vulnerability of our operations to changes in interest rates. Our Board of
Directors is responsible for reviewing policies and interest rate risk
position. Our Board of Directors reviews the position established by
management on at least a quarterly basis. In connection with this review,
our Board of Directors evaluates our business activities and strategies, the
effect of those strategies on the market value of our loans held for sale
and servicing portfolios, and the effect the changes in interest rates will
have on our loans held for sale and servicing portfolios.
We maintain a disciplined Secondary Marketing Department that is managed by
a senior officer and is responsible for taking appropriate actions to
protect us against abrupt and unpredictable interest rate fluctuations. The
operations of Secondary Marketing are subject to a formal and detailed
policy that governs the Secondary Marketing Department and sets forth
policies with respect to, among other things, our hedging strategies and
sales of mortgage loans in the secondary market.
The continuous movement of interest rates is certain. However, the extent,
timing and direction of these movements is not always predictable. Any
movement in interest rates has an effect on our profitability. The value of
loans, which we have either originated or committed to originate, decreases
as interest rates rise and conversely, the value increases as interest rates
fall. The value of mortgage servicing rights tends to move inversely to the
value of loans, increasing in value as interest rates rise and decreasing in
value as interest rates fall. In turn, this affects the prepayment speed of
loans underlying our mortgage servicing rights.
Because it is unlikely that any particular movement in interest rates could
affect only one aspect of our business, many of our products move in
offsetting directions to each other. For instance, the decrease in the
value of our mortgage servicing portfolio associated with a decline in
interest rates usually will not occur without some degree of increase in new
mortgage loan production, which may offset the decrease in the value of the
mortgage servicing portfolio.
Quantitative Information About Market Risk. The primary market risk facing
us is interest rate risk. From an enterprise perspective, we manage this
risk by striving to balance our loan origination and loan servicing
businesses, which are counter cyclical in nature. In addition, we utilize
various hedging techniques to manage the interest rate risk related
specifically to our committed pipeline loans, mortgage loan inventory, and
mortgage servicing rights. We primarily utilize forward sales of mortgage-
backed securities. These instruments most closely track the performance of
our committed pipeline of loans because the loans themselves can be
delivered directly into these contracts.
The overall objective of our interest rate risk management policies is to
offset changes in the values of these items resulting from changes in
interest rates. We do not speculate on the direction of interest rates in
our management of interest rate risk for the purpose of generating revenue.
ITEM 4. CONTROLS AND PROCEDURES
An evaluation was performed under the supervision and with the participation
of the Company's management, including the chief executive officer and chief
financial officer, of the effectiveness of the design and operation of the
Company's disclosure controls and procedures (as defined in Rule 13a-15(e)
promulgated under the Securities and Exchange Act of 1934, as amended) as of
July 31, 2004. Based on that evaluation, the Company's management, including
the chief executive officer and chief financial officer, concluded that the
Company's disclosure controls and procedures were effective. There have been
no significant changes in the Company's internal controls or in other
factors that could significantly affect internal controls.
PART II
ITEM 1. LEGAL PROCEEDINGS
The Company is involved in litigation in the normal course of its business.
The Company does not expect that the resolution of any of the legal
proceedings to which it is presently a party will have a material adverse
effect on its results of operations, financial condition or cash flows.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
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. The exhibits required by Item 601 of Regulation S-K are included with
this Form 10-Q and are listed on the "Index to Exhibits" immediately
following the Signatures.
b. The following reports on Form 8-K were filed by the Company during the
three month period ended July 31, 2004:
On June 25, 2004, the Company furnished a Form 8-K with respect to the
Company's press release announcing its earnings for the quarter and
year ended April 30, 2004
On June 29, 2004, the Company furnished a Form 8-K with respect to the
Company's press release announcing its participation in an American
Stock Exchange Online Banking Conference
On July 1, 2004, the Company furnished a Form 8-K with respect to the
Company's press release announcing the Company's implementation of a
web-based mortgage platform
On July 30, 2004, the Company furnished a Form 8-K with respect to the
Company's press release announcing the date of its annual meeting and
an update on the performance of its growth strategy
SIGNATURES
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.
UNITED FINANCIAL MORTGAGE CORP.
(Registrant)
Date: September 14, 2004 By: /s/ Steve Y. Khoshabe
----------------------------
Steve Y. Khoshabe
President and Chief Executive Officer
By: /s/ Robert L. Hiatt
----------------------------
Robert L. Hiatt
Chief Financial Officer
INDEX TO EXHIBITS
3.1 Amended and Restated Articles of Incorporation of United
Financial Mortgage Corp. as amended (filed as an exhibit to
the Company's Registration Statement on Form SB-2 filed on
May 14, 1997 and incorporated herein by reference).
3.2(i) Bylaws of United Financial Mortgage Corp (filed as an
exhibit to the Company's Registration Statement on Form SB-2
filed on May 14, 1997 and incorporated herein by reference).
3.2(ii) Amendment to Bylaws of United Financial Mortgage Corp.
4.1 Underwriter's Warrant, dated December 15, 2003.*
10.28 United Financial Mortgage Corp. 2004 Stock Incentive Plan
(filed as an exhibit to the Company's Proxy Statement on
Schedule 14A filed on August 17, 2004 and incorporated herein
by reference).
10.29 Amendment No. 16 to Master Repurchase Agreement, dated May
11, 2004
10.30 Amendment No. 17 to Master Repurchase Agreement, dated August
24, 2004
10.31 Seventh Amendment to Amended and Restated Warehousing Credit
Agreement, dated August 29, 2004.
31.1 Certification of Chief Executive Officer Pursuant to Rule
13a-14(a)/15(d)-14(a).
31.2 Certification of Chief Financial Officer Pursuant to Rule
13a-14(a)/15(d)-14(a).
32.1 Certification of Chief Executive Officer Pursuant to 18
U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
the Sarbanes- Oxley Act of 2002.
32.2 Certification of Chief Financial Officer Pursuant to 18
U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
the Sarbanes- Oxley Act of 2002.
+ Filed as an exhibit to the Company's Registration Statement on
Form SB-2/A filed on November 11, 2003 and incorporated herein
by reference.
* Filed as an exhibit to the Company's Quarterly Report on Form 10-QSB
filed on March 16, 2004 and incorporated herein by reference).